Macro economic policy debates

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MACRO ECONOMIC

POLICY DEBATES

Content…..

• What’s macro economics• Introduction of macro economic

policy debates• Classical & Keynesian view on; unemployment Price stabilityExchange rate • Conclusion

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MACRO ECONOMICS

• Macro economics concern with the behavior of the aggregate economy as a whole. Therefore it deals inter related broad system.

Macroeconomics is a branch of economics dealing with the performance, structure, Behavior and decision-making of the whole economy. This includes a national, regional or global economy.

Some Macro Economic Economists

Classical economists:Adam Smith( Scottish philosopher)Alfred Marshall(British economist)Arthur Cecil Pigou (British economist)David Ricardo (British economist)JS.MillMalthus

Keynesian economists:

• Francis Ysidro Edge Worth• Jean-Baptist Say• Paul Samuelson• John Maynard Keynes

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Introduction To Macro Economic Policy Debates

Macroeconomic policy debates inevitably revolve around discussion of fluctuations in key aggregate measures notably, national income, interest rates, inflation, unemployment, trade imbalances, exchange rates and various wealth series,

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But here we only discuss three things,a.Un employmentb.Price stabilityc.Exchange rate

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Macroeconomics emerged as a separate subject within economics in the 1930s, when the U.S. economy fell into the Great Depression.

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Before the 1930s, economics was microeconomics (the study of partial-equilibrium supply and demand).

After the 1930s, the study of the core of economic thinking was broken into two discrete areas: microeconomics, as before, and macroeconomics (the study of the economy in the aggregate).

Macroeconomic policy debates have centered on a struggle between two groups: Keynesian economists and Classical economists.

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Classical economists generally oppose government intervention in the economy; they favor a laissez-faire policy.

Keynesians are more likely to favor govern government intervention in the economy. They feel a laissez-faire policy can sometimes lead to disaster. Both views represent reasonable economic positions.

MACROECONOMIC OBJECTIVES

We begin our discussion by focusing on the objectives of macro-economic policymaking. At the most general level, the goal of economic policy is to maximize long-run societal well-being in an equitable and sustainable manner.

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Much of the recent discussion of economic policy has focused on intermediate variables, such as price stability or the balance of payments.

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Their importance derives largely from their role as possible indicators of economic performance in terms of truly significant such as growth, development and equity.

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The centre of attention of macroeconomic policymaking should be on ‘real macroeconomics’ and the use of productive capacity—the employment of capital and labour at their highest potential level—and improvements in that productivity.

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Macro economics policy debates on UnemploymentDefinition:•Unemployment is inability for willing workers to find gainful employment.•Unemployment occurs when a person who is actively searching for employment is unable to find work.•Unemployment occurs when people are without work & actively seeking work.

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The Unemployment Rate:Unemployment Rate= Unemployed x100 Labor Force Types of unemployment:•Frictional Unemployment•Seasonal Unemployment•Cyclical Unemployment

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Classical debates on unemployment:•According to classical economists the labor &the other resources are always fully employed.•General unemployment is assumed to be impossible.•If there is any unemployment, it is assumed to be temporary/ abnormal.•In the long run the economy will have full employment/natural rate of unemployment if wages & prices are flexible.

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•Classical reasons for full employment:1. Say’s law: Supply creates its own demand.2. Abstinence theory of interest: Interest rate influences people’s saving.3. Classical theorists held that wages & prices would change proportionally•Graphically the pure classical theorists would have a vertical AS curve. That shows the same GDP associated with full employment, at each level in the economy.

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(graph1)

•According to classical economists the reasons for unemployment are: 1.Intervention by the government/private monopoly. 2. Wrong calculation by entrepreneurs & inaccurate decisions 3.Artificial resistance

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•Classical unemployment occurs when real wages are kept above the market clearing wage rate, leading to a surplus of labor supplied•Classical unemployment sometimes known as real wage unemployment. Because it refers to real wages being too high.

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Wage rate D W2 S W1

Q2 Q1 Q3 Aggregate Output

(graph2)

Classical Unemployment=Q3-Q2.

Keynesian debate on unemployment:•The most forceful critic of the classical model was John Maynard Keynes, a British economist. His major work, entitled The General Theory of Employment, Interest, and Money, was first published in 1936.

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•Keynesian theory holds that unemployment is the normal state of the economy & significant government intervention is required if employment/output targets are to be reached.

