Policy: The Promise and the Problems Chapter 15

Policy: The Promise and the Problems The promise is clear: Full employment/Full sustainable capacity real GDP AS P LAS P’ AD YF Y

The Problems Include Demand Deficient Unemployment P Y Y’ YF AS LAS P’ AD Y’ YF Y

The Problems Include Inflation AS P LAS P’’’ AD’’’ P’ AD’’ AD’ YF Y

The Problems Include Stagflation P Y LAS Y’’’ YF P’’’ P’’ P’ AD’ AS’’’

Policy: The Foundation of the Debate Demand Deficient Unemployment at the Macro Level Lots of Micro Labor Markets with Excess Supplies of Workers Means there must be Wage Number of Workers S D W’ Excess Supply Generic Labor Market LAS P Y YF AS AD P’ Y’ Macro Picture

Policy :The Foundation of the Debate Under our nice assumptions, an excess supply will cause the price (wage) to fall in all of these micro markets until they reach equilibrium Falling wages (factor prices) shift AS down. When all these micro adjustments have been completed under out nice assumptions, AS will be at LAS and the macro economy will be at YF Wage Number of Workers S D W’ Excess Supply Generic Labor Market LAS P Y YF AS1 AD P’ Y’ Macro Picture AS2 We

Macro Policy : Is Intervention Necessary? The Micro and Macro economy are two perspectives on the same economy, so … given our nice assumptions, the micro adjustments that bring the Micro system to GCE will also bring the Macro economy to YF In our analysis, it is adjustments of wages in Micro labor markets that bring AS to YF We modeled the Y<YF case … micro wages fall – AS falls – Y reaches YF (previous slide) The analysis also applies if Y >YF … in which case there are excess demands in the Micro labor markets so wages will rise, shifting up AS until the economy has returned to YF

Macro Policy: Is Intervention Necessary? If you believe that our nice assumptions are weak assumptions then you believe that adjustments of wages in Micro labor markets will bring AS to YF … so there is NO NEED for Government Intervention in the Economy You think government intervention is part of the problem, not part of the solution. You are a NON-INTERVENTIONIST

Macro Policy: Is Intervention Necessary? If you believe that our nice assumptions are strong assumptions then you don’t believe that adjustments of wages in Micro labor markets will bring AS to YF … so you see a NEED for Government Intervention in the Economy You think government intervention can be a part of the solution to problems like unemployment ... You are an INTERVENTIONIST

Non-Intervention vs. Intervention A Non-Interventionist believes that the long run adjustments will occur in a reasonable amount of time, so we should wait for the markets to work their magic. A leader in this view is Friedrich Hayek An Interventionist believes that the long run adjustments occur too slowly or not at all, and in the meantime many suffer so rather than wait the government should act. A leader in this view is John Maynard Keynes who famously said: “In the long run we’re all dead.”

Macro Policy: Is Intervention Necessary? If we think of these two positions as polar cases: Most of the informed participants in the debate are somewhere along the line between these two poles. For many their position depends on the specific issue, being more non-interventionist is some cases and more interventionist in others Non- Interventionist Interventionist

Macro Policy Macro policy Fiscal Policy Trade Policy Monetary Policy Fiscal Policy Trade Policy In each case we will examine: The policy tools How they could be used The debate as to whether they should be used