Transcript monetarism & supply

Chapter Thirty Three
Debates in
Macroeconomics:
Monetarism, New
Classical Theory, and
Supply-Side Economics
Keynesian Economics
The term Keynesian is sometimes
used to refer to economists who
advocate active government
intervention in the macroeconomy.
Monetarism
 “Money matters”
 Monetarists usually argue against
government intervention in the
macroeconomy
Velocity of Money
GDP
V= M
GDP = P  Y
PY
V=
M
Quantity Theory of Money
MV=PY
Assuming that the velocity of
money (V) is constant.
Monetarists say figures like these support their
contention that inflation is a monetary
phenomenon:
Annual average percentage change 1985 to 1995 in:
Country
Money Supply
Prices (GDP Deflator)
Brazil
995.5%
875.3
Peru
388.5
398.5
Sierra Leone
51.4
61.6
Jamaica
32.8
28.3
Israel
22.1
17.1
United States
3.9
3.2
Keynesian/Monetarist Debate
Milton Friedman
 leading spokesman for monetarists
 advocates steady and slow monetary
growth
 blames most of the economy’s
instability on the federal government
New Classical Macroeconomics
 Rational Expectations
 Supply-Side Economics
Rational Expectations
Hypothesis
The rational expectations hypothesis
states that people know the “true
model” of the economy and that they
use this model to form their
expectations of the future.
Lucas Supply Function
This supply function embodies the
idea that output (Y) depends upon
the difference between the actual
price level and the expected price
level.
Y = f(P - Pe)
Real Business Cycle Theory
The real business cycle theory is an
attempt to explain business cycle
fluctuations under the assumptions
of complete price and wage
flexibility and rational expectations.
It emphasizes shocks to technology
and other shocks.
Supply-Side Economics
focuses on incentives to stimulate supply
lower taxes will prompt workers to work
harder and save more and firms will invest
and produce more
uses Laffer Curve to argue the possibility
of generating more revenues by cutting tax
rates
The Laffer Curve
Tax Rates (%)
100
A
B
0
Tax Revenues
(dollars)
Review Terms & Concepts
 Laffer Curve
 Rational-expectations
 Lucas supply function
hypothesis
 Real business cycle
theory
 Supply-side
economics
 Velocity of money (V)
 Monetarism
 New classical
macroeconomics
 Price surprise
 Quantity theory of
money