Chapter 17

Chapter 17 - Disputes over Macro Theory and Policy CHAPTER...

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Disputes over Macro Theory and Policy CHAPTER SEVENTEEN DISPUTES OVER MACRO THEORY AND POLICY LECTURE NOTES I. Introduction: Disagreements about Macro Theory and Policy A. Learning objectives – In this chapter the students will learn: 1. The differences between the historical Keynesian and classical macro perspectives. 2. About alternative perspectives on the causes of macroeconomic instability, including views held by mainstream economists, monetarists, real-business cycle advocates, and proponents of coordination failures. 3. What the equation of exchange is and how it relates to “monetarism.” 4. Why new classical economists believe the economy will “self-correct” from aggregate demand and aggregate supply shocks. 5. The variations on the debate over “rules” versus “discretion” in conducting stabilization policy. B. This chapter contrasts the classical and Keynesian macroeconomic theories. C. Contemporary disagreements on three inter-related questions are considered. 1. What causes instability in the economy? 2. Is the economy self-correcting? 3. Should government adhere to rules or use discretion in setting economic policy? II. Some History: Classical Economics and Keynes A. Classical economics dominated the discipline from Adam Smith (1776) until the 1930s. It maintained that full employment was normal and that a “laissez-faire” (let it be) policy by government is best. B. Keynes observed in the 1930s that laissez-faire capitalism is subject to recurring recessions or depressions with widespread unemployment, and contended that active government stabilization policy is required to avoid the waste of idle resources. C. Classical View. 1. The aggregate supply curve is vertical and located at the full-employment level of real output. 2. Stress that classical economists believed that real output does not change in response to changes in the price level because wages and other input prices would be flexible. 3. The economy would operate at its full employment level of output because of: a. Say’s law (See Last Word Chapter 9) which states “supply creates its own demand.” b. responsive, flexible prices and wages in cases where there might be temporary over- supply. 4. Money underlies aggregate demand. Classical economists theorize that aggregate demand will be stable as long as the supply of money is controlled with limited growth. 5. The downward sloping demand curve is stable and is solely responsible for setting the price level. (See Figure 17.1a) 10
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Disputes over Macro Theory and Policy 6. Changes in the money supply would shift AD right for an increase and left for decrease, but responsive, flexible prices and wages will insure that full employment output is maintained. D. Keynesian View.
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This note was uploaded on 09/10/2009 for the course ECO 2251 taught by Professor Kirkland during the Spring '09 term at Troy.

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Chapter 17 - Disputes over Macro Theory and Policy CHAPTER...

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