1. The Roots of Modern
Macroeconomics

2. The Roots of Modern Macroeconomics
Setting the Scene: Three Key Issues

3. THREE KEY ISSUES Issue 1: Flexibility of prices and wages
the right: flexible prices and wages
the left: price and wage rigidities
Issue 2: Flexibility of aggregate supply
the right: aggregate supply determined independently of aggregate demand 2

4. Different aggregate supply curves: (a)AS
Price level O Y
National output

5. Different aggregate supply curves: (a)AS
Price level P1
AD1 O Y
National output

6. Different aggregate supply curves: (a)AS
Price level P2 P1
AD2
AD1 O Y
National output

7. THREE KEY ISSUES Issue 1: Flexibility of prices and wages
the right: flexible prices and wages
the left: price and wage rigidities
Issue 2: Flexibility of aggregate supply
the right: aggregate supply determined independently of aggregate demand
the left: aggregate supply responsive to changes in aggregate demand 2

8. Different aggregate supply curves: (b)
Price level P AS O
National output

9. Different aggregate supply curves: (b)
Price level P AS Y1
AD1 O
National output

10. Different aggregate supply curves: (b)
Price level P AS Y2
AD2
AD1 O Y1
National output

11. THREE KEY ISSUES Issue 1: Flexibility of prices and wages
the right: flexible prices and wages
the left: price and wage rigidities
Issue 2: Flexibility of aggregate supply
the right: aggregate supply determined independently of aggregate demand
the left: aggregate supply responsive to changes in aggregate demand
some consensus on nature of short-run AS curve 2

12. Different aggregate supply curves: (c)AS
Price level O
National output

13. Different aggregate supply curves: (c)AS
Price level P1 Y1
AD1 O
National output

14. Different aggregate supply curves: (c)AS
Price level P2 Y2 P1
AD2
AD1 O Y1
National output

15. THREE KEY ISSUES
Issue 3: The role of expectations in the working of the market
the right: expectations adjust rapidly to changes in prices
the left: expectations of prices depend on expectations of output and employment 4

16. The Roots of Modern Macroeconomics
Classical Macroeconomics

17. CLASSICAL MACROECONOMICS
Classical analysis of output and employment
markets clear
labour market
market for loanable funds 5

18. The market for loanable funds
Saving (supply)
Rate of interest
Investment (demand) O
Quantity of loanable funds

19. The market for loanable funds
Saving (supply) r1
Rate of interest
Investment (demand) O
Quantity of loanable funds

20. The market for loanable funds
Saving (supply) r1
Rate of interest
Investment (demand) O
Quantity of loanable funds

21. The market for loanable funds
Saving (supply)
Rate of interest r2
Investment (demand) O
Quantity of loanable funds

22. The market for loanable funds
Saving (supply)
Rate of interest r2
Investment (demand) O
Quantity of loanable funds

23. The market for loanable funds
Saving (supply)
Rate of interest re
Investment (demand) O
Quantity of loanable funds

24. CLASSICAL MACROECONOMICS
Classical analysis of output and employment
markets clear
labour market
market for loanable funds
market for imports and exports: the gold standard 5

25. CLASSICAL MACROECONOMICS
Classical analysis of output and employment
markets clear
labour market
market for loanable funds
market for imports and exports: the gold standard
Say’s law 5

26. CLASSICAL MACROECONOMICS
Classical analysis of output and employment
markets clear
labour market
market for loanable funds
market for imports and exports: the gold standard
Say’s law
Classical analysis of prices and inflation 5

27. CLASSICAL MACROECONOMICS
Classical analysis of output and employment
markets clear
labour market
market for loanable funds
market for imports and exports: the gold standard
Say’s law
Classical analysis of prices and inflation
the quantity theory of money 5

28. CLASSICAL MACROECONOMICS
Classical analysis of output and employment
markets clear
labour market
market for loanable funds
market for imports and exports: the gold standard
Say’s law
Classical analysis of prices and inflation
the quantity theory of money
the equation of exchange: MV = PY 5

29. CLASSICAL MACROECONOMICS
Classical analysis of output and employment
markets clear
labour market
market for loanable funds
market for imports and exports: the gold standard
Say’s law
Classical analysis of prices and inflation
the quantity theory of money
the equation of exchange: MV = PY
implications for monetary policy 5

30. CLASSICAL MACROECONOMICS
The Great Depression and the return to the gold standard
the depression of the 1920s 6

31. UK unemployment and inflation: 1919 - 38

32. UK unemployment and inflation: 1919 - 38

33. CLASSICAL MACROECONOMICS
The Great Depression and the return to the gold standard
the depression of the 1920s
return to the gold standard 6

34. CLASSICAL MACROECONOMICS
The Great Depression and the return to the gold standard
the depression of the 1920s
return to the gold standard
effects on the economy 6

35. CLASSICAL MACROECONOMICS
The Great Depression and the return to the gold standard
the depression of the 1920s
return to the gold standard
effects on the economy
the policy response 6

36. CLASSICAL MACROECONOMICS
The Great Depression and the return to the gold standard
the depression of the 1920s
return to the gold standard
effects on the economy
the policy response
classical rejection of public works 6

37. CLASSICAL MACROECONOMICS
The Great Depression and the return to the gold standard
the depression of the 1920s
return to the gold standard
effects on the economy
the policy response
classical rejection of public works
the fear of inflation 6

