New Keynesian Economics
Candlefocus EditorTo the classical Keynesian framework, New Keynesian economics added rational expectations and the economic agents' optimization behavior, which are fundamental pillars of modern economic models. Such a generalized framework has allowed economists to analyze various rigidities of the macroeconomy, such as sticky prices as well as voluntary unemployment due to factors such as the minimum wage and inefficient labor contracts.
The main aspects of New Keynesian economics are based on theories developed by American economist Edmund Phelps and published in the early 1970s. Starting with the premise that prices and wages are sticky, New Keynesian economists developed models to explain how monetary policy could influence the macroeconomy. This type of macroeconomic model can also be used to explain how different levels of government spending and taxation affect economic activity, as well as to explore the consequences of different exchange rate policies.
New Keynesian economics has proved to be extremely useful and has been used to explain a wide range of macroeconomic phenomena. For example, this school of thought suggests that government austerity measures during a downturn, when wages and prices are sticky, are more likely to harm economic growth than promote it. It also explains why inflation responds more to unexpected changes in the money supply than to expected changes, and how monetary policy affects the expectations of investors, firms and workers to exert a real effect on the economy.
Overall, New Keynesian economics is a key area of macroeconomic research, providing economists and policy makers with a better understanding of the macroeconomy and how it works. The insights it offers are invaluable for helping the government to make prudent economic and fiscal policies that can help restore economic growth and stability.