Heterodox
145-626: Heterodox New Keynesian economics is a school of macroeconomics that strives to provide microeconomic foundations for Keynesian economics . It developed partly as a response to criticisms of Keynesian macroeconomics by adherents of new classical macroeconomics . Two main assumptions define the New Keynesian approach to macroeconomics. Like the New Classical approach, New Keynesian macroeconomic analysis usually assumes that households and firms have rational expectations . However,
290-520: A y ( y t − y t ∗ ) . {\displaystyle i_{t}=\pi _{t}+r_{t}^{*}+a_{\pi }(\pi _{t}-\pi _{t}^{*})+a_{y}(y_{t}-y_{t}^{*}).} In this equation, i t {\displaystyle \,i_{t}\,} is the target short-term nominal interest rate (e.g. the federal funds rate in the US, the Bank of England base rate in
435-693: A fixed exchange rate regime, aligning their currency with one or more foreign currencies, typically the US dollar or the euro . Conventional monetary policy can be ineffective in situations such as a liquidity trap . When nominal interest rates are near zero, central banks cannot loosen monetary policy through conventional means. In that situation, they may use unconventional monetary policy such as quantitative easing to help stabilize output. Quantity easing can be implemented by buying not only government bonds, but also other assets such as corporate bonds, stocks, and other securities. This allows lower interest rates for
580-635: A fixed exchange rate system or even a currency union like the Economic and Monetary Union of the European Union , drawing on the research literature on optimum currency areas . Macroeconomics as a separate field of research and study is generally recognized to start with the publication of John Maynard Keynes ' The General Theory of Employment, Interest, and Money in 1936. The terms "macrodynamics" and "macroanalysis" were introduced by Ragnar Frisch in 1933, and Lawrence Klein in 1946 used
725-436: A 2% inflation rate just because that has been the average the past few years; they will look at current monetary policy and economic conditions to make an informed forecast. In the new classical models with rational expectations, monetary policy only had a limited impact. Lucas also made an influential critique of Keynesian empirical models. He argued that forecasting models based on empirical relationships would keep producing
870-468: A 3% increase in output would lead to a 1% decrease in unemployment. The structural or natural rate of unemployment is the level of unemployment that will occur in a medium-run equilibrium, i.e. a situation with a cyclical unemployment rate of zero. There may be several reasons why there is some positive unemployment level even in a cyclically neutral situation, which all have their foundation in some kind of market failure : A general price increase across
1015-550: A VAR representation. The characterization of asset market bubbles under rational expectations, with Mark Watson. The “divine coincidence” result, derived in research with Jordi Gali , that, in the baseline New Keynesian model, stabilizing inflation, which is good on its own, also leads output to be equal to its constrained optimum; this baseline result allows to think about the nature of the trade-off that emerges between inflation and output when other distortions are introduced. The effect of real wage rigidities on fluctuations and
1160-431: A Worker Discipline Device" created a model where employees tend to avoid work unless firms can monitor worker effort and threaten slacking employees with unemployment. If the economy is at full employment, a fired shirker simply moves to a new job. Individual firms pay their workers a premium over the market rate to ensure their workers would rather work and keep their current job instead of shirking and risk having to move to
1305-804: A basis for making economic forecasting . Well-known specific theoretical models include short-term models like the Keynesian cross , the IS–LM model and the Mundell–Fleming model , medium-term models like the AD–AS model , building upon a Phillips curve , and long-term growth models like the Solow–Swan model, the Ramsey–Cass–Koopmans model and Peter Diamond 's overlapping generations model . Quantitative models include early large-scale macroeconometric model ,
1450-565: A broader class of assets beyond government bonds. A similar strategy is to lower long-term interest rates by buying long-term bonds and selling short-term bonds to create a flat yield curve , known in the US as Operation Twist . Fiscal policy is the use of government's revenue ( taxes ) and expenditure as instruments to influence the economy. For example, if the economy is producing less than potential output , government spending can be used to employ idle resources and boost output, or taxes could be lowered to boost private consumption which has
1595-571: A core part of contemporary macroeconomics. The 2007–2008 financial crisis , which led to the Great Recession , led to major reassessment of macroeconomics, which as a field generally had neglected the potential role of financial institutions in the economy. After the crisis, macroeconomic researchers have turned their attention in several new directions: Research in the economics of the determinants behind long-run economic growth has followed its own course. The Harrod-Domar model from
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#17327768278421740-495: A factory can go idle even though there are people willing to work in it, and people willing to buy its production if they had jobs. In such a scenario, economic downturns appear to be the result of coordination failure: The invisible hand fails to coordinate the usual, optimal, flow of production and consumption. Russell Cooper and Andrew John's 1988 paper "Coordinating Coordination Failures in Keynesian Models" expressed
1885-399: A firm anticipates a fall in demand, they might cut back on hiring. A lack of job vacancies might worry workers who then cut back on their consumption. This fall in demand meets the firm's expectations, but it is entirely due to the firm's own actions. New Keynesians offered explanations for the failure of the labor market to clear. In a Walrasian market, unemployed workers bid down wages until
2030-423: A firm is slow to adjust its real prices in response to a changing economic environment. For example, a firm can face real rigidities if it has market power or if its costs for inputs and wages are locked-in by a contract. Ball and Romer argued that real rigidities in the labor market keep a firm's costs high, which makes firms hesitant to cut prices and lose revenue. The expense created by real rigidities combined with
2175-495: A general form of coordination as models with multiple equilibria where agents could coordinate to improve (or at least not harm) each of their respective situations. Cooper and John based their work on earlier models including Peter Diamond 's 1982 coconut model , which demonstrated a case of coordination failure involving search and matching theory . In Diamond's model producers are more likely to produce if they see others producing. The increase in possible trading partners increases
2320-468: A lump-sum cost (menu cost) to changing the price was originally introduced by Sheshinski and Weiss (1977) in their paper looking at the effect of inflation on the frequency of price-changes. The idea of applying it as a general theory of nominal price rigidity was simultaneously put forward by several economists in 1985–86. George Akerlof and Janet Yellen put forward the idea that due to bounded rationality firms will not want to change their price unless
2465-418: A major role to movements in aggregate demand in economic fluctuations. His research runs from theoretical research to empirical and policy relevant work. He is the author or editor of 30 books and more than 150 articles. According to IDEAS/RePEc , he is one of the most cited economists in the world. The development, with Nobu Kiyotaki , of micro foundations for the role of nominal price rigidities and
2610-442: A medium-run equilibrium (or "potential") level, the process would be slow at best. Keynes coined the term liquidity preference (his preferred name for what is also known as money demand ) and explained how monetary policy might affect aggregate demand, at the same time offering clear policy recommendations for an active role of fiscal policy in stabilizing aggregate demand and hence output and employment. In addition, he explained how
