History and Alternate Views of Macroeconomics and The Modern Macroeconomic Consensus Lesson 36 Sections 35, 36

Classical Macroeconomics (35) Money and Price Level Classical economists claim that increasing the money supply has no effect on output, and only increased prices in the long run, and the aggregate supply is vertical Keynes: “in the long run, we are all dead.” The Business Cycle During the Great Depression there was no complete theory of business cycles, and in the absence of business cycle theory most economists at the time rejected doing anything about the Depression because they thought any action would just make it worse. The Great Depression and the Keynesian Revolution Keynes’s Theory Keynes believed that aggregate supply is curved and focused on short run aggregate demand and supply to show how changes in demand can change output Policy to Fight Recessions Keynes theories proposed to smooth out the business cycle by spending during recession and restraint during growth. Classical economists strongly disagreed.

Challenges to Keynesian Economics The Revival of Monetary Policy Milton Friedman: policy should be set by monetary policy, not fiscal policy because of politics (ie. Claiming that monetary policy was non-political*) Monetarism GDP will grow if the money supply expands (ex. target 3%) Discretionary Monetary Policy Changes in interest rates or money supply Quantity Theory of Money Amount of money in supply as a ratio of GDP Velocity of Money Inflation and the Natural Rate of Unemployment Natural Rate Hypothesis Back to the theory that aggregate supply is vertical Milton Friedman created this theory to discredit Keynesianism using the 1970’s stagflation as a proof (but this was caused by external crisis, not internal) The Political Business Cycle Your book once again tries to make the argument that fiscal policy is too political and that independent central banks were much better to handle these issues

Rational Expectation, Real Business Cycles, and New Classical Macroeconomics Once again trying to reject Keynesianism to go back to classical theory Rational Expectations The Rational Actor Theory New Keynesian Economics Keynesian sticky prices Real Business Cycles Real Business Cycle Theory The claim that aggregate supply is vertical and that recessions and growth occur when the aggregate supply curve moves (again rejecting Keynesianism)

The Modern Consensus(?) (35) Classical Macroeconomics Keynesian Macroeconomics Monetarism Modern Consensus Is Expansionary Monetary Policy Helpful in Fighting Recessions? No Not Very Yes Yes* Is Expansionary Fiscal Policy effective in Fighting Recessions? Can Monetary and/or Fiscal Policy Reduce Unemployment in the Long Run? Should Fiscal Policy be Used in a Discretionary Way? No* Should Monetary Policy be Used in a Discretionary Way? Still In Dispute * Except in special cases

The Modern Consensus Central Bank Targets Asset Prices Some banks target a specific number for inflation Asset Prices Should there be intervention if asset prices are in a bubble? No consensus. Unconventional Monetary Policies During the 2008 crisis, The Fed lent huge sums of money, bought commercial paper (bonds), and large scale purchases of private assets. (still controversial) The Clean Little Secret of Macroeconomics We all agree? On many things yes. (actually less agreement than the book suggests)