Macroeconomics

Circulation in macroeconomics

Macroeconomics is a branch of economics that deals with the performance, structure, and behavior of a national economy as a whole. Macroeconomists seek to understand the determinants of aggregate trends in an economy with particular focus on national income, unemployment, inflation, investment, and international trade. In contrast, microeconomics is primarily focused on the determination of prices and the role of prices in allocating scarce resources.

While macroeconomics is a broad field of study, there are two areas of research that are emblematic of the discipline: The attempt to understand the causes and consequences of short-run fluctuations in national income (the business cycle), and the attempt to understand the determinants of long-run economic growth (increases in national income).

Macroeconomic models and their forecasts are used by both governments and large corporations to assist in the development and evaluation of economic policy and business strategy.

Origin

The first published use of the term "macroeconomics" was by the Norwegian Economist Ragnar Frisch in 1933 and before this, there already was an effort to understand many of the broad elements of the field.

Until the 1930s, most economic analysis did not separate out individual behaviour from aggregate behavior. With the Great Depression of the 1930s and the development of the concept of national income and product statistics, the field of macroeconomics began to expand. Before that time, comprehensive national accounts, as we know them today, did not exist. Theoretically, the ideas of the British economist John Maynard Keynes, who worked on explaining the Great Depression, were particularly influential.

One of the challenges of economics has been a struggle to reconcile macroeconomic and microeconomic models. Starting in the 1950s, macroeconomists developed micro-based models of macroeconomic behavior, such as the consumption function. Dutch economist Jan Tinbergen developed the first comprehensive national macroeconomic model, which he first built for the Netherlands and later applied to the United States and the United Kingdom after World War II. The first global macroeconomic model, Wharton Econometric Forecasting Associates LINK project, was initiated by Lawrence Klein and was mentioned in his citation for the Nobel Memorial Prize in Economics in 1980.

Theorists such as Robert Lucas Jr suggested (in the 1970s) that at least some traditional Keynesian (after John Maynard Keynes) macroeconomic models were questionable as they were not derived from assumptions about individual behavior, but instead based on observed past correlations between macroeconomic variables. However, New Keynesian macroeconomics has generally presented microeconomic models to shore up their macroeconomic theorizing, and some Keynesians have contested the idea that microeconomic foundations are essential, if the model is analytically useful. An analogy might be, that the fact that quantum physics is not fully consistent with relativity theory does not mean that relativity is false. Many important microeconomic assumptions have never been proved, and some have proved wrong.

The various schools of thought are not always in direct competition with one another, even though they sometimes reach differing conclusions. Macroeconomics is an ever evolving area of research. The goal of economic research is not to be "right," but rather to be useful.^{[citation needed]} An economic model should accurately reproduce observations beyond the data used to calibrate or fit the model. None of the current schools of economic thought perfectly capture the workings of the economy, however each approach contributes a unique perspective to the overall puzzle. As one learns more about each school of thought, it is possible to combine aspects of each in order to reach an informed synthesis.

Analytical approaches

The traditional distinction is between two different approaches to economics: Keynesian economics, focusing on demand; and supply-side (or neo-classical) economics, focusing on supply. Neither view is typically endorsed to the complete exclusion of the other, but most schools do tend clearly to emphasize one or the other as a theoretical foundation.

• Keynesian economics focuses on aggregate demand to explain levels of unemployment and the business cycle. That is, business cycle fluctuations should be reduced through fiscal policy (the government spends more or less depending on the situation) and monetary policy. Early Keynesian macroeconomics was "activist," calling for regular use of policy to stabilize the capitalist economy, while some Keynesians called for the use of incomes policies.

• Supply-side economics delineates quite clearly the roles of monetary policy and fiscal policy. The focus for monetary policy should be purely on the price of money as determined by the supply of money and the demand for money. It advocates a monetary policy that directly targets the value of money and does not target interest rates at all. Typically the value of money is measured by reference to gold or some other reference. The focus of fiscal policy is to raise revenue for worthy government investments with a clear recognition of the impact that taxation has on domestic trade. It places heavy emphasis on Say's law, which states that recessions do not occur because of failure in demand or lack of money.

Schools

• Austrian economics is a laissez-faire school of macroeconomics. It focuses on the business cycle that arises from government or central-bank interference that leads to deviations from the rate of interest, and emphasizes the importance of credit and investment misallocation in business cycle fluctuations.
• Monetarism, led by Milton Friedman, holds that inflation is always and everywhere a monetary phenomenon. It rejects fiscal policy because it leads to "crowding out" of the private sector. Further, it does not wish to combat inflation or deflation by means of active demand management as in Keynesian economics, but by means of monetary policy rules, such as keeping the rate of growth of the money supply constant over time.
• New classical economics. The original theoretical impetus was the charge that Keynesian economics lacks microeconomic foundations—i.e. its assertions are not founded in basic economic theory. This school emerged during the 1970s. This school asserts that it does not make sense to claim that the economy at any time might be "out-of-equilibrium." Fluctuations in aggregate variables follow from the individuals in the society continuously re-optimizing as new information on the state of the world is revealed. A neo classical economist would define macroeconomics as dynamic stochastic general equilibrium theory, which means that choices are made optimally considering time, uncertainty and all markets clearing.
• New Keynesian economics, which developed partly in response to new classical economics, strives to provide microeconomic foundations to Keynesian economics by showing how imperfect markets can justify demand management.
• Post-Keynesian economics represents a dissent from mainstream Keynesian economics, emphasizing the role of uncertainty, liquidity preference and the historical process in macroeconomics.

Macroeconomic Policies

In order to try to avoid major economic shocks, such as great depression, governments make adjustments through policy changes which they hope will succeed in stabilizing the economy. Governments believe that the success of these adjustments is necessary to maintain stability and continue growth. This economic management is achieved through two types of strategies.

• Fiscal Policy
• Monetary Policy

References

ISBN links support NWE through referral fees

Brian Snowdon, Howard R. Vane,. Modern Macroeconomics: Its Origins, Development And Current State. Edward Elgar Publishing. ISBN 1-84376-394-X. 

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