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									Summary of Major Macroeconomic Theories
Theory Most popular time Mastermind Main determinant of economic performance Breakdown of Unemployment Main causes of unemployment Classical
19th century Adam Smith, Say, others Aggregate Supply If any: 1. temporary (i.e. frictional) 2. voluntary Principally n.a. – The free market clears at all times, so there is no involuntary unemployment. Non-intervention by government! if labour demand   wages  new equilibrium,  full employment. keep government budget in balance as to not increase inflation. Increase savings to provide funds for further investment Increasing government expenditure increases inflation,  “crowding out” of private spending. 1. 2. 3.

1930th ~ 1970th John Maynard Keynes Aggregate Demand frictional structural demand-deficient (“cyclical”)

1970th ~ 1990th ~ Milton Friedman Money Supply 1. frictional 2. structural 1.+2. = NAIRU

1980th ~ Keynes; Mankiw, Blanchard, etc Aggregate Demand NAIRU has a demand-deficient element

1980th ~ Lucas, others Aggregate Supply (“real business cycle theory”)

 Monetarist

Deficient demand

Inefficient labour market (labour markets are unable to clear frictional and structural unemployment) Market oriented supply-side policies, e.g.: Increase incentives to work Increase flexibility of wages and work practices Increase labour mobility

Among others: Deficient demand External shocks Persistence/Hysteresis Efficiency wage theory Power of insiders 1. 2. Demand management Interventionist supply-side policies: Increase Government expenditure on infrastructure, R&D, training and education, SME, etc.

 Monetarist

Policy Prescriptions against unemployment

“Demand management”: Stimulate aggregate demand by G. Multiplier effect: Eventual rise in income is higher than initial increase in G. Money supply would be increased accordingly as to not increase taxes or government borrowing. Labour markets do not clear at all times. Increasing savings reduces demand Money supply is not the only important variable, and it’s effect is unclear.

Non-intervention by government! (“laissez-faire”)

 Classical  Monetarist
Neo-Classical policy prescriptions are often called far-right policies.


Critique at other theories

Increase efficiency of markets for labour, goods, and services Raising aggregate demand may reduce unemployment in the short run, but only increases inflation in the long run. Government borrowing for G increases interest rates  “crowding out” of private I. Short run: negative; long run: vertical due to expectations (“Expectations augmented Phillips Curve”) Money supply Short run: Prices and output increase; long run: Only prices increase Keep money supply stable Short run: positive; long run: vertical Naturally stable; stabilisation policy unnecessary if not damaging. Rules required to avoid damaging gov. intervention



Prices and wages are sticky; markets do not clear at all times. Expectations influence output and employment decisions, not only pricing.

 Classical;
“short run” does not apply as agents apply long-term expectations instantaneously.

Slope of Phillips-Curve Main causes of Inflation Effects of increasing money supply (M) Policy Prescriptions against inflation Slope of Aggregate Supply curve Stability of Economy Rules or Discretion

 Neo-Classical
Money supply In the quantity theory of money (MV=PY), V and Y are constant. Thus, M can only increase prices: P=f(M).

Negatively sloped

Short run: negative; long run: negative if steep

Both short and long run Phillips curves are vertical because expectations are changed immediately (“rational expectations”)

Excess demand (inflationary gap)  “Demand-pull Inflation” If just M, then result unclear. But if M caused by G, then output increases Reduce aggregate demand; Price- and wage policies horizontal (up to full employment level of income) Inherently unstable; stabilisation policy with fine tuning vital. Discretion necessary for effecttive Demand Management

 Keynesian
Prices and output increase

 Monetarist
Prices increase instantaneously

 Neo-Classical
Vertical Naturally stable

 Keynesian and  Monetarist
Positive Inherently unstable; stabilisation policy with rough tuning vital.

 Monetarist
Vertical Naturally stable; stabilisation policy damaging.

 Keynesian

 Monetarist

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