Brief remark on how the New Keynesianism sprouted.
When did the basic idea came up?
During the 1970's there was the revolution of the new classical economics was going on, or say, the first stage had just begun. Also the new classicists had argued that Keynesian economics was theoretically inadequate, the need of the microeconomic foundations on the Keynesian macroeconomics was required. The need of the microeconomic foundation was due to :
Say in Keynesian model a decrease in the aggregate demand leads to the fall in the labor demand. Because there is a fixed wage rate contracted to the labor and the backward looking price expectations of the labor, the money wage does not fall sufficiently in the short run to maintain the level of initial employment level. Due all of these, the employment and output falls and hence unemployment rises. So we can see that, the wage and price rigidities seems central to the Keynesianism concept of the involuntary employment, more focus has been gone to state the rigidities could arise from the behavior of the optimizing agents.
The supreme task of the new Keynesian proposers is to provide the basic idea for the theoretical flaws that were seen in the model. With this, the supporters of the new Keynesian concept aim to construct the coherent theory of aggregate supply where the wage and price rigidities can be rationalized. However, the market clearing mechanism and that too every time can not hold true when there is the case of the lack of effective demand. Many Economists claim that the Keynesian concept has short of the continuous market clearing approach.
Snowdon and Vane (2005) state that Keynesianism also argue that the failure of prices to change quickly enough to clear markets imply that demand and supply shocks will lead to the real effect substantially in the economy's output and employment. It is said that the deviations of output and employment from their equilibrium values can be substantial and prolonged and are reducing the economic welfare in the long run.
So, What did New Keynesian geeks theorize ? 😀
The New Keynesianism argued that the concept of the business cycle basing upon the market failure is more crucial to the new classical or real business cycle alternatives. The basic idea for the difference between the new and old version of the Keynesian economics , the neo classical models assumed the nominal rigidities, while the new Keynesian approach tends to provide acceptable micro foundation to explain the phenomena of wage and price stickiness.
Source : Snowdon and Vane (2005) and Froyen (2014)
To be contd...
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Aditya
