Chapter 14
New Classical Theories
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10
20
30
40
90 91 92 93 94 95 96 97 98 99 00
Introduction to New Classical
Theories
?R.lucas Supply Function
?Rational Expectations and R.lucas
Criterion
?Policy Implications
?Comparisons between New Classical
and Keynesian Theories
14.1 R.lucas Supply Function
?Origin of New Classical Theories
?Since 1980s,Keynesianism has been animadvert by neoclassicism
macroeconomics
?Two leaders of neoclassicism macroeconomics are Rboert Lucas
(Chicago university) and T·J·Saygent( Minnesota university,whose
books named,rational expectations and econometrics practice”
include radical contribute to new classical macroeconomics,
?New classical macroeconomics began with R.lucas’ magnum opus
“Expectations and the Neutrality of Money”,the paper
“Understanding business cycles” in 1977,
14.1 R.lucas Supply Function
?Market foundation of New Classical Theories
?New classicism macroeconomics explains supply behaviors from the viewpoint
of perfect information cost,and draw the conclusions about unemployment and
inflation from changes of microcosmic corporations
?New classicism macroeconomics is based on Walras equilibrium with the
character of market clearing,and emphasize drawing macroeconomics
conclusions from the point that microcosmic behaviors pursue maximum of the
object functions,
?New classicism macroeconomics inherit traditions of neoclassicism,and after
reviewing the monetary theories and policies in the same way of thinking over
problems,it conquered drawbacks that monetarism can not explain recession
and employment effectively,so that it has set up a set of macroeconomics theory
totally different from Keynesianism,
14.1 R.lubcas Supply Function
?Market foundation of New Classical Theory
?New Classical Theory do not only explain reasons of unemployment and
recession and the drawbacks of these scenes,so that is has set up a set of
macroeconomics theory completely different from Keynesianism,
?New Classical Theory emphasized the importance,information” in economical
activities,which has the same belief as monetarism who believe market itself has
power to ensure stable economical operations,on the other hand,it believes that
basic economic unit can predict the future economic environment with all possible
information,and then they make decisions,This so called” rational prediction”,
Characters of New Classical Theory is pay attention to microeconomic foundation
of theoretical models,so their theoretical models all accord with basic
conceptions of classical economics such as,market clearing” and,Walras’s
Law”,
14.1 R.lucas Supply Function
Y
AD
AS
Summation of supply of different markets in Microeconomics,is
AS Curve of aggregate supply in Macroeconomics,while summation of
demands of different is AD Curve of aggregate demand,And the crossed point of
The two curves is equilibrium point of national economy.
P
Y*
P
e
14.1 R.lucas Supply Function
? R.lucas Supply Function
?Explanation One,Output and prices are determined by both
supply and demand,and the corresponding P and Y* of point e
are price and output,
?Explanation Two,When supply and demand are already given
in each market,there must be a price P which ensures that
supply of one market can satisfy its demand,This is the concept
of market clearing,In fact,if economy is constituted by n different
markets,and only the previous n-1 market can realize equilibrium
of supply and demand,the supply and demand of last market will
realize equilibrium,And this is the concept of Walras’s Laws,
14.1 R.lucas Supply Function
?R.lucas Supply Function
? If we presume that gross supply of
whole economy is constituted by on the
same corporations,we only need to
choose one corporation to research the
supply curve,and then we make results
timed N to get Aggregate Supply of whole
economy,
14.1 R.lucas Supply Function
Si
If potent output of the whole economy is
Y*,the optimal output for Corporation I is
Y*/N,(Y*i),And then price of this
corporation is presumed Pi,and once we
distract one microcosmic corporation from
the whole supply,we will find out that
market is actually decentralized
Yi
P
P’’i
Yi’’
Pi=P
Y*i
P’i
Y* is the potent or normal
output of representative
corporation,if it believes
price of Y’ is bigger than
P,he will hold beliefs
that expansion of
producing can bring
profit,so Y*I will
increase to Y’i。
Yi’
14.1 R.lucas Supply Function
?R.lucas Supply Function
For a typical and representative corporation,when price of
his products is exactly equal to all round price,his output is
exactly equal to his optimal output,h represents reaction to
difference between changing range of some prices and
aggregate prices,h>0 means a curve with positive slope,
*)( iii YPPhY ???
0?? PPi *iiYY?
14.1 R.lucas Supply Function
?R.lucas Supply Function
?Expectation of future price of
corporation i is constituted by two parts
? The first part is to accept public economic information
? The second part is to adjust data given by experts by
one’s own experience,and constant b is corporation’s
dependence level of his own experience,If b is equal to
0.5,that means corporations believe in half of their own
experience and half of expert predictions; and if b is
equal to 1,that means corporation fully trust their own
experience,
)?(? PPbPP ie ???
P?
14.1 R.lucas Supply Equation
R.lucas supply equation
Yi
P
P=1
Y*
e
14.2 Rational Expectations and
R.lucas Criterion
?How to use Keynesianism for economic policy making
?Policy making can be divided into two steps,
?Firstly,To measure economic structure based on the current output
Yt and Xt,which means to estimate all variable values in the economic
structures;
?Secondly,Economic policies are made based on future value of Yt+1,
For example,if aggregate output can reach 10 billion,government
expenditure and money supply can be figured out；
?Contribution of R.lucas
?Current policy making has one fateful drawbacks,that it made
mistakes to view structure variables as constants,but in fact,these
constants are changed with the change of economic environment,
14.2 Rational Expectations and
R.lucas Criterion
?Rational expectations
?When economic policies of government are changed,persons
will change their own economic behaviors with the change
of policies,In economic activities,every family and
every corporation will rationally collect all the
information related with one’s own economic activities,and
he will make the most reasonable reactions,
?When Keynesian take humans and businessmen with lives and
rations,as,constants” like machines,their economy
policies will surely not take effect
?This is the fundamental idea of,rational expectations”,
14.2 Rational Expectations and
R.lucas Criterion
?R.lucas Criterion
?Rational Expectations emphasizes that humans adjust one own economic
behaviors based on changes of economic environment,and humans will
actively collect information related with their own interest (both big
and small),then it will be analyzed and utilized,But rational
expectations do not collect all economic information as possible as
they can as rational expectations tell us,but rational persons will
try their best to look for the information they need,
?Sometimes,insufficient information” will happen in the process of
seeking,and they also make mistakes when they deal with these data,
but they can correct it when they realize it,so systematic mistakes
will not happen,
?Under this premise,all policies of government will all be observed
and reacted,And this is emphasis of rational expectations,
?The above analytic process is reduces to,R.lucas Criterion”,
14.2 Rational Expectations and R.lucas
Criterion
? Conclusions of R.lucas Criterion
,When policy changes,human’ s expectations
will change,and because of influence of
expectations to economic behaviors,changes of
behaviors will change different relationship
(coefficients) in the economic models,so that
economic policies will become inefficient,which
are drawn from this economic model.”
