Question

how the new Keynesian model framework can be used to explain the great recession, if the effects of monetary and fiscal policies implemented by the federal reserve and the federal government are also included in the model？？

And how to explain when use real business cycle models?

Answer 1

New keynesian used micro economic foundations to explain the macro economic problems. They used micro economics tools comprehensively to explain economic recession. Price and wage stickiness deviate economy from automatic mechanism to correct disequilibrium in economy.

They posits that market is imperfect and monopoly firms do not change their prices frequently. Even when recession hits, prices do not change for many goods and services. Further, there is cost of changing prices frequently.

Further, wage is sticky due to labor union and efficiency wage. So rigid wage does not cause equilibrium in economy.

unlike old keynesians, New keynesian contend that monetary policy is effective to produce right effects on output and employments. Monetary policy acts through the interest rate. Interest rate is prime factor in influencing economy.ey have agreed with effectiveness of fiscal policy.

Real Business cycle models do not agree with Keynesian explanations for recession, they play down the importance of aggregate demand. They believe that real factor such as productivity, change in technology and supply shocks are accountable for recession and boom in economy, Government must pay heed towards the supply.