CHAPTER 34 The Making of Modern Macroeconomics PowerPoint® Slides by Can Erbil © 2005 Worth Publishers, all rights reserved

2 What you will learn in this chapter: Why classical macroeconomics wasn’t adequate for the problems posed by the Great Depression The core ideas of Keynesian economics How challenges led to a revision of Keynesian ideas The ideas behind new classical macroeconomics The elements of the modern consensus, and the main remaining disputes

3 The Feds Response to the 2001 Recession

4 Classical Macroeconomics Money and the Price Level Classical macroeconomics asserted that monetary policy affected only the aggregate price level, not aggregate output, and that the short run was unimportant. By the 1930s, measurement of business cycles was a well established subject, but there was no widely accepted theory of business cycles.

5 When Did the Business Cycle Begin?

6 Classical Versus Keynesian Macroeconomics

7 Fiscal Policy and the End of the Great Depression

8 The Fisher Effect

9 Challenges to Keynesian Economics  The Revival of Monetary Policy – Milton Friedman  Monetarism

10 Fiscal Policy with a Fixed Money Supply

11 The Velocity of Money

12 Inflation and the Natural Rate of Unemployment The natural rate of unemployment is also the non-accelerating- inflation rate of unemployment, or NAIRU.  inflation eventually gets built into expectations, so any attempt to keep the unemployment rate below the natural rat will lead to an ever-rising inflation rate.

13 Rational Expectations, Real Business Cycles, and New Classical Macroeconomics New classical macroeconomics is an approach to the business cycle that returns to the classical view that shifts in the aggregate demand curve affect only the aggregate price level, not aggregate output. Rational expectations is the view that individuals and firms make decisions optimally, using all available information.

14 Total Factor Productivity and the Business Cycle Real business cycle theory says that fluctuations in the rate of growth of total factor productivity cause the business cycle.

15 The Modern Consensus Five Key Questions About Macroeconomic Policy:

16 Current Debate - Explicit inflation targets - Whether monetary policy should take asset prices into account.

17 The End of Chapter 34 coming attraction: Chapter 18: International Trade