The Roots Of Modern Macroeconomics
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The Roots of Modern Macroeconomics
The Roots of Modern Macroeconomics
Setting the Scene: Three Key Issues
THREE KEY ISSUES ■
■
Issue 1: Flexibility of prices and wages ✜
the right: flexible prices and wages
✜
the left: price and wage rigidities
Issue 2: Flexibility of aggregate supply ✜
the right: aggregate supply determined independently of aggregate demand
Different aggregate supply curves: (a)
Price level
AS
O
Y
National output
Different aggregate supply curves: (a)
Price level
AS
P1
AD1 O
Y
National output
Different aggregate supply curves: (a)
Price level
AS
P2
P1
AD2 AD1
O
Y
National output
THREE KEY ISSUES ■
■
Issue 1: Flexibility of prices and wages ✜
the right: flexible prices and wages
✜
the left: price and wage rigidities
Issue 2: Flexibility of aggregate supply ✜
the right: aggregate supply determined independently of aggregate demand
✜
the left: aggregate supply responsive to changes in aggregate demand
Price level
Different aggregate supply curves: (b)
AS
P
O
National output
Price level
Different aggregate supply curves: (b)
AS
P
AD1 O
Y1
National output
Price level
Different aggregate supply curves: (b)
AS
P
AD2 AD1 O
Y1
Y2
National output
THREE KEY ISSUES ■
■
Issue 1: Flexibility of prices and wages ✜
the right: flexible prices and wages
✜
the left: price and wage rigidities
Issue 2: Flexibility of aggregate supply ✜
the right: aggregate supply determined independently of aggregate demand
✜
the left: aggregate supply responsive to changes in aggregate demand
✜
some consensus on nature of short-run AS curve
Different aggregate supply curves: (c)
Price level
AS
O
National output
Different aggregate supply curves: (c)
Price level
AS
P1
AD1 O
Y1
National output
Different aggregate supply curves: (c)
Price level
AS
P2 P1
AD2 AD1 O
Y1
Y2
National output
THREE KEY ISSUES ■
Issue 3: The role of expectations in the working of the market ✜
the right: expectations adjust rapidly to changes in prices
✜
the left: expectations of prices depend on expectations of output and employment
The Roots of Modern Macroeconomics
Classical Macroeconomics
CLASSICAL MACROECONOMICS ■
Classical analysis of output and employment ✜
markets clear ✦ labour
market ✦ market for loanable funds
The market for loanable funds
Rate of interest
Saving (supply)
Investment (demand) O
Quantity of loanable funds
The market for loanable funds
Rate of interest
Saving (supply)
r1
Investment (demand) O
Quantity of loanable funds
The market for loanable funds
Rate of interest
Saving (supply)
r1
Investment (demand) O
Quantity of loanable funds
The market for loanable funds
Rate of interest
Saving (supply)
r2 Investment (demand) O
Quantity of loanable funds
The market for loanable funds
Rate of interest
Saving (supply)
r2 Investment (demand) O
Quantity of loanable funds
The market for loanable funds
Rate of interest
Saving (supply)
re
Investment (demand) O
Quantity of loanable funds
CLASSICAL MACROECONOMICS ■
Classical analysis of output and employment ✜
markets clear ✦ labour
market ✦ market for loanable funds ✦ market for imports and exports: the gold standard
CLASSICAL MACROECONOMICS ■
Classical analysis of output and employment ✜
markets clear ✦ labour
market ✦ market for loanable funds ✦ market for imports and exports: the gold standard ✜
Say’s law
CLASSICAL MACROECONOMICS ■
Classical analysis of output and employment ✜
markets clear ✦ labour
market ✦ market for loanable funds ✦ market for imports and exports: the gold standard ✜
■
Say’s law
Classical analysis of prices and inflation
CLASSICAL MACROECONOMICS ■
Classical analysis of output and employment ✜
markets clear ✦ labour
market ✦ market for loanable funds ✦ market for imports and exports: the gold standard ✜
■
Say’s law
Classical analysis of prices and inflation ✜
the quantity theory of money
CLASSICAL MACROECONOMICS ■
Classical analysis of output and employment ✜
markets clear ✦ labour
market ✦ market for loanable funds ✦ market for imports and exports: the gold standard ✜
■
Say’s law
Classical analysis of prices and inflation the quantity theory of money ✜ the equation of exchange: MV = PY ✜
CLASSICAL MACROECONOMICS ■
Classical analysis of output and employment ✜
markets clear ✦ labour
market ✦ market for loanable funds ✦ market for imports and exports: the gold standard ✜
■
Say’s law
Classical analysis of prices and inflation the quantity theory of money ✜ the equation of exchange: MV = PY ✜ implications for monetary policy ✜
CLASSICAL MACROECONOMICS ■
The Great Depression and the return to the gold standard ✜
the depression of the 1920s
UK unemployment and inflation: 1919 − 38 24
Unemployment
20 18 16 14 12 10 8 6 4 2 0 1919 1921 1923 1925 1927 1929 1931 1933 1935 1937
10 5 0 -5 -10 -15 -20 -25
Inflation (%)
Unemployment (% of workforce)
22
15
UK unemployment and inflation: 1919 − 38 24
Unemployment 10
20 18
Inflation
16 14 12 10 8 6 4 2 0 1919 1921 1923 1925 1927 1929 1931 1933 1935 1937
5 0 -5 -10 -15 -20 -25
Inflation (%)
Unemployment (% of workforce)
22
15
CLASSICAL MACROECONOMICS ■
The Great Depression and the return to the gold standard ✜
the depression of the 1920s
✜
return to the gold standard
CLASSICAL MACROECONOMICS ■
The Great Depression and the return to the gold standard ✜
the depression of the 1920s
✜
return to the gold standard
✜
effects on the economy
CLASSICAL MACROECONOMICS ■
The Great Depression and the return to the gold standard ✜
the depression of the 1920s
✜
return to the gold standard
✜
effects on the economy
✜
the policy response
CLASSICAL MACROECONOMICS ■
The Great Depression and the return to the gold standard ✜
the depression of the 1920s
✜
return to the gold standard
✜
effects on the economy
✜
the policy response
✜
classical rejection of public works
CLASSICAL MACROECONOMICS ■
The Great Depression and the return to the gold standard ✜
the depression of the 1920s
✜
return to the gold standard
✜
effects on the economy
✜
the policy response
✜
classical rejection of public works ✦ the
fear of inflation
CLASSICAL MACROECONOMICS ■
The Great Depression and the return to the gold standard ✜
the depression of the 1920s
✜
return to the gold standard
✜
effects on the economy
✜
the policy response
✜
classical rejection of public works ✦ the
fear of inflation
✦ the
problem of crowding out
The effect of printing extra money: the classical analysis
Price level
AS
P2
P1
AD2 AD1
O
Q1
National output
The Roots of Modern Macroeconomics
The Keynesian Revolution
THE KEYNESIAN REVOLUTION ■
Keynes’ rejection of classical theory rigidities in the labour market ✜ the problem of deficiency of demand ✜
The problem of demand deficiency in the labour market Real wage rate (W / P)
ASL
W1
ADL1 ADL2 O
Quantity of labour
THE KEYNESIAN REVOLUTION ■
Keynes’ rejection of classical theory rigidities in the labour market ✜ the problem of deficiency of demand ✜ rejection of increased saving as a means of increasing investment ✜
Disequilibrium in the market for loanable funds
Rate of interest
Savings 1
Savings 2
r1 r2 Investment O
Quantity of loanable funds
THE KEYNESIAN REVOLUTION ■
Keynes’ rejection of classical theory rigidities in the labour market ✜ the problem of deficiency of demand ✜ rejection of increased saving as a means of increasing investment ✜ rejection of simple quantity theory ✜
THE KEYNESIAN REVOLUTION ■
Keynes’ rejection of classical theory rigidities in the labour market ✜ the problem of deficiency of demand ✜ rejection of increased saving as a means of increasing investment ✜ rejection of simple quantity theory ✜ rejection of a balanced budget ✜
THE KEYNESIAN REVOLUTION ■
Keynes’ rejection of classical theory rigidities in the labour market ✜ the problem of deficiency of demand ✜ rejection of increased saving as a means of increasing investment ✜ rejection of simple quantity theory ✜ rejection of a balanced budget ✜
■
Keynes’ analysis of employment and inflation
THE KEYNESIAN REVOLUTION ■
Keynes’ rejection of classical theory rigidities in the labour market ✜ the problem of deficiency of demand ✜ rejection of increased saving as a means of increasing investment ✜ rejection of simple quantity theory ✜ rejection of a balanced budget ✜
■
Keynes’ analysis of employment and inflation ✜
the importance of aggregate demand
The effects of increases in aggregate demand on national output
Price level
AS
O
YP
National output
The effects of increases in aggregate demand on national output
Price level
AS
AD4
AD2
AD1 O
Y1
Y2
AD3
Y3
National output
Y4
YP
THE KEYNESIAN REVOLUTION ■
Keynes’ rejection of classical theory rigidities in the labour market ✜ the problem of deficiency of demand ✜ rejection of increased saving as a means of increasing investment ✜ rejection of simple quantity theory ✜ rejection of a balanced budget ✜
■
Keynes’ analysis of employment and inflation the importance of aggregate demand ✜ the multiplier process ✜
The circular flow of income
The circular flow of income
Cd
The circular flow of income
Incomes
Cd
The circular flow of income
Incomes
Cd
W=S+T+M
The circular flow of income
J=I+G+X
Incomes
Cd
W=S+T+M
The circular flow of income
J=I+G+X
Incomes
Cd
W=S+T+M
The circular flow of income
J=I+G+X
Incomes
Cd
W=S+T+M
The circular flow of income
J=I+G+X
Incomes
Cd
W=S+T+M
THE KEYNESIAN REVOLUTION ■
Keynes’ policy recommendations ✜
■
demand management by fiscal and monetary policies
Keynesian policies in 1950s and 60s ✜
stop–go policies
✜
criticisms of short-term demand management
✜
the breakdown of the Phillips curve
The Roots of Modern Macroeconomics
The Monetarist– Keynesian Debate
THE MONETARIST–KEYNESIAN DEBATE ■
The monetarist counter-revolution ✜
the restatement of the quantity theory
✜
rejection of Keynesian demand management policies
✜
the problem of inflationary expectations
✜
reappraisal of the Phillips curve ✦ unemployment ✦ inflation
Inflation (%)
The monetarist version of the long-run Phillips curve
O
Un
Unemployment
(a) Keynesian aggregate supply curve
Price level
AS
O
Ymax YP
National output
Inflation (%)
(b) Keynesian Phillips curve
O
Umin
Unemployment
THE MONETARIST–KEYNESIAN DEBATE ■
The monetarist counter-revolution ✜
the restatement of the quantity theory
✜
rejection of Keynesian demand management policies
✜
the problem of inflationary expectations
✜
reappraisal of the Phillips curve ✦ unemployment ✦ inflation
✜
monetarist policies
THE MONETARIST–KEYNESIAN DEBATE ■
The monetarist counter-revolution ✜
the restatement of the quantity theory
✜
rejection of Keynesian demand management policies
✜
the problem of inflationary expectations
✜
reappraisal of the Phillips curve ✦ unemployment ✦ inflation
✜
monetarist policies
✜
attempts at such policies in the 1980s
THE MONETARIST–KEYNESIAN DEBATE ■
Modern-day Keynesians ✜
inflation
✜
unemployment
✜
structural problems
✜
hysteresis ✦ low
capital stock
✦ deskilling ✦ insiders
and outsiders
✜
criticisms of monetarism
✜
Keynesian policy proposals
The Roots of Modern Macroeconomics
The Current Position
THE CURRENT POSITION ■
The current range of views ✜
new classical / rational expectations school
✜
moderate monetarists
✜
moderate Keynesians (new Keynesians)
✜
extreme Keynesians
✜
the radical left
✜
eclectic economists
THE CURRENT POSITION ■
A mainstream consensus? ✜
short-run effects of changes in AD
✜
long-run effects of changes in AD
✜
no simple trade-off between inflation and unemployment
✜
role of expectations
✜
effects of excessive growth in the money supply
✜
importance of supply-side policies
✜
