Question

What is the ‘New Neoclassical Synthesis’? How does it differ from early Real Business Cycle Theory?

Answer 1

The new Keynesian models also termed as “new neoclassical synthesis” combines the neoclassical economics with Keynesian macroeconomics. It has taken into consideration the elements from both schools. The new synthesis has taken elements from both schools. The contribution of New classical economics methodology behind real business cycle theory and new Keynesian economics behind the nominal rigidities (slow moving and periodic, instead to be continuous, changes in price also termed as sticky prices)

Real business cycle theory ignored the gaps possibility and used changes in efficient output, lead due to the shocks to the economy, for explaining the output fluctuations in economy. This theory was rejected by Keynesians and argued that efficient output changes were not large enough for explaining the big swings in an economy. The new neoclassical synthesis considered the elements from both schools on this problem. It stated that output gaps exist, however there are the difference among actual output and efficient output. The efficient output usage recognizes that potential output will not grow continuously, however it may move downward or upward in response to shocks.