1、CHAPTER 17The Future of Macroeconomics1Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Questions What might the future of macroeconomics bring?How might the macroeconomics taught two decades from now be different from the macroeconomics taught today?What have been the principal c
2、hanges in the way macroeconomics is taught over the past twenty years?2Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Questions What additional changes took place twenty years before that-from roughly 1960 to roughly 1980?What direction will macroeconomics take if the real busin
3、ess cycle research program is successful?What direction will macroeconomics take if the new Keynesian research program proves successful?3Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Questions How will economists understand the foundations behind the power of monetary policy?4
4、Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Past of Macroeconomics A 1936 book by John Maynard Keynes shifted economic research and macroeconomic thought into new and different directionsthe role of expectations of future profits in determining investmentthe volatility of
5、 expectations of profitsthe power of the government to affect the economy through policythe multiplier process5Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Past of Macroeconomics After World War II,more macroeconomic theory was developedthe IS-LM model was createdthe relat
6、ionship between interest rates and the money supply was investigatedthe difference between the behavior of the macroeconomy in the flexible-price long run and the fixed-price short run was clarified6Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Past of Macroeconomics But ma
7、croeconomics theory in 1960 was still incompleteno discussion of the relationship between production and inflationno detailed model of expectationsthe short run was seen as lasting for decadesfiscal policy was emphasized,while the role of monetary policy was downplayedestimates of the multiplier wer
8、e much higher than we believe now to be correct7Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Past of Macroeconomics Between 1960 and 1980,two powerful critiques of the conventional wisdom of macroeconomics occurredthe first was by Milton Friedman the standard models overes
9、timated the governments ability to control the economy the standard models overestimated the power of fiscal policy and underestimated the power of monetary policy the money supply tells us most of what we need to know about how policy is working there is a natural rate of unemployment8Copyright 200
10、2 by The McGraw-Hill Companies,Inc.All rights reserved.The Past of Macroeconomicsthe second was by Robert Lucas Keynesian economics fails to think through the importance of expectations systematic changes in economic policy would change the parameters of the consumption and investment functions as w
11、ell as the location of the Phillips curve9Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Past of Macroeconomics The late 1980s and 1990s were a time of idea generation and explorationmacroeconomists explored and tested a large number of different ideas and modelsthe mainstre
12、am policy-analytic position of macroeconomists did not shift much10Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Future of Macroeconomics:Real Business Cycles?Keynesian and monetarist economists believe that there are two key elements to understanding business cyclesthe det
13、erminants of aggregate demandthe division of changes in nominal aggregate demand into changes in production and changes in prices11Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Future of Macroeconomics:Real Business Cycles?Real business cycle economists believe that changes
14、 in nominal aggregate demand affect output and employment only slightly and have the most impact on prices Real business cycle theory begins with the assumption that the same theory that determines what happens in the long run should be applied to fluctuations in the short run12Copyright 2002 by The
15、 McGraw-Hill Companies,Inc.All rights reserved.The Future of Macroeconomics:Real Business Cycles?While real business cycle economists believe that prices can be rigid,they believe that this sluggishness of prices is not very relevantthey assume that it is a reasonable first-approximation to suppose
16、that the money supply and the level of potential output determine the price levelthe level of potential output is more-or-less equal to actual real GDP13Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Future of Macroeconomics:Real Business Cycles?Real business cycle economist
17、s believe in the classical dichotomyreal variables effectively determine the values of real quantities like real GDP even in the short runnominal variables determine the values of nominal quantities like the price level14Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Future
18、of Macroeconomics:Real Business Cycles?Real business cycle theory assumes that the level of output will vary with shocks to the economyadverse cost shocks lead to a recession as individuals should spend less time working because it is not profitablefavorable cost shocks lead to a boom period because
19、 it is advantageous to produce as much as possible15Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Problems of Real Business Cycle Theory Unemploymentreal business cycle theory assumes that the total hours worked at any moment is largely determined by how many hours it makes sen
20、se for people to workbut when work hours fall,it is not because people have chosen to work shorter shifts and avoid overtime it is because they have become unemployed16Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Problems of Real Business Cycle Theory Technology and Real Busin