•In this view AS curve is Horizontal.

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•The classical economists argue that if wages were more flexible then most unemployment could be solved.

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However, Keynesian economists argue it is not as straightforward. They argue the problem may be a lack of AD in the economy.

EX: If wages are cut, it could lead to further fall in AD, as workers have lower wages. In this case, cutting wages may be ineffective in solving classical unemployment.

•Keynesian critique of classical theories:1. Say’s law: Whereas the classical economists believed that supply created its own demand, Keynes argued that causation ran the other Way —from demand to supply. There are many ways to increase Demand more effectively than to push for more output to be produced.

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2. Abstinence theory: Keynes argued that investors & savers have different motivations.

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•Central Keynesian conclusion: 1. AD determines real GDP 2. In short run, AD can be adjusted to achieve target GDP & unemployment levels with prices not changing (fixed, flat price)

PRICE STABILITY

• Keynesian different from classical.

• The classical assumed that full employment of resources in the economy.

• Keynesian assumed that there is no full employment.

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According to them, if at anytime there is deviation from this full employment level, the

wages, interest and prices quickly and automatically adjust/ change to restore

equilibrium at the full employment level.

•

Thus ,in the classical theory the as curve of output is

perfectly inelastic(vertical straight line)at the output level corresponding to full-

employment level of resources.

• It shown below the graph AS price level

Yf aggregate output

• Keynes consider the situation of economic depression when the economy was operating before the level of full employment of resources.

• He expressed the As curve as horizontal line, it shown below,

• The classical says if the economy prevails in fullemployment.there is an increasing in AD. so the price level is automatically change. it will goes up. because cannot be further increasing in output.

AS

P2

P1 AD AD1

Yf

• But the Keynesian refused this. he believed that there is no full employment level. so to expand the out put can utilized the more resources. Therefore output level is increased (o-y) without increasing cost of production. So the price level is not changed.

conclusion• According to Keynes price and wages are stable but output and employment will change

• The classical didn’t accepted and they agree with flexible prices. They said output and employment are stable but prices and wages will change.

Exchange Rate• It is a one of the macro

Economics variables.• It means the prices at which

one currency can purchased in terms of some other currency is the exchange rate between the two countries.

• Macro economic variable determines depends on the choice of the underlying macro Economic model

It has a two criteria

• 1. By recognizing that the existing macro economic modal for open economies are still rather simple in comparison to those of a closed economy.

• 2. One country model are used for small open economies , Where foreign variables are considered as a given and two country model are contracted. When domestic and foreign macro economic variable are interdependent.

• The open economy consist the exchange rate model, include the fixed and floating exchange rates.

• Under the exchange rate we observe the two approach.

1. Classical approach 2. Keynesian approach

Keynesian and classical frame works are similar with respect to

this transmission mechanism.

Keynesian model consist• The foreign country will

realize a decrease of it real national income. There will be a rise in the real exchange rate.

Classical Model Consist• The foreign country will observe a fall in its general price level.

What factors effects the classical and Keynesian exchange of currency?

• Factors of classical exchange rate of currency

• Own country want to import goods from the abroad, they are demanding foreign currency

• In order to get these foreign currency , they have to sell own currency

• Now the own country currency value against the foreign currency is low therefore . the imports will be expensive ii. Investment in the foreign country will be un attractive iii. The demand for foreign currency will be low and will the supply of own country currency

• The exchange rate rises imports will be more attractive

• The own country will be more interest rate in foreign country investment opportunities

• The quantity of foreign currency demanded , thus the quantity of own country currency supplied will rise

Factors of Keynesian exchange rate of

currency • The supply curve of own

country currency slopes upwards to the right as do the supply curve for most commodities. By similar reasoning the demand curve for own country currency slopes down ward.

• As we said before, this is a simple application of demand and supply analysis. variations in exchange rate are associated with variations in quantity demanded and supplied.

• There is an equilibrium exchange rate at which the quantity of a currency supplied is equal to the quantity demanded.

• One major cause of instability is a divergence in monetary policy between the countries

• The exchange rate often shows periods of great instability with large up and down movements.

• Above the situations are change the exchange rate.

• The Keynesian two countries model has been developed mainly by Mundell (1968) and popularized on a more comprehensive level.

• He explained the exchange rate according to the fiscal and monetary policies.

• He explain through this instruments.

• When changing the government expenditure ,changes in taxes and changes in the interest rate are changed the exchange rates