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Part VI addresses some questions in the theory of economic stabilization by monetary and fiscal policy. The final section of this volume attempts to apply to matters of stochastic social choice, stabilization policy being one instance of such a choice, the conception of justice advanced by Rawls. We are always looking for ways to improve customer experience on Elsevier. We would like to ask you for a moment of your time to fill in a short questionnaire, at the end of your visit.
If you decide to participate, a new browser tab will open so you can complete the survey after you have completed your visit to this website. Thanks in advance for your time. Skip to content. Search for books, journals or webpages All Pages Books Journals. View on ScienceDirect. Authors: Edmund S. Editors: Karl Shell. Imprint: Academic Press. Published Date: 28th January Page Count: Flexible - Read on multiple operating systems and devices. Easily read eBooks on smart phones, computers, or any eBook readers, including Kindle.
Keynesians focus on aggregate demand as the principal factor in issues like unemployment and the business cycle. Keynesian economists believe that the business cycle can be managed by active government intervention through fiscal policy spending more in recessions to stimulate demand and monetary policy stimulating demand with lower rates. Keynesian economists also believe that there are certain rigidities in the system, particularly sticky prices and prices, that prevent the proper clearing of supply and demand.
Monetarist The Monetarist school is largely credited to the works of Milton Friedman. Monetarist economists believe that the role of government is to control inflation by controlling the money supply. Monetarists believe that markets are typically clear and that participants have rational expectations. Monetarists reject the Keynesian notion that governments can "manage" demand and that attempts to do so are destabilizing and likely to lead to inflation.
New Keynesian The New Keynesian school attempts to add microeconomic foundations to traditional Keynesian economic theories. While New Keynesians do accept that households and firms operate on the basis of rational expectations, they still maintain that there are a variety of market failures, including sticky prices and wages. Because of this "stickiness", the government can improve macroeconomic conditions through fiscal and monetary policy.
Neoclassical Neoclassical economics assumes that people have rational expectations and strive to maximize their utility. This school presumes that people act independently on the basis of all the information they can attain. The idea of marginalism and maximizing marginal utility is attributed to the neoclassical school, as well as the notion that economic agents act on the basis of rational expectations.
Since neoclassical economists believe the market is always in equilibrium, macroeconomics focuses on the growth of supply factors and the influence of money supply on price levels. The New Classical school emphasizes the importance of microeconomics and models based on that behavior. New Classical economists assume that all agents try to maximize their utility and have rational expectations. They also believe that the market clears at all times. New Classical economists believe that unemployment is largely voluntary and that discretionary fiscal policy is destabilizing, while inflation can be controlled with monetary policy.
Austrian The Austrian Schoo l is an older school of economics that is seeing some resurgence in popularity. Austrian school economists believe that human behavior is too idiosyncratic to model accurately with mathematics and that minimal government intervention is best.
Studies in Macroeconomic Theory - 1st Edition
The Austrian school has contributed useful theories and explanations on the business cycle, implications of capital intensity, and the importance of time and opportunity costs in determining consumption and value. Factors studied in both microeconomics and macroeconomics typically have an influence on one another. For example, the unemployment level in the economy as a whole has an effect on the supply of workers from which a company can hire.
A key distinction between micro and macroeconomics is that macroeconomic aggregates can sometimes behave in ways that are very different or even the opposite of the way that analogous microeconomic variables do. For example, Keynes proposed the so-called Paradox of Thrift, which argues that while for an individual, saving money may be the key building wealth, when everyone tries to increase their savings at once it can contribute to a slowdown in the economy and less wealth in the aggregate. Meanwhile, microeconomics looks at economic tendencies, or what can happen when individuals make certain choices.
Economics Microeconomics Macroeconomics Behavioral Economics. Another important feature of NCM is the utilization of a specific class of models, the DSGE, micro-founded with intertemporally maximizing agents, using the natural rates of interest and of unemployment and rational expectations hypotheses.
