Macro Roots

8/8/2019 Macro Roots

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The Roots of ModernThe Roots of ModernMacroeconomicsMacroeconomics



The Roots of Modern MacroeconomicsThe Roots of Modern Macroeconomics

Setting the Scene: Three

Key Issues

Setting the Scene: ThreeKey Issues



THREE KEY ISSUESTHREE KEY ISSUES

s Issue 1: Flexibility of prices and wages

( the right: flexible prices and wages

( the left: price and wage rigidities

s Issue 2: Flexibility of aggregate supply

( the right: aggregate supply determined

independently of aggregate demand









Different aggregate supply curves: (a)Different aggregate supply curves: (a)

O

AS

Price le

vel

National output

Y





O

P 1

Price le

vel

National output

AD2

P 2

Y

AS

AD1

Different aggregate supply curves: (a)Different aggregate supply curves: (a)










( the left: aggregate supply responsive tochanges in aggregate demand










Different aggregate supply curves: (b)Different aggregate supply curves: (b)

O

AS Price le

vel

National output

P



O

AS Price le

vel

National output

Y 1

P

AD1




O

AS

Y 1

Price le

vel

National output

Y 2

P

AD2

AD1





s Issue 1: Flexibility of prices and wages( the right: flexible prices and wages



( the right: aggregate supply determinedindependently of aggregate demand


( some consensus on nature of short-run AS curve

s Issue 1: Flexibility of prices and wages( the right: flexible prices and wages



( the right: aggregate supply determinedindependently of aggregate demand


( some consensus on nature of short-run AS curve



Different aggregate supply curves: (c)Different aggregate supply curves: (c)

O

Price le

vel

National output

AS



O

AS

Price le

vel

National output

Y 1

P 1

AD1




O

AS

Y 1

Price le

vel

National output

Y 2

P 1

P 2

AD2

AD1




s Issue 3: The role of expectations in theworking of the market

( the right: expectations adjust rapidly to

changes in prices

( the left: expectations of prices depend onexpectations of output and employment

s Issue 3: The role of expectations in theworking of the market

( the right: expectations adjust rapidly to

changes in prices

( the left: expectations of prices depend onexpectations of output and employment





Classical

Macroeconomics

Classical

Macroeconomics



CLASSICAL MACROECONOMICSCLASSICAL MACROECONOMICS

s Classical analysis of output andemployment( markets clear

3 labour market

3market for loanable funds

s Classical analysis of output andemployment( markets clear

3 labour market

3market for loanable funds



O

Saving (supply)

Investment (demand)

Rateo f

interest

Quantity of loanable funds

The market for loanable fundsThe market for loanable funds



O

Saving (supply)

Investment (demand)

Rateo f

interest


r 1




O

Saving (supply)

Investment (demand)

Rateo f

interest


r 1




O

Saving (supply)

Investment (demand)

Rateo f

interest


r 2




O

Saving (supply)

Investment (demand)

Rateo f

interest


r 2


Th k f l bl f d



O

Saving (supply)

Investment (demand)

Rateo f

interest


r e





s

Classical analysis of output andemployment( markets clear

3 labour market3

market for loanable funds3market for imports and exports:the gold standard

s


3 labour market3





s


3 labour market3


( Say’s law

s


3 labour market3


( Say’s law




s


3 labour market3


( Say’s law

s Classical analysis of prices andinflation

s


3 labour market3


( Say’s law

s Classical analysis of prices andinflation




s


3 labour market3


( Say’s law

s Classical analysis of prices andinflation( the quantity theory of money

s


3 labour market3


( Say’s law

s Classical analysis of prices andinflation( the quantity theory of money




s


3 labour market3


( Say’s law

s Classical analysis of prices andinflation( the quantity theory of money( the equation of exchange: MV = PY

s


3 labour market3


( Say’s law

s Classical analysis of prices andinflation( the quantity theory of money( the equation of exchange: MV = PY






s The Great Depression and the return tothe gold standard

( the depression of the 1920s



UK unemployment and inflation: 1919 38UK unemployment and inflation: 1919 38



4

6

8

10

12

14

16

18

20

22

24

U n e m p l o y m e

n t ( % o

f w o

r k f o r c e )

UK unemployment and inflation: 1919 − 38UK unemployment and inflation: 1919 − 38

Unemployment

UK unemployment and inflation: 1919 38UK unemployment and inflation: 1919 38



4

6

8

10

12

14

16

18

20

22

24

U n e m p l o y m e

n t ( % o

f w o

r k f o r c e )

Unemployment

Inflation

UK unemployment and inflation: 1919 − 38UK unemployment and inflation: 1919 − 38






( return to the gold standard










( effects on the economy












( the policy response














( classical rejection of public works
















3 the fear of inflation







3 the fear of inflation



The effect of printing extra money: the classical analysisThe effect of printing extra money: the classical analysis



AD2

AD1

O

AS

P 1

Price l

evel

National output

P 2

Q1

The effect of printing extra money: the classical analysisThe effect of printing extra money: the classical analysis





