Current Issues in Macro Theory and Policy McGraw-Hill/Irwin

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>Current Issues in Macro Theory and Policy McGraw-Hill/Irwin      Current Issues in Macro Theory and Policy McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

>Causes of Macro Instability Mainstream view Held by most economists Price stickiness Unexpected demand Causes of Macro Instability Mainstream view Held by most economists Price stickiness Unexpected demand shocks Variable investment spending Unexpected supply shocks LO1 36-2

>Causes of Macro Instability Monetarist view Government interference is the problem Equation of exchange 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 36-3

>Causes of Macro Instability Coordination failures Fail to reach equilibrium because of lack of 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 36-4

>Does the Economy Self Correct? New classical view  Rational expectations theory Monetarists Automatic 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 36-5

>New Classical View of Self-Correction AD2 AD1 AS1 AS2 ASLR Price Level P1 P2 New Classical View of Self-Correction AD2 AD1 AS1 AS2 ASLR Price Level P1 P2 P3 Real Domestic Output Q1 Q2 a b c Does the Economy Self Correct? LO3 36-6

>New Classical View of Self-Correction AD3 AD1 AS1 AS3 ASLR Price Level P1 P4 New Classical View of Self-Correction AD3 AD1 AS1 AS3 ASLR Price Level P1 P4 P5 Real Domestic Output Q1 Q4 Q3 a e d f Does the Economy Self Correct? LO3 36-7

>Does the Economy Self Correct? Mainstream view Downward wage inflexibility Efficiency wage theory Greater 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 36-8

>Rules or Discretion? In support of policy rules Reduce macro instability Monetary rule Shift 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 36-9

>Rules or Discretion? Defense of discretionary stabilization policy Discretionary monetary policy Velocity is not Rules or Discretion? Defense of discretionary stabilization policy Discretionary monetary policy Velocity is not stable Discretionary fiscal policy Useful during recession Policy successes LO4 36-10

>Rules or Discretion? LO4 36-11 Rules or Discretion? LO4 36-11