Question

What are the two sorts of nominal rigidities offered by New Keynesians as sources of economic instability? Briefly discuss the most prominent source of each sort of nominal rigidity. Briefly discuss the microeconomic rationale for the prominent sources cited. Discuss how the existence of each rigidity produces fluctuations in output at the macro level.

Answer 1

New Keynesianism uses micro economics foundations to explain the macro economics issues.following are nominal rigidities:

• Wage stickiness.: Wage stickiness implies the wage rate does not fall during the recession. Hence, employers are not ready to recruit more workers. Hence, it causes widespread unemployment rate.
• Inflexible price level: Price does not adjust according to demand and supply, hence demand does not rise which result into further deepening of recession.

Wage rigidity along with the price inflexibility are supreme examples of market imperfections. Wage rate does not fall during the recession due to imperfections in labor market. Hence, recession can not be tackled by the market forces. Government must intervene in economic activities to deal with such market imperfections. Market system along can not solve issue of recession.