BU204_Krugman_Chapter 17 - > The Making of Modern...

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>> GGRESSIVE MONETARY POL - icy,” declared the 2004 Eco- nomic Report of the President , “can reduce the depth of a recession.” Few modern macroeconomists would disagree. There are many public arguments about macroeconomic policy—arguments that can play a central role in political campaigns. But there is a broad consensus among macro- economists about how the economy works. The view that expansionary monetary policy can be effective in fighting recessions is part of that consensus. And that consensus is re- flected in actual policy: as the two panels of the accompanying figure show, monetary policy responded very aggressively to the 2001 recession. PURGE THE ROTTENNESS? What you will learn in this chapter: Why classical macroeconomics wasn’t adequate for the problems posed by the Great Depression The core ideas of Keynesian eco- nomics How challenges led to a revision of Keynesian ideas The ideas behind new classical macroeconomics The elements of the modern con- sensus, and the main remaining disputes A chapter 415 17 The Making of Modern Macroeconomics Yet today’s consensus about monetary policy didn’t always exist. There was a time when many economists opposed any effort to fight recessions. At the beginning of the Great Depression, Herbert Hoover’s secre- tary of the treasury, Andrew Mellon, was firmly opposed to any monetary expansion. Hoover would later claim that Mellon’s ad- vice was to let the slump take its course: “It will purge the rottenness out of the sys- tem.” This advice reflected the views of many eminent economists of the day, who regarded aggressive monetary policy as dangerous and ineffective. When Franklin Roosevelt, Hoover’s suc- cessor, took office, there was an intense de- bate among his advisers about whether to Money supply (M1, billions of dollars) Year $1,400 1,300 1,200 1,100 1996 1999 2001 2002 2005 (a) The Money Supply Rose Sharply in Response to the 2001 Recession… Federal funds rate Year 8% 6 4 2 1996 1999 2001 2002 2005 (b) …While the Federal Funds Rate Fell Sharply. 2001 Recession 2001 Recession The Fed responded to the 2001 recession, indicated by the shaded area in both panels, with a rapid expansion of the money supply (panel (a)) and sharp cuts in the federal funds rate (panel (b)). Source: Federal Reserve Bank of St. Louis; National Bureau of Economic Research. An Example of Aggressive Monetary Policy
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416 PA R T 7 EVENTS AND IDEAS Classical Macroeconomics The term macroeconomics appears to have been coined in 1933 by the Norwegian econ- omist Ragnar Frisch; the date, during the worst year of the Great Depression, is no ac- cident. Still, there were economists analyzing what we now consider macroeconomic issues—the behavior of the aggregate price level and aggregate output—before then. Money and the Price Level In Chapter 16 we described the classical model of the price level. According to the classical model, prices are flexible, making the aggregate supply curve vertical even in the short run. In this model, an increase in the money supply leads, other things equal, to an equal proportional rise in the aggregate price level, with no effect on aggregate output.
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