2755-414: A monetary authority (central bank) can control the employment rate. Since wages are fixed at a nominal rate, the monetary authority can control the real wage (wage values adjusted for inflation) by changing the money supply and thus affect the employment rate. In the 1980s the key concept of using menu costs in a framework of imperfect competition to explain price stickiness was developed. The concept of
2900-455: A new job. Since each firm pays more than market clearing wages, the aggregated labor market fails to clear. This creates a pool of unemployed laborers and adds to the expense of getting fired. Workers not only risk a lower wage, they risk being stuck in the pool of unemployed. Keeping wages above market clearing levels creates a serious disincentive to shirk that makes workers more efficient even though it leaves some willing workers unemployed. In
3045-420: A parallel division of macroeconomic policies into short-run policies aimed at mitigating the harmful consequences of business cycles (known as stabilization policy ) and medium- and long-run policies targeted at improving the structural levels of macroeconomic variables. Stabilization policy is usually implemented through two sets of tools: fiscal and monetary policy. Both forms of policy are used to stabilize
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#17327768278423190-473: A relatively simple model which could be used for the theoretical analysis of policy issues. However, the model was oversimplified in some respects (for example, there is no capital or investment). Also, it does not perform well empirically. In the new millennium there have been several advances in new Keynesian economics. Whilst the models of the 1990s focused on sticky prices in the output market, in 2000 Christopher Erceg, Dale Henderson and Andrew Levin adopted
3335-498: A similar effect. Government spending or tax cuts do not have to make up for the entire output gap . There is a multiplier effect that affects the impact of government spending. For instance, when the government pays for a bridge, the project not only adds the value of the bridge to output, but also allows the bridge workers to increase their consumption and investment, which helps to close the output gap. The effects of fiscal policy can be limited by partial or full crowding out . When
3480-545: A special case of the more general Ramsey growth model , where households' savings rates are not constant as in the Solow model, but derived from an explicit intertemporal utility function . In the 1980s and 1990s endogenous growth theory arose to challenge the neoclassical growth theory of Ramsey and Solow. This group of models explains economic growth through factors such as increasing returns to scale for capital and learning-by-doing that are endogenously determined instead of
3625-450: A term introduced in a 2014 study of fiscal stimulus policies by Kaplan and Violante. The existence of wealthy hand-to-mouth households in New Keynesian models matters for the effects of monetary policy, because the consumption behavior of those households is strongly sensitive to changes in disposable income, rather than variations in the interest rate (i.e. the price of future consumption relative to current consumption). The direct corollary
3770-488: A unique market-clearing equilibrium (at full employment ) with rational expectations. The New Keynesians used "microfoundations" to demonstrate that price stickiness hinders markets from clearing. Thus, the rational expectations-based equilibrium need not be unique. Whereas the neoclassical synthesis hoped that fiscal and monetary policy would maintain full employment , the new classicals assumed that price and wage adjustment would automatically attain this situation in
3915-403: A whole intellectural framework - a novel theory of economics that explained why markets might not clear, which would evolve into a school of thought known as Keynesian economics , also called Keynesianism or Keynesian theory. In Keynes' theory, aggregate demand - by Keynes called "effective demand" - was key to determining output. Even if Keynes conceded that output might eventually return to
4060-502: Is h {\displaystyle h} ), the greater the effect of output on current inflation. The ideas developed in the 1990s were put together to develop the new Keynesian dynamic stochastic general equilibrium used to analyze monetary policy. This culminated in the three-equation new Keynesian model found in the survey by Richard Clarida , Jordi Gali , and Mark Gertler in the Journal of Economic Literature . It combines
4205-547: Is affected. Expansionary monetary policy lowers interest rates, increasing economic activity, whereas contractionary monetary policy raises interest rates. In the case of a fixed exchange rate system, interest rate decisions together with direct intervention by central banks on exchange rate dynamics are major tools to control the exchange rate. In developed countries, most central banks follow inflation targeting , focusing on keeping medium-term inflation close to an explicit target, say 2%, or within an explicit range. This includes
4350-468: Is implemented through automatic stabilizers without any active decisions by politicians. Automatic stabilizers do not suffer from the policy lags of discretionary fiscal policy . Automatic stabilizers use conventional fiscal mechanisms, but take effect as soon as the economy takes a downturn: spending on unemployment benefits automatically increases when unemployment rises, and tax revenues decrease, which shelters private income and consumption from part of
4495-409: Is measured by the unemployment rate, i.e. the percentage of persons in the labor force who do not have a job, but who are actively looking for one. People who are retired, pursuing education, or discouraged from seeking work by a lack of job prospects are not part of the labor force and consequently not counted as unemployed, either. Unemployment has a short-run cyclical component which depends on
New Keynesian economics - Misplaced Pages Continue
4640-430: Is often contrasted with the post-Keynesianism of Paul Davidson , which emphasizes the role of fundamental uncertainty in economic life, especially concerning issues of private fixed investment . New Keynesianism was a response to Robert Lucas and the new classical school. That school criticized the inconsistencies of Keynesianism in the light of the concept of " rational expectations ". The new classicals combined
4785-416: Is referred to as an "environment's source function", and this function is depleted as resources are consumed or pollution contaminates the resources. The "sink function" describes an environment's ability to absorb and render harmless waste and pollution: when waste output exceeds the limit of the sink function, long-term damage occurs. The division into various time frames of macroeconomic research leads to
4930-532: Is sometimes called the "Calvo probability" in this context. In the Calvo model the crucial feature is that the price-setter does not know how long the nominal price will remain in place, in contrast to the Taylor model where the length of contract is known ex ante . Coordination failure was another important new Keynesian concept developed as another potential explanation for recessions and unemployment. In recessions
5075-528: Is that monetary policy is mostly transmitted via general equilibrium effects that work through the household labor income, rather than through intertemporal substitution, which is the main transmission channel in Representative Agent New Keynesian (RANK) models. There are two main implications for monetary policy. First, monetary policy interacts strongly with fiscal policy, because of the failure of Ricardian Equivalence due to
5220-464: Is that of an economy's openness, economic theory distinguishing sharply between closed economies and open economies . It is usual to distinguish between three time horizons in macroeconomics, each having its own focus on e.g. the determination of output: National output is the total amount of everything a country produces in a given period of time. Everything that is produced and sold generates an equal amount of income. The total net output of
5365-562: Is the discount factor. The constant κ {\displaystyle \kappa } captures the response of inflation to output, and is largely determined by the probability of changing price in any period, which is h {\displaystyle h} : κ = h [ 1 − ( 1 − h ) β ] 1 − h γ {\displaystyle \kappa ={\frac {h[1-(1-h)\beta ]}{1-h}}\gamma } . The less rigid nominal prices are (the higher
