New Keynesian economics
Topic: Schools of Economic Thought and Economic Laws · NCERT: Beyond NCERT
Meaning
New Keynesian economics is a school from the 1980s. It keeps Keynes's conclusion that demand shortfalls can cause unemployment. But it builds that conclusion from micro foundations, meaning the behaviour of individual firms and workers. Its key ideas are:
- sticky prices and wages (Taylor, Calvo): they adjust slowly;
- menu costs (Mankiw, 1985): changing prices has a cost;
- efficiency wages (Akerlof-Yellen): firms pay above the market wage to get more effort;
- imperfect competition: firms can set their own prices.
Because prices do not clear markets at once, monetary policy can affect output in the short run. This school is the basis of today's inflation-targeting central banks, including RBI.
Example
A restaurant does not reprint its menu each time costs change, so its prices stay fixed for months. When RBI changes the repo rate, spending and output shift before prices fully adjust.
Don't confuse with
- Post-Keynesian economics (for example Minsky): it stresses uncertainty and financial instability and rejects the mainstream micro-founded models that New Keynesians use.