Lecture Macroeconomics (19/e) - Chapter 19: Current issues in macro theory and policy

After reading this chapter, you should be able to: Describe alternative perspectives on the causes of macroeconomic instability, including the views of mainstream economists, monetarists, real-business-cycle advocates, and proponents of coordination failures; Explain what the equation of exchange is and how it relates to monetarism; discuss why new classical economists believe the economy will self-correct from aggregate demand and aggregate supply shocks.

Current Issues in Macro Theory and 

Policy

• Mainstream view

• Held by most economists

• Price stickiness

• Unexpected demand shocks

•Variable investment spending

• Unexpected supply shocks

• Monetarist view

• Government interference is the problem

• Equation of exchange MV = PQ

• Stable velocity

• Monetary causes of instability

• Inappropriate monetary policy

• Coordination failures

• Fail to reach equilibrium because of lack of coordination mechanism

• Limited information

• Expectations and self-fulfilling prophecy

•Unemployment equilibrium

•Inflation equilibrium

• New classical view

• Rational expectations theory

• Monetarists

• Automatic correction will occur

•Speed of adjustment

•Unanticipated price-level changes

•Fully anticipated price-level changes

• New Classical View of Self-Correction

P 1

P 2

P 3

Q Q

a

b c

Does the Economy Self Correct?

• New Classical View of Self-Correction

P 1

P 4

P 5

Real Domestic Output

Q 1

Q 4 Q 3

a e d

f

Does the Economy Self Correct?

• Mainstream view

• Downward wage inflexibility

• Efficiency wage theory

• Greater work effort

• Lower supervision costs

• Reduced job turnover

• Insider-outsider relationships

• In support of policy rules

• Reduce macro instability

• Monetary rule

•Shift AD to keep up with AS

•Price stability achieved

• Inflation targeting

• Balanced budget

• Defense of discretionary stabilization policy

• Discretionary monetary policy

•Velocity is not stable

• Discretionary fiscal policy

•Useful during recession

• Policy successes

Rules or Discretion?