Question

What are the differences and similarities among the New Keynesian, Monetarist and Neo-Classical models in terms of their predicted outcomes? How do the different assumptions of the models result in policy debates among their respective adherents?

Answer 1

New keynesian : Economists include Greg Mankiw , Blanchard . Markets may not be as perfect as the classical economists suggest. they stressed on imperfect competititon , coordination failure and credit restrictions . The new keyensian approach borrows the idea of new classical economists of rational expectations .

The new keynesian assumes that wages and prices are sticky and change slowly (are rigid )and taht only quantity adjustment happens .

they believed that fulle mployemnet is achieved by stabilisation policies which are formed after various market failures.

similarity :They just like monetarsist recommend that market problems are fixed majorly by monetary policy but unlike them , new kyenesian also believe that some problems are fixed by fiscal policy .

also like one version of neo classicals they belive that wages and prices are sticky .

Monetarist : It is somewhare between classical and keynesiuan thought. They allow adaptive expectations but believe in fiscal policy being ineffective . also they emphasise on monetary policy being able to manage the aggregate demand . They assumed interest sensitivity of investment is very high, so IS curve isb flat . so fiscal policy leads to crowding out. Fiscal policy ubnder monetarists is unable to influence employment and output . Monetarists like classical assume that LM curve is steep .

also they assume free market with little government intervention . The aim of monetarists is to allow money supply to grow at same pace so that the pruces remain stable or increase a little . Monetarists basically beleive in lags and long time periods in monetray policy and thus want a constant rate of monetary policy .

similaity is that both new keynesian and monetarists believe that market problems are solved by moentary policy

Neo classical : It was developed by neoclassical economists who allowed for a short run with keynesian properties and long run with classical . so this is also known as neo keynesian . It is based on three basic assumptions

people have rational preferences

individuals maximise utility and firms maximise profits

people act rationally and have full information

there are different versions of neo clssical depending on the assumption

version 1: nominal wages are rigid downwards . so there is possibility of unemployemnt , though full employment would be restored after sometime . here they assumne rigid wages similar to new keynesian thoughts

version 2: it allows wages to be fully flexible and expected price a slowly moving variable . But again the full employ,ment would be restored de3pneding on the speed of expectational errors

similarity :Neo classical believed in free market with little or no government intervention which is similar to monetarist viewpoint . according to them there are no involuntary unumeployment

The assumptions of rational expectations , full information and rigid wages differ in the various thoughts which are the policy debate matters .

Monetarist Milton freidman's fooling model was provided where the workers are fooled into additional input because they have imperfect infor,mation and the firms have full information. Edmund phelps ( new keynesian ) at the same time developed theories that both workers and firms have imperfect information .