]
to analyze the effects of changes in the rate of monetary expansion, while New
Classical (Mark I) theorists relied on the rational expectations hypothesis.
Answer the following questions about each model:HOMEWORK #3
ECON-301
Dr. Kelton
WS05
1. Orthodox
Monetarists relied on the expectations-augmented Phillips Curve []
to analyze the effects of changes in the rate of monetary expansion, while New
Classical (Mark I) theorists relied on the rational expectations hypothesis.
Answer the following questions about each model:
a.) Which school emphasizes “fooling” and which emphasizes “surprises”? Explain the role played by each.
b.) Is there a short-run tradeoff between unemployment and inflation following announced/anticipated monetary expansion? Explain.
c.) How would your answers in part (b) change if the policy is unanticipated?
d.) Can money be neutral in the short-run? Can it be neutral in the long-run? Explain.
e.) Suppose policymakers want to reduce the rate of inflation. Would a Monetarist recommend a “cold turkey” approach or a “gradual” approach? What about a New Classical? Explain.
f.) Do Monetarists believe that it would be possible to maintain unemployment below its natural rate? What about New Classicals? Explain.
2. IS/LM Keynesians and Monetarists both view business cycles as disequilibrium phenomena. In the New Classical approach, deviations in output and employment are characterized as equilibrium phenomena. Compare and contrast these approaches.
3. The New Classical approach treats unemployment entirely as a voluntary phenomenon. As a result, equilibrium in the labor market implies full employment (i.e. the absence of involuntary unemployment). New Keynesians, in contrast, argue that given efficiency wage considerations, the existence of involuntary unemployment can be considered an equilibrium phenomenon. Carefully explain both arguments.
4. Compare and contrast the monetary surprise explanation of the business cycle with the real business cycle (RBC) explanation. How did RBC combine both “cycle” and “trend”? What drives the fluctuations, according to each theory? What role does money play in each? What policy implications follow from each?