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- 1. 19 - 1 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show Disputes Over Macro Theory and Policy 19C H A P T E R
- 2. 19 - 2 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show CLASSICAL ECONOMICS AND KEYNES Classical Economics Adam Smith - 1776 Laissez-faire The Classical View Vertical Aggregate Supply Curve Stable Aggregate Demand Real Output Depends Upon… •Quantity of money possessed by households & businesses •Purchasing power of money is determined by the price level
- 3. 19 - 3 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show Classical Theory P1 Q1 PriceLevel Real Domestic Output AS AD1
- 4. 19 - 4 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show Classical Theory P1 Q1 P2 PriceLevel Real Domestic Output AS AD1 AD2
- 5. 19 - 5 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show CLASSICAL ECONOMICS AND KEYNES Keynesian Economics John Maynard Keynes, 1930s The Keynesian View Prices and Wages Downwardly Inflexible Active Government Policy Required to Stabilize the Economy Horizontal Aggregate Supply Curve to Full-Employment Unstable Aggregate Demand
- 6. 19 - 6 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show Keynesian View P1 Q1 PriceLevel Real Domestic Output AS AD1
- 7. 19 - 7 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show Keynesian View P1 Q1 PriceLevel Real Domestic Output AS AD1 AD2 Q2
- 8. 19 - 8 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show CAUSES OF MACRO INSTABILITY Ca + Ig + Xn + G = GDP Equation of Exchange M V = P Q = GDP Changes in Investment Mainstream View Monetarist View Adverse Aggregate Supply Shocks Stable Velocity
- 9. 19 - 9 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show CAUSES OF MACRO INSTABILITY Instability of Investment is the Main Cause of Output Changes Monetary Policy is a Stabilizing Factor Mainstream View Monetarist View With a Stable Velocity, Nominal GDP Depends Upon the Money Supply Summary
- 10. 19 - 10 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show Real Business Cycle View Real-Business-Cycle Theory P1 PriceLevel Real Domestic Output ASLR1 AD1 Q1
- 11. 19 - 11 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show Real Business Cycle View Real-Business-Cycle Theory P1 Q2 PriceLevel Real Domestic Output ASLR1 AD1 Q1 ASLR2
- 12. 19 - 12 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show Real Business Cycle View Real-Business-Cycle Theory P1 Q2 PriceLevel Real Domestic Output ASLR1 AD1 AD2 Q1 ASLR2 Recession With Stable Price Levels
- 13. 19 - 13 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show Real Business Cycle View Real-Business-Cycle Theory P1 Q2 PriceLevel Real Domestic Output ASLR1 AD1 AD2 Q1 ASLR2 Recession With Stable Price Levels Coordination Failures Coordination Failures
- 14. 19 - 14 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show DOES THE ECONOMY SELF-CORRECT? New Classical View Self-Correction? Rational Expectations Theory Speed of Adjustment Unanticipated Price Changes “Price Level Surprises” Fully Anticipated Price-Level Changes
- 15. 19 - 15 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show Q1 PriceLevel Real Domestic Output AD1 ASLR P1 An increase in AD AS1 Self- Correction a NEW CLASSICAL VIEW OF SELF-CORRECTION
- 16. 19 - 16 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show P2 Q1 PriceLevel Real Domestic Output AD2 AD1 ASLR P1 An increase in AD AS1 Self- Correction a b NEW CLASSICAL VIEW OF SELF-CORRECTION
- 17. 19 - 17 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show P2 Q1 PriceLevel Real Domestic Output AD2 AD1 ASLR P1 An increase in AD AS1 AS2 P3 Self- Correction a b c NEW CLASSICAL VIEW OF SELF-CORRECTION
- 18. 19 - 18 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show Mainstream View Downward Wage Inflexibility Efficiency Wage Theory •Greater Work Effort •Lower Supervision Costs •Reduced Job Turnover Insider-Outsider Theory and Relationships DOES THE ECONOMY SELF-CORRECT?
- 19. 19 - 19 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show RULES OR DISCRETION? Monetary Rule Balanced Budget In Support of Policy Rules In Defense of Discretionary Stabilization Policy Discretionary Monetary Policy Discretionary Fiscal Policy Increased Macro Stability
- 20. 19 - 20 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show RATIONALE FOR A MONETARY RULE Federal Reserve Increases Money Supply at the Long-Run Growth Rate of GDP P1 Q1 PriceLevel Real Domestic Output, GDP AD1 Q2 ASLR1 Fed Increases The Money Supply Resulting in… ASLR2 P2
- 21. 19 - 21 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show RATIONALE FOR A MONETARY RULE Federal Reserve Increases Money Supply at the Long-Run Growth Rate of GDP P1 Q1 PriceLevel Real Domestic Output, GDP ASLR2 AD2 AD1 Q2 ASLR1 Growth Without Inflation or Deflation P2
- 22. 19 - 22 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show RULES OR DISCRETION? Summary of Alternative Views Chapter Conclusions
- 23. classical view Keynesian view monetarism equation of exchange velocity real-business-cycle theory coordination failures rational expectations theory new classical economics price-level surprises efficiency wage insider-outsider theory monetary rule ENDBACKCopyright McGraw-Hill/Irwin 2002
- 24. 19 - 24 Copyright McGraw-Hill/Irwin, 2002 Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self-Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide Next Slide End Show Next: Supply And Demand Elasticities And Government-Set Prices Chapter 20