Broadly speaking, the most prestigious journals still publish primarily models adopting those new Keynesian assumptions, which dominate the scene since the new classical revolution. This shows that the convention and the belief in the methodology has not been considerably shaken, leaving room for the traditional macro-models to continue prevailing.
Chari , p. From this perspective, there is no other game in town. ENT ; Therefore, he continued, "a useful aphorism in macroeconomics is: 'If you have an interesting and coherent story to tell, you can tell it in a DSGE model. If you cannot, your story is incoherent'. Chari's thought poses some issues about the alternatives to new Keynesian modeling.
Within the current economic thinking, there is no major threat to the new Keynesians' position as the current dominant school of thought. Those that are usually associated with market clearing, such as new classical, run into great trouble in explaining the crisis and do not show enough strength to bring back to the theory the idea that financial markets work efficiently, and that prices are fully flexible. Moving toward those schools with an alternative theoretical approach, it is even harder to believe that any school of thought can take the new Keynesians' place.
First, models with rational expectations and maximizing-representative agents dominate the research within the U. Those assumptions are still major criteria for legitimizing the research and getting published in the most prestigious journals. Second, for the models with rational expectations and representative agents, the way to accept some kind of macroeconomic policies' intervention was developed and explored by the new Keynesians, through the inclusion of market frictions, which prevent market clearing in the short run.
For another school of thought to become mainstream, approaches which push rational expectations and representative agents out of the models should be more widely used, explored, financed and published. Otherwise it is rather difficult since it would depend on broadening the scope of market frictions - as, in some sense, the new Keynesians are doing. The alternative would be the discovery of a different and more incisive way to demonstrate market imperfections in models with rational expectations, which, in turn, would be in some degree related to new Keynesian thinking, and has not yet emerged.
Much research in this direction has already been published by new Keynesians, most of them following the broad outlines of what Blanchard et al. But, even within new Keynesianism, there are still diverging lines in relation to what directions should be taken by macroeconomic policy, especially concerning fiscal and macro-prudential ones. Some of the new Keynesians who were directly involved in the rise and spread of the ideas of consensus and inflation targeting are working on the reform, assuming that the models did not explain how to deal with the crisis.
For these authors, the crisis showed that the pursuit of stable inflation is insufficient to guide monetary policy; but, this does not mean that inflation targeting was completely wrong, as it helps to anchor expectations and to reduce disinflation costs. However, in this case, it opens up the possibility of criticism of the use of short-term interest rates as the only monetary policy tool which, in turn, makes it possible for new instruments to enter mainstream theory, namely, macro-prudential and regulatory policies as a macroeconomic instrument.
Regarding regulation, the possibility of policies aimed at interbank spread reduction in the case of a crisis has been incorporated into the models, which means the recognition of the possibility that the financial system negatively affects macroeconomic equilibrium determination. But the focus of macro-prudential regulation is, for some authors, being reduced to the intervention in interbank markets; hence, not including reforms to manage systemic risks and to remodel financial markets' architecture.
On fiscal policy, some changes have been made within the new Keynesian framework and, as Blanchard 11 admits, " a good normative theory of fiscal policy in the presence of nominal rigidities remains largely to be established ". On the one hand, the huge increase in sovereign debt, particularly in developed countries, contributed to the restoration of the pre-crisis convention that fiscal policy " did more harm than good " Taylor, b, p. On the other hand, one may argue that the absence of a theoretical apparatus in NCM may have contributed to the debt increase.
The expenditures were made in a non-systematic way, with a high degree of uncertainty about their effectiveness, which could have been partially avoided if there was a better understanding of the actions to be taken. This is not to say that all the essential elements for the phenomenon of comprehension will be apprehended by theoretical developments and that theory can move ahead of the facts, but that better knowledge and theoretical foundations could increase fiscal efficiency, taking economic activity and employment stabilization as targets. Given the recent discussions enumerated in section 3, fiscal policy still lacks further discussion and remains very far from a consensus.
