Pump Primer:

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Pump Primer

• Write the five key questions about Macroeconomics
  Policy.

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ModuleThe ModernMacroeconomicConsensus
36

• KRUGMAN'S
• MACROECONOMICS for AP

Margaret Ray and David Anderson
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Biblical Integration

• Money is not wealth, it is just merely a resource
  given to us by God to sustain our life her on
  this earth. Economist even recognize that gold is
  merely a shiny mineral whose sole value lies in
  the fact that others hold it to be of value. The
  true believer recognizes that Scripture and the
  blood of Christ are intrinsically valuable. They
  retain their value even if the world denies their
  efficacy.

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What you will learnin this Module

• The elements of the modern macroeconomic
  consensus
• The main remaining disputes

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The Modern Consensus
The previous module separated economic debates
into several macroeconomic schools of thought. On
paper, there are striking differences between
some of them. However in practice, as more years
of data have been observed, there exists more of
a growing consensus amongst macroeconomists then
the previous module might suggest.
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The Modern Consensus
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Should Monetary Policy Be Used in a
Discretionary Way?

• Is Expansionary Monetary Policy Helpful in
  Fighting Recessions?
• Classical economics really didnt believe that
  monetary policy would reverse a recession.
  Keynesians thought it could have limited
  effectiveness.

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Should Monetary Policy Be Used in a
Discretionary Way?

• Milton Friedman and his followers convinced
  economists that monetary policy is effective.
• Nearly all macroeconomists now agree that
  monetary policy can be used to shift the
  aggregate demand curve and to reduce economic
  instability.
• The classical view that changes in the money
  supply affect only aggregate prices, not
  aggregate output, has few supporters today.
• The view once held by some Keynesian
  economiststhat changes in the money supply have
  little effecthas equally few supporters.
• Now, it is generally agreed that monetary policy
  is ineffective only in the case of a liquidity
  trap.

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Should Monetary Policy Be Used in a
Discretionary Way?
B. Is Expansionary Fiscal Policy Effective in
Fighting Recessions? Classical macroeconomists
were even more opposed to fiscal expansion than
monetary expansion. Keynesian economists, on
the other hand, gave fiscal policy a central role
in fighting recessions.
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Should Monetary Policy Be Used in a
Discretionary Way?

• Monetarists argued that fiscal policy was
  ineffective as long as the money supply was held
  constant. But that strong view has become
  relatively rare.
• Most macroeconomists now agree that fiscal
  policy, like monetary policy, can shift the
  aggregate demand curve.
• Most macroeconomists also agree that the
  government should not seek to balance the budget
  regardless of the state of the economy they
  agree that the role of the budget as an automatic
  stabilizer helps keep the economy on an even keel.

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Should Monetary Policy Be Used in a
Discretionary Way?
C. Can Monetary and/or Fiscal Policy Reduce
Unemployment in the Long- Run? Classical
macroeconomists didnt believe the government
could do anything about unemployment. Some
Keynesian economists moved to the opposite
extreme, arguing that expansionary policies could
be used to achieve a permanently low unemployment
rate, perhaps at the cost of some inflation.
Monetarists believed that unemployment could not
be kept below the natural rate.
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Should Monetary Policy Be Used in a
Discretionary Way?

• Almost all macroeconomists now accept the natural
  rate hypothesis and agree on the limitations of
  monetary and fiscal policy.
• They believe that effective monetary and fiscal
  policy can limit the size of fluctuations of the
  actual unemployment rate around the natural rate,
  but cant keep unemployment below the natural
  rate.

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Should Monetary Policy Be Used in a
Discretionary Way?
D. Should Fiscal Policy Be Used in a
Discretionary Way? Today most macroeconomists
believe that tax cuts and spending increases are
at least somewhat effective in increasing
aggregate demand.
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Should Monetary Policy Be Used in a
Discretionary Way?

• Many, but not all, macroeconomists believe that
  discretionary fiscal policy is usually
  counterproductive the lags in adjusting fiscal
  policy mean that, all too often, policies
  Intended to fight a slump end up intensifying a
  boom.
• As a result, the macroeconomic consensus gives
  monetary policy the lead role in economic
  stabilization. Discretionary fiscal policy plays
  the leading role only in special circumstances
  when monetary policy is ineffective, such as
  those facing Japan during the 1990s when
  interest rates were at or near the zero bound
  and the economy was in a liquidity trap.

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Should Monetary Policy Be Used in a
Discretionary Way?
E. Should Monetary Policy Be Used in a
Discretionary Way? Classical macroeconomists
didnt think that monetary policy should be used
to fight recessions Keynesian economists didnt
oppose discretionary monetary policy, but they
were skeptical about its effectiveness.
Monetarists argued that discretionary
monetary policy was doing more harm than good.
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Should Monetary Policy Be Used in a
Discretionary Way?
Today there is a broad consensus among
macroeconomists on these points Monetary policy
should play the main role in stabilization
policy The central bank should be independent,
insulated from political pressures, in order to
avoid a political business cycle. Discretionary
fiscal policy should be used sparingly, both
because of policy lags and because of the risks
of a political business cycle.
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Should Monetary Policy Be Used in a
Discretionary Way?

• Central Bank Targets
• Some central banks have announced specified
  inflation targets. This provides more
  information to the public about how the central
  bank would take action if actual inflation got
  out of line with the target.
• The Federal Reserve does not announce a target
  rate of inflation, although some observers
  believe that Fed actions are consistent with a
  target of about 2.

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Should Monetary Policy Be Used in a
Discretionary Way?
2. Asset Prices Should the Fed be pro-actively
influencing the stock market, real estate market
or any asset market? For example, if the Fed
thought the stock market was at an unsustainably
high level, should the Fed intervene and try to
slow down investors? Some people dont want the
Fed to intervene in any market. However, if
the stock market bubble bursts, the damage can
be very painful, so maybe the Fed should prevent
that from happening.
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Should Monetary Policy Be Used in a
Discretionary Way?
3. Unconventional Monetary Policies Desperate
times require desperate measures. In 2008 when
the financial system seemed on the verge of
collapse, the Fed took some steps that dont
normally appear in the Feds playbook.