Macroeconomic Viewpoints:
Classical
Keynesian
Monetarist
New Classical
New Keynesian
Classical Economics: Laissez - Faire
Real GDP is determined by aggregate
supply
 The equilibrium price level is determined
by the money supply.
 Full employment is the norm
Supply creates its own demand
– The classical view prevailed before the
Great Depression.

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The
Classical
Model
•Real GDP is
determined
by aggregate
supply
•The price
level is
determined
by aggregate
demand.
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Keynesian Economics: Economic Activism
John Maynard Keynes, The General Theory of
Employment, Interest, and Money (1936)



Emphasizes aggregate demand in determining
GDP and employment.
Assumes fixed prices (horizontal AS) at relevant
levels of GDP.
inflation is not a risk when unemployment is
high.
Government must stabilize an inherently
unstable macroeconomy
–
Use demand management policies
•
Fiscal policy
•
Monetary policy
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The Fixed-Price Keynesian Model
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Monetarism: Return to Laissez - Faire
Milton Friedman, Studies in the Quantity Theory of Money (1956)
_______________, The Role of Monetary Policy (1968)
Emphasizes role of money supply in
determining real GDP and price level.
 Business cycles are largely the result of
discretionary monetary policy
 Monetary mischief
Activist policy is wrong:
Too Much Too Late

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Monetarism: Return to Laissez-Faire
Efforts to increase real GDP through
expansionary monetary policy
 Accelerating Inflation.
“Inflation is everywhere and at all
times a monetary phenomenon.”
 Economic policy operates with long and
variable lags
 accurate timing nearly impossible.
 Don’t mess with the macroeconomy
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
Long and Variable Policy Lags
1. Recognition Lag: policymakers need time
to realize that there is a problem.
– 2. Reaction Lag: they need time to formulate
an appropriate policy response.
– 3. Effect Lag: policy takes time to implement
and work through the economy.
Countercyclical policies can become
procyclical policies, worsening fluctuations
 Don’t mess with the macroeconomy
–

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New Classical Economics: Policy Ineffectiveness
 Arose in the 1970s in response to
stagflation.
 Wages and prices are perfectly flexible.
 Markets are always in equilibrium.
 Markets work!
 Expectations are rational
 only unexpected changes in policy
can affect output and employment.
– Changes in real GDP result from
unexpected changes in the prices level.
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New Classical “Policy”
Most observed unemployment is
voluntary.
 Only unanticipated policies can have any
effect.
 “policy ineffectiveness proposition”.
 Therefore, attempt no activist policy.
Follow predictable and stable monetary and
fiscal policies for long run employment
and price stability.

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New Classical Economics
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New Keynesians: Policy Can Work



Incorporate rational expectations
But prices and wages are “sticky” in short run.
 Disequilibrium prevails.
– Price-wage stickiness: impediments to
adjustment exist (contracts, adjustment costs,
etc.)
Activist policies can work
– Stabilize the economy/make things better!
– The private sector is an important source of
shifts in aggregate demand.
– Monetary and fiscal policies should be used to
offset drops in private sector spending.
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The Modern
Keynesian
Model
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