Key Terms
Both schools agree on the goals
Full employment, stable prices, economic growth. They disagree on almost everything else.
British data
An inverse (negative) relationship between unemployment and inflation.
Natural Rate Hypothesis
Because LRAS is vertical; there is no long-run tradeoff between inflation and unemployment.
John Muth formalized this
Expectations are rational if they equal the predictions of the underlying economic model.
Crowding out
Government borrowing raises interest rates; reducing private investment; weakening the fiscal multiplier.
Neoclassical view
Complete crowding out. Every dollar of government spending displaces a dollar of private investment.
Keynesian view
Incomplete crowding out. Fiscal policy is weaker than it looks; but still effective; especially during deep recessions w
Cyclical unemployment
Caused by recessions; economy producing below potential GDP; employers have less incentive to hire.
Frictional unemployment
Caused by the time it takes workers and employers to find each other. Always present; even in a strong economy.
Structural unemployment
Workers whose skills are no longer in demand. Requires deliberate policy response (retraining programs).
Natural rate of unemployment
Frictional + structural unemployment; the rate at full employment; cyclical unemployment is zero.
Preferred tool
Expansionary fiscal policy (government spending increases over tax cuts; because spending hits AD directly; tax cuts may
Goal
Shift AD to the right; eliminate the recessionary gap; get people back to work faster.
Preferred approach
Let it correct. Don't try to fine-tune aggregate demand.
Phillips curve
The tradeoff between unemployment and inflation; derived from the shape of the AS curve.