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Copyright 2008 The McGraw-Hill Companies17-1
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
17Disputes Over Macro Theory and Policy
Copyright 2008 The McGraw-Hill Companies17-2
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
Chapter Objectives• Differences Between Historical
Keynesian and Classical Macro Perspectives
• Alternative Perspectives on the Causes of Macroeconomic Instability – Alternative Theory Viewpoints
• Equation of Exchange and Monetarism
• New Classical Economics – Self-Correction and Shocks
• Debate over “Rules” and “Discretion” in Conducting Stabilization Policy
Copyright 2008 The McGraw-Hill Companies17-3
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
Classical Economics and Keynes
• The Classical View–Vertical Aggregate Supply
Curve
–Stable Aggregate Demand
• Keynesian View–Horizontal Aggregate
Supply to Full Employment
–Unstable Aggregate Demand
Copyright 2008 The McGraw-Hill Companies17-4
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
Classical Economics and Keynes
Pri
ce L
evel
Pri
ce L
evel
P2
P1
P1
Qf QfQu
Classical Theory Keynesian Theory
Real Domestic Output Real Domestic Output
AS
AS
AD1AD1
AD2AD2
a b
c
y x
Copyright 2008 The McGraw-Hill Companies17-5
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
Causes of Macro Instability
• Mainstream View
–Changes in Investment
Spending
Ca + Ig + Xn + G = GDP
–Adverse Aggregate
Supply Shocks
Copyright 2008 The McGraw-Hill Companies17-6
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
Causes of Macro Instability
• Monetarist View–Equation of Exchange
MV = PQ
–Velocity
–Stable Velocity
–Monetary Causes of Instability
O 17.1
O 17.2
W 17.1
Copyright 2008 The McGraw-Hill Companies17-7
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
Causes of Macro Instability• Real-Business-Cycle View
–Real-Business-Cycle Theory
Pri
ce L
evel
P1
Real Domestic Output
Q2 Q1
AD1
AD2
ASLR1ASLR2
Copyright 2008 The McGraw-Hill Companies17-8
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
Causes of Macro Instability
• Coordination Failures
–Unemployment
Equilibrium
–Inflation Equilibrium
Copyright 2008 The McGraw-Hill Companies17-9
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
Does the Economy Self-Correct?
• New Classical View of Self-Correction–Rational Expectations
Theory–New Classical Economics–Speed of Adjustment–Unanticipated Price-Level
Changes• Price-Level Surprises
–Fully Anticipated Price-Level Changes
O 17.3
G 17.1
Copyright 2008 The McGraw-Hill Companies17-10
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
Does the Economy Self-Correct?New Classical View of Self-Correction
AD2
AD1
AS1
AS2ASLR
Pri
ce L
evel
P1
P2
P3
Real Domestic Output
Q1 Q2
a
b
c
Copyright 2008 The McGraw-Hill Companies17-11
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
Does the Economy Self-Correct?New Classical View of Self-Correction
AD3
AD1
AS1
AS3
ASLRP
rice
Lev
el
P1
P4
P5
Real Domestic Output
Q1Q4 Q3
a
e
d
f
Copyright 2008 The McGraw-Hill Companies17-12
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
Does the Economy Self-Correct?
• Mainstream View of Self-Correction–Downward Wage
Inflexibility –Efficiency Wage Theory
• Greater Work Effort• Lower Supervision Costs• Reduced Job Turnover
• Insider-Outsider Relationships–Insider-Outsider Theory
O 17.4
Copyright 2008 The McGraw-Hill Companies17-13
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
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Rules or Discretion?• In Support of Policy Rules
–Monetary Rule• Inflation Targeting
–Balanced Budget• In Defense of
Discretionary Stabilization Policy–Discretionary Monetary
Policy–Discretionary Fiscal Policy
• Increased Macro Stability
Copyright 2008 The McGraw-Hill Companies17-14
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
Rationale for Monetary Rule
Pri
ce L
evel
P1
Real Domestic Output, GDPQ1 Q2
P2
ASLR1 ASLR2
AD1
AD2
Copyright 2008 The McGraw-Hill Companies17-15
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
Summary of Alternative Views
• Mainstream Macroeconomics (Keynesian)
• New Classical Economics–Monetarism–Rational Expectations
Theory
Copyright 2008 The McGraw-Hill Companies17-16
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
The Taylor Rule: Could a Robot Replace Ben Bernanke
• John Taylor Call for a New Monetarist Rule to Institutionalize Appropriate Fed Policy
• Rules Reflect Passive Monetary Policy• Discretion Reflects Active Monetary
Policy• Taylor Suggests the Fed Explain Why
They Deviate from the Rule Removing the Mystery of Fed Actions
• Process Would Increase Fed Credibility and Reduce Uncertainty
Last
Word
Copyright 2008 The McGraw-Hill Companies17-17
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
Key Terms• classical view• Keynesian view• monetarism• equation of exchange• velocity• real-business-cycle theory• coordination failures• rational expectations theory• new classical economics• price-level surprises• efficiency wage• insider-outsider theory• monetary rule
Copyright 2008 The McGraw-Hill Companies17-18
Classical Economics and KeynesCauses of Macro InstabilityDoes the Economy Self-Correct?Rules or DiscretionRationale for a Monetary RuleSummary of Alternative ViewsLast Word
Key Terms
End Show
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