1. Module 35 Summary
Alternate Theories

2. Classical Theory Adam Smith Stable in LONG RUN
Bad monetary policy causes instability
Wages and prices fully flexible
Laissez faire
Money supply changes increase price level but NOT output
Fiscal policy makes problems worse (inflation higher or recession deeper

3. Keynesian Theory John Maynard Keynes Unstable
AS shocks or AD changes (esp. investment)
Wages are sticky and prices are downwardly inflexible
Fiscal and monetary policy needed
Money supply change affects investment and consumption
Fiscal policy can change AD x multiplier effect

4. Monetarism Milton Friedman Stable in LONG RUN Bad monetary policy
Wages are sticky but prices are fully flexible
Monetary Rule (MV = PQ)
Money supply changes directly change AD and GDP
Fiscal policies DO NOT change output

5. Rational Expectations Theory
Ronald Lucas
Stable in LONG RUN
Unexpected AS/AD shocks
Wages and prices are fully flexible
Monetary rule (MV = PQ)
No effect because people expect price level changes
No effect because people expect PL changes