Critically examine the theoretical basis of the New Classical School’s rejection of government stabi Free Essay, Term Paper and Book Report
The Expectations-augmented Phillips curve with rational expectations (Gordon, 1976) was a simple introductory model demonstrating the policy ineffectiveness proposition of stabilisation policy with perfect market clearing. However, it is also useful to demonstrate the policy ineffectiveness within an explicitly aggregate demand framework.
New classical economists have assumed perfect market clearing along with rational expectations and this means that stabilisation policy is unnecessary as well as ineffective.
The new classical policy ineffectiveness proposition was first presented in two influential papers by Sargent and Wallace (1975, 1976). The proposition can best be illustrated using the A.D/A.S model below:
The economy is originally operating at point A where the price level p0 is fully anticipated (the actual and expected price levels coincide) and output and employment are at their long run equilibrium levels. The authorities then go and announce that they propose to increase the money supply which shall lead to rational economic age......
Word Count: 1311
Page Count: 5.2 (250 words a page / double spaced)
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