erosion of governments' power by the process of globalisation
The Roots of Modern Macroeconomics
Setting the Scene: Three Key Issues
THREE KEY ISSUES ■
■
Issue 1: Flexibility of prices and wages ✜
the right: flexible prices and wages
✜
the left: price and wage rigidities
Issue 2: Flexibility of aggregate supply ✜
the right: aggregate supply determined independently of aggregate demand
Different aggregate supply curves: (a)
Price level
AS
O
Y
National output
Different aggregate supply curves: (a)
Price level
AS
P1
AD1 O
Y
National output
Different aggregate supply curves: (a)
Price level
AS
P2
P1
AD2 AD1
O
Y
National output
THREE KEY ISSUES ■
■
Issue 1: Flexibility of prices and wages ✜
the right: flexible prices and wages
✜
the left: price and wage rigidities
Issue 2: Flexibility of aggregate supply ✜
the right: aggregate supply determined independently of aggregate demand
✜
the left: aggregate supply responsive to changes in aggregate demand
Price level
Different aggregate supply curves: (b)
AS
P
O
National output
Price level
Different aggregate supply curves: (b)
AS
P
AD1 O
Y1
National output
Price level
Different aggregate supply curves: (b)
AS
P
AD2 AD1 O
Y1
Y2
National output
THREE KEY ISSUES ■
■
Issue 1: Flexibility of prices and wages ✜
the right: flexible prices and wages
✜
the left: price and wage rigidities
Issue 2: Flexibility of aggregate supply ✜
the right: aggregate supply determined independently of aggregate demand
✜
the left: aggregate supply responsive to changes in aggregate demand
✜
some consensus on nature of short-run AS curve
Different aggregate supply curves: (c)
Price level
AS
O
National output
Different aggregate supply curves: (c)
Price level
AS
P1
AD1 O
Y1
National output
Different aggregate supply curves: (c)
Price level
AS
P2 P1
AD2 AD1 O
Y1
Y2
National output
THREE KEY ISSUES ■
Issue 3: The role of expectations in the working of the market ✜
the right: expectations adjust rapidly to changes in prices
✜
the left: expectations of prices depend on expectations of output and employment
The Roots of Modern Macroeconomics
Classical Macroeconomics
CLASSICAL MACROECONOMICS ■
Classical analysis of output and employment ✜
markets clear ✦ labour
market ✦ market for loanable funds
The market for loanable funds
Rate of interest
Saving (supply)
Investment (demand) O
Quantity of loanable funds
The market for loanable funds
Rate of interest
Saving (supply)
r1
Investment (demand) O
Quantity of loanable funds
The market for loanable funds
Rate of interest
Saving (supply)
r1
Investment (demand) O
Quantity of loanable funds
The market for loanable funds
Rate of interest
Saving (supply)
r2 Investment (demand) O
Quantity of loanable funds
The market for loanable funds
Rate of interest
Saving (supply)
r2 Investment (demand) O
Quantity of loanable funds
The market for loanable funds
Rate of interest
Saving (supply)
re
Investment (demand) O
Quantity of loanable funds
CLASSICAL MACROECONOMICS ■
Classical analysis of output and employment ✜
markets clear ✦ labour
market ✦ market for loanable funds ✦ market for imports and exports: the gold standard
CLASSICAL MACROECONOMICS ■
Classical analysis of output and employment ✜
markets clear ✦ labour
market ✦ market for loanable funds ✦ market for imports and exports: the gold standard ✜
Say’s law
CLASSICAL MACROECONOMICS ■
Classical analysis of output and employment ✜
markets clear ✦ labour
market ✦ market for loanable funds ✦ market for imports and exports: the gold standard ✜
■
Say’s law
Classical analysis of prices and inflation
CLASSICAL MACROECONOMICS ■
Classical analysis of output and employment ✜
markets clear ✦ labour
market ✦ market for loanable funds ✦ market for imports and exports: the gold standard ✜
■
Say’s law
Classical analysis of prices and inflation ✜
the quantity theory of money
CLASSICAL MACROECONOMICS ■
Classical analysis of output and employment ✜