THE KEYNESIAN REVOLUTIONTHE KEYNESIAN REVOLUTION

s Keynes’ rejection of classical theory( rigidities in the labour market

( the problem of deficiency of demand

s

Keynes’ rejection of classical theory( rigidities in the labour market


The problem of demand deficiency in the labour marketThe problem of demand deficiency in the labour market



O

ADL1

Realw

ager a

te(W/

P)

Quantity of labour

W 1

ADL2

AS L

The problem of demand deficiency in the labour marketThe problem of demand deficiency in the labour market






( rejection of increased saving as a meansof increasing investment

s




Disequilibrium in the market for loanable fundsDisequilibrium in the market for loanable funds



O

Savings1

Investment

Rateo f

interest


r 1

Savings2

r 2

Disequilibrium in the market for loanable fundsDisequilibrium in the market for loanable funds







( rejection of simple quantity theory

s












( rejection of a balanced budget

s














s Keynes’ analysis of employment andinflation

s






s Keynes’ analysis of employment andinflation




s






s Keynes’ analysis of employment andinflation( the importance of aggregate demand

s







The effects of increases in aggregate demand on national outputThe effects of increases in aggregate demand on national output



O

Price l

evel

National output

Y P

gg g pgg g p

AS

The effects of increases in aggregate demand on national outputThe effects of increases in aggregate demand on national output



O Y 1

Price l

evel

National output

Y 2

AS

Y 3 Y 4 Y P

gg g pgg g p

AD3 AD2 AD1

AD4




s



( rejection of increased saving as a means of increasing investment




( the multiplier process

s



( rejection of increased saving as a means of increasing investment




( the multiplier process

The circular flow of incomeThe circular flow of income







C d





C dIncomes





C d

W = S + T + M

Incomes





C d

W = S + T + M

J = I + G + X

Incomes





C d

W = S + T + M

J = I + G + X

Incomes





C d

W = S + T + M

J = I + G + X

Incomes





C d

W = S + T + M

J = I + G + X

Incomes






s

Keynes’ policy recommendations( demand management by fiscal and

monetary policies

s Keynesian policies in 1950s and 60s

( stop–go policies

( criticisms of short-term demandmanagement

( the breakdown of the Phillips curve

s

Keynes’ policy recommendations( demand management by fiscal and

monetary policies

s Keynesian policies in 1950s and 60s

( stop–go policies

( criticisms of short-term demandmanagement

( the breakdown of the Phillips curve




The Monetarist – Keynesian DebateThe Monetarist –

Keynesian Debate



The monetarist version of the long-run Phillips curveThe monetarist version of the long-run Phillips curve



g

O

Unemployment

Inflatio

n(%)

U n



(b) Keynesian Phillips curve(b) Keynesian Phillips curve



O

Unemployment

Inflatio

n(%)

U min



THE MONETARIST KEYNESIAN DEBATETHE MONETARIST KEYNESIAN DEBATE



THE MONETARIST–KEYNESIAN DEBATETHE MONETARIST–KEYNESIAN DEBATE

s

The monetarist counter-revolution( the restatement of the quantity theory

( rejection of Keynesian demandmanagement policies

( the problem of inflationary expectations

( reappraisal of the Phillips curve

3 unemployment

3 inflation

( monetarist policies

( attempts at such policies in the 1980s

s

The monetarist counter-revolution( the restatement of the quantity theory

( rejection of Keynesian demandmanagement policies

( the problem of inflationary expectations

( reappraisal of the Phillips curve

3unemployment

3 inflation

( monetarist policies

( attempts at such policies in the 1980s

THE MONETARIST KEYNESIAN DEBATETHE MONETARIST KEYNESIAN DEBATE



s

Modern-day Keynesians( inflation

( unemployment

(

structural problems( hysteresis

3 low capital stock

3 deskilling

3 insiders and outsiders

( criticisms of monetarism

( Keynesian policy proposals

s

Modern-day Keynesians( inflation

( unemployment

(

structural problems( hysteresis

3 low capital stock

3deskilling

3 insiders and outsiders

( criticisms of monetarism

( Keynesian policy proposals

THE MONETARIST–KEYNESIAN DEBATETHE MONETARIST–KEYNESIAN DEBATE




The Current PositionThe Current Position

THE CURRENT POSITIONTHE CURRENT POSITION




s

The current range of views( new classical / rational expectations school

( moderate monetarists

( moderate Keynesians (new Keynesians)

( extreme Keynesians

( the radical left

( eclectic economists

s

The current range of views( new classical / rational expectations school

( moderate monetarists

( moderate Keynesians (new Keynesians)

( extreme Keynesians

( the radical left

( eclectic economists




s

A mainstream consensus?( short-run effects of changes in AD

( long-run effects of changes in AD

( no simple trade-off between inflation andunemployment

( role of expectations

( effects of excessive growth in the money

supply( importance of supply-side policies

( erosion of governments' power by theprocess of globalisation

s

A mainstream consensus?( short-run effects of changes in AD

( long-run effects of changes in AD

( no simple trade-off between inflation andunemployment

( role of expectations

( effects of excessive growth in the money

supply( importance of supply-side policies

( erosion of governments' power by theprocess of globalisation


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