Question

3. Answer the following by looking at the article:

Macroeconomics: Schools Of Thought

By Stephen D. Simpson, CFA

The field of macroeconomics is organized into many different schools of thought, with differing views on how the markets and their participants operate.

Classical
Classical economists hold that prices, wages and rates are flexible and markets always clear. As there is no unemployment, growth depends upon the supply of production factors. (Other economists built on Smith's work to solidify classical economic theory. For more, see Adam Smith: The Father Of Economics.)

Keynesian
Keynesian economics was largely founded on the basis of the works of John Maynard Keynes. Keynesians focus on aggregate demand as the principal factor in issues like unemployment and the business cycle. Keynesian economists believe that the business cycle can be managed by active government intervention through fiscal policy (spending more in recessions to stimulate demand) and monetary policy (stimulating demand with lower rates). Keynesian economists also believe that there are certain rigidities in the system, particularly "sticky" wages and prices that prevent the proper clearing of supply and demand.

Monetarist
The Monetarist school is largely credited to the works of Milton Friedman. Monetarist economists believe that the role of government is to control inflation by controlling the money supply. Monetarists believe that markets are typically clear and that participants have rational expectations. Monetarists reject the Keynesian notion that governments can "manage" demand and that attempts to do so are destabilizing and likely to lead to inflation. (Learn how Milton Friedman's monetarist views shaped economic policy after World War II. For more, see Monetarism: Printing Money To Curb Inflation.)

New Keynesian
The New Keynesian school attempts to add microeconomic foundations to traditional Keynesian economic theories. While New Keynesians do accept that households and firms operate on the basis of rational expectations, they still maintain that there are a variety of market failures, including sticky prices and wages. Because of this "stickiness", the government can improve macroeconomic conditions through fiscal and monetary policy.

Neoclassical
Neoclassical economics assumes that people have rational expectations and strive to maximize their utility. This school presumes that people act independently on the basis of all the information they can attain. The idea of marginalism and maximizing marginal utility is attributed to the neoclassical school, as well as the notion that economic agents act on the basis of rational expectations. Since neoclassical economists believe the market is always in equilibrium, macroeconomics focuses on the growth of supply factors and the influence of money supply on price levels.

New Classical
The New Classical school is built largely on the Neoclassical school. The New Classical school emphasizes the importance of microeconomics and models based on that behavior. New Classical economists assume that all agents try to maximize their utility and have rational expectations. They also believe that the market clears at all times. New Classical economists believe that unemployment is largely voluntary and that discretionary fiscal policy is destabilizing, while inflation can be controlled with monetary policy.

Austrian
The Austrian school is an older school of economics that is seeing some resurgence in popularity. Austrian school economists believe that human behavior is too idiosyncratic to model accurately with mathematics and that minimal government intervention is best. The Austrian school has contributed useful theories and explanations on the business cycle, implications of capital intensity, and the importance of time and opportunity costs in determining consumption and value. (For related reading, see The Austrian School Of Economics.)

a) Explain which school(s) of thought seem most consistent with what we described as the Mainstream View. (1 point)

b) Explain which school(s) of thought seem most consistent with what we described as the Self-Correction View. (2 points)

Answer 1

Ans.(a) (1) I think "The Monetarist school " seems "Most consistent with what we described as Main Stream View". because the Monetarist Views had shaped the economic policy after World War II.

Ans.(b) (1) "The New Keynesian School" seems Most Consistent with what we described as the "Self-Correction View". because "it adds Micro economic values to the traditional Keynesian economic theories".

(2) Hence, the New Keynesians accepts that households and firms can operate on the basis of rational expectations.