• Says’s law : All that is produced will sell because supply creates its own demand. • This school cannot explain a prolonged depression. Any declines in aggregate demand would be temporary. Austrian school of economic thought: • This school is similar to neoclassical but considers the role of the money supply and government actions. • Government intervention may cause a boom-and-bust cycle. COPYRIGHT © 2014 CFA INSTITUTE 43
Keynesian theory of business cycles In the event of lower aggregate demand, lower wages result in lower spending, hence affecting demand further. Very low interest rates would not stimulate the economy because confidence would be too low. Government should intervene in a crisis, running a deficit. Criticisms of this theory: • Government debt could get out of control. • Expansionary policy may cause the economy to grow too fast, resulting in inflation and other ills. • It takes time for fiscal policies to work, so they may be ill timed for a short-term crisis. COPYRIGHT © 2014 CFA INSTITUTE 44
Monetarists Those following the monetarist school of thought object to the Keynesian approach because Keynesian theory • does not consider the role of the money supply. • is not logical in light of utility-maximizing market participants. • ignores the long-term cost of government intervention. • does not consider the unpredictability of the timing of fiscal policy changes on the economy. Monetarists advocate for a steady increase in the money supply and a limited role of government. COPYRIGHT © 2014 CFA INSTITUTE 45
New Classical School The new classical school uses the idea that utility-maximizing agents will seek to maximize profits. Real business cycle (RBC) theory: • Business cycles are the result of the efficient operation of the economy in response to real shocks. • The RBC theory considers unemployment the result of persons wanting wages that are too high. ◦ It is criticized as being an unrealistic assumption. Neo-Keynesians (new Keynesians): • Neo-Keynesians assume slow-to-adjust wages and prices. • Government intervention is needed in the event of disequilibrium. COPYRIGHT © 2014 CFA INSTITUTE 46
Unemployment and inflation Types of unemployment: • Unemployed : People who are actively seeking a job but do not have a job. ◦ Frictionally unemployed are in the process of changing jobs. ◦ Long-term unemployed have been out of work for a long time, but are still looking. • Underemployed : Employed people who have the qualifications to work a higher-paying job. • Discouraged worker : Unemployed person who stopped looking for a job. • Voluntarily unemployed : Person who is outside of the labor force voluntarily. Measures describing the labor market: • Employed : Number of people with a job.
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