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New classical macroeconomics, sometimes simply called new classical economics, is a school of thought in macroeconomics that builds its analysis entirely on a neoclassical framework. Specifically, it emphasizes the importance of rigorous foundations based on microeconomics, especially rational expectations.
New classical macroeconomics strives to provide neoclassical microeconomic foundations for macroeconomic analysis. This is in contrast with its rival new Keynesian school that uses microfoundations such as price stickiness and imperfect competition to generate macroeconomic models similar to earlier, Keynesian ones.
Classical economics is the term used for the first modern school of economics. The publication of Adam Smith's The Wealth of Nations in 1776 is considered to be the birth of the school. Perhaps the central idea behind it is on the ability of the market to be self-correcting as well as being the most superior institution in allocating resources. The central assumption implied is that all individuals maximize their utility.
The so-called marginal revolution that occurred in Europe in the late 19th century, led by Carl Menger, William Stanley Jevons, and Léon Walras, gave rise to what is known as neoclassical economics. This neoclassical formulation had also been formalized by Alfred Marshall. However, it was the general equilibrium of Walras that helped solidify the research in economic science as a mathematical and deductive enterprise, the essence of which is still neoclassical and makes up what is currently found in mainstream economics textbooks to this day.
The neoclassical school dominated the field up until the Great Depression of the 1930s. Then, however, with the publication of The General Theory of Employment, Interest and Money by John Maynard Keynes in 1936,certain neoclassical assumptions were rejected. Keynes proposed an aggregated framework to explain macroeconomic behavior, leading thus to the current distinction between micro- and macroeconomics. Of particular importance in Keynes' theories was his explanation of economic behavior as also being led by "animal spirits". In this sense, it limited the role for the so-called rational (maximizing) agent.
The Post-World War II period saw the widespread implementation of Keynesian economic policy in the United States and Western European countries. Its dominance in the field by the 1970s was best reflected by the controversial statement attributed to US President Richard Nixon and economist Milton Friedman: "We are all Keynesians now".
Problems arose during the 1973–75 recession triggered by the 1973 oil crisis. Keynesian policy responses did not reduce unemployment, instead leading to a period of high inflation and stagnant economic growth—stagflation. Keynesians were puzzled by the outbreak of stagflation because the original Phillips curve ruled out concurrent high inflation and high unemployment.
The New Classical school emerged in the 1970s as a response to the failure of Keynesian economics to explain stagflation. New Classical and monetarist criticisms led by Robert Lucas, Jr. and Milton Friedman respectively forced the rethinking of Keynesian economics. In particular, Lucas made the Lucas critique that cast doubt on the Keynesian model. This strengthened the case for macro models to be based on microeconomics.
After the 1970s and the apparent failure of Keynesian economics, the New Classical school for a while became the dominant school in Macroeconomics.
The new classical perspective takes root in three diagnostic sources of fluctuations in growth: the productivity wedge, the capital wedge, and the labor wedge. Through the neoclassical perspective and business cycle accounting one can look at the diagnostics and find the main ‘culprits’ for fluctuations in the real economy.
New classical economics is based on Walrasian assumptions. All agents are assumed to maximize utility on the basis of rational expectations. At any one time, the economy is assumed to have a unique equilibrium at full employment or potential output achieved through price and wage adjustment. In other words, the market clears at all times.
New classical economics has also pioneered the use of representative agent models. Such models have received severe neoclassical criticism, pointing to the disjuncture between microeconomic behavior and macroeconomic results, as indicated by Alan Kirman.
The concept of rational expectations was originally used by John Muth,and was popularized by Lucas. One of the most famous new classical models is the real business cycle model, developed by Edward C. Prescott and Finn E. Kydland.
It turned out that pure new classical models had low explanatory and predictive power. The models could not simultaneously explain both the duration and magnitude of actual cycles. Additionally, the model's key result that only unexpected changes in money can affect the business cycle and unemployment did not stand empirical tests.
The mainstream turned to the new neoclassical synthesis. Most economists, even most new classical economists, accepted the new Keynesian notion that for several reasons wages and prices do not move quickly and smoothly to the values needed for long-run equilibrium between quantities supplied and demanded. Therefore, they also accept the monetarist and new Keynesian view that monetary policy can have a considerable effect in the short run.The new classical macroeconomics contributed the rational expectations hypothesis and the idea of intertemporal optimisation to new Keynesian economics and the new neoclassical synthesis.
Peter Galbácsthinks that critics have a superficial and incomplete understanding of the new classical macroeconomics. He argues that one should not forget the conditional character of the new classical doctrines. If prices are completely flexible and if public expectations are completely rational and if real economic shocks are white noises, monetary policy cannot affect unemployment or production and any intention to control the real economy ends up only in a change in the rate of inflation. However, and this is the point, if any of these conditions does not hold, monetary policy can be effective again. So, if any of the conditions necessary for the equivalence does not hold, countercyclical fiscal policy can be effective. Controlling the real economy is possible perhaps in a Keynesian style if government regains its potential to exert this control. Therefore, actually, new classical macroeconomics highlights the conditions under which economic policy can be effective and not the predestined inefficiency of economic policy. Countercyclical aspirations need not to be abandoned, only the playing-field of economic policy got narrowed by new classicals. While Keynes urged active countercyclical efforts of fiscal policy, these efforts are not predestined to fail not even in the new classical theory, only the conditions necessary for the efficiency of countercyclical efforts were specified by new classicals.