markets clear ✦ labour
market ✦ market for loanable funds ✦ market for imports and exports: the gold standard ✜
■
Say’s law
Classical analysis of prices and inflation the quantity theory of money ✜ the equation of exchange: MV = PY ✜
CLASSICAL MACROECONOMICS ■
Classical analysis of output and employment ✜
markets clear ✦ labour
market ✦ market for loanable funds ✦ market for imports and exports: the gold standard ✜
■
Say’s law
Classical analysis of prices and inflation the quantity theory of money ✜ the equation of exchange: MV = PY ✜ implications for monetary policy ✜
CLASSICAL MACROECONOMICS ■
The Great Depression and the return to the gold standard ✜
the depression of the 1920s
UK unemployment and inflation: 1919 − 38 24
Unemployment
20 18 16 14 12 10 8 6 4 2 0 1919 1921 1923 1925 1927 1929 1931 1933 1935 1937
10 5 0 -5 -10 -15 -20 -25
Inflation (%)
Unemployment (% of workforce)
22
15
UK unemployment and inflation: 1919 − 38 24
Unemployment 10
20 18
Inflation
16 14 12 10 8 6 4 2 0 1919 1921 1923 1925 1927 1929 1931 1933 1935 1937
5 0 -5 -10 -15 -20 -25
Inflation (%)
Unemployment (% of workforce)
22
15
CLASSICAL MACROECONOMICS ■
The Great Depression and the return to the gold standard ✜
the depression of the 1920s
✜
return to the gold standard
CLASSICAL MACROECONOMICS ■
The Great Depression and the return to the gold standard ✜
the depression of the 1920s
✜
return to the gold standard
✜
effects on the economy
CLASSICAL MACROECONOMICS ■
The Great Depression and the return to the gold standard ✜
the depression of the 1920s
✜
return to the gold standard
✜
effects on the economy
✜
the policy response
CLASSICAL MACROECONOMICS ■
The Great Depression and the return to the gold standard ✜
the depression of the 1920s
✜
return to the gold standard
✜
effects on the economy
✜
the policy response
✜
classical rejection of public works
CLASSICAL MACROECONOMICS ■
The Great Depression and the return to the gold standard ✜
the depression of the 1920s
✜
return to the gold standard
✜
effects on the economy
✜
the policy response
✜
classical rejection of public works ✦ the
fear of inflation
CLASSICAL MACROECONOMICS ■
The Great Depression and the return to the gold standard ✜
the depression of the 1920s
✜
return to the gold standard
✜
effects on the economy
✜
the policy response
✜
classical rejection of public works ✦ the
fear of inflation
✦ the
problem of crowding out
The effect of printing extra money: the classical analysis
Price level
AS
P2
P1
AD2 AD1
O
Q1
National output
The Roots of Modern Macroeconomics
The Keynesian Revolution
THE KEYNESIAN REVOLUTION ■
Keynes’ rejection of classical theory rigidities in the labour market ✜ the problem of deficiency of demand ✜
The problem of demand deficiency in the labour market Real wage rate (W / P)
ASL
W1
ADL1 ADL2 O
Quantity of labour
THE KEYNESIAN REVOLUTION ■
Keynes’ rejection of classical theory rigidities in the labour market ✜ the problem of deficiency of demand ✜ rejection of increased saving as a means of increasing investment ✜
Disequilibrium in the market for loanable funds
Rate of interest
Savings 1
Savings 2
r1 r2 Investment O
Quantity of loanable funds
THE KEYNESIAN REVOLUTION ■
Keynes’ rejection of classical theory rigidities in the labour market ✜ the problem of deficiency of demand ✜ rejection of increased saving as a means of increasing investment ✜ rejection of simple quantity theory ✜
THE KEYNESIAN REVOLUTION ■
Keynes’ rejection of classical theory rigidities in the labour market ✜ the problem of deficiency of demand ✜ rejection of increased saving as a means of increasing investment ✜ rejection of simple quantity theory ✜ rejection of a balanced budget ✜
THE KEYNESIAN REVOLUTION ■
Keynes’ rejection of classical theory rigidities in the labour market ✜ the problem of deficiency of demand ✜ rejection of increased saving as a means of increasing investment ✜ rejection of simple quantity theory ✜ rejection of a balanced budget ✜
