• Revision Lecture 20th of May!
Keynesian Macroeconomics
Mankiw Chapter 9
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So far
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Keynesian View
• Keynes (1936) General Theory
• Particular attention to microfoundations of
macroeconomics to account for buiness cycle
fluctuations
• Optimizing consumers / firms
• Pareto Optimality
• Market clearing
• Modern macroeconomics
• There is a distinction in the short and long run
• In the short run prices or wages are sticky!
• i.e. in the short run goods and labour markets do
not clear..
• There are other BC theories that rely on ad hoc
specifications for price/wage adjustment
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• Money is not neutral in the short run
• Strong implications for policymaking
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unemployment
• Microfounded models look at employment
not unemployment
• Keynesian model has a say on this
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Quantity Theory of Money
Velocity
P×Y
V=
M
Equation of Exchange
Aggregate Demand
M×V=P×Y
• Quantity equation of aggregate demand
Quantity Theory of Money
1. Irving Fisher’s view: V is fairly constant
2. Equation of exchange no longer identity
3. Nominal income, PY, determined by M
4. Classicals assume Y fairly constant
5. P determined by M
M*V = P*Y
Or
Quantity Theory of Money Demand
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M=
× PY
V
M/P = Y/V
Md = k × PY
Implication: interest rates not important to Md
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Shifts in AD
P×Y
V=
=
M
2000
= 2
1000
Modern Quantity Theory of Money
M×V=P×Y
Implication: M determines P × Y
Deriving AD Curve
M = 1000, V = 2 ⇒ P × Y = 2000
Point A:
P=2
Y = 1000
PY = 2 × 1000
Point B:
P=1
Y = 2000
PY = 1 × 2000
Point C:
P = .5
Y = 4000
PY =.5 × 4000
Conclusion: P ↑ Y ↓, downward sloping AD
Shift in AD Curve
M ↑: P×Y ↑, so at given P, Y ↑ ⇒ AD shifts right
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Aggregate Supply
• Keynesian’s distinguish two types of AS..
– short run AS
– long run AS
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2
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In the short run prices are sticky!
• Menu costs
• Pricing to market
• Etc..
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From Short-run to Long run
• In the short run prices are sticky and AS
curve is flat
• A change in AD affects output not prices
• In the long run prices are flexible and AS
curve is vertical
• Prices adjust
• A change in the AD affects prices not
output
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According to Keynesian’s
stabilization possible
• Suppose a money demand shock after the millennium bug
fears are cleared.
• M/P = Y/V
• Given money supply, velocity of money rises,
• nominal spending should rise when prices are sticky in the
SR
• Demand push shock
• CB can reduce money supply to stabilize inflation
• Unlike the case with monetary intertemporal model assume
that CB can observe all macroeconomic data!
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Look at the Millennium Bug!
(Percentage Change in the US M1
Currency Component)
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An AS (cost pull) shock
• Suppose energy prices go up due to OPEC
cartel..
• Stagflation
• What to do about it?
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– Do nothing
– Accommodate AS shock at the cost of
permanently higher prices
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copyright: Yunus Aksoy
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