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)