Adam Smith, emphasizes the efficiency of the market economy, the ability of the price system to transmit vital information from producers to consumers, and vice versa, and to coordinate allocation decisions, in a manner far beyond the capacity of any central planner. The other has focused its concern on the shortcomings of capitalism, particularly on the periodic episodes of massive unemployment of capital and labor. Surely, adherents of this view claim, these cannot be the manifestations of an efficient economic system. To the classical believers of the efficiency of market economies, these episodes were viewed as disequilibrium situations, temporary aberrations of an otherwise efficient economy; market forces, if left to themselves, would quickly restore equilibrium. The New Classical Economists, have gone one step further: they deny the very existence of a problem; the massive changes in employment levels may best be interpreted. Keynes' and his modern day followers, these views are not just absurd: they make a mockery of the "scientific method" which their adherents claim to follow. Worse still, they are irresponsible: to the extent that governments follow the noninterventionist policies often advocated, they not only condemn those individuals who cannot obtain gainful employment to the economic deprivation which results, but they also condemn the society which condones this unemployment to a host of social and economic consequences which follow from that unemployment. One of Keynes' great contributions was, in effect, a reconciliation of the two opposing views of capitalism: rather than denying either the existence of the unemployment problem or its importance, he confronted it head-on, argued that limited government intervention could correct this malady, and with this one malady corrected, the economy would once again operate in an efficient manner: the classical view would then be restored. Samuelson dubbed this, the Neoclassical synthesis. The very reasons for the success of Keynes' approach provided the basis for the eventual disillusionment. Keynes had attempted to retain as much of the classical (neoclassical) apparatus as he could; the standard model was changed in minimal ways, with dramatic consequences. The neoclassical synthesis, as attractive ideologically as it was for those who believed in the market system, yet were disturbed by massive unemployment, was taken as an article of faith, not derived from any general theoretical structure: the fundamental question of why the failures of the market economy should only occur in the massive doses. The name, "Rational Expectations" school is, however, misleading: the central doctrines of the approach derive not from its belief in rational expectations, however plausible or implausible that assumption might be; but rather from its old classical assumptions of market clearing. And with those assumptions, the conclusion that there is no unemployment, and the irrelevance of government macro—policy. The New Keynesian Economics provides a general theory of the economy, derived from microeconomic principles (and thus integrates the two sub-disciplines.) It succeeds both in filling the lacunae in traditional Keynesian theory (e.g. by explaining partial wage rigidities, rather than simply assuming rigid wages) and resolving the paradoxes and inconsistencies of more traditional Keynesian theory (both the internal inconsistencies, e.g. concerning how expectations are formed and the inconsistencies between its predictions and observations.) It provides an explanation both for an equilibrium level of unemployment (through the efficiency wage theories) and for business fluctuations. The theory of business fluctuations it provides is simple: in broad outline, certain shocks to the economy affect the stock of working capital of firms. Even if firms had perfect access to the credit markets (that is, they could borrow as much as they wished, at the actuarially fair interest rate), the amount they would be willing to borrow is limited by their willingness to bear risk; the fixed commitments associated with loan contracts imply that, as the working capital which is available is reduced, the risk (bankruptcy probability) associated with any level of borrowing increases. Thus, if their working capital is reduced, their desired production level (given that they do not have fixed commitments to sell their products) is reduced; and it takes a number of periods before the levels of working capital are restored to normal.
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