Current Issues in Macro Theory and Policy

Causes of Macro Instability
Mainstream view
Held by most economists
Price stickiness
Unexpected demand shocks
Variable investment spending
Unexpected supply shocks
LO1
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Causes of Macro Instability
Monetarist view
Government interference is the problem
Equation of exchange MV = PQ
Stable velocity
Monetary causes of instability
Inappropriate monetary policy
LO1
36-

Causes of Macro Instability
Coordination failures
Fail to reach equilibrium because of lack of coordination mechanism
Limited information
Expectations and self-fulfilling prophecy
Unemployment equilibrium
Inflation equilibrium
LO1
36-

Does the Economy Self Correct?
New classical view
Rational expectations theory
Monetarists
Automatic correction will occur
Speed of adjustment
Unanticipated price-level changes
Fully anticipated price-level changes
LO2
36-

New Classical View of Self-Correction
AD2
AD1
AS1
AS2
ASLR
Price Level
P1
P2
P3
Real Domestic Output
Q1
Q2
a
b
c
Does the Economy Self Correct?
LO3
36-

New Classical View of Self-Correction
AD3
AD1
AS1
AS3
ASLR
Price Level
P1
P4
P5
Real Domestic Output
Q1
Q4
Q3
a
e
d
f
Does the Economy Self Correct?
LO3
36-

Does the Economy Self Correct?
Mainstream view
Downward wage inflexibility
Efficiency wage theory
Greater work effort
Lower supervision costs
Reduced job turnover
Insider-outsider relationships
LO3
36-

Rules or Discretion?
In support of policy rules
Reduce macro instability
Monetary rule
Shift AD to keep up with AS
Price stability achieved
Inflation targeting
Balanced budget
LO4
36-

Rules or Discretion?
Defense of discretionary stabilization policy
Discretionary monetary policy
Velocity is not stable
Discretionary fiscal policy
Useful during recession
Policy successes
LO4
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