Chapter 19: 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 shocksLO1Causes of Macro InstabilityMonetarist viewGovernment interference is the problemEquation of exchange MV = PQStable velocityMonetary causes of instabilityInappropriate monetary policyLO1Causes of Macro InstabilityCoordination failuresFail to reach equilibrium because of lack of coordination mechanismLimited informationExpectations and self-fulfilling prophecyUnemployment equilibriumInflation equilibriumLO1Does the Economy Self Correct?New classical view Rational expectations theoryMonetaristsAutomatic correction will occurSpeed of adjustmentUnanticipated price-level changesFully anticipated price-level changesLO2 New Classical View of Self-CorrectionAD2AD1AS1AS2ASLRPrice LevelP1P2P3Real Domestic OutputQ1Q2abcDoes the Economy Self Correct?LO3 New Classical View of Self-CorrectionAD3AD1AS1AS3ASLRPrice LevelP1P4P5Real Domestic OutputQ1Q4Q3aedfDoes the Economy Self Correct?LO3Does the Economy Self Correct?Mainstream viewDownward wage inflexibilityEfficiency wage theoryGreater work effortLower supervision costsReduced job turnoverInsider-outsider relationshipsLO3Rules or Discretion?In support of policy rulesReduce macro instabilityMonetary ruleShift AD to keep up with ASPrice stability achievedInflation targetingBalanced budgetLO4Rules or Discretion?Defense of discretionary stabilization policyDiscretionary monetary policyVelocity is not stableDiscretionary fiscal policyUseful during recessionPolicy successesLO4Rules or Discretion?LO4