Mod 35_ History and Alternative Views of...

Justin Sousa 1
December 7, 2016
Mod 35: History and Alternative Views of Macroeconomics
Money and the Price Level
- Previously discussed, the classical model of the price level states that prices are flexible,
making the aggregate supply curve vertical even in the short-run
- The attitude of regarding short-run effects as unimportant led to the development of John
Maynard Keynes’ scoff of the focus on long-run effects
The Business Cycle
- In 1920, Wesley Mitchell founded the National Bureau of Economic Research, an
independent, nonprofit organization that declares the beginnings of recessions and
expansions
- However, economists lacked a solid theory of of business cycles and therefore were
unable to settle on the proper policies to take in certain economic situations
Keynes’ Theory
- Keynes’ The General Theory of Employment, Interest, and Money is arguably one of the
most influential pieces on economics ever written
- Panel A: The short-run aggregate supply curve is vertical. The decline in AD leads to a
fall in the aggregate price level, from P
1
to P
2
, but no change in the aggregate output
- Panel B: Short-run aggregate supply curve slopes upward, so decline in AD leads to both
a fall in aggregate price level, from P
1
to P
2
, and a fall in aggregate output, from Y
1
to Y
2
.
- Keynesian economics reflected two main innovations:
- Keynes emphasized the short-run effects of shifts in aggregate demand on
aggregate output, rather than the long-run determination of the aggregate price
- Factors besides money supply affected the shifts of the AD curve (business
confidence)
Policy to Fight Recessions

Justin Sousa 2
December 7, 2016
- The main practical consequence of Keynes’ work was that it legitimized macroeconomic
policy activism, the us of monetary and fiscal policy to smooth out the business cycle
The Revival of the Monetary Policy
- The term liquidity trap , was developed through Keynes’ idea that monetary policy would
be useless in times of near 0% interest rates
- Monetary went into a short retirement from assisting in economic management when the
interest rate remained close to 0% even after WWII
- Milton Friedman and Anna Schwartz, however, reinstated the use of the monetary
policy after showing how preventions that the Fed should have taken to combat
the monetary constriction would have helped avoided the Great Depression
-