Real business cycle theorist Bernd Lucke calls the new classical macroeconomics model the ″caricature of an economy" because its underlying assumptions exclude any non-rational behaviour or the possibility of market failure, prices are always fully flexible, and the market is always in economic equilibrium. The current mission of the new classical macroeconomics is to find out to which extent this caricature of an economy already has enough predictive power to explain business cycles.
Keynesian economics are various macroeconomic theories about how in the short run – and especially during recessions – economic output is strongly influenced by aggregate demand. In the Keynesian view, aggregate demand does not necessarily equal the productive capacity of the economy; instead, it is influenced by a host of factors and sometimes behaves erratically, affecting production, employment, and inflation.
Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies. Macroeconomists study topics such as GDP, unemployment rates, national income, price indices, output, consumption, unemployment, inflation, saving, investment, energy, international trade, and international finance.
In economics, stagflation or recession-inflation is a situation in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high. It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment.
New Keynesian economics is a school of contemporary macroeconomics that strives to provide microeconomic foundations for Keynesian economics. It developed partly as a response to criticisms of Keynesian macroeconomics by adherents of new classical macroeconomics.
This aims to be a complete article list of economics topics:
Robert Emerson Lucas Jr. is an American economist at the University of Chicago, where he is currently the John Dewey Distinguished Service Professor Emeritus in Economics and the College. Widely regarded as the central figure in the development of the new classical approach to macroeconomics, he received the Nobel Prize in Economics in 1995 "for having developed and applied the hypothesis of rational expectations, and thereby having transformed macroeconomic analysis and deepened our understanding of economic policy". He has been characterized by N. Gregory Mankiw as "the most influential macroeconomist of the last quarter of the 20th century."
Neo-Keynesian economics is a school of macroeconomic thought that was developed in the post-war period from the writings of John Maynard Keynes. A group of economists, attempted to interpret and formalize Keynes' writings and to synthesize it with the neoclassical models of economics. Their work has become known as the neoclassical synthesis and created the models that formed the core ideas of neo-Keynesian economics. These ideas dominated mainstream economics in the post-war period and formed the mainstream of macroeconomic thought in the 1950s, 1960s and 1970s.
A macroeconomic model is an analytical tool designed to describe the operation of the problems of economy of a country or a region. These models are usually designed to examine the comparative statics and dynamics of aggregate quantities such as the total amount of goods and services produced, total income earned, the level of employment of productive resources, and the level of prices.
Neutrality of money is the idea that a change in the stock of money affects only nominal variables in the economy such as prices, wages, and exchange rates, with no effect on real variables, like employment, real GDP, and real consumption. Neutrality of money is an important idea in classical economics and is related to the classical dichotomy. It implies that the central bank does not affect the real economy by creating money. Instead, any increase in the supply of money would be offset by a proportional rise in prices and wages. This assumption underlies some mainstream macroeconomic models. Others like monetarism view money as being neutral only in the long-run.
Edmund Strother Phelps is an American economist and the recipient of the 2006 Nobel Memorial Prize in Economic Sciences.
The policy-ineffectiveness proposition (PIP) is a new classical theory proposed in 1975 by Thomas J. Sargent and Neil Wallace based upon the theory of rational expectations, which posits that monetary policy cannot systematically manage the levels of output and employment in the economy.
In economics the long run is a theoretical concept in which all markets are in equilibrium, and all prices and quantities have fully adjusted and are in equilibrium. The long run contrasts with the short run, in which there are some constraints and markets are not fully in equilibrium.
In economics, Aggregate behavior refers to economy-wide sums of individual behavior. It involves relationships between economic aggregates such as national income, government expenditure and aggregate demand. For example, the consumption function is a relationship between aggregate demand for consumption and aggregate disposable income.
Dynamic stochastic general equilibrium modeling is a method in macroeconomics that attempts to explain economic phenomena, such as economic growth and business cycles, and the effects of economic policy, through econometric models based on applied general equilibrium theory and microeconomic principles.
In economics, the microfoundations are the microeconomic behavior of individual agents, such as households or firms, that underpins an economic theory.
Paul Davidson is an American macroeconomist who has been one of the leading spokesmen of the American branch of the post-Keynesian school in economics. He is a prolific writer and has actively intervened in important debates on economic policy from a position that is very critical of mainstream economics.
The following outline is provided as an overview of and topical guide to economics:
Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.
The new neoclassical synthesis (NNS) or new synthesis is the fusion of the major, modern macroeconomic schools of thought, new classical and New-Keynesianism, into a consensus on the best way to explain short-run fluctuations in the economy. This new synthesis is analogous to the neoclassical synthesis that combined neoclassical economics with Keynesian macroeconomics. The new synthesis provides the theoretical foundation for much of contemporary mainstream economics. It is an important part of the theoretical foundation for the work done by the Federal Reserve and many other central banks.
Inframarginal analysis is an analytical method in the study of classical economics. Xiaokai Yang created the super marginal analysis method and revived the important thought of division of labour of Adam Smith. The new classical economics reconstructs several independent economic theories with the core of neoclassical economics from the perspective of endogenous individual choice specialization level by means of inframarginal analysis, which is the frontier subject of economics development.