Macroeconomics

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Macroeconomics takes a big-picture view of the entire economy, including examining the roles of, and relationships between, corporations, governments and households, and the different types of markets, such as the financial market and the labour market. Circulation in macroeconomics.svg
Macroeconomics takes a big-picture view of the entire economy, including examining the roles of, and relationships between, corporations, governments and households, and the different types of markets, such as the financial market and the labour market.

Macroeconomics (from the Greek prefix makro- meaning "large" + economics) is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies. [1] [2] Macroeconomists study topics such as GDP, unemployment rates, national income, price indices, output, consumption, unemployment, inflation, saving, investment, energy, international trade, and international finance.

Contents

Macroeconomics and microeconomics are the two most general fields in economics. [3] The United Nations Sustainable Development Goal 17 has a target to enhance global macroeconomic stability through policy coordination and coherence as part of the 2030 Agenda. [4]

In an opinion piece expressing despondency in the field shortly before his retirement, economist Robert J. Samuelson expressed that Macroeconomics "means using interest rates, taxes and government spending to regulate an economy’s growth and stability."[ opinion ] [5]

Development

Origins

Macroeconomics descended from the once divided fields of business cycle theory and monetary theory. [6] The quantity theory of money was particularly influential prior to World War II. It took many forms, including the version based on the work of Irving Fisher:

In the typical view of the quantity theory, money velocity (V) and the quantity of goods produced (Q) would be constant, so any increase in money supply (M) would lead to a direct increase in price level (P). The quantity theory of money was a central part of the classical theory of the economy that prevailed in the early twentieth century.

Austrian School

Ludwig Von Mises's work Theory of Money and Credit , published in 1912, was one of the first books from the Austrian School to deal with macroeconomic topics.

Keynes and his followers

Macroeconomics, at least in its modern form, [7] began with the publication of John Maynard Keynes's General Theory of Employment, Interest and Money . [6] [8] When the Great Depression struck, classical economists had difficulty explaining how goods could go unsold and workers could be left unemployed. In classical theory, prices and wages would drop until the market cleared, and all goods and labor were sold. Keynes offered a new theory of economics that explained why markets might not clear, which would evolve (later in the 20th century) into a group of macroeconomic schools of thought known as Keynesian economics – also called Keynesianism or Keynesian theory.

In Keynes's theory, the quantity theory broke down because people and businesses tend to hold on to their cash in tough economic times – a phenomenon he described in terms of liquidity preferences. Keynes also explained how the multiplier effect would magnify a small decrease in consumption or investment and cause declines throughout the economy. Keynes also noted the role uncertainty and animal spirits can play in the economy. [7]

The generation following Keynes combined the macroeconomics of the General Theory with neoclassical microeconomics to create the neoclassical synthesis. By the 1950s, most economists had accepted the synthesis view of the macroeconomy. [7] Economists like Paul Samuelson, Franco Modigliani, James Tobin, and Robert Solow developed formal Keynesian models and contributed formal theories of consumption, investment, and money demand that fleshed out the Keynesian framework. [9]

Monetarism

Milton Friedman updated the quantity theory of money to include a role for money demand. He argued that the role of money in the economy was sufficient to explain the Great Depression, and that aggregate demand oriented explanations were not necessary. Friedman also argued that monetary policy was more effective than fiscal policy; however, Friedman doubted the government's ability to "fine-tune" the economy with monetary policy. He generally favored a policy of steady growth in money supply instead of frequent intervention. [10]

Friedman also challenged the Phillips curve relationship between inflation and unemployment. Friedman and Edmund Phelps (who was not a monetarist) proposed an "augmented" version of the Phillips curve that excluded the possibility of a stable, long-run tradeoff between inflation and unemployment. [11] When the oil shocks of the 1970s created a high unemployment and high inflation, Friedman and Phelps were vindicated. Monetarism was particularly influential in the early 1980s. Monetarism fell out of favor when central banks found it difficult to target money supply instead of interest rates as monetarists recommended. Monetarism also became politically unpopular when the central banks created recessions in order to slow inflation.

New classical

New classical macroeconomics further challenged the Keynesian school. A central development in new classical thought came when Robert Lucas introduced rational expectations to macroeconomics. Prior to Lucas, economists had generally used adaptive expectations where agents were assumed to look at the recent past to make expectations about the future. Under rational expectations, agents are assumed to be more sophisticated. A consumer will not simply assume a 2% inflation rate just because that has been the average the past few years; they will look at current monetary policy and economic conditions to make an informed forecast. When new classical economists introduced rational expectations into their models, they showed that monetary policy could only have a limited impact.

Lucas also made an influential critique of Keynesian empirical models. He argued that forecasting models based on empirical relationships would keep producing the same predictions even as the underlying model generating the data changed. He advocated models based on fundamental economic theory that would, in principle, be structurally accurate as economies changed. Following Lucas's critique, new classical economists, led by Edward C. Prescott and Finn E. Kydland, created real business cycle (RB C) models of the macro economy. [12]

RB C models were created by combining fundamental equations from neo-classical microeconomics. In order to generate macroeconomic fluctuations, RB C models explained recessions and unemployment with changes in technology instead of changes in the markets for goods or money. Critics of RB C models argue that money clearly plays an important role in the economy, and the idea that technological regress can explain recent recessions is implausible. [12] However, technological shocks are only the more prominent of a myriad of possible shocks to the system that can be modeled. Despite questions about the theory behind RB C models, they have clearly been influential in economic methodology. [13]

New Keynesian response

New Keynesian economists responded to the new classical school by adopting rational expectations and focusing on developing micro-founded models that are immune to the Lucas critique. Stanley Fischer and John B. Taylor produced early work in this area by showing that monetary policy could be effective even in models with rational expectations when contracts locked in wages for workers. Other new Keynesian economists, including Olivier Blanchard, Julio Rotemberg, Greg Mankiw, David Romer, and Michael Woodford, expanded on this work and demonstrated other cases where inflexible prices and wages led to monetary and fiscal policy having real effects.

Like classical models, new classical models had assumed that prices would be able to adjust perfectly and monetary policy would only lead to price changes. New Keynesian models investigated sources of sticky prices and wages due to imperfect competition, [14] which would not adjust, allowing monetary policy to impact quantities instead of prices.

By the late 1990s, economists had reached a rough consensus. The nominal rigidity of new Keynesian theory was combined with rational expectations and the RBC methodology to produce dynamic stochastic general equilibrium (DSGE) models. The fusion of elements from different schools of thought has been dubbed the new neoclassical synthesis. These models are now used by many central banks and are a core part of contemporary macroeconomics. [15]

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.

Macroeconomic models

Aggregate demand–aggregate supply

A traditional AS-AD diagram showing a shift in AD and the AS curve becoming inelastic beyond potential output. AS + AD graph.svg
A traditional AS–AD diagram showing a shift in AD and the AS curve becoming inelastic beyond potential output.

The AD-AS model has become the standard textbook model for explaining the macroeconomy. [16] This model shows the price level and level of real output given the equilibrium in aggregate demand and aggregate supply. The aggregate demand curve's downward slope means that more output is demanded at lower price levels. [17] The downward slope is the result of three effects: the Pigou or real balance effect, which states that as real prices fall, real wealth increases, resulting in higher consumer demand of goods; the Keynes or interest rate effect, which states that as prices fall, the demand for money decreases, causing interest rates to decline and borrowing for investment and consumption to increase; and the net export effect, which states that as prices rise, domestic goods become comparatively more expensive to foreign consumers, leading to a decline in exports. [17]

In the conventional Keynesian use of the AS-AD model, the aggregate supply curve is horizontal at low levels of output and becomes inelastic near the point of potential output, which corresponds with full employment. [16] Since the economy cannot produce beyond the potential output, any AD expansion will lead to higher price levels instead of higher output.

