Money, Finance and the Economy Week 1
-The New-Keynesian Economics-
Pluriformity in macroeconomics; There are many views and schools of thought: sometimes
conclusions can be very different if one starts from a different ‘belief’ or ‘set of assumptions’
Reviewed in this course:
1. New-Keynesian economics
2. Post-Keynesian economics
3. Austrian economics
And at the end try to ‘map’ the different views in a comparative setting.
What is the key notion separating the schools of thought?
Basically, it is the view on market clearing and how agents behave.
A classical economist will argue that the price mechanism is able to allocate scarce resources
over market both in time and across agents in an efficient way: price signals do the job: in an
efficient market all information is embedded in the pricing process. (very strong
assumption!)
The other schools of thought are convinced that there can be all kinds of imperfections
disturbing this view: uncertainties, sticky prices, a lack of information, market power,
missing markets, political influences…
If there are imperfections, there is an active role for the government to increase social
welfare.
If you add fractions (like unemployment or inflation) to the model, there is room for government to
intervene or manoeuvre.
Timeline
- 1930s: classical school denominates
- 1930s-1960s: Keynesian economics
- Through those years: Classical/Austrian points of view continued to develop
- 1970s: revival of classical economics: new classical school
- 1970s: development of post-Keynesian economics
- 1980s: New-Keynesian economics
- 2000s: methodological ‘merger’ of New Classical and New Keynesian Economics: generally
considered now as Mainstream economics.
The first two weeks: Assignment I
Focusing on New-Keynesian approach, because this is rather standard in the minds of policy
makers/central bankers
Two approaches:
1. A standard dynamic view and its implications for monetary policy (this week).
This week: In this New-Keynesian school, the idea of expectations is really important. Expectations
you talk about future so using a static model or static analysis will not do the job. The model used for
policy analysis and you want to talk about expectations you have to talk about dynamics which
means how does the economy involve, how does output involve into the next period, how does
inflation grow or diminish and how do policy makers respond to those developments. The new-
Keynesian model is talking about some imperfections that are going around.
, 2. A model that focuses on the role of loans/credit and the role of the banking sector (next
week).
Next week: back to static world and talk about another type of imperfections which is called financial
imperfections. Those are extreme interesting for analyzing the financial sector because that is
typically where financial sector has to deal with. If you want to think about banks providing loans to
firms than information imperfection don’t really going around, because typically if a firm goes to a
bank and wants to get a loan, the firm knows more about project where loan needed for than the
bank and the bank is uncertain. One of the issues discussed next week which makes loans quite
special and an important feature of New-Keynesian school.
New Keynesian economics is a model-based/technological approach to macroeconomics: in this
course we do not go into the details of the models, but focus on the economic intuition.
Why New-Keynesian economics?
New-Keynesian economics combines ‘regular’ theory with appropriate frictions, such as
wage and price rigidities (built up from so-called micro-foundations), information problems
and competition issues
NKE is better able to ‘get the data/empirics’ than (neo-)classical economics
NKE is ‘mainstream’ economics
NKE has a clear focus on government interventions: what can a government do to offset the
impact of the imperfections?
International organizations, like the ECB or the European Commission, tend to rely on New-
Keynesian models.
Summarize new-keynesian view: that there is an equilibrium in the long run but there are
imperfections going on in short run. So the imperfections in the short run are crucial but in the long
run the model will go back to equilibrium. Long-run the New-Keynesian tend to agree with the
(neo-)classical model.
Classical/Neo-classical economics
Equilibrium: prices coordinate markets
Complete markets
Complete information
Rational/consistent expectations
Dynamic optimizations
No role for government interventions: any intervention is wrong.
Back to 1970s
Response to the domination of Keynesian Economics
Started with the 1968 Presidential Address of the American Economic Association by Milton
Friedman. Friedman basically addressed the vertical supply curve/Philips-curve
Introduction of Dynamic Stochastic General Equilibrium (DSGE) models: Finn Kydland and Ed
Prescott (Nobel prize 2004). Kydland and Prescott were more engineers, so they really like
modelling and technical analysis of economists and try to model the hardcore classical view
of DSGE models.
Problems in getting ‘in touch’ with empirical facts – certainly in finding an explanation of a
financial crisis!
Friedman was considered as the most prominent figure in the monetarist school. Friedman trained
some of his students so there was a whole bunch of macroeconomics which were influenced by
Friedman and classical view. They were prominent admires of the classical school.
