Macroeconomic Viewpoints : Classical Keynesian Monetarist New Classical New Keynesian

1. Macroeconomic Viewpoints: ClassicalKeynesianMonetaristNew ClassicalNew Keynesian

2. Classical Economics: Laissez - Faire • Real GDP is determined by aggregate supply • The equilibrium price level is determined by the money supply. • Full employment is the norm Supply creates its own demand • The classical view prevailed before the Great Depression.

3. The Classical Model • Real GDP is determined by aggregate supply • The price level is determined by aggregate demand.

4. Keynesian Economics: Economic ActivismJohn Maynard Keynes, The General Theory of Employment, Interest, and Money (1936) • Emphasizes aggregate demand in determining GDP and employment. • Assumes fixed prices (horizontal AS) at relevant levels of GDP. inflation is not a risk when unemployment is high. • Government must stabilize an inherently unstable macroeconomy • Use demand management policies • Fiscal policy • Monetary policy

5. The Fixed-Price Keynesian Model

6. Monetarism: Return to Laissez - FaireMilton Friedman, Studies in the Quantity Theory of Money (1956) _______________, The Role of Monetary Policy (1968) • Emphasizes role of money supply in determining real GDP and price level. • Business cycles are largely the result of discretionary monetary policy  Monetary mischief Activist policy is wrong: Too Much Too Late

7. Monetarism: Return to Laissez-Faire • Efforts to increase real GDP through expansionary monetary policy  Accelerating Inflation. “Inflation is everywhere and at all times a monetary phenomenon.” • Economic policy operates with long and variable lags • accurate timing nearly impossible.  Don’t mess with the macroeconomy

8. Long and Variable Policy Lags • 1. Recognition Lag: policymakers need time to realize that there is a problem. • 2. Reaction Lag: they need time to formulate an appropriate policy response. • 3. Effect Lag: policy takes time to implement and work through the economy. • Countercyclical policies can become procyclical policies, worsening fluctuations  Don’t mess with the macroeconomy

11. New Classical Economics: Policy Ineffectiveness • Arose in the 1970s in response to stagflation. • Wages and prices are perfectly flexible. • Markets are always in equilibrium. • Markets work! • Expectations are rational  only unexpected changes in policy can affect output and employment. • Changes in real GDP result from unexpected changes in the prices level.

12. New Classical “Policy” • Most observed unemployment is voluntary. • Only unanticipated policies can have any effect.  “policy ineffectiveness proposition”. • Therefore, attempt no activist policy. Follow predictable and stable monetary and fiscal policies for long run employment and price stability.

13. New Classical Economics

14. New Keynesians: Policy Can Work • Incorporate rational expectations • But prices and wages are “sticky” in short run.  Disequilibrium prevails. • Price-wage stickiness: impediments to adjustment exist (contracts, adjustment costs, etc.) • Activist policies can work • Stabilize the economy/make things better! • The private sector is an important source of shifts in aggregate demand. • Monetary and fiscal policies should be used to offset drops in private sector spending.

15. The Modern Keynesian Model