The AD–AS diagram can model a variety of macroeconomic phenomena, including inflation. Changes in the non-price level factors or determinants cause changes in aggregate demand and shifts of the entire aggregate demand (AD) curve. When demand for goods exceeds supply there is an inflationary gap where demand-pull inflation occurs and the AD curve shifts upward to a higher price level. When the economy faces higher costs, cost-push inflation occurs and the AS curve shifts upward to higher price levels. [18] The AS–AD diagram is also widely used as a pedagogical tool to model the effects of various macroeconomic policies. [19]

IS-LM

In this example of an IS/LM chart, the IS curve moves to the right, causing higher interest rates (i) and expansion in the "real" economy (real GDP, or Y). Islm.svg
In this example of an IS/LM chart, the IS curve moves to the right, causing higher interest rates (i) and expansion in the "real" economy (real GDP, or Y).

The IS–LM model gives the underpinnings of aggregate demand (itself discussed above). It answers the question "At any given price level, what is the quantity of goods demanded?". This model shows what combination of interest rates and output will ensure equilibrium in both the goods and money markets. [20] The goods market is modeled as giving equality between investment and public and private saving (IS), and the money market is modeled as giving equilibrium between the money supply and liquidity preference. [21]

The IS curve consists of the points (combinations of income and interest rate) where investment, given the interest rate, is equal to public and private saving, given output [22] The IS curve is downward sloping because output and the interest rate have an inverse relationship in the goods market: as output increases, more income is saved, which means interest rates must be lower to spur enough investment to match saving. [22]

The LM curve is upward sloping because the interest rate and output have a positive relationship in the money market: as income (identically equal to output) increases, the demand for money increases, resulting in a rise in the interest rate in order to just offset the incipient rise in money demand. [23]

The IS-LM model is often used to demonstrate the effects of monetary and fiscal policy. [20] Textbooks frequently use the IS-LM model, but it does not feature the complexities of most modern macroeconomic models. [20] Nevertheless, these models still feature similar relationships to those in IS-LM. [20]

Growth models

The neoclassical growth model of Robert Solow has become a common textbook model for explaining economic growth in the long-run. [24] The model begins with a production function where national output is the product of two inputs: capital and labor. The Solow model assumes that labor and capital are used at constant rates without the fluctuations in unemployment and capital utilization commonly seen in business cycles. [25]

An increase in output, or economic growth, can only occur because of an increase in the capital stock, a larger population, or technological advancements that lead to higher productivity (total factor productivity). An increase in the savings rate leads to a temporary increase as the economy creates more capital, which adds to output. However, eventually the depreciation rate will limit the expansion of capital: savings will be used up replacing depreciated capital, and no savings will remain to pay for an additional expansion in capital. Solow's model suggests that economic growth in terms of output per capita depends solely on technological advances that enhance productivity. [26]

In the 1980s and 1990s endogenous growth theory arose to challenge neoclassical growth theory. This group of models explains economic growth through other factors, such as increasing returns to scale for capital and learning-by-doing, that are endogenously determined instead of the exogenous technological improvement used to explain growth in Solow's model. [27]

Basic macroeconomic concepts

Macroeconomics encompasses a variety of concepts and variables, but there are three central topics for macroeconomic research. [28] Macroeconomic theories usually relate the phenomena of output, unemployment, and inflation. Outside of macroeconomic theory, these topics are also important to all economic agents including workers, consumers, and producers.

Circulation in macroeconomics. Circulation in macroeconomics.svg
Circulation in macroeconomics.

Output and income

National output is the total amount of everything a country produces in a given period of time. Everything that is produced and sold generates an equal amount of income. The total output of the economy is measured GDP per person. The output and income are usually considered equivalent and the two terms are often used interchangeably, output changes into income. Output can be measured or it can be viewed from the production side and measured as the total value of final goods and services or the sum of all value added in the economy. [29]

Macroeconomic output is usually measured by gross domestic product (GDP) or one of the other national accounts. Economists interested in long-run increases in output, study economic growth. Advances in technology, accumulation of machinery and other capital, and better education and human capital, are all factors that lead to increase economic output over time. However, output does not always increase consistently over time. Business cycles can cause short-term drops in output called recessions. Economists look for macroeconomic policies that prevent economies from slipping into recessions, and that lead to faster long-term growth.