A major barrier is the sensitiveness of DSGE to model specifications for assessing the effects of fiscal policy, for evaluating social costs, benefits and the optimality conditions of fiscal policy. Taking the mainstream economics, those who make the case for more meaningful changes, including in the methodology, are fewer than those working to integrate new dimensions into DSGE. Obviously, these are important claims, coming from Nobel Prize winner Stiglitz and from MIT graduate professor Caballero, and in some sense from the IMF's chief economist Olivier Blanchard, but maybe their voices get lost in the selectively-deaf academy; or maybe their work will be successful enough to cover the core flaws and silence these voices.
While making this "reform" of the theory and policy formality, some known structural issues and some inadequate premises remain outside the model, just to make it more tractable in a DSGE framework. While there is still uncertainty about the direction, it is clear that a change is occurring in mainstream macroeconomics. Nonetheless, this new wave of change inside mainstream theory is not greatly distant from the new Keynesians' old format. The inherited RBC methodology continues to pervade most papers published on macroeconomic theory and policy in the most prestigious journals, and the conclusions have not been substantially changed, with the exception of the non-neutrality of the financial system.
Leaving the methodology untouched is unlikely to create revolutionary or more meaningful changes to the main conclusions. Otherwise, the recognition of the non-neutrality of the financial system favors a discussion on the short-term interest rate as the sole macroeconomic policy tool, opening space for new kinds of regulatory and macro-prudential instruments, to address a wider set of macroeconomic goals. Opinions that mainstream theory should escape the DSGE straitjacket can be found, but they represent a minority in the publications consulted.
The main warning that one should extract from these publications, regardless of personal position on the use of the DSGE models, is that an over-reliance on a sole model can create several problems for the development of macroeconomics, primarily that the research might become increasingly skewed with its internal logic and may lose touch the limitations induced by its construction.
New Keynesians have been changing some of their macroeconomic policy recommendations, incorporating new kinds of imperfections into their models, beyond price stickiness. We believe that this internal reform will allow them to continue as the mainstream and the main provider of ideas to policy makers, in this sense having more power to influence future macroeconomic policy due to the absence of a strong enough group of economists or, until this moment, any theory capable and convenient enough to dismiss rational expectations and representative hypotheses within the dominant thought.
Moreover, the correlation among political forces does not demonstrate a movement towards a different framework to conduct macroeconomic policy, and the main institutions continue searching for answers mostly within new Keynesian and NCM frameworks. If, on the one hand, as we showed, the crisis presented some impact on economic thinking then, on the other hand, economic thinking is also capable of influencing the performance and mindset of agents and the architecture of the economic system.
Our conclusion is that economic theory has not experienced a revolutionary change in its mainstream until now, which implies that it is much harder to believe that modifications to macroeconomic policies and financial system standards will be propelled by economic theory. Current Thinking on Fiscal Policy. Basingstoke: Palgrave Macmillan, Inflation targeting: a new framework to monetary policy. The State of Macro. The two rebalancing acts. Voxeu Website, October 12th, American Economic Journal: Macroeconomicsv. In: Kopcke, R. The Macroeconomics of Fiscal Policy.
MIT Press, International Journal of Central Banking,v. Rediscovering the macroeconomic roots of financial stability policy: journey, challenges and a way forward. Bank for International Settlements: Sep, Journal of Economic Perspectivesv. Testimony before the Committee on Science and Technology.
- Micro and Macro: The Economic Divide.
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House of Representatives. July 20th, Financial factors in economic fluctuations. May, Journal of Economic Literaturev. Discussion Papers: Mar, The changing face of mainstream economics. Review of Political Economyv. Conventional and unconventional monetary policy. Federal Reserve Bank of St. Louis Review, v.