14.2 Rational Expectations and R.lucas
Criterion
?Ricardian Equivalence
?Explanations of Ricardo,If government reduces tax now,and support government
deficit by borrowing ( issue government bonds),government will pay for debts by tax
one day in the future,There are no ways except this,
?New explanations of New Classic Theory,Given that economy is at recession,
based on the theory of Keynesianism,government can stimulate recovery of
economy by reduction of tax,So tax reduction means increase of disposable income
of (1-t)Y,and humans can move aggregate demand curve to the right by increasing
consumptions,However,if humans are rational,the will understand identical equation
of government budgets,And they can expect that today’s reduction of government
tax T,should be balanced by the increase of government debts; government should
increase tax to pay for debts in the future,Therefore,humans will decrease their
Marginal Propensity to Consume (b),to ensure gross consumption unchanged,That
means,humans will save the income from tax reduction to pay for increased tax in
the future,
14.2 Rational Expectations and R.lucas
Criterion
?Ricardian Equivalence
?New Classical Theory use a good overlapping model to illuminate
that even policy has not changed some years after government
reduced tax,peOple are still worried that their sons or
daughters will have to inherit their debts,So they will not
increase consumption but leave income from tax reduction to their
sons or daughters for tax
?New Classical Theory proves from theory that,as long as
human’s ration can work,neither fiscal policy nor monetary
policy can not reach their expected result,
14.3 Policy Implications
?One proposition
?Proposition of ineffective policy,when expected
inflation is equal to actual inflation,economic policy
does not influence actual economic variables,
?Two revelations
?Two revelations,one is expected policy and unexpected
policy,whose effects are completely different; the second
is if policy maker does not know public expectation of his
policy,he will not know results of policy operations,
14.3 Policy Implications
?Two suggestions
?Suggestion One
?As long as humans can predict the aims of policy,they
will make corresponding policy to make policy ineffective,
Therefore,government should not try his best to actively
interfere economy with policy,
?In current society,it is impossible for government not
to interfere economic activities,especially in the
period of recession,when government should take actions
to show his concern of economy under voters’ pressure,
However,government should pay attention to credit of
policy-policy continuity,
14.3 Policy Implications
?Two suggestions
?Suggestion two
?Because of influence of expectations,government can
make use of it to realize his goals,
?For example,If inflation is too high,it can claim
to reduce money supply,And we know from R.lucas
Equation that consumers’ expected inflation will get
down to change their price expectation,
14.4 Comparisons between New Classical and
Keynesian Theories
?Two hypothesis of Keynesianism
?First,Price is performed in short terms and hard to change;
?Secondly,Aggregate output Y is determined by aggregate demands,
?Two hypothesis of New Classical Theory
?First,Information is insufficient in actual world,so humans can not
mast all the information they need;
?Secondly,Basic unit in economic activities—— behaviors of families
and corporations are rational,so they will make use of all possible
information to predict future environment and adjust their own economic
activities,
14.4 Comparisons between New Classical and
Keynesian Theories
?New Classical Theory
?Whole theory is based on Microeconomics,from analyses of
representative basic unit,
?General acceptable New Classical Theories have all begun
with a single economy-”Robinson Crusoe”,and after a clear
explanation of relationship between savings and consumptions,
Cass-Koopmans has been introduced to build dynamic
relationship of capital accumulation,consumption and
production,after which,labor market model will be
introduced,and at last Cash-in Advance Model is introduced
to research the interaction with money market,
14.4 Comparisons between New Classical and
Keynesian Theories
?New Classical theory
?Shortages of New Classical
?Shortage One,It lacks enough sufficient economic results to support this theory,
some of whose results drawn with analyses of technical data are opposite to what the
theory tells us,For example,R.lucas Supply Function tells us,when actual prices are
higher than expectations,actual output will be higher than potent productive capacity,
so economy is overheated,while in fact some data tell us,when prices are higher than
expectation price,so economy begins recession,
?Shortage Two,At present,it can not explain a specific scene common in the economy
industrialize countries in recent years,Aggregate output which deviates from normal
trend will never return to its primary position,whose incorporation is that when
unemployment rate rises to a level,it will never return to nature unemployment rate,
That is also basic belief of New Classical Theory,it is not right that market has