21、ess Cyclesaccording to real business cycle theory,production fluctuates because of the changing value of output and the changing productivity of the economy more is produced when technology rises recessions occur when cost increases make it inefficient to run factories at near capacitycritics claim
22、that cost increases like the 1973 oil price shock are the exception rather than the rule17Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Problems of Real Business Cycle Theory Money and Business Cyclesreal business cycle theorists tend to argue that monetary policy has little im
23、pact on production and employment fluctuations in the money stock and real interest rates are more reactions to changes already taking placethe Federal Reserve believes that it affects the level of interest rates and that its decisions cause changes in production and employment18Copyright 2002 by Th
24、e McGraw-Hill Companies,Inc.All rights reserved.The Future of Macroeconomics:New Keynesian Economics Since the 1930s,mainstream macroeconomics has attributed the sluggishness of aggregate supply to stickiness in wages and prices Therefore,fluctuations in nominal aggregate demand cause fluctuations i
25、n output and employment19Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Future of Macroeconomics:New Keynesian Economics Where does this stickiness and slow adjustment of wages and prices come from?menu costs it is costly for businesses to change pricesstaggered prices and c
26、oordination failures a firms best choice for its price may depend on the prices that other firms are charging this means that wages and prices may exhibit inertia20Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Debts and Deficits:Ricardian Equivalence If the government runs a bu
27、dget deficit,it will make up the deficit by borrowing money now and implicitly committing to raise taxes to repay the debt at some time in the future21Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Debts and Deficits:Ricardian Equivalence Economist Robert Barro argues that consu
28、mers will see the budget deficit as an increase in future taxes and cut back on consumptionwhat matters for the determination of consumption spending this year is not what taxes are levied on you this year,but what all the changes in government policy tell you about stream of taxes this year and in
29、the future22Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Debts and Deficits:Ricardian Equivalence Many economists believe that Ricardian equivalence does not hold for a number of reasons myopialiquidity constraintspeople are different23Copyright 2002 by The McGraw-Hill Compani
30、es,Inc.All rights reserved.Consumption and Saving In the early 1900s,the marginal propensity to consume was highpeople were liquidity constrained The financial system in the past 50 years has become much more flexibleeconomic theory would predict that the marginal propensity to consume would decline
31、 and the multiplier process would be more or less irrelevant to aggregate demand24Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Consumption and Saving But,consumption falls significantly when the economy goes into recession Why?one possibility is that consumers are both impatie
32、nt and risk averseanother possible explanation is that current income is a good proxy for permanent incomeanother suggestion is for economists to focus on what psychologists have to say about how humans reason25Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Does Monetary Policy
33、Have a Long-Run Future?Economists have tended to assume that monetary policy is powerful and that the reasons for its power are uninteresting The future evolution of the financial system may undermine the sources of influence that monetary policy today possesses26Copyright 2002 by The McGraw-Hill Co
34、mpanies,Inc.All rights reserved.Does Monetary Policy Have a Long-Run Future?Forecasting the future of monetary policy will require a deeper knowledge and better models of the sources of central bank power than macroeconomists currently possess27Copyright 2002 by The McGraw-Hill Companies,Inc.All rig
35、hts reserved.Chapter Summary Modern macroeconomics has its origin in the“Keynesian”theories of the Great Depression and post-WWII era Modern macroeconomics was reforged by the monetarists under Milton Friedman in the 1960s and 1970s,and by the rational expectations economists led by Robert Lucas in
36、the 1970s and 1980s28Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Chapter Summary Perhaps the focus on aggregate demand will turn out in the long run to have been a false roadperhaps a better theory of the macroeconomy can be built up out of the theory of real business cycles
37、in the Schumpeterian tradition29Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Chapter Summary Perhaps the future of macroeconomics lies in a more detailed investigation of aggregate supplyperhaps uncovering the reason why prices are sticky will lead to the next wave of progress
38、 in macroeconomics30Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Chapter Summary The entire conventional analysis of debts and deficits is under challenge by Robert Barro,who argues that individuals are far-sighted and closely linked,and that they take action to neutralize the
39、 effects of many government policies The conventional analysis of consumption-the permanent income hypothesis-is also under challenge by more psychological approaches31Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Chapter Summary The other possible interesting direction in which macroeconomics might evolve involves the future of monetary policyhow will the coming of the“new economy”and the changing institutional framework of transactions and settlements affect the power of monetary policy?32Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.
