Understanding

New Classical and

Keynesian
Macroeconomic
Perspectives
By: Mahira Ahuja
 Overview of New Classical and
Keynesian Perspectives
In macroeconomics, the New Classical and Keynesian
approaches provide different perspectives on the dynamics
of the economy. New Classical economics emerged in the
late twentieth century, advocating for the self-correction
nature of flexible prices and limited government intervention
during slumps in the economy. It emphasises the economy's
tendency to achieve full employment in the long run. On the
other hand, Keynesian economics developed in response to
the Great Depression of the twentieth century, emphasising
the need of government intervention in addressing short-
term economic issues and achieving full employment. These
opposing viewpoints have a major effect on policy debates
and our knowledge of economic system dynamics.
 New Classical
According to New Classical perspective, with flexible prices,
the economy will automatically move towards full
employment in the long run, requiring minimum government
intervention during fluctuations. It claims that falling
aggregate demand forces enterprises to minimise costs,
whilst rising demand causes brief increases in output. It is
founded on the notion that people create rational
expectations about the future, taking into account all
available information when making decisions.
 New Classical
01. Flexible Prices 02. Equilibrium 03. Policy
and Wages Unemployment Implications
According to the theory, The focus on market
New classical
unemployment is clearing suggests that
economics think that
voluntary, with government intervention
prices and wages are
individuals optimising in addressing
flexible, adjusting
their decisions based on unemployment may be
quickly to maintain
their preferences and ineffective, as it believes
market equilibrium.
available possibilities. that markets will naturally
attain equilibrium.
 Criticisms of New Classical
Assumptions of Rationality: Some claim that the assumption
of a reasonable expectation oversimplifies human behaviour
and decision-making by ignoring the impact of limited
rationality and behavioural biases.

Real-World Application: Critics argue that the theory's

dependence on market clearing and reasonable
expectations limits its applicability to real-world economic
settings, particularly during economic crises.

Policy Implications: Critics argue that the theory's

implications for policy may result in a lack of government
intervention in instances where it would be advantageous,
such as severe economic downturns.
 Keynesian
Keynesian economics developed in response to
the Great Depression, highlighting the
importance of government intervention during
economic downturns. Keynesians argue that
rigid wages and prices can keep the economy
stuck below full employment, requiring strong
government intervention to raise aggregate
demand and promote recovery.
 Keynesian

01. Nominal Rigidity 02. Wage and 03. Policy

Price Rigidities Implications
According to Keynesian Based to the hypothesis, The presence of nominal
theory, prices and wage and price limits justifies
wages are inflexible in limitations impede government
the short run, causing market clearing, involvement to reduce
market inefficiencies contributing to unemployment and
and unemployment. involuntary promote economic
unemployment. activity during
recessions.
 Criticism of Keynesian
Long-Run Implications: Many believe that Keynesian
policies, if continued indefinitely, may result in rising
prices and a crowding-out impact on private investment.

Government Intervention: Some economists question a

reliance on government involvement, noting potential
inefficiency and unforeseen consequences from
government spending initiatives.

Expectations and Rationality: Many argue that Keynesian

economics ignores the importance of expectations and
rational behaviour in influencing economic decisions,
especially over the long run.
 Comparison
Differing Assumptions: New classical and Keynesian macroeconomics make
different assumptions regarding expectations, market clearing, and the role of
government intervention in stabilising the economy.

Empirical Validations: Comparative empirical investigations have shed light on

the relative effectiveness of new classical and Keynesian strategies in tackling
economic fluctuations and unemployment.

Policy Tradeoffs: The contrasting policy implications of the two approaches

point out the compromises that must be made between market-based
solutions and government intervention for regulating economic stability.
 Economic implications of
New Classical and Keynesian
The economic implications of New Classical and Keynesian
perspectives vary significantly. New Classical economists
think that market forces efficiently drive the economy,
especially during recessions, whereas Keynesians emphasise
the possibility of long-term economic stagnation without
government involvement. The former emphasises long-term
investments and flexible prices, whereas the latter highlights
the importance of short-term measures to manage
fluctuations and achieve full employment. These opposing
viewpoints have a considerable impact on policy suggestions
and disputes over the government's acceptable role in
economic management.
 Thank you
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patiemce!