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Keynesian Economics, Monetary Policy and the Business Cycle - New and Old

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Cukierman, Alex

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Abstract

After a brief review of the main differences between New and Old Keynesian economics from the 1960s this paper focuses on a tension between traditional sluggish measures of potential output commonly used by policy-makers and the New Keynesian (NK) notion of this variable which conceptualizes it as the level of output that would have been produced under perfect competition had all prices and wages been flexible. The paper shows that, under monopolistic competition, NK potential output is often more volatile than the level of output produced under sticky prices and wages implying either of the following. Real life policy-makers mistakenly target smooth versions of output or (since actual economies are monopolistically rather than perfectly competitive) the flexible price and wage equilibrium does not necessarily maximize welfare. The paper shows, that depending on the shape of the utility function and of the distribution of productivity shocks either case is possible and proposes a criterion for discriminating between them.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5284.

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Date of creation: Oct 2005
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Handle: RePEc:cpr:ceprdp:5284

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Related research
Keywords: Relative variability of actual and potential output under flexible versus sticky prices and wages welfare ranking of sticky versus flexible prices and wages under monopolistic competition

Find related papers by JEL classification:
E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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This page was last updated on 2008-10-11.

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