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Macroeconomic Theories

Macroeconomic Theories. Classical & Keynesian versus New Classical & Supply Side. CLASSICAL VIEW. Markets are naturally self regulating No government intervention necessary Recessions are temporary Wages & prices are flexible Savings = Investment

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Macroeconomic Theories

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  1. Macroeconomic Theories Classical & Keynesian versus New Classical & Supply Side

  2. CLASSICAL VIEW • Markets are naturally self regulating • No government intervention necessary • Recessions are temporary • Wages & prices are flexible • Savings = Investment • Says law: Supply will create its own demand • Against: minimum wages, welfare & Gov’t assistance • Great Depression challenged Classical View

  3. 9-2b FIGURE 9-1 Aggregate Supply and Aggregate Demand in Classical Economics Classical View

  4. KEYNSIAN VIEW • Economy is inherently unstable & not self adjusting • Recessions are long & often permanent • Major government intervention necessary to stimulate AD • Wages & prices are sticky or fixed • Support welfare & Gov’t assistance • Lack of consumer demand caused great depression • AS curve is very flat or horizontal • Interest rates changes are not effective during recession • Money Demand not very sensitive to interest rates

  5. Keynesian View

  6. Macroeconomic Debates • Two major schools decidedly against government intervention have developed: • Monetarism & New Classical Economics

  7. Monetarism • Main message: money matters & the economy self-regulates • Monetarism believes in the Quantity Theory of Money • MV = PQ, Inflation is purely a monetary phenomena • Generally do not advocate activist monetary policy stabilization: • expanding money supply during bad times and slowing during good • Focus on price stability • Theory not compatible with upward sloping AS curve

  8. Attempted to explain stagflation of 1970’s Business Cycles happen, but recessions are temporary AS could be broken down into Short-run & Long run curves Government intervention is unnecessary Prices/wages are flexible in long run, sticky in short-run People make decisions on rational expectations This explains “shocks” to the system New Classical

  9. 9-2l LR SRAS FIGURE 9-5 Aggregate Supply in the New Classical Model New Classical Model Both models can be used as a “New Classical Model”

  10. Supply-Side Policy • Government Incentives Matter • Goal: use incentives to shift the aggregate supply curve right • The supply-side toolbox consists of: • Tax cuts to stimulate work effort, saving, and investment • Deregulation to reduce production cost/stimulate investment. • Expenditures on education training/research expands capacity to produce • Immigration policies alter the size/skill of labor force

  11. 9-4 Summary • No theory is designed to explain all the complex relationships of a macroeconomy • There is no simple relationships that can be easily manipulated to neatly solve various problems as they arise. • Assessing economic theories would be easier if we lived in closed economies.

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