You have to take away some of tax breaks for the wealthy, and you have to cut back on some entitlements. Because, unless we do all of these things, it just doesn't work. And what's good theater and what's good politics isn't necessarily good economic policy.
Debates in Macroeconomics: Monetarism, New Classical Theory, and Supply-Side Economics
(Part A)
by
Charles Lamson
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Throughout this analysis, we have noted that there are many disagreements and questions in macroeconomics. For example, economists disagree on whether the aggregate supply curve is vertical, either in the short run or in the long run. Some even doubt that the aggregate supply curve is a useful macroeconomic concept. There are different views on whether cyclical employment exists and, if it does, what causes it. Economists disagree about whether monetary and fiscal policies are effective at stabilizing the economy, and they support different views on the primary determinants of consumption and investment spending.
We discussed some of these disagreements in previous posts, but only briefly. In the next several posts, we discuss in more detail a number of alternative views of how the macroeconomy works. Keynesian Economics John Maynard Keynes's General Theory of Employment, Interest, and Money, published in 1936, remains one of the most important works in economics. While a great deal of the material in the previous posts is drawn from modern research that postdates Keynes, much of it is built around a framework constructed by Keynes. What exactly is Keynesian economics? In one sense, it is the foundation of all of macroeconomics. Keynes was the first to stress aggregate demand and links between the money market and the goods market. Keynes also stressed the possible problem of sticky wages (when workers' earnings don't adjust quickly to changes in labor market conditions). Virtually all the debates in the next several posts can be understood in terms of the aggregate output/aggregate expenditure framework suggested by Keynes.  In recent years, the term Keynesian has been used narrowly. Keynes believed in an activist federal government. He believed the government had a role to play in fighting inflation and unemployment, and he believed monetary and fiscal policy should be used to manage the macroeconomy. This is why Keynesian is sometimes used to refer to economists who advocate active government intervention in the macroeconomy. During the 1970s and 1980s, it became clear that managing the macroeconomy was more easily accomplished on paper than in practice. The inflation problems of the 1970s and early 1980s and the seriousness of the recessions of 1974 to 1975 and 1980 to 1982 led many economists to challenge the idea of active government intervention in the economy. Some were simple attacks on the bureaucracy's ability to act in a timely manner. Others were theoretical assaults that claimed to show that monetary and fiscal policy could have no effect whatsoever on the economy, even if it were efficiently managed. Two major schools decidedly against government intervention have developed: monetarism and new classical economics. Monetarism The debate between "monetarist" and "Keynesian" economics is complicated because they mean different things to different people. If we consider the main monetarist message to be that "money matters," then almost all economists would agree. In the aggregate supply/aggregate demand (AS/AD) story, for example, an increase in the money supply shifts the AD curve to the right, which leads to an increase in both aggregate output (Y) and the price level (P). Monetary policy thus has an effect on output and the price level. Monetarism, however, is usually considered to go beyond the notion that money matters.  The Velocity of Money To understand monetarist reasoning, you must understand the velocity of money. Think of velocity as the number of times a dollar bill changes hands, on average, during a year. In practice, we use gross domestic product (GDP), instead of the total value of all transactions in the economy, to measure velocity, because GDP data are more available. The income velocity of money (V) is the ratio of nominal GDP to the stock of money (M): V ☰ GDP/M The triple equal sign indicates we are dealing with an identity which is something that is true all the time. If $6 trillion worth of final goods and services are produced in a year and if the money stock is $1 trillion, then the velocity of money is $6 trillion/$1 trillion, or 6.0.  We can expand this definition slightly by noting that nominal income (GDP) is equal to real output (income) (Y) * the overall price level (P): GDP ☰ P * Y Through substitution: V ☰ P * Y / M or M * V ☰ P * Y At this point, it is worth pausing to ask if our definition has provided us with any insights into the workings of the economy. The answer is no. Because we defined V as the ratio of GDP to the money supply, the statement M * V ☰ P * Y is an identity---it is true by definition. It contains no more useful information than the statement "a bachelor is an unmarried man." The definition does not, for example, say anything about what will happen to P x Y when M changes. The final value of P x Y depends on what happens to V. If V falls when M increases, the product M x V could stay the same, in which case the change in M would have had no effect on nominal income. To give monetarism some economic content, in the next post, we turn to a simpler version of monetarism known as the quantity theory of money.  *CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 649-651* end |
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