-The New-Keynesian Economics-
Pluriformity in macroeconomics; There are many views and schools of thought: sometimes
conclusions can be very different if one starts from a different ‘belief’ or ‘set of assumptions’
Reviewed in this course:
1. New-Keynesian economics
2. Post-Keynesian economics
3. Austrian economics
And at the end try to ‘map’ the different views in a comparative setting.
What is the key notion separating the schools of thought?
Basically, it is the view on market clearing and how agents behave.
A classical economist will argue that the price mechanism is able to allocate scarce resources
over market both in time and across agents in an efficient way: price signals do the job: in an
efficient market all information is embedded in the pricing process. (very strong
assumption!)
The other schools of thought are convinced that there can be all kinds of imperfections
disturbing this view: uncertainties, sticky prices, a lack of information, market power,
missing markets, political influences…
If there are imperfections, there is an active role for the government to increase social
welfare.
If you add fractions (like unemployment or inflation) to the model, there is room for government to
intervene or manoeuvre.
Timeline
- 1930s: classical school denominates
- 1930s-1960s: Keynesian economics
- Through those years: Classical/Austrian points of view continued to develop
- 1970s: revival of classical economics: new classical school
- 1970s: development of post-Keynesian economics
- 1980s: New-Keynesian economics
- 2000s: methodological ‘merger’ of New Classical and New Keynesian Economics: generally
considered now as Mainstream economics.
The first two weeks: Assignment I
Focusing on New-Keynesian approach, because this is rather standard in the minds of policy
makers/central bankers
Two approaches:
1. A standard dynamic view and its implications for monetary policy (this week).
This week: In this New-Keynesian school, the idea of expectations is really important. Expectations
you talk about future so using a static model or static analysis will not do the job. The model used for
policy analysis and you want to talk about expectations you have to talk about dynamics which
means how does the economy involve, how does output involve into the next period, how does
inflation grow or diminish and how do policy makers respond to those developments. The new-
Keynesian model is talking about some imperfections that are going around.
, 2. A model that focuses on the role of loans/credit and the role of the banking sector (next
week).
Next week: back to static world and talk about another type of imperfections which is called financial
imperfections. Those are extreme interesting for analyzing the financial sector because that is
typically where financial sector has to deal with. If you want to think about banks providing loans to
firms than information imperfection don’t really going around, because typically if a firm goes to a
bank and wants to get a loan, the firm knows more about project where loan needed for than the
bank and the bank is uncertain. One of the issues discussed next week which makes loans quite
special and an important feature of New-Keynesian school.
New Keynesian economics is a model-based/technological approach to macroeconomics: in this
course we do not go into the details of the models, but focus on the economic intuition.
Why New-Keynesian economics?
New-Keynesian economics combines ‘regular’ theory with appropriate frictions, such as
wage and price rigidities (built up from so-called micro-foundations), information problems
and competition issues
NKE is better able to ‘get the data/empirics’ than (neo-)classical economics
NKE is ‘mainstream’ economics
NKE has a clear focus on government interventions: what can a government do to offset the
impact of the imperfections?
International organizations, like the ECB or the European Commission, tend to rely on New-
Keynesian models.
Summarize new-keynesian view: that there is an equilibrium in the long run but there are
imperfections going on in short run. So the imperfections in the short run are crucial but in the long
run the model will go back to equilibrium. Long-run the New-Keynesian tend to agree with the
(neo-)classical model.
Classical/Neo-classical economics
Equilibrium: prices coordinate markets
Complete markets
Complete information
Rational/consistent expectations
Dynamic optimizations
No role for government interventions: any intervention is wrong.
Back to 1970s
Response to the domination of Keynesian Economics
Started with the 1968 Presidential Address of the American Economic Association by Milton
Friedman. Friedman basically addressed the vertical supply curve/Philips-curve
Introduction of Dynamic Stochastic General Equilibrium (DSGE) models: Finn Kydland and Ed
Prescott (Nobel prize 2004). Kydland and Prescott were more engineers, so they really like
modelling and technical analysis of economists and try to model the hardcore classical view
of DSGE models.
Problems in getting ‘in touch’ with empirical facts – certainly in finding an explanation of a
financial crisis!
Friedman was considered as the most prominent figure in the monetarist school. Friedman trained
some of his students so there was a whole bunch of macroeconomics which were influenced by
Friedman and classical view. They were prominent admires of the classical school.
