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KW_Macro_Ch_17_Sec_04_Rational_Expectations_Real_Business_Cycles_and_New_Classical_Macroeconomics

KW_Macro_Ch_17_Sec_04_Rational_Expectations_Real_Business_Cycles_and_New_Classical_Macroeconomics

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>> The Making of Modern Macroeconomics Section 4: Rational Expectations, Real Business Cycles, and New Classical Macroeconomics chapter 17 As we have seen, one key difference between classical economics and Keynesian eco- nomics is that classical economists believed that the short-run aggregate supply curve is vertical, but Keynes emphasized the idea that the short-run aggregate supply curve slopes upward in the short run. As a result, Keynes argued that demand shocks—shifts in the aggregate demand curve—can cause fluctuations in aggregate output. The challenges to Keynesian economics that arose in the 1950s and 1960s—the renewed emphasis on monetary policy and the natural rate hypothesis—didn’t ques- tion the view that an increase in aggregate demand leads to a rise in aggregate output in the short run and that a decrease in aggregate demand leads to a fall in aggregate output in the short run. In the 1970s and 1980s, however, some economists developed
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2 C H A P T E R 1 7 S E C T I O N 4 : R AT I O N A L E X P E C TAT I O N S, R E A L B U S I N E S S C Y C L E S, A N D N E W C L A S S I C A L M A C R O E C O - an approach to the business cycle known as new classical macroeconomics, which returned to the classical view that shifts in the aggregate demand curve affect only the aggregate price level, not aggregate output. The new approach evolved in two steps. First, some economists challenged traditional arguments about the slope of the short- run aggregate supply curve based on the concept of rational expectations. Second, some economists suggested that changes in productivity cause economic fluctuations, a view known as real business cycle theory.
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