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Macroeconomic Controversies

Macroeconomic Controversies. Classical View. Vertical AS at Qf =full-capacity output Why? 1) Say’s Law (supply creates its own demand) + 2) responsive, flexible prices + wages AS doesn’t change in response to price changes: real profits and output unchanged. Stable AD.

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Macroeconomic Controversies

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  1. Macroeconomic Controversies

  2. Classical View • Vertical AS at Qf=full-capacity output • Why? 1) Say’s Law (supply creates its own demand) + 2) responsive, flexible prices + wages • AS doesn’t change in response to price changes: real profits and output unchanged

  3. Stable AD • Purchasable real output depends on: 1) Qm households + firms, 2) purchasing power of money Fixed money supply inverse relation price level + real output • Location AD: stable w/fixed M (if Q fixed, M up demand-pull; M down deflation) • Key to PL stability: control M

  4. No U • Fall M + AD ≠ U • Yes, excess supply, but downward flexible product + resource prices decline price level until equilibrium

  5. Keynesians • Say’s stupid • Investment esp. unstable • No self-correction w/in reasonable time frame

  6. Macro Instability Causes • Mainstream: 1) changes I; 2) AS shocks • Monetarism (neoclassical): 1) focus M, 2) markets highly competitive, 3) competition economic stability if not for gov’t interference • Downward price inflexibility: min wage laws, pro-union laws, farm subsidies, monopolies, etc. • Bad monetary policy

  7. Equation of Exchange • MV=PY • Money, Velocity, Price level, Yutput = Nominal GDP • Stable Velocity: 1) not constant, but gradual and predictable, 2) V changes w/ nominal GDP not M • ∆M disequilibrium try to “spend down” excess (replace cash w/other items) AD up nominal GDP up

  8. Monetary Causes Instability • Greenspan’s a hack • Mainstream: I • Monetarists: M, and GD is the proof • Policy? Want 3% growth? Announce M will grow 3%/year, et voila.

  9. Real-Business-Cycle View • Fluctuations from real factors: tech + resource availability affect productivity (output/worker) + long-run growth trend • p. 355 for explanation

  10. Coordination Failures • Fail to reach mutually beneficial equilibrium because lack joint coordination • Party in the rain? Get knifed in Berkeley hills/trash mom’s house in Moraga? • Unemployment or inflation equilibrium

  11. Self-Correct? • New Classical: divergence from f-e o internal mechanisms automatically move back (natural-rate theories) • Long-run adjustment

  12. Speed of Adjustment • “In the long-run we’re all dead” • Adaptive expectations (monetarists) 2-3 years • Rational expectations (RET): anticipate before occur quick/instantaneous • 1) Rational people + adequate info beliefs about future economic outcomes accurately reflect likelihood of outcome (efficient market hypothesis) • 2) Product + resource markets highly competitive w/flexible prices AND new info quickly incorporated

  13. Unanticipated Price-Level Changes • RET accepts may briefly affect real output • Unanticipated change misperception about price signals (demand shift rather than inflation) change in output • But once realize mistake return to original output • Anticipated changes (G policy) has no effect on Q, only P

  14. Mainstream View of Self-Correction • RET major + sig. effect, but disagreement on downward flexibility: inflexible for long periods • Why?

  15. Efficiency Wages • Efficiency wage: minimize firm’s labor cost per unit of output • May be above market wage • 1) greater work effort • 2) lower supervision costs • 3) reduced turnover

  16. Insider-Outsider Relationship • Insiders: those who keep jobs in recession • Outsiders: those who don’t • Firms unwilling to replace insiders w/outsiders; outsiders unwilling to work below others’ wages

  17. Rules or Discretion? • Monetary rule: announce set increase in M • Balanced budget: crowding-out is bad • Defense of Discretionary • Discretionary Monetary Policy: V more rapidly changing than monetarists allow • Discretionary Fiscal: crowding-out no big deal in recessions, make-up for monetary weakness/slowness; real costs of deficits/budgets vs. perceived • In fact increased macro stability

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