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Chapter 36 - Current issues in macro theory and policy. In this chapter, you will learn to: Describe alternative perspectives on the causes of macroeconomic instability, including the views of mainstream economists, monetarists, real-business-cycle advocates, and proponents of coordination failures; explain what the equation of exchange is and how it relates to "monetarism"; discuss why new classical economists believe the economy will "self-correct" from aggregate demand and aggregate supply shocks;. | Current Issues in Macro Theory and Policy Chapter 36 Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter Objectives Alternative perspectives on macroeconomic instability Equation of exchange and monetarism New classical economists and self-correction Rules vs. discretion in conducting stabilization policy 36- Causes of Macro Instability Mainstream view Held by most economists Price stickiness Unexpected demand shocks Variable investment spending Unexpected supply shocks 36- Monetarist view Government interference is the problem Equation of exchange MV = PQ Stable velocity Monetary causes of instability Inappropriate monetary policy Causes of Macro Instability 36- Real-business-cycle view Shifts in long-run aggregate supply Price Level P1 Real Domestic Output Q2 Q1 AD1 AD2 ASLR1 ASLR2 Causes of Macro Instability 36- Coordination failures Fourth modern view Limited information Expectations and self-fulfilling prophecy Unemployment equilibrium Inflation equilibrium Causes of Macro Instability 36- Self-Correction New classical view Rational expectations theory Monetarists Automatic correction will occur Speed of adjustment Unanticipated price-level changes Fully anticipated price-level changes 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 Self-Correction 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 Self-Correction 36- Mainstream view Downward wage inflexibility Efficiency wage theory Greater work effort Lower supervision costs Reduced job turnover Insider-outsider relationships Self-Correction 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 36- Rationale for Monetary Rule Price Level P1 Real Domestic Output, | Current Issues in Macro Theory and Policy Chapter 36 Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter Objectives Alternative perspectives on macroeconomic instability Equation of exchange and monetarism New classical economists and self-correction Rules vs. discretion in conducting stabilization policy 36- Causes of Macro Instability Mainstream view Held by most economists Price stickiness Unexpected demand shocks Variable investment spending Unexpected supply shocks 36- Monetarist view Government interference is the problem Equation of exchange MV = PQ Stable velocity Monetary causes of instability Inappropriate monetary policy Causes of Macro Instability 36- Real-business-cycle view Shifts in long-run aggregate supply Price Level P1 Real Domestic Output Q2 Q1 AD1 AD2 ASLR1 ASLR2 Causes of Macro Instability 36- Coordination failures Fourth modern view Limited information Expectations and self-fulfilling prophecy .
