Quiz 13: Macroeconomic Models:a Summary
Because,in economics,there are no opportunities for controlled laboratory experiments aimed at settling such controversies.To test theories,events in the real world would have to be examined and many factors vary at the same time.Also,the resulting data are open to different interpretations.
The classical and real business cycle models assert that falls in aggregate supply lead to recessions.As a result,they predict price level should rise during recessions.Likewise,changes in output are driven by changes in inputs,which drives down labor demand and real wages as output falls.The new classical,monetarist,new Keynesian and Keynesian models assert that falls in aggregate demand lead to recessions.As a result,they predict that the price level should fall during recessions.Because nominal wages in these models are inflexible,a fall in the price level as output falls leads to an increase in the real wage.
The Cambridge version of the quantity equation is utilized by the monetarists,new classical,and real business cycle models as the basis for their own strong quantity theory view that money is the dominant influence on aggregate demand and,therefore,nominal income.The equation is shown as M = kPy,where k is a constant. Keynesians models argue that money is an asset that pays a zero interest rate.As a result,in all of these models,k is not a constant but falls when interest rates rise and vice versa.Thus,aggregate demand is not only a function of the money supply but also of the variables that influence interest rates.