Debating Macroeconomics: Classical, Keynesian, Monetarist & New Theories - Prof. R. Herzog, Study notes of Economics

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Classical
Keynesian
Monetarist
New Classical Theory
Real Business Cycle
Supply Side Classical  Prior to the Great Depression – Adam Smith  Market adjusted to restore equilibrium  Wages adjusted immediately
Vertical short-run AS curve
Unemployment was always at the natural rate
Policy is ineffective 2 Keynesian  Developed after the Great Depression  Wages were sticky
Sticky wages allowed for an upward sloping AS curve
Believed stimulating AD could create jobs Monetarists  Developments coincided with Keynesians  Believe money matters  Developed the Quantity Theory of Money which hinges on the velocity of money Monetarists  Velocity of money:
The number of times a dollar bill changes hands
V=GDP/M
Velocity of money is equivalent to taking the GDP (total amounts of goods and services purchased) and dividing by the supply of money
GDP = P * Y 5 New Classical  Developed because economists were unsatisfied with how expectations were formed in the Keynesian models
Prior models believed expectations were formed naïvely; future inflation equals inflation today
If they are incorrect on their views they adjusts their views of future inflation by weighting the current periods error New Classical  Keynesian Expectations
Violated traditional microeconomic behavior
Implies people do not take account of current information  Motivated to explain the break down of the Phillips Curve in the 1970’s New Classical  Rational Expectations:
Assumes people know the “true model” of the economy and that they use this model to form their expectations of the future
The economy deviates from the long-run equilibrium when events are unpredictable (i.e. oil shocks)
When developing inflationary expectations it is assumed the benefits of gathering information far outweigh the costs 6 New Classical  Market Clearing
If firms are rational then wages and prices will be set similarly and the labor market will always be near equilibrium  Lucas Supply Function
A firms output depends on price surprises Y f P Pe= −( ) New Classical  Lucas Supply Function
Output only deviates when prices levels differ from expected  If the price level is higher than expected, firms believe this is partially contributed to an increase in demand for their good
Firms and workers have better information for the prices of goods/services they supply
They do not realize the increase in prices is economy wide
When firms and workers come to realize the economy price level increased they return back to their previous levels New Classical  Policy
When policy is fully anticipated it will have no effect on output
When policy is unannounced it will have a temporary effect on output 7 New Classical  Are rational expectations feasible?
Requires households and firms to know a lot of information
Assumes households know the true model of the economy  Economists do not even know the true model Real Business Cycle  An attempt to explain business cycle fluctuations  View wages and prices as completely flexible  AS is vertical in the short run  Agents are assumed to be rational  It emphasizes shocks to technology and other shocks. Supply Side Economics  Believed macroeconomic policies failed because they focused entirely on demand  Supply-side economists believe that the real problem was that high rates of taxation and heavy regulation had reduced the incentive to work, to save, and to invest.  What was needed was not a demand stimulus but better incentives to stimulate supply 10  Most monetarists, including Milton Friedman, blame most of the instability in the economy on:
a. The volatility of investment spending.
b. Changes in aggregate demand.
c. Changes in aggregate supply.
d. The federal government.  Most monetarists, including Milton Friedman, blame most of the instability in the economy on:
a. The volatility of investment spending.
b. Changes in aggregate demand.
c. Changes in aggregate supply.
d. The federal government.  Which of the following events helped motivate the formulation of new classical economics?
a. The Great Depression.
b. The mercantilist revolution and the birth of laissez faire.
c. The stagflation of the 1970s.
d. The turnaround from federal budget deficits to surpluses during the Clinton administration. 11  Which of the following events helped motivate the formulation of new classical economics?
a. The Great Depression.
b. The mercantilist revolution and the birth of laissez faire.
c. The stagflation of the 1970s.
d. The turnaround from federal budget deficits to surpluses during the Clinton administration.  When expectations are rational, which of the following stabilization policies is more desirable?
a. Fiscal policy tools as the preferred means of stabilization.
b. Monetary policy tools as the preferred means of stabilization.
c. Intervention only when unpredictable shocks affect the economy.
d. No need for government stabilization policies of any kind.  When expectations are rational, which of the following stabilization policies is more desirable?
a. Fiscal policy tools as the preferred means of stabilization.
b. Monetary policy tools as the preferred means of stabilization.
c. Intervention only when unpredictable shocks affect the economy.
d. No need for government stabilization policies of any kind. 12  To derive his supply function, Lucas starts with the idea that:
a. People and firms are specialists in production but generalists in consumption.
b. People and firms are specialists in consumption but generalists in production.
c. People are generalists in both consumption and production.
d. Firms are specialists in production, and households are specialists in consumption.  To derive his supply function, Lucas starts with the idea that:
a. People and firms are specialists in production but generalists in consumption.
b. People and firms are specialists in consumption but generalists in production.
c. People are generalists in both consumption and production.
d. Firms are specialists in production, and households are specialists in consumption.  In the context of the AS/AD model, if prices and wages are perfectly flexible, then:
a. The AS curve is vertical in the long run but not in the short run.
b. Events that shift the AD curve have a strong impact on real output.
c. The AS curve is vertical, even in the short run.
d. Nominal wages are always ahead of real wages.