Economics.

Part 2:
Macroeconomics
Professor Anna
Ząbkowicz
Lecture 4. Faculty of
Economics and
Modernized Macro Sociology
Policy Model anna.zabkowicz
@uni.lodz.pl
 Part I. Classical and
Keynesian judgements: Why
Lecture 4. economists differ in their
advice?
Modernized • Keynesian approach and
Macro Policy Classical-monetarist
Model approach. Recollection.
Part II. Modern Classical supply-
side macro policies
• Modern Classical-structuralist
approach: How the real sector*
could increase its output in the
long run.
 Part I. Classical and Keynesian
judgements: Why economists
differ in their advice?

Debatable government’s activism and

effects of intervention. Stabilization.
Taxing. Flexibility of prices.
Classical* (A) and Keynesian** (B)
judgements: Government
(A) Any policy that increases (B) Government is an expression of
Trust government’s role is highly the will of the people.
suspect and should be avoided.

(A) Real-world government (B) It is a legitimate method of

Inter- intervention is more likely to do correcting problems of the economy.
vention harm than good.

(A) Politicians often are guided (B) True, government is sometimes

Interest by politics and narrow interests, misled by interest groups who direct
groups not by society’s best interest. the government to do their own
bidding rather than follow the general
interest, but this is simply a cost of
government.
 Intervention in the
sake of stabilization?
Other
questions Taxing of whom and
which rise for what?
controversy
Beliefs about
flexibility of prices
Need for government’s
intervention
• Due to intervention market failures
should be improved.
• Both Keynesians and modern Classicals
regard effects of intervention on total
output (income) and average price level.
• They disagree on “how and to what
extent” to intervene.
Classical* (A) and Keynesian** (B) judgements:
Counter-recessionary intervention
(A) Cons (B) Pros
Economic downturns eliminate ineffective Production and income in the
actors and projects. Economy recovers to be economy fluctuate (business cycles).
more sound than ever. Market does this job. This instability affects propensity to
invest (I). Economy in distress means
loss of jobs and income (C). Counter-
action is required.
Intervention must be reasonable otherwise it Stabilizaton policy is required to have
can imply reverse effects. It can contribute investment rising and more effective,
to rising uncertainty and lower propensity to and to see more jobs in the economy.
invest, and thus to rise in unemployment. The result is rise in employment and
real output.
Governments welcome counter- What matters is government’s
recessionary intervention, however, they activism or intervention capable to
seem to be not equally eager to restrict revert the recession phase of a
expansionary fiscal policies under recovery. business cycle, and contribute to
Intervention for stabilization: how and
what for
• Classical-monetarist economists:
• recommend money supply adjustment and broader monetary policy
• in the sake of stable value of money (price level) and output
• Keynesian economists:
• recommend aggregate demand management and prefer fiscal policy
• in the sake of stabilization of output, income and employment
• With regard to effectiveness of macro policies both schools
acknowledge that :
• expansionary monetary policy has potential long-run inflation effects
but…
• lower taxing (expansionary fiscal policy) stimulates growth of output
but….
Debate on lower taxing: for higher
output, tax incomes and employment
(A) Classicals - higher-income groups relief:
make taxes lower in aim to protect profits of
investors and employers:
=> higher saving & investment (I) =>
entrepreneurial and labour activisation vel
supply of capital and labour =>
higher output, tax incomes, employment
Debate on lower taxing: for higher
output, tax incomes and employment
(B) Keynesians: lower-income groups
relief
make taxes lower in aim to subsidize
labour or poorer social groups
=> higher consumption (C) => higher
aggregate expenditure and demand =>
higher output, tax incomes, employment
Taxing: Summing up the divergencies
A. Classicals: less government involvement
means more competitive economy.
• Taxes must be low for high-income social
groups.
• Income of entreprenuers and employers
must be sheltered.
• Social spending should be constrained
instead.
Taxing: Summing up the divergencies
B. Keynesians: an economy with zero taxes means
no government structure holding economy together.
• Income of employees and unemployed should be
sheltered.
• Taxing rates must be progressive which means
progress in accordance with private income level.
• Spending programs and social transfers are
necessary in the sake of social solidarity and
public good.*
Different beliefs regarding flexibility
of prices
• Prices are flexible and they respond to
output/demand.
• As the economy expands and output Q
increases, at some point the price level P
begins to rise.
• The problem is that no one knows precisely
where that point is due to different beliefs
regarding flexibility of prices*
How expansionary policies’ effects will be
