ECON 1102-01 Principles of Macroeconomics - Lecture 11 A Short by plj11999

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									       Classical vs. Keynesian vs. Monetarist
 New Classical and New Keynesian Economics
                      The Modern Consensus




ECON 1102-01: Principles of Macroeconomics
 Lecture 11: A Short History of Economic Thought or Is
                 Economics a Science?




                                   March 30, 2007




                                                ECON 1102-01: Principles of Macroeconomics
                                                      Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Keynesian Economics
       New Classical and New Keynesian Economics
                                                      Monetarism
                            The Modern Consensus
                                                      Broader Perspective


Classical Economics
  Classical Economics is considered to have started with Adam
  Smith’s publishing ”The Wealth of Nations” in 1776.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Keynesian Economics
       New Classical and New Keynesian Economics
                                                      Monetarism
                            The Modern Consensus
                                                      Broader Perspective


Adam Smith



  Adam Smith is best known for metaphor of the Invisible Hand, the
  idea that free markets achieve the ’best’ outcomes.

  ”It is not from the benevolence of the butcher, the brewer, or the
  baker, that we expect our dinner, but from their regard to their
  own interest.”

  Dramatic implication: privatize schools




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Keynesian Economics
       New Classical and New Keynesian Economics
                                                      Monetarism
                            The Modern Consensus
                                                      Broader Perspective


Other Big Names: David Ricardo
  Adam Smith also emphasized the importance of specialization and
  the gains from trade.

  David Ricardo offered further support for free trade with his
  discussion of comparative advantage.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                     Classical Economics
            Classical vs. Keynesian vs. Monetarist
                                                     Keynesian Economics
      New Classical and New Keynesian Economics
                                                     Monetarism
                           The Modern Consensus
                                                     Broader Perspective


Other Big Names: Thomas Malthus
  Thomas Malthus argued that population would always keep wages
  at a subsistence level.




                                                     ECON 1102-01: Principles of Macroeconomics
                                                      Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Keynesian Economics
       New Classical and New Keynesian Economics
                                                      Monetarism
                            The Modern Consensus
                                                      Broader Perspective


Other Big Names: Karl Marx
  Karl Marx actually made major contributions to classical
  economics, though we are still waiting for the collapse of
  capitalism.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Keynesian Economics
       New Classical and New Keynesian Economics
                                                      Monetarism
                            The Modern Consensus
                                                      Broader Perspective


An Economy Dominated by Agriculture
  Even in the most industrialized nations, the economy was
  dominated by agricultural production.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Keynesian Economics
       New Classical and New Keynesian Economics
                                                      Monetarism
                            The Modern Consensus
                                                      Broader Perspective


AD-AS in the Classical Model

  In classical economics the aggregate supply curve is perfectly
  inelastic - vertical.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Keynesian Economics
       New Classical and New Keynesian Economics
                                                      Monetarism
                            The Modern Consensus
                                                      Broader Perspective


No Short Run




  As a result, there was no short run theory for fighting business
  cycles.

  What is the government going to do? Make it rain?




                                                      ECON 1102-01: Principles of Macroeconomics
                                                     Classical Economics
            Classical vs. Keynesian vs. Monetarist
                                                     Keynesian Economics
      New Classical and New Keynesian Economics
                                                     Monetarism
                           The Modern Consensus
                                                     Broader Perspective


The Rise of Business Cycles
  As manufacturing became more important, business cycles became
  more and more important.




                                                     ECON 1102-01: Principles of Macroeconomics
                                                     Classical Economics
            Classical vs. Keynesian vs. Monetarist
                                                     Keynesian Economics
      New Classical and New Keynesian Economics
                                                     Monetarism
                           The Modern Consensus
                                                     Broader Perspective


John Maynard Keynes
  John Maynard Keynes caused a dramatic change in the way
  economists think about short run business cycles with the
  publication of ”A General Theory of Employment, Interest
  and Money” in 1936.




                                                     ECON 1102-01: Principles of Macroeconomics
                                                      Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Keynesian Economics
       New Classical and New Keynesian Economics
                                                      Monetarism
                            The Modern Consensus
                                                      Broader Perspective


Keynesian AD-AS

  Keynes introduced the classic upward-sloping SRAS curve.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Keynesian Economics
       New Classical and New Keynesian Economics
                                                      Monetarism
                            The Modern Consensus
                                                      Broader Perspective


Fiscal Policy


  Keynes emphasized the role of fiscal policy in returning the
  economy to long run equilibrium.

  This view gained popularity when


      Classical theories seemed to fail in the great depression.