38. CLASSICAL MACROECONOMICS
The Great Depression and the return to the gold standard
the depression of the 1920s
return to the gold standard
effects on the economy
the policy response
classical rejection of public works
the fear of inflation
the problem of crowding out 6

39. The effect of printing extra money: the classical analysis
AD2
AD1 AS
Price level P2 P1 O Q1
National output

40. The Roots of Modern Macroeconomics
The Keynesian Revolution

41. THE KEYNESIAN REVOLUTION
Keynes’ rejection of classical theory
rigidities in the labour market
the problem of deficiency of demand 7

42. The problem of demand deficiency in the labour market
ASL
ADL2
Real wage rate (W / P) W1
ADL1 O
Quantity of labour

43. THE KEYNESIAN REVOLUTION
Keynes’ rejection of classical theory
rigidities in the labour market
the problem of deficiency of demand
rejection of increased saving as a means of increasing investment 7

44. Disequilibrium in the market for loanable funds
Savings 2
Savings 1
Rate of interest r1 r2
Investment O
Quantity of loanable funds

45. THE KEYNESIAN REVOLUTION
Keynes’ rejection of classical theory
rigidities in the labour market
the problem of deficiency of demand
rejection of increased saving as a means of increasing investment
rejection of simple quantity theory 7

46. THE KEYNESIAN REVOLUTION
Keynes’ rejection of classical theory
rigidities in the labour market
the problem of deficiency of demand
rejection of increased saving as a means of increasing investment
rejection of simple quantity theory
rejection of a balanced budget 7

47. THE KEYNESIAN REVOLUTION
Keynes’ rejection of classical theory
rigidities in the labour market
the problem of deficiency of demand
rejection of increased saving as a means of increasing investment
rejection of simple quantity theory
rejection of a balanced budget
Keynes’ analysis of employment and inflation 7

48. THE KEYNESIAN REVOLUTION
Keynes’ rejection of classical theory
rigidities in the labour market
the problem of deficiency of demand
rejection of increased saving as a means of increasing investment
rejection of simple quantity theory
rejection of a balanced budget
Keynes’ analysis of employment and inflation
the importance of aggregate demand 7

49. The effects of increases in aggregate demand on national output
Price level O YP
National output

50. The effects of increases in aggregate demand on national output
AD4 AS
AD3
AD2
Price level
AD1 O Y1 Y2 Y3 Y4 YP
National output

51. THE KEYNESIAN REVOLUTION
Keynes’ rejection of classical theory
rigidities in the labour market
the problem of deficiency of demand
rejection of increased saving as a means of increasing investment
rejection of simple quantity theory
rejection of a balanced budget
Keynes’ analysis of employment and inflation
the importance of aggregate demand
the multiplier process 7

52. The circular flow of income

53. The circular flow of incomeCd

54. The circular flow of income
Incomes Cd

55. The circular flow of income
Incomes Cd
W = S + T + M

56. The circular flow of income
J = I + G + X
Incomes Cd
W = S + T + M

57. The circular flow of income
J = I + G + X
Incomes Cd
W = S + T + M

58. The circular flow of income
J = I + G + X
Incomes Cd
W = S + T + M

59. The circular flow of income
J = I + G + X
Incomes Cd
W = S + T + M

60. THE KEYNESIAN REVOLUTION
Keynes’ policy recommendations
demand management by fiscal and monetary policies
Keynesian policies in 1950s and 60s
stop–go policies
criticisms of short-term demand management
the breakdown of the Phillips curve 8

61. The Roots of Modern Macroeconomics
The Monetarist– Keynesian Debate

62. THE MONETARIST–KEYNESIAN DEBATE
The monetarist counter-revolution
the restatement of the quantity theory
rejection of Keynesian demand management policies
the problem of inflationary expectations
reappraisal of the Phillips curve
unemployment
inflation 9

63. The monetarist version of the long-run Phillips curve
Inflation (%) O Un
Unemployment

64. (a) Keynesian aggregate supply curveAS YP
Ymax
Price level O
National output

65. (b) Keynesian Phillips curve
Umin
Inflation (%) O
Unemployment

66. THE MONETARIST–KEYNESIAN DEBATE
The monetarist counter-revolution
the restatement of the quantity theory
rejection of Keynesian demand management policies
the problem of inflationary expectations
reappraisal of the Phillips curve
unemployment
inflation
monetarist policies 9

67. THE MONETARIST–KEYNESIAN DEBATE
The monetarist counter-revolution
the restatement of the quantity theory
rejection of Keynesian demand management policies
the problem of inflationary expectations
reappraisal of the Phillips curve
unemployment
inflation
monetarist policies
attempts at such policies in the 1980s 9

68. THE MONETARIST–KEYNESIAN DEBATE
Modern-day Keynesians
inflation
unemployment
structural problems
hysteresis
low capital stock
deskilling
insiders and outsiders
criticisms of monetarism
Keynesian policy proposals 10

69. The Roots of Modern Macroeconomics
The Current Position

70. THE CURRENT POSITION The current range of views
new classical / rational expectations school
moderate monetarists
moderate Keynesians (new Keynesians)
extreme Keynesians
the radical left
eclectic economists 11

71. THE CURRENT POSITION A mainstream consensus?
short-run effects of changes in AD
long-run effects of changes in AD
no simple trade-off between inflation and unemployment
role of expectations
effects of excessive growth in the money supply
importance of supply-side policies
erosion of governments' power by the process of globalisation