strong self-adjustment ability,
14.4 Comparisons between New Classical and
Keynesian Theories
?Conclusions,
?New classical theory does not only explain
reasons of economic fluctuations and
unemployment while giving up the basic
hypothetic premise of Keynesian,but most
important it bring a big reform in the theory
research of economics
Chapter 14
The End
0
10
20
30
40
90 91 92 93 94 95 96 97 98 99 00
New Classical Theories
0
10
20
30
40
90 91 92 93 94 95 96 97 98 99 00
Introduction to New Classical
Theories
?R.lucas Supply Function
?Rational Expectations and R.lucas
Criterion
?Policy Implications
?Comparisons between New Classical
and Keynesian Theories
14.1 R.lucas Supply Function
?Origin of New Classical Theories
?Since 1980s,Keynesianism has been animadvert by neoclassicism
macroeconomics
?Two leaders of neoclassicism macroeconomics are Rboert Lucas
(Chicago university) and T·J·Saygent( Minnesota university,whose
books named,rational expectations and econometrics practice”
include radical contribute to new classical macroeconomics,
?New classical macroeconomics began with R.lucas’ magnum opus
“Expectations and the Neutrality of Money”,the paper
“Understanding business cycles” in 1977,
14.1 R.lucas Supply Function
?Market foundation of New Classical Theories
?New classicism macroeconomics explains supply behaviors from the viewpoint
of perfect information cost,and draw the conclusions about unemployment and
inflation from changes of microcosmic corporations
?New classicism macroeconomics is based on Walras equilibrium with the
character of market clearing,and emphasize drawing macroeconomics
conclusions from the point that microcosmic behaviors pursue maximum of the
object functions,
?New classicism macroeconomics inherit traditions of neoclassicism,and after
reviewing the monetary theories and policies in the same way of thinking over
problems,it conquered drawbacks that monetarism can not explain recession
and employment effectively,so that it has set up a set of macroeconomics theory
totally different from Keynesianism,
14.1 R.lubcas Supply Function
?Market foundation of New Classical Theory
?New Classical Theory do not only explain reasons of unemployment and
recession and the drawbacks of these scenes,so that is has set up a set of
macroeconomics theory completely different from Keynesianism,
?New Classical Theory emphasized the importance,information” in economical
activities,which has the same belief as monetarism who believe market itself has
power to ensure stable economical operations,on the other hand,it believes that
basic economic unit can predict the future economic environment with all possible
information,and then they make decisions,This so called” rational prediction”,
Characters of New Classical Theory is pay attention to microeconomic foundation
of theoretical models,so their theoretical models all accord with basic
conceptions of classical economics such as,market clearing” and,Walras’s
Law”,
14.1 R.lucas Supply Function
Y
AD
AS
Summation of supply of different markets in Microeconomics,is
AS Curve of aggregate supply in Macroeconomics,while summation of
demands of different is AD Curve of aggregate demand,And the crossed point of
The two curves is equilibrium point of national economy.
P
Y*
P
e
14.1 R.lucas Supply Function
? R.lucas Supply Function
?Explanation One,Output and prices are determined by both
supply and demand,and the corresponding P and Y* of point e
are price and output,
?Explanation Two,When supply and demand are already given
in each market,there must be a price P which ensures that
supply of one market can satisfy its demand,This is the concept
of market clearing,In fact,if economy is constituted by n different
markets,and only the previous n-1 market can realize equilibrium
of supply and demand,the supply and demand of last market will
realize equilibrium,And this is the concept of Walras’s Laws,
14.1 R.lucas Supply Function
?R.lucas Supply Function
? If we presume that gross supply of
whole economy is constituted by on the
same corporations,we only need to
choose one corporation to research the
supply curve,and then we make results
timed N to get Aggregate Supply of whole
economy,
14.1 R.lucas Supply Function
Si
If potent output of the whole economy is
Y*,the optimal output for Corporation I is
Y*/N,(Y*i),And then price of this
corporation is presumed Pi,and once we
distract one microcosmic corporation from
the whole supply,we will find out that
market is actually decentralized
Yi
P
P’’i
Yi’’
Pi=P
Y*i
P’i
Y* is the potent or normal
output of representative
corporation,if it believes
price of Y’ is bigger than
P,he will hold beliefs
that expansion of
producing can bring
profit,so Y*I will
increase to Y’i。
Yi’
14.1 R.lucas Supply Function
?R.lucas Supply Function
For a typical and representative corporation,when price of
his products is exactly equal to all round price,his output is
exactly equal to his optimal output,h represents reaction to
difference between changing range of some prices and
aggregate prices,h>0 means a curve with positive slope,
*)( iii YPPhY ???
0?? PPi *iiYY?
14.1 R.lucas Supply Function
?R.lucas Supply Function
?Expectation of future price of
corporation i is constituted by two parts
? The first part is to accept public economic information
? The second part is to adjust data given by experts by
one’s own experience,and constant b is corporation’s
dependence level of his own experience,If b is equal to
0.5,that means corporations believe in half of their own
experience and half of expert predictions; and if b is
equal to 1,that means corporation fully trust their own
experience,
)?(? PPbPP ie ???
P?
14.1 R.lucas Supply Equation
R.lucas supply equation
Yi
P
P=1
Y*
e
14.2 Rational Expectations and
R.lucas Criterion
?How to use Keynesianism for economic policy making
?Policy making can be divided into two steps,
?Firstly,To measure economic structure based on the current output
Yt and Xt,which means to estimate all variable values in the economic
structures;
?Secondly,Economic policies are made based on future value of Yt+1,
For example,if aggregate output can reach 10 billion,government
expenditure and money supply can be figured out；
?Contribution of R.lucas
?Current policy making has one fateful drawbacks,that it made
mistakes to view structure variables as constants,but in fact,these
constants are changed with the change of economic environment,
14.2 Rational Expectations and
R.lucas Criterion
?Rational expectations
?When economic policies of government are changed,persons
will change their own economic behaviors with the change
of policies,In economic activities,every family and
every corporation will rationally collect all the
information related with one’s own economic activities,and
he will make the most reasonable reactions,
?When Keynesian take humans and businessmen with lives and
rations,as,constants” like machines,their economy
policies will surely not take effect
?This is the fundamental idea of,rational expectations”,
14.2 Rational Expectations and
R.lucas Criterion
?R.lucas Criterion
?Rational Expectations emphasizes that humans adjust one own economic
behaviors based on changes of economic environment,and humans will
actively collect information related with their own interest (both big
and small),then it will be analyzed and utilized,But rational
expectations do not collect all economic information as possible as
they can as rational expectations tell us,but rational persons will
try their best to look for the information they need,
?Sometimes,insufficient information” will happen in the process of
seeking,and they also make mistakes when they deal with these data,
but they can correct it when they realize it,so systematic mistakes
will not happen,
?Under this premise,all policies of government will all be observed
and reacted,And this is emphasis of rational expectations,
?The above analytic process is reduces to,R.lucas Criterion”,
14.2 Rational Expectations and R.lucas
Criterion
? Conclusions of R.lucas Criterion
,When policy changes,human’ s expectations
will change,and because of influence of
expectations to economic behaviors,changes of
behaviors will change different relationship
(coefficients) in the economic models,so that
economic policies will become inefficient,which
are drawn from this economic model.”
