A Brief History of Macroeconomic Thought

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• A Brief History of Macroeconomic Thought
• and Policy in the 20th Century
• Read Chapter 17 pages 350-368

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• I The Great Depression and Keynesian Economics
• A) The Classical School and the Great depression.
• 1) Classical economics is the body of
  macroeconomics thought associated primarily with
  nineteenth-century British economist David
  Ricardo. It emphasized the ability of flexible
  wages and prices to keep the economy at or near
  its natural level of employment.

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• 2) The classical school saw the great
  depression as a short term aberration that would
  correct itself. Clearly they were wrong.
• B) Keynesian Economics
• 1) Keynesian economics asserts that changes in
  aggregate demand can create gaps between the
  actual and potential levels of output that can
  persist.
• 2) The adjustment process is thwarted because
  prices tend to be sticky.

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• 3) Keynesian Economics and the Great Depression
• i) Started with an investment collapse
  following the excessive build-up during the
  roaring 20s.
• ii) This shifted aggregate demand to the
  left.
• iii) Two other factors contributed
• a) Stock market collapse created a wealth
  effect.
• b) Contractionary fiscal policy.
• 4) Keynesian solution Expansionary fiscal
  policy.

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• II Keynesian Economics in the 1960s and 1970s
• A) Expansionary Policy in the 1960s Two
  Phases.
• 1) Correcting a Recessionary Gap in the early
  1960s Kennedy Tax cuts and expansionary
  monetary policy.
• 2) Too much stimulus during the late 1960s
• created an inflationary gap.
• B) The 1970s Troubles from the supply side.

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• C) The Monetarist Challenge
• 1) The Monetarist school holds that changes in
  the money supply are the primary cause of changes
  in nominal GDP.
• 2) They do not advocate interventionist policy
  because they believe that lags associated with
  monetary policy are so long and variable that
  they are hard to control and can be
  destabilizing.

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• D) New Classical Economics A Focus on Aggregate
  Supply
• 1) New classical economics is the approach to
  macroeconomic analysis built from an analysis of
  individual maximizing choices.
• 2) Key assumption behind new classical
  economics is the assumption of rational
  expectations.
• 3) Individuals have rational expectations if
  their expectations for the future are based on
  all information available to them and they act on
  those expectations.

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• 4) One of the implications of classical economics
  is that policy effects are reduced.
• E) Lessons from the 1970s
• 1) Short run aggregate supply can shift over
  time.
• 2) Money matters a lot.
• 3) Policy stabilization is a delicate process.

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• III An Emerging Consensus Macroeconomics for the
  Twenty-first Century
• Modern economic thinking is for the most part a
  hybrid of all these views, being neither pure
  Keynesian, nor pure monetarist, nor pure
  classical.
• The New Keynesian economics is a body of
  macroeconomic thought that stresses the
  stickiness of prices and need for activist
  stabilization policies though manipulation of
  aggregate demand.

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• B) The 1980s and 1990s Advances in
  Macroeconomic Policy.
• 1) The Revolution in Monetary Policy.
• Fed policy moved to focus on inflation.
• 2) Fiscal Policy Stepping back. Focus more on
  long term goals and in particular aggregate
  supply growth. Less focus on short term
  stabilization.

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