Chapter 18 Flashcards
Increases in the money supply lead to ____________
inflation
Thanks to Wesley Mitchell’s work, the _____________ of the business cycles was well advanced by 1930. Bit there was no widely accepted _________ of business cycles
measurement; theory
Modern business cycles are largely the result of __________________________
shifts in the aggregate demand curve
Two innovations of Keynesian economics
Emphasized the short-run effects of changes in aggregate demand on aggregate output, rather than the long-run determination of the aggregate price level
- Other factors, especially the “animal spirits” are mainly responsible for business cycles
animal spirits = business confidence
Classical view graph
SRAS curve is vertical, so shifts in aggregate demand affect the aggregate price level but not aggregate output
The Keynesian View Graph
SRAS curve slopes upward, so shifts in the aggregate demand affect aggregate output as wella s aggregate prices
Keynesian economics
Rests on two main tenets:
- Changes in aggregate demand affect aggregate output, employment and prices
- Changes in business confidence cause the business cycle
Some people consider Keynesian economics a synonym for ________________
left-wing economics
Macroeconomic policy activism
The use of monetary and fiscal policy to smooth out the business cycle
Monetarism
Asserts that GDP will grow steadily if the money supply grows steadily
Discretionary monetary policy
The use of changes in the interest rate or the money supply to stabilize the economy
*Face the same problem of lags as fiscal policy, but to a lesser extent
Crowding out
When a government deficit drives up interest rates and leads to reduced investment spending
Monetary policy rule
A formula that determines the central bank’s actions
Leaves it relatively little discretion
Velocity of money
The ratio of nominal GDP to the money supply
*The measure of the number of times the average dollar bill in the economy turns over per year between buyers and sellers
Velocity equation
M x V = P x Y
M = money supply
V = velocity
P = aggregate price level
Y = Real Gdp
From 1960 to 1980, the velocity of money was __________, leading monetarists to believe that steady growth in the money supply would lead to a stable economy
stable
Natural rate hypothesis
Because inflation is eventually embedded into expectations, to avoid accelerating inflation over time the unemployment rate must be high enough that the actual inflation rate equals the expected inflation rate
Because the government can’t keep unemployment below the natural rate, its task is not to keep unemployment low but to keep it _________ – to prevent large fluctuations in unemployment in either direction
stable
The Friedman-Phelps hypothesis made a strong prediction:
that the apparent trade-off between unemployment and inflation would not survive an extended period of rising prices
Political business cycle
Results when politicians use macroeconomic policy to serve political ends
New classical macroeconomics
An approach to the business cycle that returns to the classical view that shifts in the aggregate demand curve affect only the aggregate price level, not aggregate output
New classical macroeconomics evolved in two steps:
- Economists challenged traditional arguments about the slope of the short-run aggregate supply curve based on the concept of rational expectations
- Economists suggested that changes in productivity cause economic fluctuations, known as real business cycle theory
Rationa expectations
The view that individuals and firms make decisions optimally, using all available information
*introduced by John Muth
Under rational expectations, government intervention ___________________
fails in the short run and the long run
Rational expectatioins model
According to it, expected changes in monetary policy have no effect on unemployment and output and only affect the price level
New Keynesian economics
Market imperfections can lead to price stickiness for the economy as a whole
Total factor productivity
Real business cycle theory
Claims that fluctuations in the rate of growth of total factor productivity cause the business cycle
Laffer curve
A hypothetical relationship between rax rates and total rax revenue that slopes upward at low tax rates but turns downard when tax rates are high
Great Moderation
The period from 1985 to 2007 when the U.S. economy experienced relatively small fluctuations and low inflation
Great Moderation consensus
Combines a belief in monetary policy as the main tool of stabilization with skepticism toward the use of fiscal policy, and an acknowledgement of the policy constraints imposed by the natural rate of unemployment and the political business cycle
Now it is generally agreed that monetary policy is ineffective only in the case of ____________
a liquidity trap
Is expansionary monetary policy helpful in fighting recessions?
Classical macroeconomics: no
Keynesian macroeconomics: Not very
Monetarism: yes
Great Moderation Consensus: yes, except in special circumstances
Is expansionary fiscal policy effective in fighting recessions?
Classical macroeconomics: no
Keynesian macroeconomics: yes
Monetarism: no
Great Moderation Consensus: yes
Can monetary and or fiscal policy reduce unemployment in the long run?
Classical macroeconomics: no
Keynesian macroeconomics: yes
Monetarism: no
Great Moderation Consensus: no
Should fiscal policy be used in a discretionary way?
Classical macroeconomics: no
Keynesian macroeconomics: yes
Monetarism: no
Great Moderation Consensus: No, except possibly in special circumstances
Should monetary policy be used in a discretionary way?
Classical macroeconomics: no
Keynesian macroeconomics: yes
Monetarism: no
Great Moderation Consensus: Still in dispute
The role of the budget as an ________________ helps keep the economy on an even keel
automatic stabilizer
What has the lead role in economic stabilization?
monetary policy
Many economists believe that _______________ is usually counterproductive
discretionary fiscal policy
*the lags in adjusting fiscal policy mean that policies intended to fighta slump end up intensifying a boom
Macroeconomists agree on three 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
Ricardian equivalence
Households and firms would see any rise in government spending as a sign that tax burdens were likely to rise in the future, leading to a fall in private spending that would undo any positive effect
Arguments for the fiscal stimulus
- fiscal expasion necessary since monetary policy could not be used anymore (interest rates were zero)
- Expansiaory fiscal policy would not crowd out investment spending because it is unlikely in a depressed economy with intereset rates close to zero
- Discretionary policy would get going faster because it was going to be depressed for an extended period of time
Arguments against the fiscal stimulus
- Ricardian equivalence
- Spending programs might undermine investors’ faith in the government’s abilty to repay its debts, leading to an increase in long-term interest rates despite loose monetary policy
quantitative easing
Buying assets other than short-term government debt, notably long-term debt whose interest rate was still significantly above zero
*idea is to drive down longer-term interest rates, which arguably matter more for private spending than short-term rates