14.2 Rational Expectations and R.lucas
Criterion
?Ricardian Equivalence
?Explanations of Ricardo,If government reduces tax now,and support government
deficit by borrowing ( issue government bonds),government will pay for debts by tax
one day in the future,There are no ways except this,
?New explanations of New Classic Theory,Given that economy is at recession,
based on the theory of Keynesianism,government can stimulate recovery of
economy by reduction of tax,So tax reduction means increase of disposable income
of (1-t)Y,and humans can move aggregate demand curve to the right by increasing
consumptions,However,if humans are rational,the will understand identical equation
of government budgets,And they can expect that today’s reduction of government
tax T,should be balanced by the increase of government debts; government should
increase tax to pay for debts in the future,Therefore,humans will decrease their
Marginal Propensity to Consume (b),to ensure gross consumption unchanged,That
means,humans will save the income from tax reduction to pay for increased tax in
the future,
14.2 Rational Expectations and R.lucas
Criterion
?Ricardian Equivalence
?New Classical Theory use a good overlapping model to illuminate
that even policy has not changed some years after government
reduced tax,peOple are still worried that their sons or
daughters will have to inherit their debts,So they will not
increase consumption but leave income from tax reduction to their
sons or daughters for tax
?New Classical Theory proves from theory that,as long as
human’s ration can work,neither fiscal policy nor monetary
policy can not reach their expected result,
14.3 Policy Implications
?One proposition
?Proposition of ineffective policy,when expected
inflation is equal to actual inflation,economic policy
does not influence actual economic variables,
?Two revelations
?Two revelations,one is expected policy and unexpected
policy,whose effects are completely different; the second
is if policy maker does not know public expectation of his
policy,he will not know results of policy operations,
14.3 Policy Implications
?Two suggestions
?Suggestion One
?As long as humans can predict the aims of policy,they
will make corresponding policy to make policy ineffective,
Therefore,government should not try his best to actively
interfere economy with policy,
?In current society,it is impossible for government not
to interfere economic activities,especially in the
period of recession,when government should take actions
to show his concern of economy under voters’ pressure,
However,government should pay attention to credit of
policy-policy continuity,
14.3 Policy Implications
?Two suggestions
?Suggestion two
?Because of influence of expectations,government can
make use of it to realize his goals,
?For example,If inflation is too high,it can claim
to reduce money supply,And we know from R.lucas
Equation that consumers’ expected inflation will get
down to change their price expectation,
14.4 Comparisons between New Classical and
Keynesian Theories
?Two hypothesis of Keynesianism
?First,Price is performed in short terms and hard to change;
?Secondly,Aggregate output Y is determined by aggregate demands,
?Two hypothesis of New Classical Theory
?First,Information is insufficient in actual world,so humans can not
mast all the information they need;
?Secondly,Basic unit in economic activities—— behaviors of families
and corporations are rational,so they will make use of all possible
information to predict future environment and adjust their own economic
activities,
14.4 Comparisons between New Classical and
Keynesian Theories
?New Classical Theory
?Whole theory is based on Microeconomics,from analyses of
representative basic unit,
?General acceptable New Classical Theories have all begun
with a single economy-”Robinson Crusoe”,and after a clear
explanation of relationship between savings and consumptions,
Cass-Koopmans has been introduced to build dynamic
relationship of capital accumulation,consumption and
production,after which,labor market model will be
introduced,and at last Cash-in Advance Model is introduced
to research the interaction with money market,
14.4 Comparisons between New Classical and
Keynesian Theories
?New Classical theory
?Shortages of New Classical
?Shortage One,It lacks enough sufficient economic results to support this theory,
some of whose results drawn with analyses of technical data are opposite to what the
theory tells us,For example,R.lucas Supply Function tells us,when actual prices are
higher than expectations,actual output will be higher than potent productive capacity,
so economy is overheated,while in fact some data tell us,when prices are higher than
expectation price,so economy begins recession,
?Shortage Two,At present,it can not explain a specific scene common in the economy
industrialize countries in recent years,Aggregate output which deviates from normal
trend will never return to its primary position,whose incorporation is that when
unemployment rate rises to a level,it will never return to nature unemployment rate,
That is also basic belief of New Classical Theory,it is not right that market has
strong self-adjustment ability,
14.4 Comparisons between New Classical and
Keynesian Theories
?Conclusions,
?New classical theory does not only explain
reasons of economic fluctuations and
unemployment while giving up the basic
hypothetic premise of Keynesian,but most
important it bring a big reform in the theory
research of economics
Chapter 14
The End
0
10
20
30
40
90 91 92 93 94 95 96 97 98 99 00
