Download School`s of Economic Thought

Macroeconomic Theories
Classical & Keynesian
versus
New Classical & Supply Side
CLASSICAL VIEW
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Markets are naturally self regulating
No government intervention necessary
Recessions are temporary
Wages & prices are flexible
Savings = Investment
Says law: Supply will create its own demand
Against: minimum wages, welfare & Gov’t assistance
Great Depression challenged Classical View
9-2b
Classical View
FIGURE 9-1
Aggregate Supply and Aggregate Demand in Classical Economics
KEYNSIAN VIEW
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Economy is inherently unstable & not self adjusting
Recessions are long & often permanent
Major government intervention necessary to stimulate AD
Wages & prices are sticky or fixed
Support welfare & Gov’t assistance
Lack of consumer demand caused great depression
AS curve is very flat or horizontal
Interest rates changes are not effective during recession
– Money Demand not very sensitive to interest rates
Keynesian View
AS
Price
Level
AD
Real GDP
Macroeconomic Debates
• Two major schools decidedly against government
intervention have developed:
– Monetarism & New Classical Economics
Monetarism
• Main message: money matters & the economy self-regulates
• Monetarism believes in the Quantity Theory of Money
– MV = PQ, Inflation is purely a monetary phenomena
• Generally do not advocate activist monetary policy stabilization:
– expanding money supply during bad times and slowing during good
• Focus on price stability
• Theory not compatible with upward sloping AS curve
New Classical
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Attempted to explain stagflation of 1970’s
Business Cycles happen, but recessions are temporary
AS could be broken down into Short-run & Long run curves
Government intervention is unnecessary
–Prices/wages are flexible in long run, sticky in short-run
• People make decisions on rational expectations
–This explains “shocks” to the system
9-2l
New Classical Model
Both models can be used as a “New Classical Model”
LR
FIGURE 9-5
Aggregate Supply in the New Classical Model
SRAS
Supply-Side Policy
• Government Incentives Matter
• Goal: use incentives to shift the aggregate supply curve right
• The supply-side toolbox consists of:
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Tax cuts to stimulate work effort, saving, and investment
Deregulation to reduce production cost/stimulate investment.
Expenditures on education training/research expands capacity to produce
Immigration policies alter the size/skill of labor force
9-4
Summary
• No theory is designed to explain all the complex
relationships of a macroeconomy
• There is no simple relationships that can be easily
manipulated to neatly solve various problems as they arise.
• Assessing economic theories would be easier if we lived in
closed economies.