Macroeconomic Viewpoints

Dr. M Manjunath Shettigar

Macroeconomic Viewpoints:
Classical
Keynesian
Monetarist
New Classical
New Keynesian
Classical Economics: Laissez - Faire

Real GDP is determined by aggregate

supply
The equilibrium price level is determined
by the money supply.
Full employment is the norm
Supply creates its own demand
The classical view prevailed before the
Great Depression.
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The
Classical
Model

Real GDP is
determined
by aggregate
supply
The price
level is
determined
by aggregate
demand.
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 Keynesian Economics: Economic Activism
John Maynard Keynes, The General Theory of
Employment, Interest, and Money (1936)
Emphasizes aggregate demand in determining
GDP and employment.
Assumes fixed prices (horizontal AS) at relevant
levels of GDP.
inflation is not a risk when unemployment is
high.
Government must stabilize an inherently
unstable macroeconomy
Use demand management policies
Fiscal policy
Monetary policy 5
The Fixed-Price Keynesian Model

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Monetarism: Return to Laissez - Faire
Milton Friedman, Studies in the Quantity Theory of Money (1956)
_______________, The Role of Monetary Policy (1968)

Emphasizes role of money supply in

determining real GDP and price level.
Business cycles are largely the result of
discretionary monetary policy
Monetary mischief
Activist policy is wrong:
Too Much Too Late

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Monetarism: Return to Laissez-Faire

Efforts to increase real GDP through

expansionary monetary policy
Accelerating Inflation.
Inflation is everywhere and at all
times a monetary phenomenon.
Economic policy operates with long and
variable lags
accurate timing nearly impossible.
Dont mess with the macroeconomy 8
 Long and Variable Policy Lags

1. Recognition Lag: policymakers need time

to realize that there is a problem.
2. Reaction Lag: they need time to formulate
an appropriate policy response.
3. Effect Lag: policy takes time to implement
and work through the economy.
Countercyclical policies can become
procyclical policies, worsening fluctuations
Dont mess with the macroeconomy
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 New Classical Economics: Policy Ineffectiveness
Arose in the 1970s in response to
stagflation.
Wages and prices are perfectly flexible.
Markets are always in equilibrium.
Markets work!
Expectations are rational
only unexpected changes in policy
can affect output and employment.
Changes in real GDP result from
unexpected changes in the prices level.
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 New Classical Policy
Most observed unemployment is
voluntary.
Only unanticipated policies can have any
effect.
policy ineffectiveness proposition.
Therefore, attempt no activist policy.
Follow predictable and stable monetary and
fiscal policies for long run employment
and price stability.

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New Classical Economics

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 New Keynesians: Policy Can Work
Incorporate rational expectations
But prices and wages are sticky in short run.
Disequilibrium prevails.
Price-wage stickiness: impediments to
adjustment exist (contracts, adjustment costs,
etc.)
Activist policies can work
Stabilize the economy/make things better!
The private sector is an important source of
shifts in aggregate demand.
Monetary and fiscal policies should be used to
offset drops in private sector spending.
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The Modern
Keynesian
Model

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