Chapter 39 – Current Issues in Macro Theory and Policy
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Chapter 39 – Current Issues in Macro Theory and Policy
McConnell Brue Flynn 21e
DISCUSSION QUESTIONS
1. According to mainstream economists, what is the usual cause of macroeconomic instability?
What role does the spending-income multiplier play in creating instability? How might adverse
aggregate supply factors cause instability, according to mainstream economists? LO1
2. What is an efficiency wage? How might payment of an above-market wage reduce shirking by
employees and reduce worker turnover? How might efficiency wages contribute to downward
wage inflexibility, at least for a time, when aggregate demand declines? LO1
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3. How might relationships between so-called insiders and outsiders contribute to downward
wage inflexibility? LO1
4. Briefly describe the difference between a so-called real business cycle and a more traditional
“spending” business cycle. LO1
5. Craig and Kris were walking directly toward each other in a congested store aisle. Craig moved
to his left to avoid Kris, and at the same time Kris moved to his right to avoid Craig. They
bumped into each other. What concept does this example illustrate? How does this idea relate to
macroeconomic instability? LO1
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6. State and explain the basic equation of monetarism. What is the major cause of macroeconomic
instability, as viewed by monetarists? LO1
7. Use the equation of exchange to explain the rationale for a monetary rule. Why will such a rule
run into trouble if V unexpectedly falls because of, say, a drop in investment spending by
businesses? LO1
8. Explain the difference between “active” discretionary fiscal policy advocated by mainstream
economists and “passive” fiscal policy advocated by new classical economists. Explain: “The
problem with a balanced-budget amendment is that it would, in a sense, require active fiscal
policy—but in the wrong direction—as the economy slides into recession.” LO3
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9. You have just been elected president of the United States, and the present chairperson of the
Federal Reserve Board has resigned. You need to appoint a new person to this position, as well as
a person to chair your Council of Economic Advisers. Using Table 39.1 and your knowledge of
macroeconomics, identify the views on macro theory and policy you would want your appointees
to hold. Remember, the economic health of the entire nation—and your chances for reelection—
may depend on your selections. LO4
10. LAST WORD Compare and contrast the market monetarist 5-percent target for nominal
GDP growth with the older, simpler monetary rule advocated by Milton Friedman.
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REVIEW QUESTIONS
1. If prices are sticky and the number of dollars of gross investment unexpectedly increases, the
_________ curve will shift ____________ . LO1
a. AD; right.
b. AD; left.
c. AS; right.
d. AS; left.
2. First, imagine that both input and output prices are fixed in the economy. What does the
aggregate supply curve look like? If AD decreases in this situation, what will happen to
equilibrium output and the price level? Next, imagine that input prices are fixed, but output prices
are flexible. What does the aggregate supply curve look like? In this case, if AD decreases, what
will happen to equilibrium output and the price level? Finally, if both input and output prices are
fully flexible, what does the aggregate supply curve look like? In this case, if AD decreases, what
will happen to equilibrium output and the price level? (To check your answers, review Figures
32.3, 32.4, and 32.5 in Chapter 32). LO1
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3. Suppose that the money supply is $1 trillion and money velocity is 4. Then the equation of
exchange would predict nominal GDP to be: LO1
a. $1 trillion.
b. $4 trillion.
c. $5 trillion.
d. $8 trillion.
4. If the money supply fell by 10 percent, a monetarist would expect nominal GDP to _________.
LO1
a. Rise.
b. Fall.
c. Stay the same.
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5. An economy is producing at full employment when AD unexpectedly shifts to the left. A new
classical economist would assume that as the economy adjusted back to producing at full
employment, the price level would ___________. LO2
a. Increase.
b. Decrease.
c. Stay the same.
6. Use an AD-AS graph to demonstrate and explain the price-level and real-output outcome of an
anticipated decline in aggregate demand, as viewed by RET economists. (Assume that the
economy initially is operating at its full-employment level of output.) Then demonstrate and
explain on the same graph the immediate outcome as viewed by mainstream economists. LO2
7. Place “MON,” “RET,” or “MAIN” beside the statements that most closely reflect monetarist,
rational expectations, or mainstream views, respectively: LO4
a. Anticipated changes in aggregate demand affect only the price level; they have no effect on
real output.
b. Downward wage inflexibility means that declines in aggregate demand can cause long-lasting
recession.
c. Changes in the money supply M increase PQ; at first only Q rises because nominal wages are
fixed, but once workers adapt their expectations to new realities, P rises and Q returns to its
former level.
d. Fiscal and monetary policies smooth out the business cycle.
e. The Fed should increase the money supply at a fixed annual rate.
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Answer:
PROBLEMS
1. Suppose that the money supply and the nominal GDP for a hypothetical economy are $96
billion and $336 billion, respectively. What is the velocity of money? How will households and
businesses react if the central bank reduces the money supply by $20 billion? By how much will
nominal GDP have to fall to restore equilibrium, according to the monetarist perspective? LO1
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2. Assume the following information for a hypothetical economy in year 1: money supply = $400
billion; long-term annual growth of potential GDP = 3 percent; velocity = 4. Assume that the
banking system initially has no excess reserves and that the reserve requirement is 10 percent.
Also suppose that velocity is constant and that the economy initially is operating at its full–
employment real output. LO1
a. What is the level of nominal GDP in year 1?
b. Suppose the Fed adheres to a monetary rule through open-market operations. What amount of
U.S. securities will it have to sell to, or buy from, banks or the public between years 1 and 2 to
meet its monetary rule?
Part a:
Part b: