New consensus macroeconomics

Definition

New consensus macroeconomics is a framework that emphasizes the role of expectations, particularly rational expectations, and the importance of monetary policy in stabilizing the economy. This approach integrates microeconomic foundations with macroeconomic analysis, suggesting that central banks should focus on controlling inflation while also accommodating output fluctuations through counter-cyclical policies.

5 Must Know Facts For Your Next Test

1. New consensus macroeconomics emerged in the 1990s as a response to limitations in previous Keynesian models and real business cycle theories.
2. It stresses the importance of central banks in maintaining price stability, with a focus on inflation control as a primary goal.
3. The framework suggests that markets are generally efficient but can be influenced by monetary policy through expectations management.
4. Fiscal policy is often considered less effective in stabilizing the economy compared to monetary policy within this framework.
5. New consensus macroeconomics has been influential in shaping central banking practices globally, especially in developed economies.

Review Questions

• How does new consensus macroeconomics explain the role of expectations in economic decision-making?
  • New consensus macroeconomics posits that expectations play a critical role in shaping economic decisions, particularly through the lens of rational expectations. Individuals and firms form their forecasts about the future based on all available information, which influences their consumption, investment, and pricing behaviors. This reliance on expectations means that monetary policy must effectively manage these anticipations to stabilize the economy, as people's actions are guided by what they expect to happen rather than just current conditions.
• Evaluate the implications of new consensus macroeconomics for central banking practices in managing inflation and output.
  • New consensus macroeconomics has significant implications for central banking practices, primarily advocating for an inflation-targeting approach. Central banks are encouraged to focus on maintaining price stability, as low and stable inflation supports sustainable economic growth. Additionally, by using tools like interest rate adjustments, central banks can respond to economic fluctuations while also managing public expectations about future inflation and output levels, creating a stabilizing effect on the overall economy.
• Discuss the critique of new consensus macroeconomics in relation to its assumptions about market efficiency and the role of fiscal policy.
  • Critiques of new consensus macroeconomics often focus on its assumption that markets are generally efficient and can self-correct with minimal intervention. Detractors argue that this perspective underestimates the complexities of real-world markets, particularly during crises when irrational behavior may prevail. Additionally, the framework tends to downplay the effectiveness of fiscal policy, suggesting it plays a secondary role compared to monetary policy. This critique raises questions about the adequacy of relying solely on monetary measures for stabilization during severe economic downturns.

Related terms

Rational Expectations: The theory that individuals and firms make decisions based on their best forecasts of the future, using all available information.

Inflation Targeting: A monetary policy strategy where the central bank sets a specific inflation rate as its goal and adjusts its policy tools to achieve that target.

Dynamic Stochastic General Equilibrium (DSGE) Models: A class of macroeconomic models that incorporates random shocks and time-based changes to analyze economic dynamics under uncertainty.