      The spending explosion due to WWII seemed to cure the
      Great Depression




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Keynesian Economics
       New Classical and New Keynesian Economics
                                                      Monetarism
                            The Modern Consensus
                                                      Broader Perspective


Fiscal Policy




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Keynesian Economics
       New Classical and New Keynesian Economics
                                                      Monetarism
                            The Modern Consensus
                                                      Broader Perspective


Another Crisis - the 70s



  In 1975 Richard Nixon declared ”We are all Keynesians now.”
  Keynesianism promptly died.

  In the 1970s we saw something that wasn’t expected in Keynesian
  Economics - stagflation.

  Efforts to alleviate the slow down seemed to cause even more
  inflation, people were open to new ideas.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                     Classical Economics
            Classical vs. Keynesian vs. Monetarist
                                                     Keynesian Economics
      New Classical and New Keynesian Economics
                                                     Monetarism
                           The Modern Consensus
                                                     Broader Perspective


Milton Friedman
  Monetarism is most strongly associated with Milton Friedman.
  His most famous work, written with Anna Schwartz, is ”A
  Monetary History of the United States” in 1963.




                                                     ECON 1102-01: Principles of Macroeconomics
                                                      Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Keynesian Economics
       New Classical and New Keynesian Economics
                                                      Monetarism
                            The Modern Consensus
                                                      Broader Perspective


Monetarism


  Monetarism emphasizes the role of monetary policy in smoothing
  the business cycle.


      Inflation dampens the multiplier

      Quicker implementation

      Political business cycle




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Keynesian Economics
       New Classical and New Keynesian Economics
                                                      Monetarism
                            The Modern Consensus
                                                      Broader Perspective


A Great Battle



  People often think this debate is deeply moral or personal or
  philosophical.

  Keynesians are often associated with being liberal and classical
  economists and later monetarists with being conservative.

  This is probably because people latch onto theories that go with
  their other beliefs, either for or against government intervention.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Keynesian Economics
       New Classical and New Keynesian Economics
                                                      Monetarism
                            The Modern Consensus
                                                      Broader Perspective


Where’s the Beef




  But what are we talking about here?

  There is only one question: how to deal with the business cycle.

  This is a scientific question - we need theories to give us answers
  and data to determine which theories are correct.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      New Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Rational Expectations
       New Classical and New Keynesian Economics
                                                      Real Business Cycles
                            The Modern Consensus
                                                      New Keynesian Economics


The Changing Face of Macroeconomics


  Macroeconomics underwent a major change in the 1970s.

  In micro we start with preferences of individual people, and profit
  maximizing firms.

  We derive their supply and demand curves.

  If we want to know what a whole market is doing, we add up all
  the supply and demand curves.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      New Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Rational Expectations
       New Classical and New Keynesian Economics
                                                      Real Business Cycles
                            The Modern Consensus
                                                      New Keynesian Economics


The Changing Face of Macroeconomics



  Most of the macro in our textbook doesn’t do that. No one is
  maximizing here.

  We just tell a story and draw a graph that we think looks right

  Starting in the 70’s people put greater emphasis on ’micro
  foundations,’ - models of the economy with microeconomic agents
  picking stuff to buy and firms maximizing profits.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      New Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Rational Expectations
       New Classical and New Keynesian Economics
                                                      Real Business Cycles
                            The Modern Consensus
                                                      New Keynesian Economics


New Classical Economics



  The most important papers at the beginning of this trend
  reinforced the old classical economic ideas.

  They came to be known as new classical economics. Major
  elements in new classical economics are:
      Rational Expectations

      Real Business Cycle




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      New Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Rational Expectations
       New Classical and New Keynesian Economics
                                                      Real Business Cycles
                            The Modern Consensus
                                                      New Keynesian Economics


Rational Expectations



  The future is uncertain.

  When you make a model, you need to decide how firms and
  consumers will predict the future.

  The rational expectations theory says that you should make a
  model where these agents are right about future probabilities.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                     New Classical Economics
            Classical vs. Keynesian vs. Monetarist
                                                     Rational Expectations
      New Classical and New Keynesian Economics
                                                     Real Business Cycles
                           The Modern Consensus
                                                     New Keynesian Economics


Robert Lucas


  A very important paper in this movement was Robert Lucas’ 1972
  papers ”Expectations and the Neutrality of Money.”




                                                     ECON 1102-01: Principles of Macroeconomics
                                                      New Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Rational Expectations
       New Classical and New Keynesian Economics
                                                      Real Business Cycles
                            The Modern Consensus
                                                      New Keynesian Economics


Rational Expectations




  This paper argued that if consumers have rational expectations
  then fiscal policy will only be effective if it is unexpected.

  Rational Expectations is the view that individual firms make
  decisions optimally, using all available information.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      New Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Rational Expectations
       New Classical and New Keynesian Economics
                                                      Real Business Cycles
                            The Modern Consensus
                                                      New Keynesian Economics


Is The Fed Irrelevant?



  The rational expectations hypothesis suggests that the Fed is
  irrelevant.

