New neoclassical synthesis

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New neoclassical synthesis or new synthesis is the fusion of the major, modern macroeconomic schools of thought, new classical and new Keynesian, into a consensus on the best way to explain short-run fluctuations in the economy. This new synthesis is analogous to the neoclassical synthesis that combined neoclassical economics with Keynesian macroeconomics. The new synthesis provides the theoretical foundation for much of contemporary mainstream economics. It is an important part of the theoretical foundation for the work done by the Federal Reserve and many other central banks.

Prior to the synthesis macroeconomics was split between new Keynesian work on market imperfections demonstrated with small models and new classical work on real export businesses or business cycle theory that used fully specified general equilibrium models and used changes in technology to explain fluctuations in economic output. The new synthesis has taken elements from both schools. New classical economics contributed the methodology behind real business cycle theory and new Keynesian economics contributed nominal rigidities (slow moving and periodic, rather than continuous, price changes also called sticky prices).

Four Elements

Goodfriend and King (1997) proposed a list of four elements that are central to the new synthesis: intertemporal optimization, rational expectations, imperfect competition, and costly price adjustment (menu costs). Goodfriend and King also find that the consensus models produce certain policy implications. In contradiction with some new classical thought, monetary policy can impact real output in the short-run, but there is no long-run trade-off: Money is not neutral in the short-run but it is in the long-run. Inflation has negative welfare effects. It is important for central banks to maintain credibility through rules based policy like inflation targeting.



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