5510-437: Is the information that is sticky, not the prices. Thus when a firm gets lucky and can re-plan its current and future prices, it will choose a trajectory of what it believes will be the optimal prices now and in the future. In general, this will involve setting a different price every period covered by the plan. This is at odds with the empirical evidence on prices. There are now many studies of price rigidity in different countries:
5655-441: Is the logarithm of real GDP, and y t ∗ {\displaystyle y_{t}^{*}} is the logarithm of potential output , as determined by a linear trend. The New Keynesian Phillips curve was originally derived by Roberts in 1995, and has since been used in most state-of-the-art New Keynesian DSGE models. The new Keynesian Phillips curve says that this period's inflation depends on current output and
5800-470: Is the product of two inputs: capital and labor. The Solow model assumes that labor and capital are used at constant rates without the fluctuations in unemployment and capital utilization commonly seen in business cycles. In this model, increases in output, i.e. economic growth, can only occur because of an increase in the capital stock, a larger population, or technological advancements that lead to higher productivity ( total factor productivity ). An increase in
5945-729: The American Economic Association in 1995-1996, and President in 2018-2019. He is a fellow of the Econometric Society and was a council member from 2001 to 2007. He is a member of the American Academy of Sciences . He was made a chevalier de la Legion d’honneur in 2008, and an officier in 2016. He is also a commander de l’ordre du mérite since 2021. He was a co-editor of the Quarterly Journal of Economics from 1979 to 1998,
New Keynesian economics - Misplaced Pages Continue
6090-608: The Federal Reserve and the European Central Bank , which are generally considered to follow a strategy very close to inflation targeting, even though they do not officially label themselves as inflation targeters. In practice, an official inflation targeting often leaves room for the central bank to also help stabilize output and employment, a strategy known as "flexible inflation targeting". Most emerging economies focus their monetary policy on maintaining
6235-505: The Great Recession Blanchard supported global fiscal stimulus. During its slow recovery, he urged a cautious removal of stimulus and advocated quantitative easing . In 2012, looking at output forecasts and realizations across advanced economies, Blanchard and Daniel Leigh found that the countries where fiscal consolidation was strongest were also those that underperformed relative to forecasts. They concluded that
6380-632: The Paris School of Economics , and as the C. Fred Bergsten Senior Fellow at the Peterson Institute for International Economics . Blanchard was born in Amiens (France) . His father was a neurologist, his mother a psychiatrist. Blanchard says he was attracted to economics because of the student protests in France in 1968 , showing the importance of economics for society’s welfare, and
6525-598: The central bank , to changes in inflation, output , or other economic conditions. In particular, the rule describes how, for each one-percent increase in inflation, the central bank tends to raise the nominal interest rate by more than one percentage point. This aspect of the rule is often called the Taylor principle . Although such rules provide concise, descriptive proxies for central bank policy, they are not, in practice, explicitly proscriptively considered by central banks when setting nominal rates. Taylor's original version of
6670-475: The multiplier effect would magnify a small decrease in consumption or investment and cause declines throughout the economy, and noted the role that uncertainty and animal spirits can play in the economy. The generation following Keynes combined the macroeconomics of the General Theory with neoclassical microeconomics to create the neoclassical synthesis . By the 1950s, most economists had accepted
6815-411: The 1940s attempted to build a long-run growth model inspired by Keynesian demand-driven considerations. The Solow–Swan model worked out by Robert Solow and, independently, Trevor Swan in the 1950s achieved more long-lasting success, however, and is still today a common textbook model for explaining economic growth in the long-run. The model operates with a production function where national output
6960-568: The 1990s, which forms the basis of mainstream economics today, and the Keynesian stress on the importance of centralized coordination of macroeconomic policies (e.g., monetary and fiscal stimulus), international economic institutions such as the World Bank and International Monetary Fund (IMF), and of the maintenance of a controlled trading system was highlighted during the 2008 global financial and economic crisis. This has been reflected in
7105-737: The Blanchard and Kiyotaki model of unionized labor markets by combining it with the Calvo pricing approach and introduced it into a new Keynesian DSGE model. To have models that worked well with the data and could be used for policy simulations, quite complicated new Keynesian models were developed with several features. Seminal papers were published by Frank Smets and Rafael Wouters and also Lawrence J. Christiano , Martin Eichenbaum and Charles Evans The common features of these models included: The idea of sticky information found in Fischer's model
7250-499: The Great Depression struck, the reigning economists had difficulty explaining how goods could go unsold and workers could be left unemployed. In the prevailing neoclassical economics paradigm, prices and wages would drop until the market cleared, and all goods and labor were sold. Keynes in his main work, the General Theory , initiated what is known as the Keynesian revolution . He offered a new interpretation of events and
7395-646: The IMF as chief economist in September 2008, two weeks before the Lehman collapse . His formal title was “Economic Counsellor and Head of the Research Department". He stayed until 2015, so that much of his time was spent analyzing the global financial crisis, and later the euro crisis. With the support, first of Dominique Strauss Kahn , then of Christine Lagarde , he was given wide range to think about
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#17327768278427540-402: The IMF should take into account". as the effects of the financial crisis slowly diminish, another trend may come to dominate the scene, namely rising inequality. Though inequality has always been perceived to be a central issue, until recently it was not seen as having major implications for macroeconomic developments. This belief is increasingly called into question. How inequality affects both
7685-418: The Keynesian school. A central development in new classical thought came when Robert Lucas introduced rational expectations to macroeconomics. Prior to Lucas, economists had generally used adaptive expectations where agents were assumed to look at the recent past to make expectations about the future. Under rational expectations, agents are assumed to be more sophisticated. Consumers will not simply assume
7830-1173: The Lucas critique. Like classical models, new classical models had assumed that prices would be able to adjust perfectly and monetary policy would only lead to price changes. New Keynesian models investigated sources of sticky prices and wages due to imperfect competition , which would not adjust, allowing monetary policy to impact quantities instead of prices. Stanley Fischer and John B. Taylor produced early work in this area by showing that monetary policy could be effective even in models with rational expectations when contracts locked in wages for workers. Other new Keynesian economists, including Olivier Blanchard , Janet Yellen , Julio Rotemberg , Greg Mankiw , David Romer , and Michael Woodford , expanded on this work and demonstrated other cases where various market imperfections caused inflexible prices and wages leading in turn to monetary and fiscal policy having real effects. Other researchers focused on imperferctions in labor markets, developing models of efficiency wages or search and matching (SAM) models, or imperfections in credit markets like Ben Bernanke . By
7975-582: The Peterson Institute. Olivier has mentored a number of notable students throughout his academic career, including David Laibson , Tobias Adrian , Laurence M. Ball , Roland Bénabou , Ricardo J. Caballero , and Pierre-Olivier Gourinchas , among many others. He is married to Noelle Blanchard, and has three daughters, Marie, Serena, and Julia. Blanchard is one of the leaders of “ New Keynesian economics ”, an approach to macroeconomics that captures and extends Keynes’ general vision and gives
8120-569: The UK), π t {\displaystyle \,\pi _{t}\,} is the rate of inflation as measured by the GDP deflator , π t ∗ {\displaystyle \pi _{t}^{*}} is the desired rate of inflation, r t ∗ {\displaystyle r_{t}^{*}} is the assumed equilibrium real interest rate, y t {\displaystyle \,y_{t}\,}
8265-661: The United States, the Eurozone, the United Kingdom and others. These studies all show that whilst there are some sectors where prices change frequently, there are also other sectors where prices remain fixed over time. The lack of sticky prices in the sticky information model is inconsistent with the behavior of prices in most of the economy. This has led to attempts to formulate a "dual stickiness" model that combines sticky information with sticky prices. The 2010s saw
8410-400: The absence real imperfections such as sticky wages, and the divine coincidence no longer holds. Over the years, a sequence of 'new' macroeconomic theories related to or opposed to Keynesianism have been influential. After World War II , Paul Samuelson used the term neoclassical synthesis to refer to the integration of Keynesian economics with neoclassical economics . The idea was that
8555-487: The adverse effects of fiscal consolidation, the so called “multipliers”, were larger than those assumed by the IMF and the EU commission , and that fiscal adjustment should be slower. This led to a reassessment of IMF advice. Blanchard also argued that the IMF view that capital controls were bad should be revisited. In particular, he argued that short horizon capital flows were often costly, both when they came in and overwhelmed
8700-699: The attractiveness of thinking about the issues through quantitative methods. He obtained a DES in economics at the University of Nanterre in 1972. He then moved from France to the United States in 1973. He obtained a PhD from MIT in 1977, under the supervision of Stanley Fischer and Robert Solow . He was an assistant professor, then an associate professor at Harvard from 1977 to 1983, when he moved back to MIT. He became full professor in 1985, class of 1941 Professor from 1994 to 2010, and Robert Solow Professor of Economics from 2010 to 2020. He has been Robert Solow Professor Emeritus since then. He
8845-408: The benefit is more than a small amount. This bounded rationality leads to inertia in nominal prices and wages which can lead to output fluctuating at constant nominal prices and wages. Gregory Mankiw took the menu-cost idea and focused on the welfare effects of changes in output resulting from sticky prices . Michael Parkin also put forward the idea. Although the approach initially focused mainly on
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#17327768278428990-447: The business cycle, and a more permanent structural component, which can be loosely thought of as the average unemployment rate in an economy over extended periods, and which is often termed the natural or structural rate of unemployment. Cyclical unemployment occurs when growth stagnates. Okun's law represents the empirical relationship between unemployment and short-run GDP growth. The original version of Okun's law states that
9135-459: The case of a very low interest level, the economy may be in a liquidity trap in which monetary policy becomes ineffective, which makes fiscal policy the more potent tool to stabilize the economy. Thirdly, in regimes where monetary policy is tied to fulfilling other targets, in particular fixed exchange rate regimes, the central bank cannot simultaneously adjust its interest rates to mitigate domestic business cycle fluctuations, making fiscal policy
9280-404: The central bank should adjust the nominal interest rate in response to changes in inflation and output. (More precisely, optimal rules usually react to changes in the output gap , rather than changes in output per se .) In some simple New Keynesian DSGE models, it turns out that stabilizing inflation suffices, because maintaining perfectly stable inflation also stabilizes output and employment to
9425-409: The consequences of international trade in goods , financial assets and possibly factor markets like labor migration and international relocation of firms (physical capital). It explores what determines import , export , the balance of trade and over longer horizons the accumulation of net foreign assets . An important topic is the role of exchange rates and the pros and cons of maintaining
9570-441: The current period: 25% of prices will be based on the latest information available; the rest on information that was available when they last were able to replan their price trajectory. Mankiw and Reis found that the model of sticky information provided a good way of explaining inflation persistence. Sticky information models do not have nominal rigidity: firms or unions are free to choose different prices or wages for each period. It
9715-419: The degree of imperfect competition in the output market, the lower the real wage and hence the more the reduction falls on leisure (i.e. households work more) and less on consumption. Hence the fiscal multiplier is less than one, but increasing in the degree of imperfect competition in the output market. In 1983 Guillermo Calvo wrote "Staggered Prices in a Utility-Maximizing Framework". The original article
9860-559: The demand for workers meets the supply. If markets are Walrasian, the ranks of the unemployed would be limited to workers transitioning between jobs and workers who choose not to work because wages are too low to attract them. They developed several theories explaining why markets might leave willing workers unemployed. The most important of these theories was the efficiency wage theory used to explain long-term effects of previous unemployment , where short-term increases in unemployment become permanent and lead to higher levels of unemployment in
10005-500: The development of models incorporating household heterogeneity into the standard New Keynesian framework, commonly referred as 'HANK' models (Heterogeneous Agent New Keynesian). In addition to sticky prices, a typical HANK model features uninsurable idiosyncratic labor income risk which gives rise to a non-degenerate wealth distribution. The earliest models with these two features include Oh and Reis (2012), McKay and Reis (2016) and Guerrieri and Lorenzoni (2017). The name "HANK model"
10150-404: The development of the macroeconomic research mainstream . Macroeconomics encompasses a variety of concepts and variables, but above all the three central macroeconomic variables are output, unemployment, and inflation. Besides, the time horizon varies for different types of macroeconomic topics, and this distinction is crucial for many research and policy debates. A further important dimension
10295-678: The difference may be considerable. Economists interested in long-run increases in output study economic growth. Advances in technology, accumulation of machinery and other capital , and better education and human capital , are all factors that lead to increased economic output over time. However, output does not always increase consistently over time. Business cycles can cause short-term drops in output called recessions . Economists look for macroeconomic policies that prevent economies from slipping into either recessions or overheating and that lead to higher productivity levels and standards of living . The amount of unemployment in an economy
10440-530: The domestic financial system, and when they suddenly went out. This led to a long discussion and a more nuanced position of the IMF stance on capital mobility. Under Blanchard's tenure at IMF, Jonathan D. Ostry and Andy Berg published their findings that "inequality was detrimental to sustained growth." By April 2014, in the World Economic Outlook , Blanchard situated inequality as a "central issue" for "macroeconomic developments and one that
10585-550: The dynamic effects of spending and tax changes on both the level and the composition of output, with Roberto Perotti. The effects of debt and deficits on output and welfare in a model in which people have finite horizons. The effects of debt and deficits in an economy where interest rates are low, potentially lower than the growth rate. The way to think about and assess public debt sustainability, using stochastic debt sustainability analysis. Fiscal dominance of monetary policy, with an application to Brazil. The exploration of
10730-455: The early 1990s, economists began to combine the elements of new Keynesian economics developed in the 1980s and earlier with Real Business Cycle Theory . RBC models were dynamic but assumed perfect competition; new Keynesian models were primarily static but based on imperfect competition. The new neoclassical synthesis essentially combined the dynamic aspects of RBC with imperfect competition and nominal rigidities of new Keynesian models. Tack Yun
10875-440: The economic system is dependant upon the environment. In this case, the circular flow of income diagram may be replaced by a more complex flow diagram reflecting the input of solar energy, which sustains natural inputs and environmental services which are then used as units of production . Once consumed, natural inputs pass out of the economy as pollution and waste. The potential of an environment to provide services and materials
11020-529: The economy , i.e. limiting the effects of the business cycle by conducting expansive policy when the economy is in a recession or contractive policy in the case of overheating . Structural policies may be labor market policies which aim to change the structural unemployment rate or policies which affect long-run propensities to save, invest, or engage in education or research and development. Central banks conduct monetary policy mainly by adjusting short-term interest rates . The actual method through which
11165-454: The economy is usually measured as gross domestic product (GDP). Adding net factor incomes from abroad to GDP produces gross national income (GNI), which measures total income of all residents in the economy. In most countries, the difference between GDP and GNI are modest so that GDP can approximately be treated as total income of all the inhabitants as well, but in some countries, e.g. countries with very large net foreign assets (or debt),
11310-445: The economy may fail to attain full employment . Therefore, New Keynesians argue that macroeconomic stabilization by the government (using fiscal policy ) and the central bank (using monetary policy ) can lead to a more efficient macroeconomic outcome than a laissez faire policy would. New Keynesianism became part of the new neoclassical synthesis that incorporated parts of both it and new classical macroeconomics , and forms
11455-502: The economy was sufficient to explain the Great Depression , and that aggregate demand oriented explanations were not necessary. Friedman also argued that monetary policy was more effective than fiscal policy; however, Friedman doubted the government's ability to "fine-tune" the economy with monetary policy. He generally favored a policy of steady growth in money supply instead of frequent intervention. Friedman also challenged
11600-463: The economy, could hardly generate the large short-run output fluctuations that we observe. In addition, there is strong empirical evidence that monetary policy does affect real economic activity, and the idea that technological regress can explain recent recessions seems implausible. Despite criticism of the realism in the RBC models, they have been very influential in economic methodology by providing
11745-444: The economy, who take turns to choose wages. When it is a union's turn, it chooses the wages it will set for the next two periods. This contrasts with John B. Taylor 's model where the nominal wage is constant over the contract life, as was subsequently developed in his two articles: one in 1979, "Staggered wage setting in a macro model", and one in 1980, "Aggregate Dynamics and Staggered Contracts". Both Taylor and Fischer contracts share
11890-664: The empirical evidence for the “aggregate matching function”, examining how hires depend on workers looking for jobs and jobs looking for workers. The nature of the Beveridge curve , i.e. the relation between unemployment and vacancies, with Peter Diamond. The mobility of workers across US states in response to demand shocks, with Laurence Katz . The set of optimal labor market institutions, from unemployment insurance to severance payments, with Jean Tirole . Blanchard has argued that, between short run fluctuations and long run growth trends, there are important evolutions at
12035-601: The entire economy is called inflation . When prices decrease, there is deflation . Economists measure these changes in prices with price indexes . Inflation will increase when an economy becomes overheated and grows too quickly. Similarly, a declining economy can lead to decreasing inflation and even in some cases deflation. Central bankers conducting monetary policy usually have as a main priority to avoid too high inflation, typically by adjusting interest rates. High inflation as well as deflation can lead to increased uncertainty and other negative consequences, in particular when
12180-466: The exogenous technological improvement used to explain growth in Solow's model. Another type of endogenous growth models endogenized the process of technological progress by modelling research and development activities by profit-maximizing firms explicitly within the growth models themselves. Since the 1970s, various environmental problems have been integrated into growth and other macroeconomic models to study their implications more thoroughly. During
12325-649: The expectations of next period's inflation. The curve is derived from the dynamic Calvo model of pricing and in mathematical terms is: π t = β E t [ π t + 1 ] + κ y t {\displaystyle \pi _{t}=\beta E_{t}[\pi _{t+1}]+\kappa y_{t}} The current period t expectations of next period's inflation are incorporated as β E t [ π t + 1 ] {\displaystyle \beta E_{t}[\pi _{t+1}]} , where β {\displaystyle \beta }
12470-405: The fall in market income. There is a general consensus that both monetary and fiscal instruments may affect demand and activity in the short run (i.e. over the business cycle). Economists usually favor monetary over fiscal policy to mitigate moderate fluctuations, however, because it has two major advantages. First, monetary policy is generally implemented by independent central banks instead of
12615-423: The feature that only the unions setting the wage in the current period are using the latest information: wages in half of the economy still reflect old information. The Taylor model had sticky nominal wages in addition to the sticky information: nominal wages had to be constant over the length of the contract (two periods). These early new Keynesian theories were based on the basic idea that, given fixed nominal wages,
12760-504: The field, one in the 1990s and one in the 2000s, assessing what he saw as progress, and what he saw as dead ends. After the global financial crisis, he organized a series of conferences on the lessons of the crisis, whether and how we should rethink macroeconomics and macroeconomic policy. MIT Press published those conclusions in a series of books, containing short articles by a wide set of important economists, and summaries by Blanchard and different co-editors. Blanchard joined
12905-478: The first examples of general equilibrium models based on microeconomic foundations and a specification of underlying shocks that aim to explain the main features of macroeconomic fluctuations, not only qualitatively, but also quantitatively. In this way, they were forerunners of the later DSGE models. New Keynesian economists responded to the new classical school by adopting rational expectations and focusing on developing micro-founded models that were immune to
13050-420: The future. Instead, they advocate using monetary policy for stabilization . That is, suddenly increasing the money supply just to produce a temporary economic boom is not recommended as eliminating the increased inflationary expectations will be impossible without producing a recession. However, when the economy is hit by some unexpected external shock, it may be a good idea to offset the macroeconomic effects of
13195-441: The government and the central bank would maintain rough full employment, so that neoclassical notions—centered on the axiom of the universality of scarcity —would apply. John Hicks ' IS/LM model was central to the neoclassical synthesis. Later work by economists such as James Tobin and Franco Modigliani involving more emphasis on the microfoundations of consumption and investment was sometimes called neo-Keynesianism . It
13340-429: The government takes on spending projects, it limits the amount of resources available for the private sector to use. Full crowding out occurs in the extreme case when government spending simply replaces private sector output instead of adding additional output to the economy. A crowding out effect may also occur if government spending should lead to higher interest rates, which would limit investment. Some fiscal policy
13485-536: The induced role of aggregate demand in a general equilibrium model with monopolistic competition ; this model has become the basis for later (and much more sophisticated) models with the same general approach. The derivation of the solution to linear models with rational expectations, with Charles Kahn. The analysis of the co-movements between asset prices and economic activity under the assumption of rational expectations. The identification of demand and supply shocks, with Danny Quah , through long-run restrictions in
13630-498: The inflation (or deflation) is unexpected. Consequently, most central banks aim for a positive, but stable and not very high inflation level. Changes in the inflation level may be the result of several factors. Too much aggregate demand in the economy will cause an overheating , raising inflation rates via the Phillips curve because of a tight labor market leading to large wage increases which will be transmitted to increases in
13775-538: The interest rate is changed differs from central bank to central bank, but typically the implementation happens either directly via administratively changing the central bank's own offered interest rates or indirectly via open market operations . Via the monetary transmission mechanism , interest rate changes affect investment , consumption , asset prices like stock prices and house prices , and through exchange rate reactions export and import . In this way aggregate demand , employment and ultimately inflation
13920-485: The issues raised by the two crises, and influence the position of the Fund on issues such as unconventional monetary policy, macro prudential policy, fiscal austerity, the pros and cons of capital flows, the effect of the crisis on emerging market countries. There were two episodes in particular where there was intense internal and external pushback. During his tenure as chief economist, Blanchard reshaped IMF policies. During
14065-466: The late 1990s, economists had reached a rough consensus. The market imperfections and nominal rigidities of new Keynesian theory was combined with rational expectations and the RBC methodology to produce a new and popular type of models called dynamic stochastic general equilibrium (DSGE) models. The fusion of elements from different schools of thought has been dubbed the new neoclassical synthesis . These models are now used by many central banks and are
14210-459: The likelihood of a given producer finding someone to trade with. As in other cases of coordination failure, Diamond's model has multiple equilibria, and the welfare of one agent is dependent on the decisions of others. Diamond's model is an example of a "thick-market externality " that causes markets to function better when more people and firms participate in them. Other potential sources of coordination failure include self-fulfilling prophecies . If
14355-609: The long run, the classical dichotomy holds: changes in the money supply are neutral . However, because prices are sticky in the New Keynesian model, an increase in the money supply (or equivalently, a decrease in the interest rate) does increase output and lower unemployment in the short run. Furthermore, some New Keynesian models confirm the non-neutrality of money under several conditions. Nonetheless, New Keynesian economists do not advocate using expansive monetary policy for short run gains in output and employment, as it would raise inflationary expectations and thus store up problems for
14500-575: The long-run. In efficiency wage models, workers are paid at levels that maximize productivity instead of clearing the market. For example, in developing countries, firms might pay more than a market rate to ensure their workers can afford enough nutrition to be productive. Firms might also pay higher wages to increase loyalty and morale, possibly leading to better productivity. Firms can also pay higher than market wages to forestall shirking. Shirking models were particularly influential. Carl Shapiro and Joseph Stiglitz 's 1984 paper "Equilibrium Unemployment as
14645-417: The macro economy. RBC models were created by combining fundamental equations from neo-classical microeconomics to make quantitative models. In order to generate macroeconomic fluctuations, RBC models explained recessions and unemployment with changes in technology instead of changes in the markets for goods or money. Critics of RBC models argue that technological changes, which typically diffuse slowly throughout
14790-434: The macro/micro divide is institutionalized in the field of economics. Most economists identify as either macro- or micro-economists. Macroeconomics is traditionally divided into topics along different time frames: the analysis of short-term fluctuations over the business cycle , the determination of structural levels of variables like inflation and unemployment in the medium (i.e. unaffected by short-term deviations) term, and
14935-543: The macroeconomy, and the design of macroeconomic policy, will likely be increasingly important items on our agenda for a long time to come. In 1989, Blanchard and Stanley Fischer published “Lectures on Macroeconomics”, a review of macroeconomic theory based on their joint graduate course in macroeconomics at MIT. While not conceived as a graduate textbook, it quickly became one and has been widely used in graduate courses up to this day. Blanchard has also written an undergraduate textbook, “Macroeconomics”. The first edition
15080-476: The maximum degree desirable. Blanchard and Galí have called this property the 'divine coincidence'. However, they also show that in models with more than one market imperfection (for example, frictions in adjusting the employment level, as well as sticky prices), there is no longer a 'divine coincidence', and instead there is a tradeoff between stabilizing inflation and stabilizing employment. Further, while some macroeconomists believe that New Keynesian models are on
15225-490: The medium run frequency, reflecting major structural changes or distributional conflicts. This could for example explain the evolution of the share of labor income from the 1970s. In the early 1990s, Blanchard became involved in transition from central planning to a market economy in Eastern Europe. In a book based on a series of lectures , he discussed how to think about the various privatization options, and about
15370-426: The menu cost of changing prices makes it less likely that firm will cut prices to a market clearing level. Even if prices are perfectly flexible, imperfect competition can affect the influence of fiscal policy in terms of the multiplier. Huw Dixon and Gregory Mankiw developed independently simple general equilibrium models showing that the fiscal multiplier could be increasing with the degree of imperfect competition in
15515-496: The money market is modeled as giving equilibrium between the money supply and liquidity preference (equivalent to money demand). Olivier Blanchard Olivier Jean Blanchard ( French: [blɑ̃ʃaʁ] ; born December 27, 1948) is a French economist and professor. He is Robert M. Solow Professor Emeritus of Economics at the Massachusetts Institute of Technology , Professor of Economics at
15660-414: The more demand focused Anglo-Saxon approach to macroeconomic policy. In 2019, at the request of President Macron , Blanchard and Jean Tirole put together an international commission of experts to suggest policies aimed at fighting global warming, improving the retirement system, and improving redistribution. The report, “Les grands defis économiques” came out in 2021. Blanchard was Vice President of