split between Q changes and P changes
A. Classicals tend to see the economy in the
perfectly flexible price-level range
• When the economy is close to the Classical range,
expansionary aggregate demand policy increases
real output by a small amount. Much of this
increase leads to an increase in the price level P
(inflation).
• Expansionary monetary policy in the long run
affects exclusively inflation.
How expansionary policies’ effects will be
split between Q changes and P changes
B. Keynesians tend to see the economy in the fixed
price-level range
• When the economy is close to the Keynesian range,
expansionary aggregate demand policy has a much
larger effect on real output, and a smaller effect on
the price level.
• Keynesians doubt whether moderate expansionary
pressures will always lead to inflation in the long
run and advocate more activist policies*.
Projections concerning increase in average
price level in the long run diverge*.
1. The most of economists today are in a moderate range of
economy: between poles of perfectly flexible prices (A) and
fixed prices (B).
2. The debates go on because:
• On the one hand, to use expansionary policy in moderate range
is to take a chance that inflation expectations will get built in.
• On the other hand, to use contractionary policy can lead to
slow growth and high unemployment.
3. Finally inflation, and its relation to growth and unemployment
comes to center stage in any discussion of macro policy.**
 Part II. Classical-structural
Approach or Modern Supply-
side Macro Policies
How to stimulate growth of domestic output in
the long run? Real and free economy matters.
Taxes, deregulation, liberalization,
privatization*.
Understanding
Structural Supply-side
Macro Policies
Historical backgrounds of
contemporary macroeconomics
1. Traditional Classical policy advice (before
World War II)
• looked at the supply side: relied on wage-
price adjustment
• No notorious excess in supply is possible.
• dictated little government
• Government budget deficits are bad and
they should be avoided.
Historical backgrounds of
contemporary macroeconomics
2. Keynesian economics* (around World War II
replaced Classical policy advice)
• notorius excess in productive capacities and
goods: Wage-price adjustment failed
• Looked at the demand side: shortage-of-demand
problem
• recommended to stimulate aggregate demand in
order to reduce, removed the stigma connected
with deficits and government’s activism.
Historical backgrounds of
contemporary macroeconomics
3. Classical-monetarist economics
• replaced Keynesian approach in the
1980s and began another counter-
revolution in macroeconomic thinking;
• relied on money-supply adjustment
• were concerned with price level
(inflation) and aimed at monetary sector.
The contemporary stage of
macroeconomics development
4. Modern Classical supply-side policy regime
(since the 1980s)
• says: The structure of production of real
goods and services* matters;
• focus on tax cuts whenever they can possibly
be implemented as a key to economic
prosperity**;
• is dedicated to real economy.
Structural supply-side macro policies
• “macro policies” because they are suggested to
solve major macroeconomic problems
• increase in potential output and reduce
unemployment
• “supply-side” since they are about production,
aimed to increase output which the economy can
potentially achieve
• „structural” because they are about to change the
structure of this output.
Why “modern” then?*
1. Traditional Classical approach: How economic
system produces output without intervention.
• What, and how much, to produce.
• How to produce it.
• For whom to produce it.
2. Modernized Classical approach: How to constrain
intervention?
• How to induce structural adjustment which is
essential to see real output growing in the long
run.
Traditional Classical
Approach: How Economic
System Produces Output
without Intervention
What traditional Classicals believed
about supply-side decisions
1. The division of labor and trade make individuals
better off.
• Markets provide a place where people know they
can trade.
• Markets imply specialization and allow
individuals to utilize their comparative
advantages.
• take comparative advantage – being better suited to
the production of one good than to production of
another good
What traditional Classical economists
believed about supply-side decisions
2.Thinking in terms of comparative advantage
implies a choice with regard to inputs and
outputs (production possibility).
• An output is simply a result of activity.
• An input is what you put into a production
process to achieve output.
• What alternative outputs you can achieve
with your inputs?*
What traditional Classical economists
believed about supply-side decisions
3. If you regard productive efficiency you can
be even more successful in terms of
competitive advantage.
• Efficiency involves achieving as much
output as possible from a given amount of
inputs or resources.
• To put it other way, efficiency involves
achieving a goal as cheaply as possible.
Classical questions of supply-side
economics:
what, and how much, to produce;

how to produce it;

for whom to produce it*.