  You may be surprised to learn that the Fed disagrees, so do many
  policy analysts.

  What am I trying to say here?




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      New Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Rational Expectations
       New Classical and New Keynesian Economics
                                                      Real Business Cycles
                            The Modern Consensus
                                                      New Keynesian Economics


Real Business Cycles




  Real business cycle theory tries to understand short-run economic
  fluctuations in terms of technology shocks - short term changes in
  potential output.

  If you make a model with the short term technology shocks, many
  results from the model look much like the data.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      New Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Rational Expectations
       New Classical and New Keynesian Economics
                                                      Real Business Cycles
                            The Modern Consensus
                                                      New Keynesian Economics


Real Business Cycles

  This suggests that we do not need to invoke ’animal spirits’ or
  ’business confidence’ to explain the business cycle.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                     New Classical Economics
            Classical vs. Keynesian vs. Monetarist
                                                     Rational Expectations
      New Classical and New Keynesian Economics
                                                     Real Business Cycles
                           The Modern Consensus
                                                     New Keynesian Economics


Edward Prescott

  RBC models took off with the publication of ”Time to Build and
  Aggregate Fluctuations” by Edward Prescott and Finn Kydland.




                                                     ECON 1102-01: Principles of Macroeconomics
                                                      New Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Rational Expectations
       New Classical and New Keynesian Economics
                                                      Real Business Cycles
                            The Modern Consensus
                                                      New Keynesian Economics


RBC Models


  According to real business cycle theory, fluctuations in the rate of
  growth of total factor productivity cause the business cycle.

  RBC models do a pretty good job of capturing the economic data
  without having to make stuff up. They are widely used in all fields
  of macroeconomics.

  They don’t capture everything, but that’s why you should become
  an economist.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      New Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Rational Expectations
       New Classical and New Keynesian Economics
                                                      Real Business Cycles
                            The Modern Consensus
                                                      New Keynesian Economics


RBC Models




  Again, RBC models generally do not support a role for active
  economic policy.

  Policy makers believe there is a role for economic policy.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      New Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Rational Expectations
       New Classical and New Keynesian Economics
                                                      Real Business Cycles
                            The Modern Consensus
                                                      New Keynesian Economics


New Keynesian Economics




  As models got more sophisticated in the 80’s, some economist
  tried to give Keynesian ideas ’micro foundations.’

  A good example are models which explain ’sticky prices’ and
  ’sticky wages’.




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      New Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Rational Expectations
       New Classical and New Keynesian Economics
                                                      Real Business Cycles
                            The Modern Consensus
                                                      New Keynesian Economics


Gregory Mankiw


  A famous guy in this tradition is Gregory Mankiw, with his 1985
  paper ”Small Menu Costs and Large Business Cycles: A
  Macroeconomic Model of Monopoly.”




                                                      ECON 1102-01: Principles of Macroeconomics
                                                      New Classical Economics
             Classical vs. Keynesian vs. Monetarist
                                                      Rational Expectations
       New Classical and New Keynesian Economics
                                                      Real Business Cycles
                            The Modern Consensus
                                                      New Keynesian Economics


New Keynesian Economics


  These models show that using math and insisting on
  ’micro-foundations’ area good way for anyone to make her ideas
  about the economy clearer

  Even though Minnesota is though of as a very new classical school,
  people here take new Keynesian models very seriously.

  In the end, we’re all looking for good theories which explain the
  data.




                                                      ECON 1102-01: Principles of Macroeconomics
           Classical vs. Keynesian vs. Monetarist
     New Classical and New Keynesian Economics
                          The Modern Consensus




Is expansionary monetary policy helpful in fighting Recessions?

Yes. Definitely.




                                                    ECON 1102-01: Principles of Macroeconomics
           Classical vs. Keynesian vs. Monetarist
     New Classical and New Keynesian Economics
                          The Modern Consensus




Is fiscal policy effective at fighting inflations.

Yes, but there are some reasons to worry about it.




                                                    ECON 1102-01: Principles of Macroeconomics
           Classical vs. Keynesian vs. Monetarist
     New Classical and New Keynesian Economics
                          The Modern Consensus




Can monetary/fiscal policy reduce unemployment in the long run?

No. Definitely not.




                                                    ECON 1102-01: Principles of Macroeconomics
            Classical vs. Keynesian vs. Monetarist
      New Classical and New Keynesian Economics
                           The Modern Consensus




Should fiscal policy be used in a discretionary way?

No.




                                                     ECON 1102-01: Principles of Macroeconomics
           Classical vs. Keynesian vs. Monetarist
     New Classical and New Keynesian Economics
                          The Modern Consensus




Should monetary policy be used in a discretionary way?

Well...




                                                    ECON 1102-01: Principles of Macroeconomics

								
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