Answer to Question #171621 in Macroeconomics for Zaheer

Question

“People are rational and therefore form expectations rationally. It follows that New Classical macroeconomics is realistic, and thus that government macroeconomic policy can have no effects on real variables.” Discuss.

Answer 1

Real variables such as output and real interest rates can be completely analyzed without considering what is happening to their nominal counterparts, the money value of output and the interest rate. In particular, this means that real GDP and other real variables can be determined without knowing the level of the nominal money supply or the rate of inflation. An economy shows that if money is unbiased (neutral), it influences only the rate (price) level, and not the actual variable. Since the idea suggests that real variables are separate or independent of their nominal equivalents, the main function of money in an economy is to act as a lubricant for the efficient exchange and production of goods. For example, an economy contains two sides, real and financial. The real side has real variables, involving production and employment while the other side is the financial one involving aggregate rate levels and nominal interest rates.