The new classical macroeconomics

Abstract

The new classical macroeconomics (ncm) is not particularly useful in explaining stark episodes. To be successful, the new classical approach will have to be developed in a number of areas including coordination problems and political economy issues of stabilization. These modifications can in principle be worked into the ncm classical approach, but that will change the main thrust. So far, the message reads: markets clear, productivity shocks are the dominant source of fluctuations, intertemporal substitution in consumption and labor supply are the chief amplifying factors, and government policy is substantially irrelevant. On these key propositions, the evidence fails and the emphasis is misdirected. The issue is not whether markets work, but rather bow they work, a concern rightly emphasized by the new keynesian economics. The ncm models the maximization problem of the individual rational and forward-looking agent. Three implications follow from the methodology and are the distinguishing characteristic of this approach. The role of relive prices is pervasive once the proper distinctions are made between intra and intertemporal terms of trade, and, between price changes that are current and future, transitory and permanent, and anticipated and unanticipated. Next, because economic agents' policy environment is part of the information set and budget constraint, one obtain informed answers to questions about the effects of policy realizations or changes in rules.