Unemployment

A chart using US data showing the relationship between economic growth and unemployment expressed by Okun's law. The relationship demonstrates cyclical unemployment. Economic growth leads to a lower unemployment rate. Okuns law differences 1948 to mid 2011.png
A chart using US data showing the relationship between economic growth and unemployment expressed by Okun's law. The relationship demonstrates cyclical unemployment. Economic growth leads to a lower unemployment rate.

The amount of unemployment in an economy is measured by the unemployment rate, i.e. the percentage of workers without jobs in the labor force. The unemployment rate in the labor force only includes workers actively looking for jobs. People who are retired, pursuing education, or discouraged from seeking work by a lack of job prospects are excluded.

Unemployment can be generally broken down into several types that are related to different causes.

Inflation and deflation

The ten-year moving averages of changes in price level and growth in money supply (using the measure of M2, the supply of hard currency and money held in most types of bank accounts) in the US from 1875 to 2011. Over the long run, the two series show a close relationship. M2andInflation.png
The ten-year moving averages of changes in price level and growth in money supply (using the measure of M2, the supply of hard currency and money held in most types of bank accounts) in the US from 1875 to 2011. Over the long run, the two series show a close relationship.

A general price increase across the entire economy is called inflation. When prices decrease, there is deflation. Economists measure these changes in prices with price indexes. Inflation can occur when an economy becomes overheated and grows too quickly. Similarly, a declining economy can lead to deflation.

Central bankers, who manage a country's money supply, try to avoid changes in price level by using monetary policy. Raising interest rates or reducing the supply of money in an economy will reduce inflation. Inflation can lead to increased uncertainty and other negative consequences. Deflation can lower economic output. Central bankers try to stabilize prices to protect economies from the negative consequences of price changes.

Changes in price level may be the result of several factors. The quantity theory of money holds that changes in price level are directly related to changes in the money supply. Most economists believe that this relationship explains long-run changes in the price level. [36] Short-run fluctuations may also be related to monetary factors, but changes in aggregate demand and aggregate supply can also influence price level. For example, a decrease in demand due to a recession can lead to lower price levels and deflation. A negative supply shock, such as an oil crisis, lowers aggregate supply and can cause inflation.

Macroeconomic policy

Macroeconomic policy is usually implemented through two sets of tools: fiscal and monetary policy. Both forms of policy are used to stabilize the economy, which can mean boosting the economy to the level of GDP consistent with full employment. [37] Macroeconomic policy focuses on limiting the effects of the business cycle to achieve the economic goals of price stability, full employment, and growth. [38]

Monetary policy

Central banks implement monetary policy by controlling the money supply through several mechanisms. Typically, central banks take action by issuing money to buy bonds (or other assets), which boosts the supply of money and lowers interest rates, or, in the case of contractionary monetary policy, banks sell bonds and take money out of circulation. Usually policy is not implemented by directly targeting the supply of money.

Central banks continuously shift the money supply to maintain a targeted fixed interest rate. Some of them allow the interest rate to fluctuate and focus on targeting inflation rates instead. Central banks generally try to achieve high output without letting loose monetary policy that create large amounts of inflation.

Conventional monetary policy can be ineffective in situations such as a liquidity trap. When interest rates and inflation are near zero, the central bank cannot loosen monetary policy through conventional means.

An example of intervention strategy under different conditions Economic Policy - Intervention Strategy Matrix.png
An example of intervention strategy under different conditions

Central banks can use unconventional monetary policy such as quantitative easing to help increase output. Instead of buying government bonds, central banks can implement quantitative easing by buying not only government bonds, but also other assets such as corporate bonds, stocks, and other securities. This allows lower interest rates for a broader class of assets beyond government bonds. In another example of unconventional monetary policy, the United States Federal Reserve recently made an attempt at such a policy with Operation Twist. Unable to lower current interest rates, the Federal Reserve lowered long-term interest rates by buying long-term bonds and selling short-term bonds to create a flat yield curve.