15805-420: The new classical real business cycle models , microfounded computable general equilibrium (CGE) models used for medium-term (structural) questions like international trade or tax reforms, Dynamic stochastic general equilibrium (DSGE) models used to analyze business cycles, not least in many central banks, or integrated assessment models like DICE . The IS–LM model, invented by John Hicks in 1936, gives
15950-564: The oil crises of the 1970s when scarcity problems of natural resources were high on the public agenda, economists like Joseph Stiglitz and Robert Solow introduced non-renewable resources into neoclassical growth models to study the possibilities of maintaining growth in living standards under these conditions. More recently, the issue of climate change and the possibilities of a sustainable development are examined in so-called integrated assessment models , pioneered by William Nordhaus . In macroeconomic models in environmental economics ,
16095-606: The only usable tool for such countries. Macroeconomic teaching, research and informed debates normally evolve around formal ( diagrammatic or equational ) macroeconomic models to clarify assumptions and show their consequences in a precise way. Models include simple theoretical models, often containing only a few equations, used in teaching and research to highlight key basic principles, and larger applied quantitative models used by e.g. governments, central banks, think tanks and international organisations to predict effects of changes in economic policy or other exogenous factors or as
16240-480: The original simple Phillips curve relationship between inflation and unemployment. Friedman and Edmund Phelps (who was not a monetarist) proposed an "augmented" version of the Phillips curve that excluded the possibility of a stable, long-run tradeoff between inflation and unemployment. When the oil shocks of the 1970s created a high unemployment and high inflation, Friedman and Phelps were vindicated. Monetarism
16385-401: The output market. The reason for this is that imperfect competition in the output market tends to reduce the real wage , leading to the household substituting away from consumption towards leisure . When government spending is increased, the corresponding increase in lump-sum taxation causes both leisure and consumption to decrease (assuming that they are both a normal good). The greater
16530-465: The political institutions that control fiscal policy. Independent central banks are less likely to be subject to political pressures for overly expansionary policies. Second, monetary policy may suffer shorter inside lags and outside lags than fiscal policy. There are some exceptions, however: Firstly, in the case of a major shock, monetary stabilization policy may not be sufficient and should be supplemented by active fiscal stabilization. Secondly, in
16675-523: The presence of hand-to-mouth households. In particular, changes in the interest rate shift the Government's budget constraint, and the fiscal response to this shift affects households' disposable income. Second, aggregate monetary shocks are not distributional neutral since they affect the return on capital, which affects households with different levels of wealth and assets differently. New Keynesian economists agree with New Classical economists that in
16820-449: The price level are directly caused by changes in the money supply . Whereas there is empirical evidence that there is a long-run positive correlation between the growth rate of the money stock and the rate of inflation, the quantity theory has proved unreliable in the short- and medium-run time horizon relevant to monetary policy and is abandoned as a practical guideline by most central banks today. Open economy macroeconomics deals with
16965-518: The price of the products of employers. Too little aggregate demand will have the opposite effect of creating more unemployment and lower wages, thereby decreasing inflation. Aggregate supply shocks will also affect inflation, e.g. the oil crises of the 1970s and the 2021–2023 global energy crisis . Changes in inflation may also impact the formation of inflation expectations , creating a self-fulfilling inflationary or deflationary spiral. The monetarist quantity theory of money holds that changes in
17110-783: The rigidity of nominal prices, it was extended to wages and prices by Olivier Blanchard and Nobuhiro Kiyotaki in their influential article "Monopolistic Competition and the Effects of Aggregate Demand". Huw Dixon and Claus Hansen showed that even if menu costs applied to a small sector of the economy, this would influence the rest of the economy and lead to prices in the rest of the economy becoming less responsive to changes in demand. While some studies suggested that menu costs are too small to have much of an aggregate impact, Laurence M. Ball and David Romer showed in 1990 that real rigidities could interact with nominal rigidities to create significant disequilibrium. Real rigidities occur whenever
17255-460: The role of monetary policy, with Jordi Gali. The nature of the wage-price spiral , and the conditions under which it can emerge. The analysis of the US inflation episode of the 2020s, with Ben Bernanke . Blanchard has also argued for a higher inflation target for central banks, to decrease the risk of hitting the zero lower bound which dramatically decreases the scope for using monetary policy for stabilization purposes. The characterization of
17400-420: The rule describes how the nominal interest rate responds to divergences of actual inflation rates from target inflation rates and of actual gross domestic product (GDP) from potential GDP: i t = π t + r t ∗ + a π ( π t − π t ∗ ) +
17545-416: The same predictions even as the underlying model generating the data changed. He advocated models based on fundamental economic theory (i.e. having an explicit microeconomic foundation ) that would, in principle, be structurally accurate as economies changed. Following Lucas's critique, new classical economists, led by Edward C. Prescott and Finn E. Kydland , created real business cycle (RBC) models of
17690-494: The savings rate leads to a temporary increase as the economy creates more capital, which adds to output. However, eventually the depreciation rate will limit the expansion of capital: savings will be used up replacing depreciated capital, and no savings will remain to pay for an additional expansion in capital. Solow's model suggests that economic growth in terms of output per capita depends solely on technological advances that enhance productivity. The Solow model can be interpreted as
17835-541: The shock with monetary policy. This is especially true if the unexpected shock is one (like a fall in consumer confidence) which tends to lower both output and inflation; in that case, expanding the money supply (lowering interest rates) helps by increasing output while stabilizing inflation and inflationary expectations. Studies of optimal monetary policy in New Keynesian DSGE models have focused on interest rate rules (especially ' Taylor rules '), specifying how
17980-408: The short run. The new Keynesians, on the other hand, saw full employment as being automatically achieved only in the long run, since prices are "sticky" in the short run. Government and central-bank policies are needed because the "long run" may be very long. Ultimately, the differences between new classical macroeconomics and New Keynesian economics were resolved in the new neoclassical synthesis of
18125-437: The short-run, but there is no long-run trade-off: money is not neutral in the short-run but it is in the long-run. Inflation has negative welfare effects. It is important for central banks to maintain credibility through rules based policy like inflation targeting. In 1993, John B Taylor formulated the idea of a Taylor rule , which is a reduced form approximation of the responsiveness of the nominal interest rate , as set by
18270-434: The speed of transition. In an article with Michael Kremer , he argued that the large decrease in output at the start of the transition, despite the shift to a set of market prices, was due to “disorganization”, the failure of supply chains; the mechanism became relevant again in the face of supply chain disruptions during the covid and energy crisis inflation of the early 2020s. Blanchard wrote two surveys of
