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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.

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Presentation on theme: "Macroeconomic Conflict and Consensus. Classical Economics  Focused on long run only  Short run effects, like changes in output, were unimportant  Awareness."— Presentation transcript:

1 Macroeconomic Conflict and Consensus

2 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

3 Keynesian Economics  Emphasized importance of short run effects of shifts  SRAS upward-sloping, not vertical  Legitimized macroeconomic policy activism, use of policy to smooth out the business cycle

4 Monetarism  Believed GDP would grow steadily if money supply grew steadily  Supported by Quantitative Theory of Money MV=PQ  Wanted to see constant growth of money supply regardless of economic conditions

5 Inflation and Unemployment  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

6 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

7 New Classical Macroeconomics 1. Rational Expectations Theory – Individuals and businesses make decisions based on all available information 2. Real Business Cycle Theory – Slowdowns in productivity growth (attributed to pauses in technology progress) cause recessions

8 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

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

10 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.

11 5 Key Questions of Macroeconomic Theory


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