Macroeconomic Conflict and Consensus

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Oct 28, 2013 (3 years and 9 months ago)

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Macroeconomic
Conflict and
Consensus

Classical Economics


Focused on long run only


Short run effects, like changes in output, were
unimportant


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

Monetarism


Believed GDP would grow steadily if money supply grew
steadily


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
unemployment


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

1.
Rational Expectations Theory


Individuals and
businesses make decisions based on all available
information


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

New Classical Macroeconomics

2.
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:

1.
Monetary policy


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

2.
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:

3.
NAIRU


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

4.
Discretionary
f
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:

5.
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