Fundamental Questions

1. What do Keynesian economists believe about macroeconomic policy?

2. What role do monetarists believe the government should play in the economy?

3. What is new classical economics?

4. How do new theories of economics develop over time?

Teaching Objectives

The primary purpose of this chapter is to introduce the major alternative schools of macroeconomic thought.

The unique feature of the chapter is the discussion of the policy prescriptions of Keynesian, monetarist, and new classical economists. Each group differs in its view of the role that government should play in the economy. Keynesians tend to argue for activist monetary and fiscal policies. Monetarists and new classical economists argue for nonactivist rules with respect to monetary policy and a balanced budget on the fiscal side.

Special attention should be paid to working through the policy prescriptions of the alternative schools with the aggregate supply-aggregate demand model. You can easily point out how if aggregate supply adjusts before aggregate demand, anticipated policy can induce instability.

Key Term Review

Keynesian economics
monetarist economics
classical economics
new classical economics

Lecture Outline and Teaching Strategies

1. Keynesian Economics

1.a. The Keynesian model: Keynesians argue that equilibrium income is determined by aggregate expenditures. New Keynesians point to wage and price rigidities as the reason that the economy finds its equilibrium at less than potential output.

1.b. The policymakers' role: Keynesians rely on monetary and fiscal policies to restore long-run equilibrium.

Teaching Strategy: The main arena for the macroeconomic debate is policy. Each of the competing views has a different set of policy recommendations. Hence, in your lectures you may wish to emphasize the policy implications of the theories.

2. Monetarist Economics

2.a. The monetarist model: A change in the money supply leads to a change in the price level in the long run. Real output is affected only in the short run.

2.b. The policymakers' role: The money supply should grow at a rate that is consistent with the long-run growth of potential output.

Teaching Strategy: Spend some extra time explaining the idea that policy affects the economy with variable lags. Point out how, under these conditions, policies might introduce more instability into the system instead of acting as a stabilizing force.

3. New Classical Economics

3.a. The new classical model: The two major components of new classical economics are rational expectations and market clearing.

3.b. The policymakers' role: Only unexpected changes in policy affect the economy in the short run. In the long run, policy is ineffective.

Teaching Strategy: Ask students to devise a policy strategy that could work if agents have rational expectations. They will gradually come up with a nonsystematic policy strategy by themselves.

4. Comparison and Influence

Teaching Strategy: It is important to note that a key distinction between the major schools of macroeconomics is their reliance on the self-adjusting mechanism.