Module 35 Summary Alternate Theories.

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Presentation transcript:

Module 35 Summary Alternate Theories

Classical Theory Adam Smith Stable in LONG RUN Bad monetary policy causes instability Wages and prices fully flexible Laissez faire Money supply changes increase price level but NOT output Fiscal policy makes problems worse (inflation higher or recession deeper

Keynesian Theory John Maynard Keynes Unstable AS shocks or AD changes (esp. investment) Wages are sticky and prices are downwardly inflexible Fiscal and monetary policy needed Money supply change affects investment and consumption Fiscal policy can change AD x multiplier effect

Monetarism Milton Friedman Stable in LONG RUN Bad monetary policy Wages are sticky but prices are fully flexible Monetary Rule (MV = PQ) Money supply changes directly change AD and GDP Fiscal policies DO NOT change output

Rational Expectations Theory Ronald Lucas Stable in LONG RUN Unexpected AS/AD shocks Wages and prices are fully flexible Monetary rule (MV = PQ) No effect because people expect price level changes No effect because people expect PL changes