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New and Old Keynesians

  • Bruce Greenwald
  • Joseph E. Stiglitz

The purpose of this paper is to describe one strand of New Keynesian literature which explores how increased flexibility of wages and prices might exacerbate the economy's downturn, and to contrast it with other strands of New Keynesian literature. This strand of literature holds that even if wages and prices were perfectly flexible, output and employment would be highly volatile. It sees the economy as amplifying the shocks that it experiences and making their effects persist. It identifies incomplete contracts, and, in particular, imperfect indexing, as central market failures, and it attempts both to explain the causes and consequences of these market failures. The models described here contain three basic ingredients: risk-averse firms; a credit allocation mechanism in which credit-rationing, risk-averse banks play a central role; and new labor market theories, including efficiency wages and insider-outsider models. These building blocks should help to explain how price flexibility contributes to macroeconomic fluctuations and to unemployment. In particular, the first two building blocks will explain why small shocks to the economy can give rise to large changes in output, while the new labor market theories will explain why those changes in output (with their associated changes in the demand curve for labor) result in unemployment.

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Article provided by American Economic Association in its journal Journal of Economic Perspectives.

Volume (Year): 7 (1993)
Issue (Month): 1 (Winter)
Pages: 23-44

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Handle: RePEc:aea:jecper:v:7:y:1993:i:1:p:23-44
Note: DOI: 10.1257/jep.7.1.23
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  1. Greenwald, Bruce C & Stiglitz, Joseph E, 1993. "Financial Market Imperfections and Business Cycles," The Quarterly Journal of Economics, MIT Press, vol. 108(1), pages 77-114, February.
  2. Mankiw, N Gregory, 1989. "Real Business Cycles: A New Keynesian Perspective," Journal of Economic Perspectives, American Economic Association, vol. 3(3), pages 79-90, Summer.
  3. Charles W. Calomiris, 1993. "Financial Factors in the Great Depression," Journal of Economic Perspectives, American Economic Association, vol. 7(2), pages 61-85, Spring.
  4. Newbery, David M G & Stiglitz, Joseph E, 1985. "Wage Rigidity, Implicit Contracts, Unemployment and Economic Efficiency," CEPR Discussion Papers 67, C.E.P.R. Discussion Papers.
  5. Alan S. Blinder & Louis J. Maccini, 1991. "Taking Stock: A Critical Assessment of Recent Research on Inventories," Journal of Economic Perspectives, American Economic Association, vol. 5(1), pages 73-96, Winter.
  6. Greenwald, Bruce C & Stiglitz, Joseph E, 1986. "Externalities in Economies with Imperfect Information and Incomplete Markets," The Quarterly Journal of Economics, MIT Press, vol. 101(2), pages 229-64, May.
  7. Akerlof, George A, 1982. "Labor Contracts as Partial Gift Exchange," The Quarterly Journal of Economics, MIT Press, vol. 97(4), pages 543-69, November.
  8. Plosser, C.I., 1989. "Understanding Real Business Cycles," Papers 89-03, Rochester, Business - General.
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