How the „what, how and for whom”
problems are solved via trade
(market)
• Belief no 1 & belief no 2: After considering
comparative advantage and production
possibilities you should know “what, and how
much, to produce”.
• Belief no 3: Considering productive efficiency you
are solving the problem “how to produce it”.
• The question of distribution “for whom to produce
it” or “Who gets what” is easily skipped down.
Traditional Classical thinking
• Economic system (market) is capable to
meet these challenges and produce
output without intervention.
• Let the market do the job (laissez-faire).
• Advocate keeping the government out of
the market economy as much as
possible.
Modernized Classical
Approach: Constrained
Intervention and Structural
Adjustment for Growth*
Constraining intervention or how to deal
with the supply side of the real economy
1. make tax rates lower;
• lower taxes contribute to potential output increase.*
2. reduce government social welfare spending programs;
• Welfare allows people to eat when they have not worked.
Reducing welfare increases people’s incentives to work.
• Memo: Pensions, benefits, healthcare, primary education,
etc. are at stake
3. have government regulations reduced.
• Deregulation encourages competition, new businesses
and new jobs which they create**.
Structural adjustment: Four
recommendations

1. Tax reforms
2. Privatization
3. Liberalization
4. Deregulation…
…in the sake of supply of labour and capital
and growth of domestic output in the long
run
Reforms on supply side of real
economy
1. Tax reforms that are beneficial for high-
income groups:
• lower average tax rates, taxing
consumption rather than investors’
incomes, etc.
bring
• Increase in savings, new incentives to
invest, increase in capital*
Reforms on supply side of real
economy
2. Privatization of wealth…
• public property, social security (e.g. pension
funds), etc.
…brings
• new opportunities for private investors (e.g.
private hospitals)
• paid social services, activisation of labour
and employees.
Reforms on supply side of real
economy
3. Liberalization of economic
activities…
•E.g. of trade, capital
…brings
•new opportunities of doing business,
competitiveness and economic
performance, employment.
Reforms on supply side of real
economy

4. Deregulation…
•E.g. of prices, wages (indexation)
and labour market
…brings
•flexible employment, more liberty for
businesses and employers.
Structural adjustment in result
Supply-side reforms Structure of economy

Privatization (wealth) Private/public output

Liberalization (e.g. International/domestic

currency output
convertibility)
Deregulation (e.g. Free market/government’s
domestic prices) domain
Classical-structuralist thinking
• Desirable structural adjustment: The required reforms on
supply side of economy imply change in economy’s
structure.
• Question of long-run growth: Economy will produce more
as soon as supply of factors of production (labour and
capital) is induced.
• The „what, how and for whom” problems are solved thanks
to constraining state’s involvement which means:
• moderate rates of taxation, privatization, liberalization,
deregulation*
• Thus economic system wil produce output despite state’s
intervention.
The „for whom” problem solution
…must be on benefit of investors and employers:
• Changes in tax systems – on behalf of wealthy
taxpayers and potential investors
• moderate rates of taxation, constraining progressive
taxing, consumption taxes rather
• Changes in labour relations - in the sake of limiting
wage factor and the role of trade unions
• shrinkig the scope of wage indexation and
unemployment benefits, weaking bargaining power
of trade unions
• Privatization
• shrinking public domain and welfare
Supplement: Keynesian
Structural Supply-side
Policies*
Keynesian structural supply-side
policies
1. These are policies far from Classicals’ sense of
correctness:
A. Sector enhancing policies
B. Policies re-distributing income between business and
employees

2. Policies changing structure of the economy, accordingly:

Ad A. Activist industrial policy, trade policy included
Ad B. Income policy, that is administrative control of prices &
wages
Ad A. Activist industrial policy
• The government works directly with businesses,
providing funds, background research, and
encouragement to specific industries.
• Funds are supposed to be channeled mostly to
high-growth industries, increasing the potential
output and international competitiveness.
• Heavy and high-technology industries*
• Exporting industries**
• Defence industry***
Ad B. Income policy
• Programs of temporary wage and price controls.
• The government holds down nominal wage and price
increases to eliminate expectations of inflation,
thereby reducing the cost necessary to fight inflation.
• The government places direct pressure on individuals
to hold down their nominal wages and prices.
• Direct administrative regulations
• „Nominal” as opposed to „real”, prices and wages you
actually see and pay.
Modernized Macro
Policy Model: Summary
Modern Classical-structural economists
on structural adjustment in the real
economy
• decrease taxes in order to stimulate supply of labor and
capital and make labour market free (of trade unions);
• foster free market, release initiatives rather than manage
demand
In effect: induce structural adjustment, which is specific as
compared with
• Keynesians’ aggregate demand management (real
sector).
• Classical-monetarist economists’ money-supply
adjustment (monetary sector).
There is no
objective way
of deciding
which group is
right or wrong.
Glossary
• Policy activism. Active role for governments in regulating markets and
redistribution of income. A close term is intervention.
• Welfare. Redistribution of tax revenues and funds to members of society
who are in need. Pensions, benefits, healthcare, primary education, etc.
• Structural adjustment. The expected results of supply-side reforms which
are increased domain of the market as well as economic structure change.
• Incomes policy. The government directly holds down nominal wage and
price increases.
• Industrial policy. The government provides funds, background research,
and encouragement to specific industries.