ap economics: module 35 terms

main macroeconomic issues

the behavior of the APL and a.o.

the classical model of the price level

• prices are flexible → AS curve is vertical in both SR and LR

• changes in the money supply affect APL proportionately, but don’t affect a.o. (only leads to inflation/deflation)

National Bureau of Economic Research (NBER)

non-profit organization that declares the beginnings of recessions and expansions

two main innovations of Keynesian economics

1. emphasis of SR effects of changes in AD on a.o. AND APL (previously dismissed as unimportant) and how the SRAS is upward-sloping

2. emphasis on how business confidence (“animal spirits”) mainly impacts AD (previously believed that changes in MS mainly affected AD)

macroeconomic policy activism

the use of MP and FP to smooth out the business cycle

t or f: Keynes believed that economic recovery requires fiscal expansion-deficit spending to create jobs

t

what did Keynes’s The General Theory say about using MP in a depression?

claimed that it wasn’t effective

• however, Keynes wrote this when NIR was almost zero (a liquidity trap could’ve been in effect)

A Monetary History of the United States

• led to the increased discussion + use of MP

• showed that changes in MS correlated with business cycles

how do MP and FP differ when considering politics?

FP (changes in taxes and govt. spending) creates a burden on politicians, as these changes in taxes/spending impact specific groups (have to choose who to affect).

MP decreases political tension, since it’s controlled by an independent central bank and affects everyone.

monetarism

asserts that GDP will grow steadily if MS grows steadily

discretionary fiscal policy

changes in taxes and govt. spending (G + transfers)

discretionary monetary policy

changes in interest rates and the money supply

t or f: MP faces a lower time lag than FP

t: an independent central bank will work faster than the govt.

crowding out

increased govt. deficit → more borrowing → higher interest rates → decreased investment spending from other businesses

why did Friedman generally oppose fiscal policy?

Friedman believed crowding out limits the effect of FP on AD (its effectiveness) when MS is fixed

• believed that the increased IR offsetted the initial rise in AD from exp. FP

• the R shift of AD is so small w/ a fixed MS, and the multiplier is so small that there’s no point in using FP

Quantity Theory of Money

emphasizes the relationship between the price level and the money supply

• relies on the velocity equation

velocity equation

M * V = P * Y

• M = MS

• V = velocity

• P = APL

• Y = RGDP

velocity of money

the ratio of NGDP to the MS; measure of the number of times the avg. dollar bill is spent (turned over between buyers and sellers) per year

what were monetarists’ belief concering velocity in the short run?

they believed it was stable enough so that the steady growth of MS would lead to a steady growth of RGDP

• false: velocity actually started fluctuating, they were misled by its past stability

natural rate hypothesis

since inflation is eventually included in expectations, to avoid accelerating inflation over time, the UR must be high enough that the actual inflation rate equals the expected inflation rate

• goal: keep UR stable, not low

why won’t the trade-off between UR and inflation work w/ persistent inflation?

since increasing inflation is already in expectations, it will keep increasing even with an increasing UR

how can activist macroeconomic policy lead to political manipulation?

elections are greatly impacted by the state of the economy

• people can use policy during election year for a SR gain, but they will face LR consequences

• this causes instability and a political business cycle (hence why MP is controlled by an independent central bank, and FP is limited is extreme circumstances)

classical vs. Keynesian economics (views on the SRAS curve + how demand shocks affect APL and a.o)

classical: vertical SRAS, demand shocks only affect APL

• new classical macroeconomics holds the same view about SRAS

Keynesian: upward-sloping SRAS, demand shocks affect APL and a.o.

challenges to Keynesian economics

• emphasis on monetary policy

• natural rate hypothesis

the 2 steps in which new classical macroeconomics evolved

1. challenged arguments about the slope of SRAS based on rational expectations

2. suggested that changes in productivity led to economic fluctuations

rational expectations

individuals and firms make decisions optimally, using all available information

• changes the effects of govt. policy

New Keynesian Economics believed that market imperfections led to what?

temporary sticky prices

real business cycle theory

fluctuations in the rate of growth of total factor productivity (AS) cause the business cycle

• shifts of AS lead to the business cycle (L shift → recession, R shift → expansion)

• denied that changes in AD could affect a.o.

total factor productivity

amount of output that can be made with a given level of inputs

t or f: Keynesian economics believes that FP and MP should be used to smooth the business cycle.

t

in Keynesian economics, prices are ____, and wages are ____.

downwardly flexible, sticky