Final: New Classical Macroeconomics and Austrian Capital Theory Flashcards
New Classical economists generally thought
That economies were generally stable
In fact, that monetary/fiscal policy might be what introduces instability, in sharp contrast to Keynesians
Three parts of New Classical Macroeconomics
Rational Expectations
Continuous Market Clearing
The Aggregate supply hypothesis
Expectations for Keynes
In the general theory, expectations were exogenous
“Animal Spirits”
Monetarism expectations
Adaptive expectations
New Classical Macroeconomics Expectations
Rational Expectations
Weak version of rational expectations
Agents make use of all available information to forecast future events
In regard to which variables they think will affect these events
Utility maximizing behavior, hence, rational
Example: Agents will use money supply data to predict future inflation
Strong Version of Rational Expectations
At large, the subjective expectations of economic agents’ will correspond to the true or objective mathematical conditional expectations of these variables.
I.e. this version implies on average that agents’ correctly guess the objective mathematical mean
But there is variance
Continuous Market Clearing
Flexible prices means markets work (clear) continuously (controversial). This incorporates the Walrasian general equilibrium elements, where theoretical economies have no frictions and perfect information, and thus result in continuous clearing and perfectly flexible prices.
Keynesians thought markets failed to clear vary often due to…
In contrast, Keynesians thought markets failed to clear very often due to the slow adjustment of prices. This creates the potential for the economy to be in a constant state of disequilibrium.
Monetarists think markets clear and prices adjust rapidly, but that there is the
Monetarists think markets clear and prices adjust rapidly, but that there is the potential for short-run disequilibrium.
Continuous Market Clearing framework
Rationality -> Optimizing -> Equilibrium
1) Strong emphasis in underpinning macro theory with classical choice-theoretic microfoundations
Within a Walrasian general equilibrium framework
2) All agents are rational
Meaning, they continuously optimize subject to constraints they face
Firms max profits while households max utility
3) Agents do not suffer from money illusion, and therefore only real (relative) prices affect decisions
4) Perfect wage/price flexibility
No rigidities
Markets clear
All mutually beneficially gains from trade are exhausted
The Aggregate Supply Hypothesis (Lucas Island)
Signal extraction problem: Short-run tradeoff between inflation and unemployment due to imperfect information.
Producers can be fooled by inflation and think that an increase in the price of the goods they sell is an increase in demand, and not a general increase in prices.
Therefore, they attribute some portion of the increase in the price of their goods as in increase in demand and produce more/employ more labor.
Using this reasoning, deflation would trick the producer into thinking there is decreasing demand for its goods, and the producer will cut back production and unemploy factors of production as necessary.
Firms and workers adjust as new P info becomes available (via SRAS curve)
Implications of the aggregate supply hypothesis
Only unexpected inflation matters!
If expected, no influence on output.
Without unexpected changes in the price level, output is at the natural rate.
Neoclassical Business Cycle Model
No disturbances/nominal rigidities
Money is totally neutral
No reason/role for monetary or fiscal policy
Prices are perfectly flexible
Technological shocks drive business cycles
Only real supply shocks matter
The economy/markets are efficient, always optimize to given changes in underlying structural conditions
Bank Capital
“Bank Capital” = Assets – Liabilities = Net worth
