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post_keynesian_monetary_theory - HAKAN YILMAZKUDAY ECO 641...

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HAKAN YILMAZKUDAY ECO 641 - TOPICS IN MONETARY ECONOMICS AND POLICY Topic 3 : POST KEYNESIAN MONETARY THEORY “Has Post-Keynesianism been very sound recently? How did they react to monetarist revival which emerged in the last twenty years?” The Great Depression convinced most economists that their traditional emphasis on the efficiency of unfettered markets was misplaced (Mankiw and Romer, 1991). The invisible hand works in normal times but can it explain the Great Depression? Because of the need for such an explanation, a theory capable of explaining market failure had to be introduced. This theory was not something different from Keynesian economics. The ascent of Keynesian economics reached its peak with the Keynesian consensus of the 1960s. Many macroeconomists at that time believed that our understanding of the economy was nearly complete, that there were only details to fill in. The IS-LM model provided the theory of aggregate demand. Although the theory of aggregate supply remained cloudy, the Phillips Curve was widely viewed as providing a useful empirical summary of how wages and prices adjust over time. This consensus rested crucially on the assumption that wages and prices adjust only gradually to changes in aggregate demand. This Keynesian consensus in macroeconomics faltered in the 1970s with the birth of the new classical macroeconomics. The new classical economists argued persuasively that Keynesian economics was theoretically inadequate, that macroeconomics must be built on a firm microeconomic foundation. They also argued that Keynesian economics should be replaced with macroeconomic theories
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Post Keynesian Monetary Theory 2 based on the assumptions that markets always clear and that economic actors always optimize. This research program evolved in the 1980s into real business cycle theory. Because these real business cycle models are Walrasian general equilibrium models, they imply that the invisible hand always guides the economy to the efficient allocation of resources. Building on foundations laid in the late 1970s by Stanley Fischer (1977) and Edmund Phelps and John Taylor (1977), new Keynesian economics arose in the 1980s in response to the theoretical crisis of the 1970s 1 . Much research during the past decade was devoted to providing rigorous microeconomic foundations for the central elements of Keynesian economics. Because wage and price rigidities are often viewed as central to Keynesian economics, much effort was aimed at showing how these rigidities arise from the microeconomics of wage and price setting. In general, New Keynesian theory has two crucial features. First, it violates the classical dichotomy. In other words, the fluctuations in nominal variables like the money supply influence fluctuations in real variables like output and employment.
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