Question

Compare and contrast the views of new classical economists and mainstream economists on the issue of policy rules versus the use of discretionary monetary and fiscal policy. 2. What rationale does rational expectations theory provide for the ineffectiveness of discretionary policies?3. What have been the changes or modifications in thinking about monetary rules in recent decades? 4. Explain the mainstream economists’ justification for the use of discretionary fiscal and monetary policy and their criticisms of policy rules.

Answer 1

Monetarists and new classical economics argue for policy rules to reduce government intervention in the economy that they belive cause macroeconomic instability .in regard to monetary policy monetarists have proposed monetary rule that the money supply be increased at the same annual rate as the potential annual rate of increase in the real GDP . a monetary rule would shift aggragate demand rightward to match a shift in the long run aggregate supply curve that course because of economic growth thus keeping the price level stable over time

Monetarists and new classical economists question the value of fiscal policy and some extreme proposals have called for a required balanced federal budget over time reasonthat monetarists and new classical economists dislike fiscal policy in that it will tend to crowd out also think that fiscal policy is ineffective and that people will anticipate it and their acts will counteract its intended effects

QUE 4 ANS:.

Mainstream economists think that discretionary fiscal and monetary policy can be effective and are oppsed to monetary rule and a balanced budget requriment see velocity as realitively unstable and a loose link between changes in the money supply and aggragate demand this means that a monetary rule might produce too great shift in aggregate demand (and demand -pull inflation)or too small a shift (and deflation )to match the shift in aggragate supply such a rule would contribute to price instability not price stability. they support the use of fiscal policy during a ression or to counter growing inflation . fiscal policy however should be reserved for those situations where monetary policy is relatively inffective they also oppse a balanced budget amendment because its effects would be procyclical and reinforce recessionary or inflationary monetary and fiscal policy was being more actively used to moderate the effects of the business

QUE 2 ANS:

2. when I wrote that rational expectations was a theory Y a commenter asked me to explain rational expectations .I will do so below the fold

1. start with a theory of business cycles that says that employment is driven by the relationship between labour productivity and real wages . in particulatr when real wages are high relative to productivity yoy get at lot of unemployment.

2. next think of workers as setting wage demands on the basis of expect prices to rise at 3% per year then they look for wages plus the rate of increase in productivity.

together (1)and (2) provide a model of employment by the forecast error in prices .if workers are surprised by high inflatiob they will set real wages at a low levek and there will be a lot of labour demand and hence very little unemployment .if they are surprised by low labour demand and hence a lot of unemployment

this in turn suggest that expansions in aggregate demand are effective at increasing output if and only if they cause upside surprise in inflation .

3. so far we have workers making systematic errors in forecasting prices. the fed can always surprise them by speeding up the money printing process and causing more inflation than expected what if workers instead of naively looking backward start to anticipate fed behaviour in that case known as rational expectations workers will not commit systematic forecasting errors. they can be surprised but they cannot be fooled means being surprised by the monetary authority and that does not happen . in that case discretionary monetary policy is ineffective.

4. whats rong with rational expections for me the problem is that I have never bought 1 and 2 as an explation for unemployment in gradute school what I preferred was general disequlibrium theory if one market get out of whack . the challenge was to explain how markets get out of whack .I thought in terms of sticky prices

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