18415-749: The study of long-term economic growth. It also studies the consequences of policies targeted at mitigating fluctuations like fiscal or monetary policy , using taxation and government expenditure or interest rates, respectively, and of policies that can affect living standards in the long term, e.g. by affecting growth rates. Macroeconomics as a separate field of research and study is generally recognized to start in 1936, when John Maynard Keynes published his The General Theory of Employment, Interest and Money , but its intellectual predecessors are much older. Since World War II, various macroeconomic schools of thought like Keynesians , monetarists , new classical and new Keynesian economists have made contributions to
18560-414: The synthesis view of the macroeconomy. Economists like Paul Samuelson , Franco Modigliani , James Tobin , and Robert Solow developed formal Keynesian models and contributed formal theories of consumption, investment, and money demand that fleshed out the Keynesian framework. Milton Friedman updated the quantity theory of money to include a role for money demand. He argued that the role of money in
18705-481: The theoretical basis of mainstream macroeconomics today. The first wave of New Keynesian economics developed in the late 1970s. The first model of Sticky information was developed by Stanley Fischer in his 1977 article, Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule . He adopted a "staggered" or "overlapping" contract model. Suppose that there are two unions in
18850-554: The two equations of the new Keynesian Phillips curve and the Taylor rule with the dynamic IS curve derived from the optimal dynamic consumption equation (household's Euler equation). y t = E t y t + 1 − 1 σ ( i t − E t π t + 1 ) + v t {\displaystyle y_{t}=E_{t}y_{t+1}-{\frac {1}{\sigma }}(i_{t}-E_{t}\pi _{t+1})+v_{t}} These three equations formed
18995-505: The two most general fields in economics. The focus of macroeconomics is often on a country (or larger entities like the whole world) and how its markets interact to produce large-scale phenomena that economists refer to as aggregate variables. In microeconomics the focus of analysis is often a single market, such as whether changes in supply or demand are to blame for price increases in the oil and automotive sectors. From introductory classes in "principles of economics" through doctoral studies,
19140-465: The two schools differ in that New Keynesian analysis usually assumes a variety of market failures . In particular, New Keynesians assume that there is imperfect competition in price and wage setting to help explain why prices and wages can become " sticky ", which means they do not adjust instantaneously to changes in economic conditions. Wage and price stickiness, and the other present descriptions of market failures in New Keynesian models , imply that
19285-419: The underpinnings of aggregate demand (itself discussed below). It answers the question "At any given price level, what is the quantity of goods demanded?" The graphic model shows combinations of interest rates and output that ensure equilibrium in both the goods and money markets under the model's assumptions. The goods market is modeled as giving equality between investment and public and private saving (IS), and
19430-435: The verge of being useful for quarter-to-quarter quantitative policy advice, disagreement exists. Alves (2014) showed that the divine coincidence does not necessarily hold in the non-linear form of the standard New-Keynesian model. This property would only hold if the monetary authority is set to keep the inflation rate at exactly 0%. At any other desired target for the inflation rate, there is an endogenous trade-off, even under
19575-402: The word "macroeconomics" itself in a journal title in 1946. but naturally several of the themes which are central to macroeconomic research had been discussed by thoughtful economists and other writers long before 1936. In particular, macroeconomic questions before Keynes were the topic of the two long-standing traditions of business cycle theory and monetary theory . William Stanley Jevons
19720-611: The work of IMF economists and of Donald Markwell . Macroeconomics Macroeconomics is a branch of economics that deals with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies . Macroeconomists study topics such as output / GDP (gross domestic product) and national income , unemployment (including unemployment rates ), price indices and inflation , consumption , saving , investment , energy , international trade , and international finance . Macroeconomics and microeconomics are
19865-464: The “ hysteresis ” hypothesis, namely that transitory shocks may have a permanent effect on participation or unemployment, with Lawrence Summers . The channels through which this may happen, union wage setting with insiders and outsiders, or loss of skills or morale when unemployment is high. The examination of gross flows in labor markets, and the determination of equilibrium unemployment and vacancies, with Peter Diamond . The theoretical foundations and
20010-636: Was Chair of the economics department from 1998 to 2003. In 2008, he took a leave from MIT to be the Chief Economist of the International Monetary Fund , where he stayed until 2015. In 2015, he became the Fred Bergsten Senior Fellow at the Peterson Institute for International Economics . In 2023, he returned to France, joined the Paris School of Economics , and remains a Senior Fellow of
20155-699: Was coined by Greg Kaplan , Benjamin Moll and Gianluca Violante in a 2018 paper that additionally models households as accumulating two types of assets, one liquid and the other illiquid. This translates into rich heterogeneity in portfolio composition across households. In particular, the model fits empirical evidence by featuring a large share of households holding little liquid wealth: the 'hand-to-mouth' households. Consistent with empirical evidence, about two-thirds of these households hold non-trivial amounts of illiquid wealth, despite holding little liquid wealth. These households are known as wealthy hand-to-mouth households,
20300-401: Was later developed by Gregory Mankiw and Ricardo Reis . This added a new feature to Fischer's model: there is a fixed probability that a worker can replan their wages or prices each period. Using quarterly data, they assumed a value of 25%: that is, each quarter 25% of randomly chosen firms/unions can plan a trajectory of current and future prices based on current information. Thus if we consider
20445-481: Was one of the first to do this, in a model that used the Calvo pricing model. Goodfriend and King proposed a list of four elements that are central to the new synthesis: intertemporal optimization, rational expectations, imperfect competition, and costly price adjustment (menu costs). Goodfriend and King also find that the consensus models produce certain policy implications: whilst monetary policy can affect real output in
20590-468: Was one of the pioneers of the first tradition, whereas the quantity theory of money , labelled the oldest surviving theory in economics, as an example of the second was described already in the 16th century by Martín de Azpilcueta and later discussed by personalities like John Locke and David Hume . In the first decades of the 20th century monetary theory was dominated by the eminent economists Alfred Marshall , Knut Wicksell and Irving Fisher . When
20735-416: Was particularly influential in the early 1980s, but fell out of favor when central banks found the results disappointing when trying to target money supply instead of interest rates as monetarists recommended, concluding that the relationships between money growth, inflation and real GDP growth are too unstable to be useful in practical monetary policy making. New classical macroeconomics further challenged
20880-406: Was published in 1997. The ninth edition was published in 2024. The textbook has been translated and adapted in 21 foreign editions. Among the other books, Blanchard and Herbert Giersch (and other authors) co-wrote in 1985 “Employment and growth: A two-handed approach”, emphasizing the role of both supply and demand, and attempting to integrate the supply focused German approach and
21025-460: Was written in a continuous time mathematical framework, but nowadays is mostly used in its discrete time version. The Calvo model has become the most common way to model nominal rigidity in new Keynesian models. There is a probability that the firm can reset its price in any one period h (the hazard rate ), or equivalently the probability ( 1 − h ) that the price will remain unchanged in that period (the survival rate). The probability h
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