In this video, I discuss the need for a model that offers a role for stabilisation policy. This gives a basis for developing the New Keynesian model.

The RBC model assumes perfect competition and flexible prices. This means that the economy is always at an optimal point, with individual decisions and prices adapting so that output is at potential. This gives no room for stabilisation policy, as we are already at optimum.

The RBC model is thus not very useful for those deciding on monetary policy, as it tells them that their job is effectively pointless. In this video, I thus compare and contrast a simple model with flexible prices and sticky prices. With sticky prices, we have a role for monetary policy to move the economy back to its potential level.

Check out the playlist for a number of past and future videos on the topic of business cycles.

We begin with a basic overview of what is meant by business cycles. This involves detrending the data such that we can isolate the short run cyclical effects on output.

We then develop some models for examining the propagation mechanisms involved in causing cyclical behaviour. This begins with Real Business Cycle Models. These models focus on real variables, so do not generate predictions for nominal variables. We have shocks to the supply side of the economy, causing uncertainty and fluctuations that may propagate into the future.

We then move to New Keynesian models. These introduce nominal frictions into the model, including some level of imperfect competition, normally monopolistic competition. There is then some cost involved with changing prices, often called "menu costs". These can involve costs of printing a new catalogue, but could also be extended broader to informational costs such as customers wanting a constant price, as rapidly changing prices can cause uncertainty. We the have fluctuations arising from shocks to both demand and supply sides of the economy.

We can extend these models by altering the assumptions to better capture the economy.

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My videos are intended for educational and entertainment purposes. I try to credit the relevant parties for any work that I refer to in my videos (for example, citing relevant academic papers). If you believe a video does not observe good academic practice, please do not hesitate to contact me by email at everythingbetting@gmail.com

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