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What it means to be a New Classical Economist
Abstract
The New Classical School works with rational expectations and full flexibility of prices and wages in all markets. The concept of rational expectations hypothesis (REH) was first introduced by J.F. Muth (1961). Robert E.R. Lucas Jr. (1972) developed and popularized this hypothesis. Thomas Sargent, Neil Wallace, Robert Barro are other distinguished representatives of this school.
What is important in the New Classical School is first of all the assumption of full flexibility of prices and wages. As a result of this assumption, all markets will reach perfect equilibrium, economy will automatically settle at the point of full employment. Unemployment will be voluntary which will be denoted as “natural rate of unemployment”.
According to REH, on the other hand, all the economic agents have full knowledge and information about economic decisions – including government policies and their effects – and take into account their future expectations in a right way. In this case, the government policies which will be expected and known to everybody will be already taken into account and the decisions on prices and quantities are formed accordingly, thus prices are formed in a complex fashion. In this manner, efficiency of government policies neutralized. Hence, as much as Keynesian financial policies, monetarist monetary policies are ineffective as well. The only effective impact in economy seems to be “unexpected shocks” and accordingly “unexpected” or “shock”.
New Classical School have had weight after 70s due to inflationary effects of the Vietnam War and the stagflation following 1973-1974 oil shock. Hence the economic conservatism both during Regan era in the United States and Thatcher era in Britain effected the policy implementations for a while. However, it was not possible to prevent inflation; on the contrary, unemployment reached a new and higher dimension. Therefore, once more but this time with more cautious approach, a mix Keynesian and Monetarist policy implementation was adopted. On one hand, radical fiscal policies were implemented in order to prevent or decrease the budgetary gaps, on the other hand, monetary policies were applied for fine-tuning of economy, however this fine-tuning was not in the form of fixing money supply in the long run as recommended by the Monetarists. These policies were particularly based on the Keynesian analysis taken up in a broader perspective; that is to say, monetary policies being more effective in recession periods rather than fiscal policies.
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DOI: http://dx.doi.org/10.52155/ijpsat.v23i1.2269
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