A severe blow to active Keynesian policy intervention occurred as a result of the New Classical resurgence in macroeconomics. With a vertical aggregate supply curve in the short and the long runs (New Classicals) or at least in the long run (New Keynesians), it has been argued that the economy settles down at a unique non-accelerating inflation rate of unemployment (NAIRU) without any government intervention. Implicit in the NAIRU theory is that the prices can decrease just as they can increase. However, if the prices cannot decrease, the aggregate supply curve would be an inverse-L shaped curve, both in the short and the long runs. Furthermore, with globalization, the expectations-augmented Phillips curve becomes horizontal because of an absolute decline in the bargaining power of the working class in the advanced countries. This means that not only would the economy settle at less than ‘full employment’, but the only way it could be brought closer to that is through active policy intervention. In the present case, manoeuvrability of fiscal policy increases since the threat of accelerating inflation practically disappears.
04_2012 (Download the full text in PDF format)