Macroeconomic Conflict and Consensus

Classical Economics Focused on long run only Short run effects, like changes in output, were unimportant Awareness of business cycle, but no consensus on how to respond to it

Keynesian Economics Emphasized importance of short run effects of shifts SRAS upward-sloping, not vertical Legitimized macroeconomic policy activism, use of policy to smooth out the business cycle

Monetarism Believed GDP would grow steadily if money supply grew steadily Supported by Quantitative Theory of Money MV=PQ Wanted to see constant growth of money supply regardless of economic conditions

Inflation and Unemployment Keynes believed macroeconomic policy could be used to maintain full employment in the long run One implication of the natural rate hypothesis is that inflation will continue even in times of high unemployment Stability, not low level, should be the goal

Political Business Cycle Results of election tend to be tied to economic conditions in the six months prior to the election Why monetary policy is preferred by many economists

New Classical Macroeconomics Rational Expectations Theory – Individuals and businesses make decisions based on all available information Real Business Cycle Theory – Slowdowns in productivity growth (attributed to pauses in technology progress) cause recessions

Modern Macroeconomic Consensus General level of Consensus on Five Key Issues: Monetary policy – Effective in shifting AD to reduce economic instability by affecting both price and output; only ineffective in case of liquidity trap Fiscal policy – Effective in shifting AD; should not seek balanced budget, as budget surpluses and deficits act as a stabilizer

Modern Macroeconomic Consensus General level of Consensus on Five Key Issues: NAIRU – Almost universally accepted as true; limited ability of policy to keep unemployment below NAIRU, but can help stabilize near this level Discretionary fiscal policy – Usually counterproductive due to lags; most favor monetary policy except in liquidity trap

Modern Macroeconomic Consensus General level of Consensus on Five Key Issues: Discretionary monetary policy – Still an area of contention, though there is agreement that central bank should be independent Unconventional monetary policies exercised during 2008 Financial Crisis were very controversial.

5 Key Questions of Macroeconomic Theory