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Old Monday, April 05, 2010
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Default Classical Inconsistensy

What is Classical inconsistensy and what is its relationship with Liquidity Trap?

Also When Leisure is treated as inferior good can we still have backward bending supply curve?

And What was lucas critique?
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Old Tuesday, April 06, 2010
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I think by classical inconsistency you mean classical dichotomy. It referes to the classical economists perception that real and nominal variables should be treated differently. Thus money was treated as a veil that can not influence real variables like output. Keynesians argued that money supply can not influence the real variables if economy is in liquidity trap, i.e. if money supply is increased people will simply keep this money with themselves as in liquidity trap people will not get interest from that money balances because interest rates in liquidity trap are already near zero. Thus money would not affect real variables like output and employment.

Lucas criticized the traditional econometric models because those models didnt took into account the dynamic nature of economy. His main argument was against the static nature of econometric models. Classical example is that of Philips curve which shows the relationship between unemployment and inflation. Now if policy makers use the philips curve as a policy instrument by increasing inflation to control unemployment then people would expect inflation to rise in future and adjusting themselves accordingly, therefore any anticipated inflation would not result in decrease in unemployment. Therefore use of inflation to control unemployment will fail, because of dynamic adjustments of people to inflation.

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