What is New Keynesian Economics?

New Keynesian Economics was developed from the classical Keynesian economics, it is a contemporary macroeconomics school of thought that studies the rate at which prices and wages change. New Keynesian Economics as a modern version of the classical theory seeks to provide a response to how fast wages and prices adjust. There are two key assumptions central to the New Keynesian Economics, these are the stickiness of wages and stickiness of prices. With wages and prices being sticky, they tend to adjust quickly to fluctuations in an economy but might adjust slowly when the fluctuation is short-termed.

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How does New Keynesian Economics Work?

The several criticisms leveled against the classical Keynesian approach to macroeconomics gave rise to the emergence of the new Keynesian macroeconomics. The new Keynesian economics, however, became prominent in the 1980s giving explanations to diverse economic issues including how market inadequacies are caused by federal monetary policy, among other factors. As a contemporary school of thought, this theory provides response to the sticky nature of wages and prices which explain their tendencies to adjust fast amidst economic fluctuations. The likely sluggish behavior of prices in an economy and the causes are also provided answers to by this theory. This modern school of thought also gives an explanation to economic factors such as involuntary unemployment and the effect of federal monetary policies on the economy.

Issues with New Keynesian Economics

Despite that new Keynesian economics is a contemporary approach to macroeconomics, there are certain issues that critics and opponents have identified. One major issue with the new Keynesian economics as argued by economists is that as a modern theory, it posits that firms that are run as a monopoly or are very competitive in nature set their prices and determine their sales level which creates a constraint. When prices are set by monopoly firms and competitive firms they have specific expectations that might not be achieved given that imperfect competition and asymmetric information create failures in the market, thereby affecting their expectations.