Assessing New Classical Macroeconomics

Today new classical macroeconomics is often said to be irrelevant in terms of the conditions of national economies. Some of the new classical doctrines, i.e. first, the costless reduction of the rate of inflation by controlling public expectations, or, second, the inefficiency of monetary and fiscal policy, rarely work in practice. This fact leads some economists to think that new classical macroeconomics is only an incomplete theory that fails in terms of reality. However, as some recent researches highlight it, this attitude is only the consequence of a superficial and incomplete understanding. It is argued that, actually, new classical macroeconomics did not underline the inefficiency of economic policy but the conditions under which countercyclical economic policy can be effective. In other words, one should not forget the conditional character of the new classical doctrines. If prices are completely flexible and if public expectations are completely rational and if real economic shocks are white noises, monetary policy cannot affect unemployment or production and any intention to control the real economy only ends up in a change in the rate of inflation. However, and this is the point, if any of these conditions do not hold, monetary policy can be effective again. In terms of fiscal policy it is the Barro-Ricardo equivalence theorem that has crucial importance. As it is known, if processes of the public sector remain unchanged and agents form rational expectations, cuts in taxes imply a later pressure to rise taxes, since government has to fill the resource gap in the budget which is the result of the initial tax cut. So, rational agents will treasure up the additional income from the tax cut and consumption will not rise. In this story, public operations should stand in the focus of reasoning: if these processes can be changed, or, in any way, the additional income can be believed not be withdrawn later, the initial tax cut will induce a rise in consumption expenditures. So, any of the conditions necessary for the equivalence do not hold, countercyclical fiscal policy can be effective. Perhaps controlling the real economy is possible in a Keynesian style if government regains its potential to exert this control. Therefore, actually, new classical macroeconomics highlights the conditions under which economic policy can be effective and not the inefficiency of economic policy. Countercyclical aspirations need not to be abandoned, only the playing-field of economic policy has been narrowed by new classicals. Although Keynes urged active countercyclical efforts of fiscal policy, these efforts are not predestined to fail in the new classical theory either, only the conditions necessary for the efficiency of countercyclical efforts were specified by new classicals.

Pictorial (from left to right): Robert Lucas, Tom Sargent, Robert Barro and Neil Wallace.

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