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Neoclassical, mainstream, orthodox, and heterodox economics. Journal of Post Keynesian Economics, v. Not Going Away? Journal of Money, Credit and Bankingv. HALL, R. Brookings Papers on Economic Activityv. A Macroprudential Approach to Financial Regulation. The Quarterly Journal of Economicsv. Credit Cycles. Journal of Political Economyv.
The Macroeconomist as Scientist and Engineer. American Economic Reviewv. MUTH, J. Rational Expectations and the Theory of Price Movements. The "austerity mith": gain without pain? Economic Modellingv. Rational Expectations and the Theory of Economic Policy. Journal of Monetary Economicsv. Keynes e os Novos-Keynesianos. Brazilian Journal of Political Economyv.
Modern macroeconomics: its origins, development and current state. Elgar, Is fiscal policy possible? Is it desirable? Lisbon, September, Journal of the European Economic Associationv. An Exit Rule for Monetary Policy. Testimony before the Committee on Financial Services U.
March 25th, a. Getting back on track: macroeconomic policy lessons from the financial crisis. Louis Reviewv. February, Reassessing Discretionary Fiscal Policy. Simple Analytics of the Government Expenditure Multiplier. Bank of Canada: Working Paper See Duarte On the other hand, orthodox generally refers "to what historians of economic thought have classified as the most recent dominant "school of thought" Colander et al. It is important to emphasize that this does not mean that the agents can correctly predict the future. Agents can make mistakes in forming their expectations, as this hypothesis allows forecasting with incomplete information.
But, with rational expectations, on average, expectations will be correct, i. See Snowdon and Vane , p. Instead, it was counterrevolutionary: its aim was to defend the essence of the neoclassical-Keynesian synthesis from the new classical assault ". A notable feature of these papers is that they were published in the aftermath of the Asian Crisis.
In their theoretical framework, if the nominal interest rate passes its lower value, the central bank should increase the level of inflation, implementing a monetary expansion quantitative easing - or even announce a credible one. The announcement of a monetary expansion would raise future expected inflation and, as the current inflation depends on expected future inflation, will cause the current inflation to rise.
In this case, with the same nominal interest rates, the real interest rates are lower than before; i. That would be desirable if real, but the crisis showed that, in a world with large shocks, deflationary pressure is much greater than central banks' capacity to anchor the expectations of inflation. The U. Therefore, this contributed to both the spread reduction and, especially, to the return of liquidity in the interbank market. But if the central banks observe an increase in interbank spread, they should, through a clear and transparent rule, prevent financial institutions from bankrupting by opening an exceptional credit channel Taylor, a, p.
Thus, in periods with typically higher losses, the banks are obligated to worsen their results by increasing their reserves. In general, the fiscal plans should demonstrate to financial markets the way out of fiscal stimulus and toward debt consolidation, to prevent the market from questioning the state's solvency in the medium-term. It is important for the measures to be clearly reversible; that implemented policies eliminate distortions, amplify the scope of automatic stabilizers and show how the deficit caused by present measures should be reverted in the future; and, to strengthen fiscal governance, increasing spending transparency.
The author quotes, for example, the Japan case, that only came partially out of its 90's depression after a strong monetary expansion - and not by the use of fiscal policy instruments. This is an open-access article distributed under the terms of the Creative Commons Attribution License. Services on Demand Journal. Abstract: The failure of mainstream macroeconomics to provide a suitable set of instruments to understand and fight against the economic crisis has triggered a debate among the dominant theoretical tendency, on its own foundations and on the macroeconomic policy that should be implemented after the crisis.
Introduction Throughout the economic crisis that started in the United States in , governments have had to use various policy instruments that, until recently, were considered unsuitable by mainstream economists. New Keynesian policies framework before the crisis Since the 80s, mainstream research has moved towards a compromise between new classical and new Keynesian economics, based on the use of some new classical theoretical concepts and methodology by the new Keynesians, adding alternative hypotheses and market failures into the models.
The main ones are: skepticism about its effectiveness based on Ricardian equivalence arguments.