Download Module The Modern Macroeconomic Consensus

Pump Primer:
• Write the five key questions
about Macroeconomics
Policy.
Module 36
The Modern
Macroeconomic
Consensus
KRUGMAN'S
MACROECONOMICS for AP*
Margaret Ray and David Anderson
Biblical Integration:
• Money is not wealth, it is just merely a
resource given to us by God to sustain
our life her on this earth. Economist even
recognize that gold is merely a shiny
mineral whose sole value lies in the fact
that others hold it to be of value. The true
believer recognizes that Scripture and
the blood of Christ are intrinsically
valuable. They retain their value even if
the world denies their efficacy.
What you will learn
in this Module:
• The elements of the modern
macroeconomic consensus
• The main remaining disputes
The Modern Consensus
The previous module separated
economic debates into several
macroeconomic schools of thought. On
paper, there are striking differences
between some of them.
However in practice, as more years of
data have been observed, there exists
more of a growing consensus amongst
macroeconomists then the previous
module might suggest.
The Modern Consensus
Should Monetary Policy Be Used in a
Discretionary Way?
A. Is Expansionary Monetary Policy Helpful in
Fighting Recessions?
Classical economics really didn’t believe that monetary
policy would reverse a recession. Keynesians thought
it could have limited effectiveness.
Should Monetary Policy Be Used in a
Discretionary Way?
• Milton Friedman and his followers convinced
economists that monetary policy is effective.
• Nearly all macroeconomists now agree that monetary
policy can be used to shift the aggregate demand
curve and to reduce economic instability.
• The classical view that changes in the money supply
affect only aggregate prices, not aggregate output,
has few supporters today.
• The view once held by some Keynesian
economists—that changes in the money supply have
little effect—has equally few supporters.
• Now, it is generally agreed that monetary policy is
ineffective only in the case of a liquidity trap.
Should Monetary Policy Be Used in a
Discretionary Way?
B. Is Expansionary Fiscal Policy Effective in
Fighting Recessions?
Classical macroeconomists were even more
opposed to fiscal expansion than monetary
expansion.
Keynesian economists, on the other hand, gave
fiscal policy a central role in fighting recessions.
Should Monetary Policy Be Used in a
Discretionary Way?
Monetarists argued that fiscal policy was ineffective
as long as the money supply was held constant. But
that strong view has become relatively rare.
Most macroeconomists now agree that fiscal
policy, like monetary policy, can shift the
aggregate demand curve.
Most macroeconomists also agree that the
government should not seek to balance the
budget regardless of the state of the economy:
they agree that the role of the budget as an
automatic stabilizer helps keep the economy on
an even keel.
Should Monetary Policy Be Used in a
Discretionary Way?
C. Can Monetary and/or Fiscal Policy Reduce
Unemployment in the Long- Run?
Classical macroeconomists didn’t believe the
government could do anything about
unemployment. Some Keynesian economists
moved to the opposite extreme, arguing that
expansionary policies could be used to achieve
a permanently low unemployment rate, perhaps
at the cost of some inflation. Monetarists
believed that unemployment could not be kept
below the natural rate.
Should Monetary Policy Be Used in a
Discretionary Way?
 Almost all macroeconomists now accept the
natural rate hypothesis and agree on the
limitations of monetary and fiscal policy.
 They believe that effective monetary and fiscal
policy can limit the size of fluctuations of the
actual unemployment rate around the natural
rate, but can’t keep unemployment below the
natural rate.
Should Monetary Policy Be Used in a
Discretionary Way?
D. Should Fiscal Policy Be Used in a
Discretionary Way?
Today most macroeconomists believe that tax
cuts and spending increases are at least
somewhat effective in increasing aggregate
demand.
Should Monetary Policy Be Used in a
Discretionary Way?
Many, but not all, macroeconomists believe that
discretionary fiscal policy is usually
counterproductive: the lags in adjusting fiscal
policy mean that, all too often, policies
Intended to fight a slump end up intensifying a
boom.
As a result, the macroeconomic consensus gives
monetary policy the lead role in economic
stabilization. Discretionary fiscal policy plays
the
leading role only in special circumstances
when monetary policy is ineffective, such as
those facing Japan during the 1990s when
interest rates were at or near the zero bound
Should Monetary Policy Be Used in a
Discretionary Way?
E. Should Monetary Policy Be Used in a
Discretionary Way?
Classical macroeconomists didn’t think that
monetary policy should be used to fight
recessions; Keynesian economists didn’t
oppose discretionary monetary policy, but
they were skeptical about its
effectiveness.
Monetarists argued that discretionary
monetary policy was doing more harm
than
good.
Should Monetary Policy Be Used in a
Discretionary Way?
Today there is a broad consensus among
macroeconomists on these points:
Monetary policy should play the main role in stabilization
policy
The central bank should be independent, insulated from
political pressures, in order to avoid a political
business cycle.
Discretionary fiscal policy should be used sparingly,
both because of policy lags and because of the risks
of a political business cycle.
Should Monetary Policy Be Used in a
Discretionary Way?
1. Central Bank Targets
Some central banks have announced
specified inflation targets. This provides more
information to the public about how the
central bank would take action if actual inflation
got out of line with the target.
The Federal Reserve does not announce a
target rate of inflation, although some
observers believe that Fed actions are
consistent with a target of about 2%.
Should Monetary Policy Be Used in a
Discretionary Way?
2. Asset Prices
Should the Fed be pro-actively influencing the stock
market, real estate market or any asset market?
For example, if the Fed thought the stock market
was at an unsustainably high level, should the Fed
intervene and try to slow down investors? Some
people don’t want the Fed to intervene in any
market.
However, if the stock market bubble bursts, the
damage can be very painful, so maybe the Fed
should prevent that from happening.
Should Monetary Policy Be Used in a
Discretionary Way?
3. Unconventional Monetary Policies
Desperate times require desperate measures.
In 2008 when the financial system seemed on
the verge of collapse, the Fed took some
steps that don’t normally appear in the Fed’s
playbook.