Chapter 36: Current Issues in Macro Theory and Policy

Current Issues in Macro Theory and PolicyMcGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.Causes of Macro InstabilityMainstream viewHeld by most economistsPrice stickinessUnexpected demand shocksVariable investment spendingUnexpected supply shocksLO136-*Causes of Macro InstabilityMonetarist viewGovernment interference is the problemEquation of exchange MV = PQStable velocityMonetary causes of instabilityInappropriate monetary policyLO136-*Causes of Macro InstabilityCoordination failuresFail to reach equilibrium because of lack of coordination mechanismLimited informationExpectations and self-fulfilling prophecyUnemployment equilibriumInflation equilibriumLO136-*Does the Economy Self Correct?New classical view Rational expectations theoryMonetaristsAutomatic correction will occurSpeed of adjustmentUnanticipated price-level changesFully anticipated price-level changesLO236-* New Classical View of Self-CorrectionAD2AD1AS1AS2ASLRPrice LevelP1P2P3Real Domestic OutputQ1Q2abcDoes the Economy Self Correct?LO336-* New Classical View of Self-CorrectionAD3AD1AS1AS3ASLRPrice LevelP1P4P5Real Domestic OutputQ1Q4Q3aedfDoes the Economy Self Correct?LO336-*Does the Economy Self Correct?Mainstream viewDownward wage inflexibilityEfficiency wage theoryGreater work effortLower supervision costsReduced job turnoverInsider-outsider relationshipsLO336-*Rules or Discretion?In support of policy rulesReduce macro instabilityMonetary ruleShift AD to keep up with ASPrice stability achievedInflation targetingBalanced budgetLO436-*Rules or Discretion?Defense of discretionary stabilization policyDiscretionary monetary policyVelocity is not stableDiscretionary fiscal policyUseful during recessionPolicy successesLO436-*Rules or Discretion?LO436-*