Fiscal policy

Fiscal policy is the use of government's revenue and expenditure as instruments to influence the economy. Examples of such tools are expenditure, taxes, debt.

For example, if the economy is producing less than potential output, government spending can be used to employ idle resources and boost output. Government spending does not have to make up for the entire output gap. There is a multiplier effect that boosts the impact of government spending. For instance, when the government pays for a bridge, the project not only adds the value of the bridge to output, but also allows the bridge workers to increase their consumption and investment, which helps to close the output gap.

The effects of fiscal policy can be limited by crowding out. When the government takes on spending projects, it limits the amount of resources available for the private sector to use. Crowding out occurs when government spending simply replaces private sector output instead of adding additional output to the economy. Crowding out also occurs when government spending raises interest rates, which limits investment. Defenders of fiscal stimulus argue that crowding out is not a concern when the economy is depressed, plenty of resources are left idle, and interest rates are low. [39] [40]

Fiscal policy can be implemented through automatic stabilizers. Automatic stabilizers do not suffer from the policy lags of discretionary fiscal policy. Automatic stabilizers use conventional fiscal mechanisms but take effect as soon as the economy takes a downturn: spending on unemployment benefits automatically increases when unemployment rises and, in a progressive income tax system, the effective tax rate automatically falls when incomes decline.

Comparison

Economists usually favor monetary over fiscal policy because it has two major advantages. First, monetary policy is generally implemented by independent central banks instead of the political institutions that control fiscal policy. Independent central banks are less likely to make decisions based on political motives. [37] Second, monetary policy suffers shorter inside lags and outside lags than fiscal policy. Central banks can quickly make and implement decisions while the discretionary fiscal policy may take time to pass and even longer to carry out. [37]

See also

Notes

  1. O'Sullivan, Arthur; Sheffrin, Steven M. (2003), Economics: Principles in Action, Upper Saddle River, New Jersey 07458: Pearson Prentice Hall, p. 57, ISBN   978-0-13-063085-8 CS1 maint: location (link)
  2. Steve Williamson, Notes on Macroeconomic Theory, 1999
  3. Blaug, Mark (1985), Economic theory in retrospect, Cambridge: Cambridge University Press, ISBN   978-0-521-31644-6
  4. "Goal 17 | Department of Economic and Social Affairs". sdgs.un.org. Retrieved 2020-09-26.
  5. Samuelson, Robert (2020), "Goodbye, readers, and good luck — you'll need it", The Washington Post
  6. 1 2 Dimand (2008).
  7. 1 2 3 Blanchard (2011), 580.
  8. Snowdon, Brian; Vane, Howard R. (2005). Modern Macroeconomics – Its origins, development and current state. Edward Elgar. ISBN   1-84542-208-2.
  9. Blanchard (2011), 581.
  10. Blanchard (2011), 582–83.
  11. "Phillips Curve: The Concise Encyclopedia of Economics | Library of Economics and Liberty". www.econlib.org. Retrieved 2018-01-23.
  12. 1 2 Blanchard (2011), 587.
  13. Kariappa Bheemaiah, The Blockchain Alternative: Rethinking Macroeconomic Policy and Economic Theory (Dordrecht NL: Apress/Springer Nature, 2017), 169-70. ISBN   1484226747, 9781484226742
  14. The role of imperfect competition in new Keynesian economics, Chapter 4 of Surfing Economics by Huw Dixon
  15. Blanchard (2011), 590.
  16. 1 2 Healey 2002, p. 12.
  17. 1 2 Healey 2002, p. 13.
  18. Healey 2002, p. 14.
  19. Colander 1995, p. 173.
  20. 1 2 3 4 Durlauf & Hester 2008.
  21. Peston 2002, pp. 386–87.
  22. 1 2 Peston 2002, p. 387.
  23. Peston 2002, pp. 387–88.
  24. Banton, Caroline. "The Neoclassical Growth Theory Explained". Investopedia. Retrieved 2020-09-21.
  25. Solow 2002, pp. 518–19.
  26. Solow 2002, p. 519.
  27. Blaug 2002, pp. 202–03.
  28. Blanchard (2011), 32.
  29. Blanchard (2011), 22.
  30. Pettinger, Tejvan. "Involuntary unemployment". Economics Help. Retrieved 2020-09-21.
  31. Dwivedi, 443.
  32. Freeman (2008). http://www.dictionaryofeconomics.com/article?id=pde2008_S000311.
  33. Dwivedi, 444–45.
  34. Dwivedi, 445–46.
  35. Neely, Christopher J. "Okun's Law: Output and Unemployment. Economic Synopses. Number 4. 2010. http://research.stlouisfed.org/publications/es/10/ES1004.pdf.
  36. Mankiw 2014, p. 634.
  37. 1 2 3 Mayer, 495.
  38. "AP Macroeconomics Review".
  39. Ye, Fred Y. (2017). Scientific Metrics: Towards Analytical and Quantitative Sciences. Springer. ISBN   978-981-10-5936-0.
  40. Arestis, Philip; Sawyer, Malcolm (2003). "Reinventing fiscal policy" (PDF). Levy Economics Institute of Bard College (Working Paper, No. 381). Retrieved 7 December 2018.

