Module 36 The Modern Macroeconomic Consensus KRUGMANS MACROECONOMICS

Module 36 The Modern Macroeconomic Consensus KRUGMAN'S MACROECONOMICS for AP* Margaret Ray and David Anderson

Housekeeping • Read Modules 35 -36 • Test on Modules 31 -36 • Wednesday P 5 s • Thursday P 3 s

What you will learn in this Module: • Disinflation, deflation and the liquidity trap • Primary macro-economic theories: Classical, Keynesian, and Monetarist • Modern consensus on effectiveness of fiscal and monetary policies.

Disinflation vs. Deflation What is…… § Disinflation § Deflation What are the effects of each?

Liquidity Trap & Zero Bound

Applying theory • Assume disinflation changes inflationary expectations. • Show this affects the SRPC. • Assume we are in a liquidity trap. • Draw a money market graph and indicate where the liquidity trap may occur.

Quiz Hayek & Friedman

Hayek vs. Keynes What are their views on fiscal policy? Keynes vs Hayek

Classical Macroeconomics: Money and the Price Level • %∆ M = % ∆ PL • Short-Run Effects Unimportant • Focus on the Long. Run • Keynes - “ (in the long run) we are all dead. ”

Classical Macroeconomics: The Business Cycle • Business cycle caused by expansion and contraction of credit. • Self-correcting • Fiscal policies distort prices and production. Delay natural correction.

Keynes’s Theory Classical Theory Keynesian Theory

Keynes’s Theory • The General Theory • Classical View • Keynesian View • “Animal Spirits”

Challenges to Keynesian Economics: The Revival of Monetary Policy • A Monetary History of the United States, 1867 - 1960 • Great Depression caused by Fed contracting the money supply • Money matters. University of Chicago Economist, Milton Friedman

Challenges to Keynesian Economics: Monetarism § Expansionary fiscal policy leads to crowding out. § Discretionary monetary policy has lags and may make things worse. § Monetary rule: steady money supply growth leads to stable economic growth.

Economics Debate: January 2009 § Teams represent classical, Keynesian and monetarist economics. § One team will present opening arguments. The other will give the rebuttal. § What advice would you give President Obama?

Challenges to Keynesian Economics: Inflation and the Natural Rate of Unemployment • Natural Rate Hypothesis • Limit to Discretionary Policy • Stagflation of 1970 s proof of Hypothesis • Natural Rate widely accepted

Challenges to Keynesian Economics: The Political Business Cycle • Consequences of Keynes on Politics • Election Day Economics • Political Business Cycle President Obama and Senator Mc. Cain • The need for central bank independence

Rational Expectations, Real Business Cycles, and New Classical Macroeconomics • Rational Expectations: prices and wages are not sticky. React to anticipated inflation. • Real Business Cycle Theory: cycles result from changes in productivity.

Modern Consensus • Expansionary fiscal policy – ineffective due to lags. • Automatic stabilizers – effective • Expansionary monetary policy – effective • Long run unemployment – unaffected by either fiscal or monetary policy.

The Modern Consensus