Classical Economics and Keynes Classical Theory Keynesian View

Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View 19 CHAPTER Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide End Show 19 - 1 Disputes Over Macro Theory and Policy Next Slide Copyright Mc. Graw-Hill/Irwin, 2002

CLASSICAL ECONOMICS AND KEYNES Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide End Show 19 - 2 Next Slide Classical Economics Adam Smith - 1776 Laissez-faire The Classical View Vertical Aggregate Supply Curve Stable Aggregate Demand Real Output Depends Upon… • Quantity of money possessed by households & businesses • Purchasing power of money is determined by the price level Copyright Mc. Graw-Hill/Irwin, 2002

Classical Theory Classical Economics and Keynes AS Classical Theory Keynesian View Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Price Level Causes of Macro Instability P 1 AD 1 Key Terms Previous Slide End Show 19 - 3 Next Slide Q 1 Real Domestic Output Copyright Mc. Graw-Hill/Irwin, 2002

Classical Theory Classical Economics and Keynes AS Classical Theory Keynesian View Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Price Level Causes of Macro Instability P 1 P 2 AD 1 Key Terms AD 2 Previous Slide End Show 19 - 4 Next Slide Q 1 Real Domestic Output Copyright Mc. Graw-Hill/Irwin, 2002

CLASSICAL ECONOMICS AND KEYNES Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide End Show 19 - 5 Next Slide Keynesian Economics John Maynard Keynes, 1930 s The Keynesian View Prices and Wages Downwardly Inflexible Active Government Policy Required to Stabilize the Economy Horizontal Aggregate Supply Curve to Full-Employment Unstable Aggregate Demand Copyright Mc. Graw-Hill/Irwin, 2002

Keynesian View AS Classical Economics and Keynes Classical Theory Keynesian View Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Price Level Causes of Macro Instability P 1 AD 1 Key Terms Previous Slide End Show 19 - 6 Next Slide Q 1 Real Domestic Output Copyright Mc. Graw-Hill/Irwin, 2002

Keynesian View AS Classical Economics and Keynes Classical Theory Keynesian View Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Price Level Causes of Macro Instability P 1 AD 1 Key Terms AD 2 Previous Slide End Show 19 - 7 Next Slide Q 2 Q 1 Real Domestic Output Copyright Mc. Graw-Hill/Irwin, 2002

CAUSES OF MACRO INSTABILITY Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide End Show 19 - 8 Mainstream View Changes in Investment Ca + Ig + Xn + G = GDP Adverse Aggregate Supply Shocks Monetarist View Equation of Exchange M V = P Q = GDP Next Slide Stable Velocity Copyright Mc. Graw-Hill/Irwin, 2002

CAUSES OF MACRO INSTABILITY Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide End Show 19 - 9 Next Slide Summary Mainstream View Instability of Investment is the Main Cause of Output Changes Monetary Policy is a Stabilizing Factor Monetarist View With a Stable Velocity, Nominal GDP Depends Upon the Money Supply Copyright Mc. Graw-Hill/Irwin, 2002

Real Business Cycle View Classical Economics and Keynes Real-Business-Cycle Theory ASLR 1 Classical Theory Keynesian View Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Price Level Causes of Macro Instability P 1 AD 1 Key Terms Previous Slide End Show 19 - 10 Next Slide Q 1 Real Domestic Output Copyright Mc. Graw-Hill/Irwin, 2002

Real Business Cycle View Classical Economics and Keynes Real-Business-Cycle Theory ASLR 2 ASLR 1 Classical Theory Keynesian View Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Price Level Causes of Macro Instability P 1 AD 1 Key Terms Previous Slide End Show 19 - 11 Next Slide Q 2 Q 1 Real Domestic Output Copyright Mc. Graw-Hill/Irwin, 2002

Real Business Cycle View Classical Economics and Keynes Real-Business-Cycle Theory ASLR 2 ASLR 1 Classical Theory Keynesian View Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Price Level Causes of Macro Instability Recession With Stable Price Levels P 1 AD 2 Key Terms Previous Slide End Show 19 - 12 Next Slide Q 2 Q 1 Real Domestic Output Copyright Mc. Graw-Hill/Irwin, 2002

Real Business Cycle View Classical Economics and Keynes Real-Business-Cycle Theory ASLR 2 ASLR 1 Classical Theory Keynesian View Causes of Macro Instability Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Recession With Stable Price Levels Coordination P Failures Price Level Real Business Cycle View 1 AD 2 Key Terms Previous Slide End Show 19 - 13 Next Slide Q 2 Q 1 Real Domestic Output Copyright Mc. Graw-Hill/Irwin, 2002

