No Slide Title CHAPTER 17 The Future of Macroeconomics Questions What might the future of macroeconomics bring? How might the macroeconomics taught two decades from now be different from the macroecon.
CHAPTER 17 The Future of Macroeconomics 17-1 Copyright © 2002 by The McGraw-Hill Companies, Inc All rights reserved Questions • What might the future of macroeconomics bring? • How might the macroeconomics taught two decades from now be different from the macroeconomics taught today? • What have been the principal changes in the way macroeconomics is taught over the past twenty years? 17-2 Copyright © 2002 by The McGraw-Hill Companies, Inc All rights reserved Questions • What additional changes took place twenty years before that from roughly 1960 to roughly 1980? • What direction will macroeconomics take if the real business cycle research program is successful? • What direction will macroeconomics take if the new Keynesian research program proves successful? 17-3 Copyright © 2002 by The McGraw-Hill Companies, Inc All rights reserved Questions • How will economists understand the foundations behind the power of monetary policy? 17-4 Copyright © 2002 by The McGraw-Hill Companies, Inc All rights reserved The Past of Macroeconomics • A 1936 book by John Maynard Keynes shifted economic research and macroeconomic thought into new and different directions – the role of expectations of future profits in determining investment – the volatility of expectations of profits – the power of the government to affect the economy through policy – the multiplier process 17-5 Copyright © 2002 by The McGraw-Hill Companies, Inc All rights reserved The Past of Macroeconomics • After World War II, more macroeconomic theory was developed – the IS-LM model was created – the relationship between interest rates and the money supply was investigated – the difference between the behavior of the macroeconomy in the flexible-price long run and the fixed-price short run was clarified 17-6 Copyright © 2002 by The McGraw-Hill Companies, Inc All rights reserved The Past of Macroeconomics • But macroeconomics theory in 1960 was still incomplete – no discussion of the relationship between production and inflation – no detailed model of expectations – the short run was seen as lasting for decades – fiscal policy was emphasized, while the role of monetary policy was downplayed – estimates of the multiplier were much higher than we believe now to be correct 17-7 Copyright © 2002 by The McGraw-Hill Companies, Inc All rights reserved The Past of Macroeconomics • Between 1960 and 1980, two powerful critiques of the conventional wisdom of macroeconomics occurred – the first was by Milton Friedman • the standard models overestimated the government’s ability to control the economy • the standard models overestimated the power of fiscal policy and underestimated the power of monetary policy • the money supply tells us most of what we need to know about how policy is working • there is a natural rate of unemployment 17-8 Copyright © 2002 by The McGraw-Hill Companies, Inc All rights reserved The Past of Macroeconomics – the second was by Robert Lucas • Keynesian economics fails to think through the importance of expectations • systematic changes in economic policy would change the parameters of the consumption and investment functions as well as the location of the Phillips curve 17-9 Copyright © 2002 by The McGraw-Hill Companies, Inc All rights reserved The Past of Macroeconomics • The late 1980s and 1990s were a time of idea generation and exploration – macroeconomists explored and tested a large number of different ideas and models – the mainstream policy-analytic position of macroeconomists did not shift much 17-10 Copyright © 2002 by The McGraw-Hill Companies, Inc All rights reserved Problems of Real Business Cycle Theory • Money and Business Cycles – real business cycle theorists tend to argue that monetary policy has little impact on production and employment • fluctuations in the money stock and real interest rates are more reactions to changes already taking place – the Federal Reserve believes that it affects the level of interest rates and that its decisions cause changes in production and employment 17-18 Copyright © 2002 by The McGraw-Hill Companies, Inc All rights reserved The Future of Macroeconomics: New Keynesian Economics • Since the 1930s, mainstream macroeconomics has attributed the sluggishness of aggregate supply to stickiness in wages and prices • Therefore, fluctuations in nominal aggregate demand cause fluctuations in output and employment 17-19 Copyright © 2002 by The McGraw-Hill Companies, Inc All rights reserved The Future of Macroeconomics: New Keynesian Economics • Where does this stickiness and slow adjustment of wages and prices come from? – menu costs • it is costly for businesses to change prices – staggered prices and coordination failures • a firm’s best choice for its price may depend on the prices that other firms are charging • this means that wages and prices may exhibit inertia 17-20 Copyright © 2002 by The McGraw-Hill Companies, Inc All rights reserved ... Copyright © 2002 by The McGraw-Hill Companies, Inc All rights reserved Questions • How will economists understand the foundations behind the power of monetary policy? 17-4 Copyright © 2002 by The. .. clarified 17-6 Copyright © 2002 by The McGraw-Hill Companies, Inc All rights reserved The Past of Macroeconomics • But macroeconomics theory in 1960 was still incomplete – no discussion of the relationship... correct 17-7 Copyright © 2002 by The McGraw-Hill Companies, Inc All rights reserved The Past of Macroeconomics • Between 1960 and 1980, two powerful critiques of the conventional wisdom of macroeconomics