ModuleHistory andAlternative Views ofMacroeconomics

KRUGMAN'SMACROECONOMICS for AP*

35

Margaret Ray and David Anderson

John Maynard Keynes & Milton Friedman

What you will learnWhat you will learn

in thisin this ModuleModule::• Why classical macroeconomics wasn’t

adequate for the problems posed by the Great Depression

• How Keynes and the experience of the Great Depression legitimized macroeconomic policy activism

• What monetarism is and its views about the limits of monetary policy

• How challenges led to a revision of Keynesian ideas and the emergence of the new classical macroeconomics

Classical Macroeconomics:Classical Macroeconomics: Money and the Price Level Money and the Price Level

•%∆ M = % ∆ PL

•Short-Run Effects Unimportant

•Focus on the Long-Run

•Keynes - “ (in the long run) we are all dead.”

Classical Macroeconomics: TheClassical Macroeconomics: The Business Cycle Business Cycle

•The Business Cycle

•No theory of business cycles

•Lack of consensus

•Necessity is the mother of invention

Keynes’s TheoryKeynes’s Theory

•The General Theory

•Classical View

•Keynesian View

•“Animal Spirits” (business confidence)

Keynes’s TheoryKeynes’s Theory

Classical Classical TheoryTheory

KeynesianKeynesianTheoryTheory

Challenges to Keynesian Economics:Challenges to Keynesian Economics: The Revival of Monetary Policy The Revival of Monetary Policy

•A Monetary History of the United States, 1867 - 1960

•Great Depression caued by Fed contracting the money supply

•Monetary policy is important - less political

University of University of Chicago Economist, Chicago Economist,

Milton FriedmanMilton Friedman

Challenges to KeynesianChallenges to Keynesian Economics: Monetarism Economics: Monetarism

•Monetarism

•Discretionary Policies - bad

•Crowding Out

•Monetary Policy Rule

•Quantity Theory of Money, MV = PY

•Velocity of Money

•Erratic Velocity undermines Monetarism

Challenges to Keynesian Economics: Inflation Challenges to Keynesian Economics: Inflation and the Natural Rate of Unemploymentand the Natural Rate of Unemployment

•Natural Rate Hypothesis

•Limit to Discretionary Policy

•Stagflation of 1970s proof of Hypothesis

•Natural Rate widely accepted

Challenges to Keynesian Economics: Challenges to Keynesian Economics: The Political Business CycleThe Political Business Cycle

•Consequences of Keynes on Politics

•Election Day Economics

•Political Business Cycle

•The need for central bank independencePresident Obama and Senator McCain

Rational Expectations, Real Business Rational Expectations, Real Business Cycles, and New Classical MacroeconomicsCycles, and New Classical Macroeconomics

• New Classical Macroeconommics

• Rational Expectations

• New Keynesian Economics

• Real Business Cycle Theory

Unnumbered Figure 35.1 The End of the Great DepressionRay and Anderson: Krugman’s Macroeconomics for AP, First

EditionCopyright © 2011 by Worth Publishers

Figure 35.2 Fiscal Policy with a Fixed Money SupplyRay and Anderson: Krugman’s Macroeconomics for AP,

First EditionCopyright © 2011 by Worth Publishers

Figure 35.3 The Velocity of MoneyRay and Anderson: Krugman’s Macroeconomics for AP, First

EditionCopyright © 2011 by Worth Publishers