Related Research Articles

Keynesian economics

Keynesian economics are various macroeconomic theories about how economic output is strongly influenced by aggregate demand. In the Keynesian view, aggregate demand does not necessarily equal the productive capacity of the economy. Instead, it is influenced by a host of factors. According to Keynes, the productive capacity of the economy sometimes behaves erratically, affecting production, employment, and inflation.

Stagflation

In economics, stagflation or recession-inflation is a situation in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high. It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment.

Inflation Rise in price level in an economy over time

In economics, inflation is a general rise in the price level in an economy over a period of time, resulting in a sustained drop in the purchasing power of money. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy. The opposite of inflation is deflation, a sustained decrease in the general price level of goods and services. The common measure of inflation is the inflation rate, the annualized percentage change in a general price index, usually the consumer price index, over time.

Monetarism

Monetarism is a school of thought in monetary economics that emphasizes the role of governments in controlling the amount of money in circulation. Monetarist theory asserts that variations in the money supply have major influences on national output in the short run and on price levels over longer periods. Monetarists assert that the objectives of monetary policy are best met by targeting the growth rate of the money supply rather than by engaging in discretionary monetary policy.

New Keynesian economics

New Keynesian economics is a school of macroeconomics that strives to provide microeconomic foundations for Keynesian economics. It developed partly as a response to criticisms of Keynesian macroeconomics by adherents of new classical macroeconomics.

Fiscal policy

In economics and political science, fiscal policy is the use of government revenue collection and expenditure (spending) to influence a country's economy. The use of government revenues and expenditures to influence macroeconomic variables developed as a result of the Great Depression, when the previous laissez-faire approach to economic management became unpopular. Fiscal policy is based on the theories of the British economist John Maynard Keynes, whose Keynesian economics theorized that government changes in the levels of taxation and government spending influences aggregate demand and the level of economic activity. Fiscal and monetary policy are the key strategies used by a country's government and central bank to advance its economic objectives. The combination of these policies enables these authorities to target inflation and to increase employment. Additionally, it is designed to try to keep GDP growth at 2%–3% and the unemployment rate near the natural unemployment rate of 4%–5%. This implies that fiscal policy is used to stabilize the economy over the course of the business cycle.

Phillips curve Single-equation economic model

The Phillips curve is a single-equation economic model, named after William Phillips, describing an inverse relationship between rates of unemployment and corresponding rates of rises in wages that result within an economy. Stated simply, decreased unemployment, in an economy will correlate with higher rates of wage rises. Phillips did not himself state there was any relationship between employment and inflation; this notion was a trivial deduction from his statistical findings. Samuelson and Solow made the connection explicit and subsequently Milton Friedman and Edmund Phelps put the theoretical structure in place. In so doing, Friedman was to successfully predict the imminent collapse of Phillips' a-theoretic correlation.

Economic policy

The economic policy of governments covers the systems for setting levels of taxation, government budgets, the money supply and interest rates as well as the labour market, national ownership, and many other areas of government interventions into the economy.

