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After reading this chapter, you should be able to: Describe alternative perspectives on the causes of macroeconomic instability, including the views of mainstream economists, monetarists, real-business-cycle advocates, and proponents of coordination failures; Explain what the equation of exchange is and how it relates to monetarism; discuss why new classical economists believe the economy will self-correct from aggregate demand and aggregate supply shocks.
19 CurrentIssuesinMacroTheoryand Policy McGrawưHill/Irwin Copyrightâ2012byTheMcGrawưHillCompanies,Inc.Allrightsreserved CausesofMacroInstability Mainstream view Held by most economists • Price stickiness • Unexpected demand shocks • Variable investment spending • Unexpected supply shocks LO1 19-2 Causes of Macro Instability • Monetarist view • Government interference is the problem • Equation of exchange MV = PQ • Stable velocity • Monetary causes of instability • Inappropriate monetary policy LO1 19-3 Causes of Macro Instability • Coordination failures • Fail to reach equilibrium because of lack of coordination mechanism • Limited information • Expectations and self-fulfilling prophecy • Unemployment equilibrium • Inflation equilibrium LO1 19-4 Does the Economy Self Correct? • New classical view • Rational expectations theory • Monetarists • Automatic correction will occur • Speed of adjustment • Unanticipated price-level changes • Fully anticipated price-level changes LO2 19-5 Does the Economy Self Correct? • New Classical View of Self-Correction Price Level ASLR AS2 AS1 c P3 b P2 a P1 AD2 AD1 Q1 Q2 Real Domestic Output LO3 19-6 Does the Economy Self Correct? • New Classical View of Self-Correction ASLR Price Level AS1 AS3 P1 P4 f a d P5 e AD1 AD3 Q Q Q1 Real Domestic Output LO3 19-7 Does the Economy Self Correct? • Mainstream view • Downward wage inflexibility • Efficiency wage theory • Greater work effort • Lower supervision costs • Reduced job turnover • Insider-outsider relationships LO3 19-8 Rules or Discretion? • In support of policy rules • Reduce macro instability • Monetary rule • Shift AD to keep up with AS • Price stability achieved • Inflation targeting • Balanced budget LO4 19-9 Rules or Discretion? • Defense of discretionary stabilization policy • Discretionary monetary policy • Velocity is not stable • Discretionary fiscal policy • Useful during recession • Policy successes LO4 19-10 Rules or Discretion? LO4 19-11 ...Causes of Macro Instability • Mainstream view • Held by most economists • Price stickiness • Unexpected demand shocks • Variable investment spending • Unexpected supply shocks LO1 1 9-2 Causes of Macro Instability... LO1 1 9-3 Causes of Macro Instability • Coordination failures • Fail to reach equilibrium because of lack of coordination mechanism • Limited information • Expectations and self-fulfilling prophecy... Rules or Discretion? • In support of policy rules • Reduce macro instability • Monetary rule • Shift AD to keep up with AS • Price stability achieved • Inflation targeting • Balanced budget LO4 1 9-9 Rules or Discretion?