35
John Maynard Keynes & Milton Friedman
KRUGMAN'S
MACROECONOMICS for AP*
Margaret Ray and David Anderson

:
• Why classical macroeconomics wasn’t adequate for the problems posed by the
Great Depression
• How Keynes and the experience of the
Great Depression legitimized macroeconomic policy activism
• What monetarism is and its views about the limits of monetary policy
• How challenges led to a revision of
Keynesian ideas and the emergence of the new classical macroeconomics

Classical Macroeconomics:
Money and the Price Level
•%∆ M = % ∆ PL
•Short-Run Effects
Unimportant
•Focus on the Long-
Run
•Keynes - “ (in the long run) we are all dead.”

Classical Macroeconomics: The
Business Cycle
•The Business Cycle
•No theory of business cycles
•Lack of consensus
•Necessity is the mother of invention

Keynes’s Theory
• The General Theory
•Classical View
•Keynesian View
•“Animal Spirits”
(business confidence)

Keynes’s Theory
Classical
Theory
Keynesian
Theory

Challenges to Keynesian Economics:
The Revival of Monetary Policy
• A Monetary History of the United
States, 1867 - 1960
•Great Depression caued by Fed contracting the money supply
•Monetary policy is important - less political
University of Chicago
Economist, Milton
Friedman

Challenges to Keynesian
Economics: Monetarism
•Monetarism
•Discretionary Policies - bad
•Crowding Out
•Monetary Policy Rule
•Quantity Theory of Money, MV = PY
•Velocity of Money
•Erratic Velocity undermines Monetarism

Challenges to Keynesian Economics: Inflation and the Natural Rate of Unemployment
•Natural Rate Hypothesis
•Limit to Discretionary Policy
•Stagflation of 1970s proof of
Hypothesis
•Natural Rate widely accepted

Challenges to Keynesian Economics:
The Political Business Cycle
•Consequences of Keynes on Politics
•Election Day Economics
•Political Business Cycle
President Obama and Senator McCain
•The need for central bank independence

Rational Expectations, Real Business
Cycles, and New Classical Macroeconomics
• New Classical
Macroeconommics
• Rational Expectations
• New Keynesian Economics
• Real Business Cycle Theory

Unnumbered Figure 35.1 The End of the Great Depression
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers

Figure 35.2 Fiscal Policy with a Fixed Money Supply
Ray and Anderson: Krugman’s Macroeconomics for AP, First
Edition
Copyright © 2011 by Worth Publishers

Figure 35.3 The Velocity of Money
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers