What are the four different views of the causes of macroeconomic instability in the economy?

Question

What will be an ideal response?

Answer 1

First, the mainstream view holds that instability in the economy arises from: (a) the volatility in investment spending that makes aggregate demand unstable; and (b) occasional aggregate supply shocks which cause cost-push inflation and recession. Second, monetarists focus on the money supply, think markets are highly competitive, and that government intervention destabilizes the economy. Monetarists see macroeconomic instability as a result of inappropriate monetary policy. An increase in the money supply will increase aggregate demand, output, and the price level; it will also reduce unemployment. Eventually, nominal wages rise to restore real wages, and real output and the unemployment rate falls back to its natural level at long-run aggregate supply. Third, real-business cycle theorists see macroeconomic instability as being caused by real factors influencing aggregate supply instead of monetary factors causing shifts in aggregate demand. Changes in technology and resources will affect productivity, and thus the long-run growth rate of aggregate supply. Fourth, another view of instability in the macro economy attributes the reasons to coordination failures. These failures occur when people are not able to coordinate their actions to achieve an optimal equilibrium. A self-fulfilling prophecy can lead to recession because if households and firms expect it, they individually cut back on spending and employment. If, however, they were to act jointly, they could take actions to counter the recession expectations to achieve an optimal equilibrium.