macroecon notes-unit6.docx - 6.01 Modern Theories One of...

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6.01 Modern Theories One of the things that makes solving national economic problems so difficult is that often the experts do not agree on how to solve the problem and, often, even disagree on what is the problem! This is not unique to economics, as this occurs with many problems, but unlike many other issues, the economy affects us all. Why do the experts disagree in economics? There are several possible reasons: o Different Time Period: Economists might have different opinions on the effect of national policy, and they may all be correct because some are discussing a six- month time period and the others may be discussing a two-year time period. o Different Assumptions: In considering what the problem is or how a solution will work, each economist might have different basic assumptions. If you believe that the GDP will grow in the next fiscal year, and I do not, we would have completely different ideas about what national problems will occur and how to deal with them. o Different Theories: There are several schools of thought that economists have in the Macroeconomic world. If one is a Keynesian and another is a Classicalist, they will have very different opinions on what is right or wrong with the economy and how to deal with that situation. o Different Values: Some economists may share the same assumptions and theories, but some believe that inflation is the most important issue that must be dealt with, while the others believe that unemployment is the most important issue facing the economy. These different values would lead to different opinions on what steps to take. Monetarism Similar to Classical theory, monetarism is most often associated with Milton Friedman, who argued that Keynesian policy was ineffective because of crowding out and crowding in. Monetarists believe that the economy is stable in the long run. Therefore, the Fed should follow a monetary rule designed to increase the money supply by three to five percent per year to spur a matching increase in GDP. By doing that, there will not be enough money flowing through the economy to sustain inflation, or, in the case of a recession, the injection of money will increase output causing unemployment to decrease. Supply Side Economics Ronald Reagan summed up supply side economics with one famous quote: "Government is not the answer to your problems; Government is the problem." What the president meant by this statement is that decades of taxing and regulation had reduced the nation's ability to produce at maximum levels of efficiency. Economically speaking, the government had, by way of taxing and regulation, reduced the aggregate supply of the nation—shifting the AS curve to the left. The result was a permanent state of reduced output, which, supply side economists argued, could only be addressed by shifting the AS curve back to the right. Please read the information below to see how the policy of supply side economics works, as well as some of the pitfalls that come with this school of thought.
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