1. Policy: The Promise and the Problems
Chapter 15

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

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

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

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

6. 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

7. 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

8. 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

10. 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

11. 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

12. 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.”

13. 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

14. 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