Keynesian Macrodynamics - Two Models

Abstract

Recently there has been a resurgence in the utility of New Keynesian models in the world. The financial crisis has been in many ways a wakeup call for a large part of economics and the importance of this previously underrated field has been increasing. The neoclassical synthesis of macroeconomics with its emphasis on rational actors and perfect market clearing has been relegated to an interesting side note while Keynesian monetary policies are now in vogue. The recently emergent DSGE (Dynamic Stochastic General Equilibrium) models have emphasised this as well giving each theory their day in the sun. Even major policy making institutions such as the ECB are now using these DSGE models to figure out how they should approach policy challenges. We aim to look thus at two approaches that contain within themselves the seeds of ideological differences while preserving real world utility. This analysis aims to give an overview of the major aspects of the New Keynesian model and its implication towards policy setting in macroeconomic settings, including major importance placed on elements of inflation targeting, structural unemployment and monetary policy. We investigate the Aggregate Demand (henceforth "AD") and Aggregate Supply (henceforth "AS") constraints and will look at the stickiness of prices with the help of the model created by Guillermo Antonio Calvo, the "Calvo pricing" model. Our emphasis will be two-fold. First will be to look at the mathematics underlying the sticky price New Keynesian model and understand its importance and applicability to the present day macroeconomic scenario. Second would be to look at the variety of areas in which this type of analysis might be inapplicable and to analyse the shortcomings of such an approach.