Next Chapter: Controversies in Macroeconomics 2:
The Nature of Unemployment
This chapter has sketched some controversies arising from two major attempts, over the last half-century, to reformulate the pre-Keynesian "classical" economic ideas and to restore credibility, in particular, to "the Market-Clearing Proposition," that is, the idea that employment is determined by the supply and demand for labor, or in other words, that the supply and demand for labor are equal. These attempts have had a considerable measure of success, and today a large proportion of American economists subscribe to the "New Classical" position. All the same, the dialog has not been closed, and a variety of New Keynesian economists continue to question the Market-Clearing Proposition and to think in terms of alternatives to it.
The first round of the discussion focused on the role of monetary policy. While Monetarists held that changes in the money supply could have a powerful influence on production, they did not favor an active monetary or fiscal policy. Instead, they opposed fiscal policy as an illusion and suggested that monetary policy ought to follow "rules rather than discretion," increasing the money supply gradually at a steady rate.
The New Classical school went still further. Arguing from logical consistency that rational people would have "rational expectations," they drew the conclusion that any policies, monetary or fiscal, that tried to move the economy away from the NAIRGDP would be ineffective, and expressed this as the "Policy Ineffectiveness Proposition."
This view runs into trouble, though, when we observe that sometimes the NAIRGDP moves toward the recent level of production rather than the other way 'round. This "path dependence" seems to open the possibility for effective aggregate demand policy within a fairly wide range of RGDP at any given time. Some of the hottest controversies in practical economic policy in the 1990's are the controversies about just where the limits of this range of path dependency are. Cautious central bankers, afraid of moving beyond it and causing accelerating inflation, are accused by some economists of being overcautious and causing a stagnation that is worse than modest inflation.
In summary, the Monetarist and New Classical movements have given us some insights that are clearly true and have contributed to our understanding of the modern economy, and have stimulated at least one discovery that seems to undermine their own view. The contributions are
Next Chapter: Controversies in Macroeconomics 2:
The Nature of Unemployment
