Question

Discuss the general policy implications of New Keynesian economics.

Answer 1

General policy implications of new Keynesian are :

1. Monetary and fiscal policy :

• No unified view of economic policy
• Theories /models are based on imperfectly competitive markets with assymetric information
• Leads to declining demands, economic failure recessions,unemployments
• Main elements include menu cost, contracts, coordination failures, efficiency wages
• New Keynesian economics provide a rational government intervention
• This is in the form of active monetary and fiscal policies to prevent recession, unemployment etc

2. Prices and income policies :

• It provides prices and income agreements between firms and unions
• There are huge asymmetrics and imperfections according to this theory
• They lead to unemployment
• To avoid this prices and income policies increase the power of outsiders in relation to insiders
• This reduces the effect of market imperfections

3. Government and corporate policies:

• Important implication which occurs when unemployment persists in long run
• Also called hysterisis or lagged effect

4. Re-establisment of policy effectiveness :

• Money and policy effectiveness are re-established in new Keynesian theories
• Main emphasis is on wage and price stickiness
• Monetary policy is used in establishing the economy

5. Favour rough or coarse tuning :

• New Keynesian economists favour rough or coarse tuning
• Here monetary and fiscal policy are used to avoid large deviations from GDP

6. Existence of involuntary unemployment :

• New Keynesian economy maintains an equilibrium of involuntary unemployment