So throughout this course, we focus mainly on the Keynesian model of economics. Let's go ahead and see another model, the new classical model of economics. So the new classical model of economics, well, guess what? It has similar views to the classical model of economics that was used prior to the Great Depression. During the Great Depression, the Keynesian model was developed that focused on government intervention to help fight recessions and to help fight inflation as well. So the new classical model was developed by a few people, Robert Lucas, Thomas Sargent, Robert Barro in the 1970s. Likely, you don't have to know those names but that's who developed it. And it has some big similarities to the classical model. That's why it's called the new classical model.
So this model believes that the economy tends to be at potential GDP. So we're at full employment and available resources are in use. So that's a big similarity between the classical model and the new classical model that we tend to be at full employment, potential GDP. They also believe that wages and prices are flexible, that they are able to adjust quickly, to changes in supply and demand. This is one of the main differences from the Keynesian models. Remember that the Keynesian model viewed prices as sticky. They're not able to change as quickly, right? Especially when it comes to wages, a lot of times, your wage isn't able to change or adjust that quickly, right? If you're going through a recession, if the economy is going through a recession and then your employer says: Hey, we're going to cut your pay by 10%. It's not so easy to lower your wage, right? Or if you're in a union and you have a contracted amount of wage, whether prices go up or down, the price level changes, inflation or recession, well, your contracted wage is going to stay the same. So that's one of the main views of the Keynesian model while the new classical model believes that these are more flexible, that they are adjustable, they can adjust quickly, okay?
So one of the big additions that the new classical model brings is the idea of rational expectations and this tends to deal mainly with inflation when we think about this rational expectations in this model. So the idea is that firms and workers have expectations about the future value of economic variables. So they're going to make decisions today based on what they think the future is going to be like, such as what they think inflation is going to be like in the future, okay?
So one of the main things with the rational expectations theory is that if the actual inflation rate is different from the expected inflation rate, if they expect a certain level inflation, we think prices are going to be 2% higher next year, but they end up being 10% higher next year. Well, that's going to have economic repercussions. And we talk about that a lot more when we discuss the short run Phillips curve and we discuss expected inflation. We discuss this idea of rational expectations in that video a lot. But it leads to shifts in the short run Phillips curve. When these expectations are not met, and that has effects on inflation as well as on unemployment as well, okay?
So to try and fight these differences between actual inflation and expected inflation, the new classical theory agrees that there should be some sort of monetary growth rule. So basically, increases in the money supply. So another model we discussed is the monetarist model, and the monetarist model focuses on money supply. So this is an agreement that they have with this model. The new classical theory believes that there should be steady growth, a steady growth rule in the money supply. So when I say steady growth rule for the money supply, which will help firms and workers make expectations about inflation, okay? So they're trying to make expectations about what inflation is going to be like. So if there's this steady constant rule that we're following regarding our money supply, well, we can make better guesses about what the future is going to be like. And that's what the new classical model thinks about. On a high level, you just kind of have to know about this, but we focus mainly on that Keynesian model in this class. That's the main focus of an introductory course like this.
Alright? So that is our new classical model. Let's go ahead and pause, and we'll move on to the next video.