Chapter Thirty Three Debates in Macroeconomics: Monetarism, New Classical Theory, and Supply-Side Economics

Keynesian Economics Keynesian The term Keynesian is sometimes used to refer to economists who advocate active government intervention in the macroeconomy.

Monetarism 4 “Money matters” 4 Monetarists usually argue against government intervention in the macroeconomy

Velocity of Money V= GDP M GDP = P  Y V = P  Y M

Quantity Theory of Money M  V = P  Y Assuming that the velocity of money (V) is constant.

Monetarists say figures like these support their contention that inflation is a monetary phenomenon:

Keynesian/Monetarist Debate Milton Friedman 4 leading spokesman for monetarists 4 advocates steady and slow monetary growth 4 blames most of the economy’s instability on the federal government

New Classical Macroeconomics 4 Rational Expectations 4 Supply-Side Economics

Rational Expectations Hypothesis rational expectations hypothesis The rational expectations hypothesis states that people know the “true model” of the economy and that they use this model to form their expectations of the future.

Lucas Supply Function This supply function embodies the idea that output (Y) depends upon the difference between the actual price level and the expected price level. Y = f(P - P e )

Real Business Cycle Theory real business cycle theory The real business cycle theory is an attempt to explain business cycle fluctuations under the assumptions of complete price and wage flexibility and rational expectations. It emphasizes shocks to technology and other shocks.

Supply-Side Economics 4 focuses on incentives to stimulate supply 4 lower taxes will prompt workers to work harder and save more and firms will invest and produce more 4 uses Laffer Curve to argue the possibility of generating more revenues by cutting tax rates

The Laffer Curve Tax Rates (%) Tax Revenues (dollars) A B

Review Terms & Concepts 4 Laffer Curve 4 Lucas supply function 4 Monetarism 4 New classical macroeconomics 4 Price surprise 4 Quantity theory of money 4 Rational-expectations hypothesis 4 Real business cycle theory 4 Supply-side economics 4 Velocity of money (V)