The roots of modern macroeconomics

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  • The roots of modern macroeconomics

    1. 1. The Roots of Modern MacroeconomicsSetting the Scene: Three Key Issues
    2. 2. 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
    3. 3. Different aggregate supply curves: (a) ASPrice level O Y National output
    4. 4. Different aggregate supply curves: (a) ASPrice level P1 AD1 O Y National output
    5. 5. Different aggregate supply curves: (a) ASPrice level P2 P1 AD2 AD1 O Y National output
    6. 6. 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
    7. 7. Price level Different aggregate supply curves: (b) P AS O National output
    8. 8. Price level Different aggregate supply curves: (b) P AS AD1 O Y1 National output
    9. 9. Price level Different aggregate supply curves: (b) P AS AD2 AD1 O Y1 Y2 National output
    10. 10. 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
    11. 11. Different aggregate supply curves: (c) ASPrice level O National output
    12. 12. Different aggregate supply curves: (c) ASPrice level P1 AD1 O Y1 National output
    13. 13. Different aggregate supply curves: (c) ASPrice level P2 P1 AD2 AD1 O Y1 Y2 National output
    14. 14. 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
    15. 15. The Roots of Modern Macroeconomics ClassicalMacroeconomics
    16. 16. CLASSICAL MACROECONOMICS• Classical analysis of output and employment – markets clear • labour market • market for loanable funds
    17. 17. The market for loanable funds Saving (supply)Rate of interest Investment (demand) O Quantity of loanable funds
    18. 18. The market for loanable funds Saving (supply)Rate of interest r1 Investment (demand) O Quantity of loanable funds
    19. 19. The market for loanable funds Saving (supply)Rate of interest r1 Investment (demand) O Quantity of loanable funds
    20. 20. The market for loanable funds Saving (supply)Rate of interest r2 Investment (demand) O Quantity of loanable funds
    21. 21. The market for loanable funds Saving (supply)Rate of interest r2 Investment (demand) O Quantity of loanable funds
    22. 22. The market for loanable funds Saving (supply)Rate of interest re Investment (demand) O Quantity of loanable funds
    23. 23. CLASSICAL MACROECONOMICS• Classical analysis of output and employment – markets clear • labour market • market for loanable funds • market for imports and exports: the gold standard
    24. 24. 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
    25. 25. 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
    26. 26. 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
    27. 27. 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
    28. 28. 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
    29. 29. CLASSICAL MACROECONOMICS• The Great Depression and the return to the gold standard – the depression of the 1920s
    30. 30. UK unemployment and inflation: 1919 − 38 24 15 Unemployment 22 10 20Unemployment (% of workforce) 18 5 16 0 Inflation (%) 14 12 -5 10 -10 8 6 -15 4 -20 2 0 -25 1919 1921 1923 1925 1927 1929 1931 1933 1935 1937
    31. 31. UK unemployment and inflation: 1919 − 38 24 15 Unemployment 22 10 20Unemployment (% of workforce) 18 Inflation 5 16 0 Inflation (%) 14 12 -5 10 -10 8 6 -15 4 -20 2 0 -25 1919 1921 1923 1925 1927 1929 1931 1933 1935 1937
    32. 32. CLASSICAL MACROECONOMICS• The Great Depression and the return to the gold standard – the depression of the 1920s – return to the gold standard
    33. 33. 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
    34. 34. 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
    35. 35. 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
    36. 36. 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
    37. 37. 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
    38. 38. The effect of printing extra money: the classical analysis ASPrice level P2 P1 AD2 AD1 O Q1 National output
    39. 39. The Roots of Modern Macroeconomics The Keynesian Revolution
    40. 40. THE KEYNESIAN REVOLUTION• Keynes’ rejection of classical theory – rigidities in the labour market – the problem of deficiency of demand
    41. 41. The problem of demand deficiency in the labour market ASLReal wage rate (W / P) W1 ADL1 ADL2 O Quantity of labour
    42. 42. 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
    43. 43. Disequilibrium in the market for loanable funds Savings 1 Savings 2Rate of interest r1 r2 Investment O Quantity of loanable funds
    44. 44. 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
    45. 45. 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
    46. 46. 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
    47. 47. 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
    48. 48. The effects of increases in aggregate demand on national output ASPrice level O YP National output
    49. 49. The effects of increases in aggregate demand on national output ASPrice level AD4 AD3 AD1 AD2 O Y1 Y2 Y3 Y4 YP National output
    50. 50. 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
    51. 51. The circular flow of income
    52. 52. The circular flow of income Cd
    53. 53. The circular flow of incomeIncomes Cd
    54. 54. The circular flow of incomeIncomes Cd W=S+T+M
    55. 55. The circular flow of income J=I+G+XIncomes Cd W=S+T+M
    56. 56. The circular flow of income J=I+G+XIncomes Cd W=S+T+M
    57. 57. The circular flow of income J=I+G+XIncomes Cd W=S+T+M
    58. 58. The circular flow of income J=I+G+XIncomes Cd W=S+T+M
    59. 59. 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
    60. 60. The Roots of Modern MacroeconomicsThe Monetarist– Keynesian Debate
    61. 61. 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
    62. 62. Inflation (%) The monetarist version of the long-run Phillips curve O Un Unemployment
    63. 63. (a) Keynesian aggregate supply curve ASPrice level O Ymax YP National output
    64. 64. Inflation (%) (b) Keynesian Phillips curve O Umin Unemployment
    65. 65. 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
    66. 66. 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
    67. 67. 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
    68. 68. The Roots of Modern MacroeconomicsThe Current Position
    69. 69. 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
    70. 70. 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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