Hopefully, the title of this question is quite descriptive. Whilst I have a broad understanding of the research agenda of macroeconomics, I don't have a very good picture of how it is divided into various schools and traditions. Is there a way to briefly summarise what exactly New Keynesian macro is and how it relates to the rest of what is going on in macroeconomics?
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1$\begingroup$ It's hard enough just getting the timeline right... Keynesianism -> neo-Keynesianism -> Post-Keynesianism -> New Keynesianism ... sheeesh! $\endgroup$– Steve SCommented Nov 22, 2014 at 20:45
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3 Answers
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In essence New-Keynesians adapt micro to macro theory. This is in contrast to new classicals which adapt macro theory to orthodox neoclassical market-clearing microfoundations. New-Keynesians adapt the rational expectations hypothesis but accept that market may fails due to wage and price stickiness and Friedman's natural rate hypothesis. The New-Keynesians, the RBC school and New Classicals focus on issues relating to aggregate supply and have been the dominating schools since the 1970's, especially the new-Keynesians have dominated the last one to two decades. On the other hand "old"-Keynesians and the orthodox monetarists mainly focused on issues relating to aggregate demand and these dominated economic thinking pre-1970's.
As an example of the differences between New-Keynesian New Classicals and the RBC school consider an increase in money: This increase will have real effect in a New-Keynesian model due to these market imperfections. In a new classical model on the other hand money will only have real effects if they are unanticipated (Lucas' Island model) while in a RBC model the increase will only feed into higher prices due to perfect clearing markets and rational expectations.
Note that it has been argued by N. Gregory Mankiw that the New-Keynesian school could just as well have been called New-Monetarist.
For an excellent reference on the different schools, what they represent and their differences see Snowdon and Vane: "Modern Macroeconomics: It's Origins, Development and Current State"
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1$\begingroup$ Not sure I agree with the phrasing "while in an RBC model the increase will only [...]". The New Keynesian model is an RBC model. I'd prefer to read "the simplest frictionless RBC model" or something along those lines. $\endgroup$– FooBarCommented Nov 23, 2014 at 21:12
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$\begingroup$ No the New-Keynesian model is not a RBC model. It stems from the RBC literature but because of the market imperfections it incorporates nominal shocks can have real effects in the economy while in a RBC model only real shocks have an effect. Yes they are similar but they are from different schools and should be addressed in that way. I have actually never heard anyone refer to a NK-DSGE model as a RBC model with frictions. One could perhaps get away with saying a DSGE model with friction and a DSGE without frictions. $\endgroup$– PlisskenCommented Nov 23, 2014 at 21:35
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1$\begingroup$ I disagree: RBC models are all DSGE where business cycle fluctuations come from a real shock. As far as I remember, this is the case for NK. But as long as we agree on the content, this is just a matter of definitions. $\endgroup$– FooBarCommented Nov 23, 2014 at 21:38
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1$\begingroup$ In a NK-model both nominal and real shocks can have effects on say GDP. Nominal shocks will have effects du to market imperfections among others. In a RBC model only real shocks will have an effect on say GDP. Nominal shocks such as an increase in money will only feed into higher prices because of perfect markets. But yes as long as we agree on the content. $\endgroup$– PlisskenCommented Nov 23, 2014 at 22:09
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(Old) Keynesian Theory is what you might get taught in undergrad. It comes from behavioral rules and features the good old IS-LM etc diagrams. It rises the Keynesian traps, situations, where the economy might be stuck in downturns of the business cycle for a long time. These situations give rise to, for example, fiscal policy.
Then came the Rational Expectation paradigm, which required a general equilibrium story which is in itself consistent. These guys believed that you can only evaluate the impact of policy if the model is robust to changes in the environment. That is, if you empirically observe a behavior rule (say, consumption), but then the environment changes, the behavioral rule might change. To the extent that we expect policy to adjust the environment, we can only predict policy outcomes if we have a model which is robust to changes in the environment (Lucas critique).
These guys dismissed the old Keynesian Theory because it was built on Behavioral rules, rather than microfundations, and proceeded to create Dynamic Stochastic General Equilibrium models (DSGE), which are supposedly internally consistent and based on micro-foundations: Empirical relationships that are always true and do not change with the environment. This DSGE framework was taken over into most parts of mainstream Economics, most importantly macroeconomics.
New Keynesian Theory is an extension of the simplest possible Real Business Cycle model (which satisfies the DSGE paradigm), which contains most importantly
- market power of firms
- price stickiness
It is designed to give reason for policy intervention, just as the old keynesian theory. However, the intuition and the mechanism are completely different than from the Old Keynesian Story, Cochrane has nice papers and even blog posts on the exact mechanism. It's very debated, not just because its policy implications, but also because price stickiness is again implemented as a "behavioral rule", breaking with the DSGE paradigm.
If you want to know more, you should read up on the papers or ask a more precise question, otherwise this will head nowhere.
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The economics and public policy website, Crooked Timber, devoted a question entirely to that subject recently. New Old Keynesianism delineates the differences between
- Old Old Keynesianism,
- Old New Keynesianism,
- New Old Keynesianism and
- New New Keynesianism
such that "New" means “post Global Financial Crisis” and “Old” to refers to a belief that the economy can be in a long-run high unemployment equilibrium.
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5$\begingroup$ This starts to look ridiculous (the classification I mean). Let's hope that by the centenary of the General Theory, "stickiness" will be an economic phenomenon only, and not a "can't-let-go" naming mantra of the past. $\endgroup$ Commented Nov 21, 2014 at 11:28
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$\begingroup$ @AlecosPapadopoulos Quite true! Although it wasn't meant to be satire, I almost laughed when I first read the article ;O) $\endgroup$ Commented Nov 22, 2014 at 2:00