Macroeconomic Conflict and Consensus


Oct 28, 2013 (4 years and 8 months ago)


Conflict and

Classical Economics

Focused on long run only

Short run effects, like changes in output, were

Awareness of business cycle, but no consensus on how to
respond to it

Keynesian Economics

Emphasized importance of short run effects of shifts

SRAS upward
sloping, not vertical

Pointed out the importance of “business confidence”

Legitimized macroeconomic policy activism, use of
policy to smooth out the business cycle

Challenges to Keynes

Keynes felt that monetary policy would be ineffective in
depressed economy

Economists reassessed monetary policy in the 1960s


Believed GDP would grow steadily if money supply grew

Supported by Quantitative Theory of Money

Concerned about fiscal policy lags and crowding out,
wanted to see constant growth of money supply
regardless of economic conditions

Little discretionary policy

Inflation and Unemployment

NAIRU was also a challenge to Keynes, as Keynes
believed macroeconomic policy could be used to
maintain full employment in the long run

One implication of the
natural rate hypothesis

is that
inflation will continue even in times of high

Stability, not low level, should be the goal

Political Business Cycle

Results of election tend to be tied to economic conditions
in the six months prior to the election

Why monetary policy is preferred by many economists

New Classical Macroeconomics

Rational Expectations Theory

Individuals and
businesses make decisions based on all available

Because monetary and fiscal policy is known to the
public, they will figure this into expectations,
neutralizing effects of policy

New Classical Macroeconomics

Real Business Cycle Theory

Slowdowns in
productivity growth (attributed to pauses in technology
progress) caused recessions

Total factor productivity is the amount of output that
can be generated with a given level of inputs

In effect, this explains business cycle in terms of
supply instead of demand

Many advocates of this view now acknowledge potential
role of Aggregate Demand.

Modern Macroeconomic Consensus

General level of Consensus on Five Key Issues:

Monetary policy

Effective in shifting AD to reduce
economic instability by affecting both price and output;
only ineffective in case of liquidity trap

Fiscal policy

Effective in shifting AD; should not seek
balanced budget, as budget surpluses and deficits act as
a stabilizer

Modern Macroeconomic Consensus

General level of Consensus on Five Key Issues:


Almost universally accepted as true; limited
ability of policy to keep unemployment below NAIRU,
but can help stabilize near this level

iscal policy

Usually counterproductive
due to lags; most favor monetary policy except in
liquidity trap

Modern Macroeconomic Consensus

General level of Consensus on Five Key Issues:

Discretionary monetary policy

Still an area of
contention, though there is agreement that central
bank should be independent

Unconventional monetary policies exercised during 2008
Financial Crisis were very controversial.

5 Key Questions of Macroeconomic Theory