■
Keynes’ analysis of employment and inflation
THE KEYNESIAN REVOLUTION ■
Keynes’ rejection of classical theory rigidities in the labour market ✜ the problem of deficiency of demand ✜ rejection of increased saving as a means of increasing investment ✜ rejection of simple quantity theory ✜ rejection of a balanced budget ✜
■
Keynes’ analysis of employment and inflation ✜
the importance of aggregate demand
The effects of increases in aggregate demand on national output
Price level
AS
O
YP
National output
The effects of increases in aggregate demand on national output
Price level
AS
AD4
AD2
AD1 O
Y1
Y2
AD3
Y3
National output
Y4
YP
THE KEYNESIAN REVOLUTION ■
Keynes’ rejection of classical theory rigidities in the labour market ✜ the problem of deficiency of demand ✜ rejection of increased saving as a means of increasing investment ✜ rejection of simple quantity theory ✜ rejection of a balanced budget ✜
■
Keynes’ analysis of employment and inflation the importance of aggregate demand ✜ the multiplier process ✜
The circular flow of income
The circular flow of income
Cd
The circular flow of income
Incomes
Cd
The circular flow of income
Incomes
Cd
W=S+T+M
The circular flow of income
J=I+G+X
Incomes
Cd
W=S+T+M
The circular flow of income
J=I+G+X
Incomes
Cd
W=S+T+M
The circular flow of income
J=I+G+X
Incomes
Cd
W=S+T+M
The circular flow of income
J=I+G+X
Incomes
Cd
W=S+T+M
THE KEYNESIAN REVOLUTION ■
Keynes’ policy recommendations ✜
■
demand management by fiscal and monetary policies
Keynesian policies in 1950s and 60s ✜
stop–go policies
✜
criticisms of short-term demand management
✜
the breakdown of the Phillips curve
The Roots of Modern Macroeconomics
The Monetarist– Keynesian Debate
THE MONETARIST–KEYNESIAN DEBATE ■
The monetarist counter-revolution ✜
the restatement of the quantity theory
✜
rejection of Keynesian demand management policies
✜
the problem of inflationary expectations
✜
reappraisal of the Phillips curve ✦ unemployment ✦ inflation
Inflation (%)
The monetarist version of the long-run Phillips curve
O
Un
Unemployment
(a) Keynesian aggregate supply curve
Price level
AS
O
Ymax YP
National output
Inflation (%)
(b) Keynesian Phillips curve
O
Umin
Unemployment
THE MONETARIST–KEYNESIAN DEBATE ■
The monetarist counter-revolution ✜
the restatement of the quantity theory
✜
rejection of Keynesian demand management policies
✜
the problem of inflationary expectations
✜
reappraisal of the Phillips curve ✦ unemployment ✦ inflation
✜
monetarist policies
THE MONETARIST–KEYNESIAN DEBATE ■
The monetarist counter-revolution ✜
the restatement of the quantity theory
✜
rejection of Keynesian demand management policies
✜
the problem of inflationary expectations
✜
reappraisal of the Phillips curve ✦ unemployment ✦ inflation
✜
monetarist policies
✜
attempts at such policies in the 1980s
THE MONETARIST–KEYNESIAN DEBATE ■
Modern-day Keynesians ✜
inflation
✜
unemployment
✜
structural problems
✜
hysteresis ✦ low
capital stock
✦ deskilling ✦ insiders
and outsiders
✜
criticisms of monetarism
✜
Keynesian policy proposals
The Roots of Modern Macroeconomics
The Current Position
THE CURRENT POSITION ■
The current range of views ✜
new classical / rational expectations school
✜
moderate monetarists
✜
moderate Keynesians (new Keynesians)
✜
extreme Keynesians
✜
the radical left
✜
eclectic economists
THE CURRENT POSITION ■
A mainstream consensus? ✜
short-run effects of changes in AD
✜
long-run effects of changes in AD
✜
no simple trade-off between inflation and unemployment
✜
role of expectations
✜
effects of excessive growth in the money supply
✜
importance of supply-side policies
✜
erosion of governments' power by the process of globalisation
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