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Macroeconomics, 9th Canadian Edition
Macroeconomics, 9/e
Campbell R. McConnell, University of Nebraska, Lincoln
Stanley L. Brue, Pacific Lutheran University
Thomas P. Barbiero, Ryerson University

Disputes over Macro Theory and Policy [ Internet-Only chapter ]

Chapter Highlights

  1. In classical economics the aggregate supply curve is vertical and establishes the level of real output, while the aggregate demand curve is generally stable and establishes the price level. In this view the economy is highly stable.
  2. In Keynesian economics the aggregate supply curve is horizontal at less-than-full-employment levels of real output, while the aggregate demand curve is inherently unstable. In this view the economy is highly unstable.
  3. The mainstream view is that macro instability is caused by the volatility of investment spending, which shifts the aggregate demand curve. If aggregate demand increases too rapidly, demand-pull inflation may occur; if aggregate demand decreases, recession may occur. Occasionally, adverse supply shocks also cause instability.
  4. Monetarism focuses on the equation of exchange: MV = PQ. Because velocity is thought to be stable, changes in M create changes in nominal GDP (= PQ). Monetarists believe that the most significant cause of macroeconomic instability has been inappropriate monetary policy. Rapid increases in M cause inflation; insufficient growth of M causes recession. In this view, a major cause of the Great Depression was inappropriate monetary policy, which allowed the money supply to decline.
  5. Real-business-cycle theory views changes in resource availability and technology (real factors), which alter productivity, as the main causes of macroeconomic instability. In this theory, shifts in the economy's longrun aggregate supply curve change real output. In turn, money demand and money supply change, shifting the aggregate demand curve in the same direction as the initial change in long-run aggregate supply. Real output thus can change without a change in the price level.
  6. A coordination failure is said to occur when people lack a way to coordinate their actions in order to achieve a mutually beneficial equilibrium. Depending on people's expectations, the economy can come to rest at either a good equilibrium (non-inflationary full-employment output) or at a bad equilibrium (less-than-fullemployment output or demand-pull inflation). A bad equilibrium is a result of a coordination failure.
  7. The rational expectations theory (RET) rests on two assumptions: (1) With sufficient information, people's beliefs about future economic outcomes accurately reflect the likelihood that those outcomes will occur; and (2) markets are highly competitive, and prices and wages are flexible both upward and downward.
  8. New classical economists (monetarists and rational expectations theorists) see the economy as automatically correcting itself when disturbed from its full-employment level of real output. In RET, unanticipated changes in aggregate demand change the price level, which in the short run leads firms to change output. But once the firms realize that all prices are changing (including nominal wages) as part of general inflation or deflation, they restore their output to the previous level. Anticipated changes in aggregate demand produce only changes in the price level, not changes in real output.
  9. Mainstream economists reject the new classical view that all prices and wages are flexible downward. They contend that nominal wages, in particular, are inflexible downward because of several factors, including labour contracts, efficiency wages, and insider-outsider relationships. This means that declines in aggregate demand lower real output, not only wages and prices.
  10. Monetarist and RET economists recommend a monetary rule according to which the central bank is directed to increase the money supply at a fixed annual rate equal to the long-run growth of potential GDP. They also support maintaining a "neutral" fiscal policy, as opposed to using discretionary fiscal policy to create budget deficits or budget surpluses. A few monetarists and RET economists favour a constitutional amendment that would require the federal government to balance its budget annually.
  11. Mainstream economists oppose a monetary rule and a balanced-budget requirement and vigorously defend discretionary monetary and fiscal policies. They say that both theory and evidence suggest that such policies are helpful in achieving full employment, price stability, and economic growth.