Eco 200 – Principles of Macroeconomics Chapter 16: Alternative macroeconomic models

Alternative macroeconomic models Fixed-price Keynesian model New Keynesian model Monetarist model New classical model

Fixed-price Keynesian model Assumes a constant price level This model was popular during and immediately after during the Great Depression little concern about inflation

Fixed-price Keynesian model

Policmakers’ role in fixed-price Keynesian model private economy is inherently unstable advocates active role for government in stabilizing the economy

New Keynesian model Recognizes that the price level is not constant

New Keynesian model argue that prices and wages are not flexible (especially in a downward direction) in the short run Firms respond to a reduction in the demand for output by cutting production (and labor use), not prices (and wages)

Policymakers’ role in the New Keynesian model Essentially the same as for traditional Keynesians (but with more attention paid to inflation)

Monetarist economics Money supply affects output and the price level in the short run Economy is believed to be inherently stable, with rapid self-adjustment. Lags: recognition lag reaction lag effect lag

Policymakers’ role under monetarist economics Believe that discretionary policy is inherently destabilizing due to long and variable lags Prefer a reliance on fixed rules

New classical model Classical model was the dominant macroeconomic theory until the Keynesian revolution

New classical model Relies on rational expectations Wages and other resource prices are assumed to respond immediately to any anticipated policy change.

New classical model

Policymakers’ role under the new classical model discretionary policy is not effective prefer the use of fixed rules (with credible policy announcements)