What is a liquidity trap? What is the difference between debt deflation, disinflation and deflation?

Liquidity Trap When interest rates reach 0%, lenders quit lending. Because the FED can’t lower interest rates any lower than 0%, monetary policy becomes ineffective. This is the liquidity trap Debt deflation is the reduction in aggregate demand arising from the increase in the real burden of outstanding debt caused by deflation Disinflation: the process of lowering inflation

Module 35 and 36 History and Alternative Views of Macroeconomics

Quantity Theory of Money https://www.youtube.com/watch?v=q59tZKP0HME https://www.youtube.com/watch?v=XSilTPId7-o

Classical versus Keynesian Macroeconomics Section 6 | Module 35

Wide gaps in economic debate of the 20th century are narrowing Wide gaps in economic debate of the 20th century are narrowing. There are a few concepts that share broad acceptance across macroeconomics. 1. Most economists agree that monetary policy is usually preferred to discretionary fiscal policy to reverse the effects of a recession.

Is Expansionary Monetary Policy Helpful in Fighting Recessions? Classical economists didn’t believe that monetary policy would reverse a recession. Keynesians thought it could have limited effectiveness. Friedman convinced economists that monetary policy is effective Now all macroeconomists now agree that monetary policy can be used to shift the aggregate demand curve to reduce economic instability. Now most economists don’t follow the old classical or old Keynesian philosophies. Now –it is generally agreed that monetary policy is ineffective only in the case of a liquidity trap

Is Expansionary Fiscal Policy Effective in Fighting Recessions? Classical Macroeconomists were even more opposed to fiscal expansion than monetary expansion. Keynesians gave fiscal policy a central role in fighting recessions Monetarists argued that fiscal policy was ineffective as long as the money supply was held constant. TODAY-Most macroeconomists agree that fiscal policy like monetary policy can shift the aggregate demand curve Most agree that the federal government should not seek to balance the budget regardless of the state of the economy; the role of the budget as an automatic stabilizer helps keep the economy on an even keel

Can Monetary or Fiscal Policy reduce unemployment in the Long-run? Most macroeconomists now accept the Natural rate hypothesis and agree on the limitation of monetary and fiscal policy They believe that both policies can limit the size of fluctuations of the actual unemployment rate around the natural rate but can’t keep unemployment below the natural rate

Should Fiscal Policy be used in a Discretionary way? Many but not all, economists believe that discretionary fiscal policy is usually counterproductive due to the lags in adjusting fiscal policy that can end up making things worse or do the opposite of what they intended. As a result monetary policy is touted as the lead role in economic stabilization.

Mr. Clifford and Keynes https://www.youtube.com/watch?v=xKGtmzLP8gw What is Austrian Economics? https://www.youtube.com/watch?v=SLfnpwHu4Hw

Should Monetary Policy be used in a Discretionary Way? Monetary policy should play a main role in stabilization policy Central bank should be independent, insulated from political pressures, in order to avoid a political business cycle. Discretionary fiscal policy should be used sparingly, both because of policy lags and the risks of a political business cycle.

Last and not least The Federal Reserve does not announce a target rate of inflation but its actions are consistent with a target of about 2% Should the FED be in The business of managing the Stock Market? Most economist say NO! Unconventional Monetary Policy: In the wake of the 2008 financial crisis the FED used some steps outside the box.

Supply Side Economics Popular in the 80 and early 90’s Thatcher and Reagan incorporated ideas into their fiscal policy. Supply Side Economics advocates for the production side of the market. Infrastructure spending Education spending Lower Corporate and individual taxes– Laffer Curve Less Union influence Deregulation Free Trade- no barriers

Supply Side Policies of Economics http://www.investopedia.com/articles/05/011805.asp /http://www.economicshelp.org/blog/31/supply-side/supply-side-policies http://snbchf.com/economic-theory/supply-side-economics/

Natural Rate hypothesis To avoid accelerating inflation over time- the unemployment rate must be high enough that the actual inflation rate equals the expected inflation rate. Limits the role of activist macroeconomic policy.

Rational Expectations Theory Instability in the economy is caused by unanticipated AD or AS shocks in the short run Monetary or fiscal policy will have no effect on output because rational consumers will build changes into their expectations. Individuals and firms make decisions optimally using all available information

Real Business Cycle Theory Aggregate supply curve is vertical, so AS shocks change the business cycle. A recession occurs when a slowdown in productivity growth shifts the aggregate supply curve leftward. A recovery occurs when a pick up in productivity growth shifts the aggregate supply curve rightward.