Page 404 - Krugmans Economics for AP Text Book_Neat

13. Deflation poses several problems. It can lead to nently low unemployment rate. Fears of a political
debt deflation, in which a rising real burden of business cycle led to a consensus that monetary policy
outstanding debt intensifies an economic downturn. should be insulated from politics.
Also, interest rates are more likely to run up against 18. Rational expectations suggests that even in the short
the zero bound in an economy experiencing defla- run there might not be a trade off between inflation and

tion. When this happens, the economy enters a liq- unemployment because expected inflation would
uidity trap, rendering conventional monetary policy change immediately in the face of expected changes
ineffective. in policy. Real business cycle theory claims that
14. Classical macroeconomics asserted that monetary pol- changes in the rate of growth of total factor productiv-
icy affected only the aggregate price level, not aggregate ity are the main cause of business cycles. Both of these
output, and that the short run was unimportant. By the versions of new classical macroeconomics received
1930s, measurement of business cycles was a well - wide attention and respect, but policy makers and many
established subject, but there was no widely accepted economists haven’t accepted the conclusion that mone-
theory of business cycles. tary and fiscal policy are ineffective in changing aggre-
15. Keynesian economics attributed the business cycle gate output.
to shifts of the aggregate demand curve, often the 19. New Keynesian economics argues that market imper-
result of changes in business confidence. Keynesian eco- fections can lead to price stickiness, so that changes in
nomics also offered a rationale for macroeconomic aggregate demand have effects on aggregate output
policy activism. after all.
16. In the decades that followed Keynes’s work, economists 20. The modern consensus is that monetary and fiscal pol-
came to agree that monetary policy as well as fiscal icy are both effective in the short run but that neither
policy is effective under certain conditions. Mone- can reduce the unemployment rate in the long run. Dis-
tarism is a doctrine that called for a monetary policy cretionary fiscal policy is considered generally unadvis-
rule as opposed to discretionary monetary policy. able, except in special circumstances.
The argument of monetarists—based on a belief that the 21. There are continuing debates about the appropriate role
velocity of money was stable—that GDP would grow of monetary policy. Some economists advocate the ex-
steadily if the money supply grew steadily, was plicit use of an inflation target, but others oppose it.
influential for a time but was eventually rejected by There’s also a debate about whether monetary policy
many macroeconomists. should take steps to manage asset prices and what kind
17. The natural rate hypothesis became almost universally of unconventional monetary policy, if any, should be
accepted, limiting the role of macroeconomic policy to adopted to address a liquidity trap.
stabilizing the economy rather than seeking a perma-

Key Terms

Cyclically adjusted budget balance, p. 298 Inflation tax, p. 325 Discretionary monetary policy, p. 348
Fiscal year, p. 300 Cost-push inflation, p. 327 Monetary policy rule, p. 349
Public debt, p. 300 Demand-pull inflation, p. 327 Quantity Theory of Money, p. 349
Debt–GDP ratio, p. 301 Short -run Phillips curve, p. 331 Velocity of money, p. 349
Implicit liabilities, p. 303 Non accelerating inflation rate of Natural rate hypothesis, p. 350
Target federal funds rate, p. 307 unemployment (NAIRU), p. 336 Political business cycle, p. 351
Expansionary monetary policy, p. 310 Long -run Phillips curve, p. 336 New classical macroeconomics, p. 351
Contractionary monetary policy, p. 310 Debt deflation, p. 339 Rational expectations, p. 352
Taylor rule for monetary policy, p. 311 Zero bound, p. 339 New Keynesian economics, p. 352
Inflation targeting, p. 312 Liquidity trap, p. 339 Real business cycle theory, p. 352
Monetary neutrality, p. 317 Macroeconomic policy activism, p. 346
Classical model of the price level, p. 322 Monetarism, p. 348

362 section 6 Inflation, Unemployment, and Stabilization Policies