DOES THE ECONOMY SELF-CORRECT? Classical Economics and Keynes New Classical View Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide End Show 19 - 14 Next Slide Self-Correction? Rational Expectations Theory Speed of Adjustment Unanticipated Price Changes “Price Level Surprises” Fully Anticipated Price-Level Changes Copyright Mc. Graw-Hill/Irwin, 2002

NEW CLASSICAL VIEW OF SELF-CORRECTION An increase in AD ASLR Classical Economics and Keynes AS 1 Classical Theory Causes of Macro Instability Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Price Level Keynesian View Self. Correction P 1 a Key Terms AD 1 Previous Slide End Show 19 - 15 Next Slide Q 1 Real Domestic Output Copyright Mc. Graw-Hill/Irwin, 2002

NEW CLASSICAL VIEW OF SELF-CORRECTION An increase in AD ASLR Classical Economics and Keynes AS 1 Classical Theory Causes of Macro Instability Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Price Level Keynesian View Selfb Correction P 2 P 1 a Key Terms AD 2 AD 1 Previous Slide End Show 19 - 16 Next Slide Q 1 Real Domestic Output Copyright Mc. Graw-Hill/Irwin, 2002

NEW CLASSICAL VIEW OF SELF-CORRECTION An increase in AD ASLR Classical Economics and Keynes AS 2 Classical Theory AS 1 Causes of Macro Instability Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Price Level Keynesian View Selfc b Correction P 3 P 2 P 1 a Key Terms AD 2 AD 1 Previous Slide End Show 19 - 17 Next Slide Q 1 Real Domestic Output Copyright Mc. Graw-Hill/Irwin, 2002

DOES THE ECONOMY SELF-CORRECT? Classical Economics and Keynes Mainstream View Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide End Show 19 - 18 Next Slide Downward Wage Inflexibility Efficiency Wage Theory • Greater Work Effort • Lower Supervision Costs • Reduced Job Turnover Insider-Outsider Theory and Relationships Copyright Mc. Graw-Hill/Irwin, 2002

RULES OR DISCRETION? Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide End Show 19 - 19 Next Slide In Support of Policy Rules Monetary Rule Balanced Budget In Defense of Discretionary Stabilization Policy Discretionary Monetary Policy Discretionary Fiscal Policy Increased Macro Stability Copyright Mc. Graw-Hill/Irwin, 2002

RATIONALE FOR A MONETARY RULE Classical Economics and Keynes Federal Reserve Increases Money Supply at the Long-Run Growth Rate of GDP ASLR 1 ASLR 2 Classical Theory Keynesian View Fed Increases The Money Supply Resulting in… Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide End Show 19 - 20 Price Level Causes of Macro Instability P 1 P 2 AD 1 Next Slide Q 1 Q 2 Real Domestic Output, GDP Copyright Mc. Graw-Hill/Irwin, 2002

RATIONALE FOR A MONETARY RULE Classical Economics and Keynes Federal Reserve Increases Money Supply at the Long-Run Growth Rate of GDP ASLR 1 ASLR 2 Classical Theory Keynesian View Growth Without Inflation or Deflation Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide End Show 19 - 21 Price Level Causes of Macro Instability P 1 P 2 Next Slide AD 2 AD 1 Q 2 Real Domestic Output, GDP Copyright Mc. Graw-Hill/Irwin, 2002

RULES OR DISCRETION? Classical Economics and Keynes Classical Theory Keynesian View Summary of Alternative Views Causes of Macro Instability Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Chapter Conclusions Key Terms Previous Slide End Show 19 - 22 Next Slide Copyright Mc. Graw-Hill/Irwin, 2002

classical view Keynesian view monetarism equation of exchange velocity real-business-cycle theory coordination failures rational expectations theory new classical economics price-level surprises efficiency wage insider-outsider theory monetary rule Copyright Mc. Graw-Hill/Irwin 2002 BACK END

Next: Classical Economics and Keynes Classical Theory Keynesian View Causes of Macro Instability Real Business Cycle View Does the Economy Self. Correct? New Classical View of Self-Correction Rules or Discretion Rationale for Monetary Rule Key Terms Previous Slide End Show 19 - 24 Supply And Demand Elasticities And Government-Set Prices Next Slide Chapter 20 Copyright Mc. Graw-Hill/Irwin, 2002