OutlineChapter 12 – Aggregate Supply, Aggregate Demand and

InflationSection 4 – Competing TheoriesSection 5 – Stabilization vs. Sustainability

Macroeconomic Issues and ApplicationsCh 14 – How Economies Grow and Develop

Section 1 – Standard Theory of Economic Growth (1.1 only)Section 2 – Patterns of Growth and DevelopmentSection 3 – What Explains the Variety in Growth Experiences

Competing TheoriesSo far – tried to understand the dynamics using

ADE/ASR model. Fluctuations coupled with and informed by

interventions – e.g. expansionary fiscal policies of 1960s to get out of slump, inflation targeting in 1980s etc.

Remember – classical vs. keynesian perspectives as two poles in assessing the role of government intervention

Contoversial in relation to ADE/ASR framework

Competing TheoriesClassicals – self-adjusting free market systemLabour markets clear at eqm wage, market for

loanable funds equate S&I at an eqm i => FEASR curve – output would always be at FE level, level

of AD determines only inflation rate At FE, all agents are optimizing their choices; if deviate from FE, smooth and quick restoration

Output (Y )

Classical ASR

Y*

ADE

Infla

tion

rate

(π

)

Competing Theories

Classicals – self-adjusting free market systemEffect of AD management policies? No effect on Y*- Expansionary fiscal policies: crowding out priv. I- Expansionary monetary policy: lead to only

inflation! CB should choose a target inflation rate or interest rate and not concern about Y or UN.

Politically conservative policies – small governments, strict rules on monetary policies

Competing TheoriesKeynesians – market economies are inherently

unsustainableAnimal spirits of the investors – tendency of private

agents to get over-optimistic and create booms in I and thus Y.

Perpetual business cycles - ADE moving back and forth (peaks : A; troughs: B)

Competing TheoriesKeynesians – market economies are inherently

unsustainableImpossible to have “settling down” at a FE eqm.No assumption of rationality but rather

optimism/pessimism; societal determinants.Traditional model unable to cope with supply

shocks or sustainability issues – need to have more flexible models so as to incorporate new issues and variety of forces as well

Stabilization vs. SustainabilityRemember the goals of macroeconomic policies:

maintain living standards, stabilization and sustainability.

Up to now, talking about first two, sustainability?Stabilization and ecological sustainability are in

direct conflictHave been assuming:More employment is better – high levels of output are

necessary to keep employment high Levels of C, II, G and NX are important rather than

composition or production methods

Stabilization vs. SustainabilityNeed to focus on the quality, types and intensity of

employment rather than the level only.Also composition of output is important – need to

shift towards producing goods and services that are environmentally less destructive; investments in energy saving infrastructure

Transition towards more sustainable macroeconomy is essential

Policy examples – subsidies, investment tax credits

Standard Theory of Economic GrowthEconomic Growth: increases in aggregate levels of

production and income; measured as the percentage change in GDP or GDP per capita from year to year

Use real GDP (GDP adjusted for inflation)Growth Rate = 100* (real GDPt - real GDPt-1 )/ real GDPt-1

Focus on GDP per capita (output per person)GDP per capita = GDP / population

GDP Growth = population growth + GDP per capita growth

Standard Theory of Economic GrowthGDP per capita indicates the actual increase in

GDP experienced

Economic growth is the rightward shift ot ASR – increasing maximum capacity

In general growth is accompanied with increase in AD

Output ↑but overall impact on inflation is ambiguous

Patterns of Growth and DevelopmentIndustrial Revolution – important not just as a

historical episode but because the pattern of economic development it established became a model for worldwide.

A process of social and economic change starting in early 18th C, that developed and applied new methods of production and work organization resulting in substantial increases in output per worker

Patterns of Growth and DevelopmentIndustrial Revolution 1)Agriculture: new techniques, increases in

productivity2)Mechanization: new sources of power,

inventions + railroads and other advances in transportation (Manchester : Cottonopolis)

3)Colonies serving as both supplier of raw materials and markets for finished goods

Global Economic GrowthIndustrial revolution began in England but then

spread to much of Western Europe in 19th and 20th C – “early industrializing countries”

Rapid growth in 20th C; much came in the aftermath of 1960s – golden era of capitalism

Global Economic GrowthThough rapid, growth does not translate into

even/equitable distribution across countries as well as among people in the countries

Global Economic GrowthGrowth experience of developed countries (US, Japan,

Europe) – GDP increase due to a combination of factors: growth in AD, labour productivity, technological innovation, investment in manufactured K etc. + trade opportunities.

Variety in patterns of growthJapan – economic miracle (1950-80)East Asian tigers – S. Korea, Taiwan, Singapore, Hong Kong (at least until

1997 crisis)

Virtuous cycles – high S & I lead to greater productivity, competitive X and growth of domestic industries

Global Economic GrowthNo single/unique recipe to be applied to all!!Also need to consider human capital – educational

attainmentJapan – I in technology intensive industries+X

favourable policies = world leader in technology goods! (complemented by tariffs + channeling I to favoured industries)

Can we talk about “convergence”??Underlying economic forces will cause poorer

countries and regions to catch up with richer ones!

Global Economic GrowthUneven pattern of economic growth = small portion

of world’s population benefits disproportionately from productionConvergence is not occuring in the majority of developing countries. Only valid for China, less valid for India!

What Explains the Variety?

Striking differences between countries

Why?S&I: some of output

not spent may be set aside or spent on assets that would increase productivity

Size of spheres proportional to population

What Explains the Variety?I may take different forms: industrial capital,

agriculture, human capital.Technological Innovation – by adopting new

tech. developed elsewhere, R&D activities etc.China and India – counterexamples for std.

economic theory (L-int cou but high-tech X)Gov. policies encouraging organizational

innovation, enterpreneurship, selective industrial support (e.g. Japan)

What Explains the Variety?Macroeconomic policies – stabilization of AD (prevent

or aid recovery from recession); access to international markets for inputs and for finished goods; infant industry protection

Natural resources – important assets but overuse may lead to environmental degradation and economic distortion

Foreign capital – in the form of FDI, development assistance (aids or loans)

Institutions – regulation, monitoring, “governance”, effective systems of IPR and contract enforcement