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Flashcards in Economic Shools Of Thought Deck (20):

Managing the business cycle

Policy intervention

Objective high and stable growth
Supply side policies
Increasing potential output (LRAS)

Demand side (fiscal and monetary)
Affect aggregate demand
Used to mitigate the effects of economic recessions and booms


Market oriented policies

Policies to increase aggregate supply by freeing up the market


Reducing government expenditure

Tax cuts
Effects on supply of labour
Effects on demand

Tax cuts for business
Cutting taxes on profits
Greater tax relief for investment

Reducing power of labour (increased flexibility of labour markets)
Reducing welfare payments

Policies to encourage competition
Free trade and capital movements


Interventionist supply side policies

Policies to increase aggregate supply by gov intervention to counteract the deficiencies of the market

Funding R&D
Training and education
Information,advice and persuasion
Assistance to small firms
Direct provision


Policy making key questions

1)Labour market
Right wing- keep prices and wages flexible
Left wing allow for price and wage rigidities

2)Should the state try to stimulate AD during recession to promote growth

Right wing can't do
Left wing yes should do

3) how do expectations affect market behaviour
Right wing- expectations adjust rapidly to changes in prices - expansions in AD then should lead to inflationary pressure

Left wing- expectation of prices depends on expectations of output and employment

(What should we do (if anything) to promote high growth, low inflation, low unemployment

And shall we use demand or supply side policies


Main schools of thought

Classical economists- free markets clear, no intervention

Keynesian economists- free markets don't clear, intervene!

Monetarist economists- free markets work, any interventions should focus on long run


Classical key elements

Price flexibility ensures that D=S
In the labour market and market for loanable funds

Says law - supply creates its own demand

The quantity theory of money


Classical on labour and capital markets

Classical analysis on output and employment

Free market works

Markets clear in the long run:
Labour market
-full employment in the LR
-frictional unemployment only

Market for loanable funds

Interest rates will adjust to ensure market clearing
-C(-) > S(+) > (through r ) I(+)


Classical on price and inflation

Quantity of money theory

General level of prices depends on money supply
Inflation is then purely a monetary phenomenon

Implications for monetary policy


Policy implications of classical

Monetary (at best ) does not work extra money causes inflation m

Fiscal policy (at best) does not work

Gov expenditure must come from extra taxes, extra borrowing, or extra money

Extra taxes and extra borrowing reduce private AD by the same amount

Extra money causes Inflation


Keynes on labour markets

They do not clear on their ow


Keynes on labour markets

Keynes rejection of classical theory

Markets won't clear

Rigidities in the labour market
The problem of deficiency of demand

Workers are also consumers
When you cut wages you also affect AD
This offsets any benefits and puts the economy deeper into recession


Keynes on capital markets

Savings,consumption and animal spirits

Rejection of increased savings as a means of increasing investment

More savings less consumption
Less consumption means less sales for firms

Which deters investment (the paradox of thrift )

S and I are not just tested through r

Behaviour is motivated by perceptions of how others will behave (animal spirits )


Keynes on says law

Demand rules!

Keynesians emphasise the role of AD

Says law"supply creates its own demand "

Keynes - no AD can drop and this reduction can cause AS to drop as well (at least for some time )


Keynes on inflation

More money does not automatically lead to high inflation


Keynes on prices

Classical economists


Hence more M should lead to higher P (inf)


Not necessarily

Depends on the position of the AD curve


Keynes on policy making

AD too volatile needs to be managed

Remedy - manage AD


Boost AD in recession
Reduce AD during booms

Also known as stop go policies

Fiscal policy G^ or T(V) > AD ^ -Y^

Monetary M^> G^ or I^ > AD^ - Y^


Monetarist economics

Monetarist Keynesian argument

Monetarist counter revolution

Return to old classical theory (nkw extended to stag flation)
Rejection of Keynesian demand management policies

Inflation is always everywhere a monetary phenomenon

The problem of inflationary expectations

A vertical LR phillls curve , the natural rate of unemployment NARU


The monetarist punter revolution

Use supply side policies to boost employment

In practice

I'm 70s employment was boosted with AD policies (Keynesian)

Brought about inflation

In 80's thatcher used supply side for employment and inflation was effectively controlled after a while


Modern day Keynesian (inflation)

Inflation - not merely a problem of excess demand

Expectations or increasingly rising wages and real living standards which could not be met by a rise in national Income


Modern day Keynesian (unemployment)

Why the boom in the 80s was not accompanied by a fall in unemployment

Structural problems

Low capital stock
Insiders and outsiders