New Keynesian Phillips curve - Essay Example

Meanwhile, New Keynesians (characterized by the inclusion of microeconomic foundations in Keynesian theory as an answer to the New Classical School), differs from traditional Keynesians by arguing that in the long run both an active fiscal policy and an expansive monetary policy are neutral and have no effect in aggregate demand, returning to equilibrium. In addition, New Keynesians also believe that an expansive monetary policy, combined with an active fiscal policy, would only lead to inflationary expectations, leading to more problems in the long-run.

However, despite these assumptions, New Keynesians still believes that government stabilization, especially through both monetary and fiscal policies, is still beneficial to the economy especially in times of economic shocks, given that wages and prices are sticky. In addition, New Keynesians differ from Traditional Keynesians by arguing that economic agents always act rationally. . conomic thought, nominal rigidity (referring to the stickiness of wages and prices) is actually a central theme, wherein prices actually fail to change instantaneously with regards to changes in economic conditions, such as changes in aggregate demand.

Due to the concept of nominal rigidities, New Keynesian Economists actually argue that in the short-run, government stabilization through monetary policy can be beneficial in decreasing unemployment and increasing output if there is a presence of unexpected negative economic shocks. And it is such rigidities, combined with real rigidities that actually lead to incomplete nominal adjustment. The question that may arise here is that: how come price reacts so slowly to altering economic conditions?

There are several models that are formulated by New Keynesian Economists to explain this phenomenon. One of the most popular models is the nominal rigidity models, as expounded by Calvo and Taylor. In the model of Taylor (1980), firms actually change prices according to multi periodic contracts. In this model, the assumption is that such contracts may actually lead to the adjustment of price levels according to economic disturbances. However, in reality, the adjustment of prices comes at a staggered basis, because not all actors in the economy change prices every period; it is this staggered adjustment of prices that results to the slow adjustment of prices and wages in the economy to disturbances.

In this case, there are instances wherein aggregate demand is determined after the first prices are set. But, firms who are able to adjust their prices first actually consider other firms who have not yet changed their prices, and results to a situation wherein price setters actually change their prices, although not too far from the