New Classical Economics
Graduate Macroeconomics I ECON 309 – Cunningham

New Classical Economics
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Accepts model of GE with no imperfections. Prices are perfectly flexible, and all markets are permanently cleared (S=D). All markets are self-correcting. Individuals do not leave prices at “false” levels since this would result in disadvantages. Equilibrium is optimal. Because present actions entail future consequences, all agents deliberately form rational expectations. That is, they exploit all expectations available information at all times since it is in their best interests to do so.
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New Classical Economics (2)
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Agents adjust their decisions and actions so that their plans will be fulfilled optimally when their expectations are correct. Therefore, expectations (and information) play the information dominant role in determining the state of the economy at any point in time. They replace the deterministic setting with a stochastic one. People habitually suffer from expectational errors. It is the errors that explain economic fluctuations. Fluctuations and unemployment can be traced to voluntary deviations of supply and demand. Thus the business cycle is an equilibrium phenomenon, phenomenon and is therefore optimal.
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Two Types of Monetarism
Kevin Hoover, JEL (March 1984)
Monetarism (Friedman)
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Marshallian:
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Small (partial equilibrium) models Aggregate Prices

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Money can “fool” agents on the short-run Mistakes can cause agents to act in ways apparently inconsistent with optimization Transient behavior occurs as agents “learn” (adaptive expectations) Walrasian:
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New Classicals (Lucas, Sargent-Wallace, Barro)
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Large (general equilibrium) models Relative Prices

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Decisions made entirely on real factors Agents (to the limits of their information) act in ways