Neo-Keynesian economics Post-war school of macroeconomic thought based on the work of John Maynard Keynes

Neo-Keynesian economics is a school of macroeconomic thought that was developed in the post-war period from the writings of John Maynard Keynes. A group of economists, attempted to interpret and formalize Keynes' writings and to synthesize it with the neoclassical models of economics. Their work has become known as the neoclassical synthesis and created the models that formed the core ideas of neo-Keynesian economics. These ideas dominated mainstream economics in the post-war period and formed the mainstream of macroeconomic thought in the 1950s, 1960s and 1970s.

Macroeconomic model

A macroeconomic model is an analytical tool designed to describe the operation of the problems of economy of a country or a region. These models are usually designed to examine the comparative statics and dynamics of aggregate quantities such as the total amount of goods and services produced, total income earned, the level of employment of productive resources, and the level of prices.

Neutrality of money is the idea that a change in the stock of money affects only nominal variables in the economy such as prices, wages, and exchange rates, with no effect on real variables, like employment, real GDP, and real consumption. Neutrality of money is an important idea in classical economics and is related to the classical dichotomy. It implies that the central bank does not affect the real economy by creating money. Instead, any increase in the supply of money would be offset by a proportional rise in prices and wages. This assumption underlies some mainstream macroeconomic models. Others like monetarism view money as being neutral only in the long-run.

The policy-ineffectiveness proposition (PIP) is a new classical theory proposed in 1975 by Thomas J. Sargent and Neil Wallace based upon the theory of rational expectations, which posits that monetary policy cannot systematically manage the levels of output and employment in the economy.

In macroeconomics, the classical dichotomy is the idea, attributed to classical and pre-Keynesian economics, that real and nominal variables can be analyzed separately. To be precise, an economy exhibits the classical dichotomy if real variables such as output and real interest rates can be completely analyzed without considering what is happening to their nominal counterparts, the money value of output and the interest rate. In particular, this means that real GDP and other real variables can be determined without knowing the level of the nominal money supply or the rate of inflation. An economy exhibits the classical dichotomy if money is neutral, affecting only the price level, not real variables. As such, if the classical dichotomy holds, money only affects absolute rather than the relative prices between goods.

Dynamic stochastic general equilibrium modeling is a method in macroeconomics that attempts to explain economic phenomena, such as economic growth and business cycles, and the effects of economic policy, through econometric models based on applied general equilibrium theory and microeconomic principles.

New classical macroeconomics

New classical macroeconomics, sometimes simply called new classical economics, is a school of thought in macroeconomics that builds its analysis entirely on a neoclassical framework. Specifically, it emphasizes the importance of rigorous foundations based on microeconomics, especially rational expectations.

AD–AS model

The AD–AS or aggregate demand–aggregate supply model is a macroeconomic model that explains price level and output through the relationship of aggregate demand and aggregate supply.

History of macroeconomic thought

Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.

New neoclassical synthesis

The new neoclassical synthesis (NNS) or new synthesis is the fusion of the major, modern macroeconomic schools of thought, new classical and New-Keynesianism, into a consensus on the best way to explain short-run fluctuations in the economy. This new synthesis is analogous to the neoclassical synthesis that combined neoclassical economics with Keynesian macroeconomics. The new synthesis provides the theoretical foundation for much of contemporary mainstream economics. It is an important part of the theoretical foundation for the work done by the Federal Reserve and many other central banks.

Disequilibrium macroeconomics

Disequilibrium macroeconomics is a tradition of research centered on the role of disequilibrium in economics. This approach is also known as non-Walrasian theory, equilibrium with rationing, the non-market clearing approach, and non-tâtonnement theory. Early work in the area was done by Don Patinkin, Robert W. Clower, and Axel Leijonhufvud. Their work was formalized into general disequilibrium models, which were very influential in the 1970s. American economists had mostly abandoned these models by the late 1970s, but French economists continued work in the tradition and developed fixprice models.

Emi Nakamura is an American economist and the Chancellor's Professor of Economics at University of California, Berkeley.

References