Transcript Where Macro is, and Where it`s Going

A Student’s Guide to the
Current Economic Crisis
Dave Colander
Middlebury College
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Outline of Talk
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Provide a bit of history of
macroeconomics
Discuss how the AS/AD model can be
used to explain the current crisis
Discuss why the crisis is scary and the
government’s attempt to get us out of
the crisis.
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The Macro Economy as a
complex system
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Some Macro History
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Macroeconomics as a course developed in the
1930s
Before then, the was Classical economics,
and quantity theory of money
Macroeconomics became associated with
Keynesian economics and a specific limited
interpretation of Keynesian economics
Keynesian economic theory was soon
sidetracked into simple equilibrium models
that didn’t capture possible dynamic
instability.
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Explaining the current crisis in
words
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Structural economy changed in 1990s—inflation
ended due to global competition
Government expanded money supply; private sector
expanded leverage.
Bubbles in asset markets were created by leverage
and expectations.
Not noticed because there was no goods market
inflation
Nominal wealth increased more than real wealth
could. People had irrational exuberance and
expectations.
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Causes of the Current Crisis
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Too Easy Monetary Policy
Too Easy regulation
Too strong reliance on models and past
history
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Explaining the Current Crisis in
the AS/AD Model
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The Use and Abuse of the AS/AD model
The one thing at a time approach
What’s being held constant?
Standard Story is an equilibrium story
What’s missing? Dynamic
disequilibrium problems
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The Dynamic Disequilibrium Story: When
Other Things Don’t Remain Constant
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Explaining the Current crisis in
a Picture
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A 450 pound 5 ft 10 inch man has a
heart attack.
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Explaining the Current Crisis in
the Quantity Theory
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MV = PY
Global competition changed the
connection; asset price bubble
Failure to distinguish between real
wealth and nominal wealth
Money no longer the relevant issue—
the quantity theory of credit.
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Government Response to the
Crisis
Triage Policy
 Treatment Policy
 Rehabilitation
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Triage Policy
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Why is the financial sector different. It
is the economic equivalent to the heart.
If the financial sector stops beating, the
economy stops.
The Troubled Asset Rescue Package
(TARP)—the 700 billion triage policy.
Keep the financial sector going.
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Treatment policy
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Monetary policy
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Fiscal policy
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Liquidity trap
Quantitative easing
Fiscal stimulus
Automatic stabilizers
Expectations policy
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Rehabilitation Stage
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Repairing the Damage Done in the Triage and
Treatment Stage
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Eliminating the Deficit
Creating a sense of fairness
Countering the sense of unfairness from the
bailout programs.
Too big to fail and the moral hazard problem
The Problem waiting in the Wings:
International Financial Crisis
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Trade deficit
Dollar overhang
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Three Ideas to Keep in Mind in
Structuring new Regulation
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The golden rule of economics: Him who
has the money makes the rules.
If you will bail out, you have to
regulate; avoid the moral hazard
problem
Law of Diminishing Regulation:
Technological change and leaning by
sneaking around undermines regulation
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