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Chapter 37 Current Issues in Macro Theory and Policy Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Causes of Macro Instability • Mainstream view • Held by most economists • Price stickiness • Unexpected demand shocks • Variable investment spending • Unexpected supply shocks LO1 37-2 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 37-3 Causes of Macro Instability • Real-business-cycle view • Shifts in long-run aggregate supply Price Level ASLR2 ASLR1 P1 AD1 AD2 Q2 LO1 Q1 Real Domestic Output 37-4 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 37-5 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 37-6 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 LO2 37-7 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 LO3 37-8 Rules or Discretion? • Defense of discretionary stabilization policy • Discretionary monetary policy • Velocity is not stable • Discretionary fiscal policy • Useful during recession • Policy successes LO3 37-9 Rules or Discretion? LO4 37-10 The Taylor Rule • • • • Rules: Passive monetary policy Discretion: Active monetary policy Hybrid policy rule to dictate Fed actions Policy responds to changes in real GDP and inflation • Fed explains deviations from the rule • Increase Fed credibility and reduce uncertainty 37-11
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