Macro-Economic Situation From Historical Perspective

Subject: Economics
Pages: 3
Words: 603
Reading time:
2 min

Macroeconomics is a branch of economics that focuses on the decision-making process, performance and structure of the economy as a whole. It utilises tools such as GDP and price indices to analyse the economy. Various schools of thought have participated in macroeconomic development. They explain various phenomenons chronologically. The origin of macroeconomics is the business cycle theory and the monitory theory. The monitory theory argues that money velocity and the number of goods produced will be constant. In the business cycle theory, the architects claim that the business process is subdivided into growth, crisis, recession, and recovery. The two theories influenced the macroeconomic decision heavily at the beginning of the 20th century.

Later, Keynes and his followers developed a new thought. After the occurrence of the great recession, the existing classical economic theories failed to explain various economic phenomena that occurred. The theory could not explain the reason why the market failed to clear despite the fall in prices and wages. Keynes advanced an argument that people and commercial organisations will opt to save the money they had during difficult times. He also introduced the multiplier factor and exhibited its effect on investment and consumption.

Monetarists incorporated the importance of money demanded. The theory claimed that money demand would be used to explain the enormous crises and discredited the explanation that relied on aggregate demand. He claimed that although the government was not properly placed to attenuate the economy with monitory policy, they were more effective than fiscal policies. Friedman, the architect of the monetarism theory, dismissed Philips curves that sought to explain the lack of employment and inflation connection. This theory was influential in the 1980s, but later on, the central banks were unable to target the supply of money other than the interest rates as the monetarist advocated.

The Keynes school of thought was further challenged by new classical economists. This challenge to Keynes was hugely based on rational expectation as advanced by Robert Lucas. Previously, economists relied on adaptive expectation. Adaptive expectation stipulates that the agents of the economy observe the recent occurrences to make future decisions. The new classical theory depicts consumers as elites who look at the current economic conditions and monitory policies in decision making. The introduction of adaptive expectation implies that the monitory policy would have a small impact on the economy. He advocated that the forecast should be based on fundamental economic theory, which is affected by changes in the economy minimally.

The criticism by a new classical economist on Keynes and other schools of thought resulted in the development of the real business cycle model. The model is generated from the combination of fundamental equations and neoclassical equations and policies. This model effectively explains the unemployment rate and low productivity associated with the recession based on changes in technology as opposed to changes in the market for products or money. The model faces challenges since it fails to attach much weight to its consideration of the role of money in the economy. The thought that technology contributed to the recession is unsatisfactory and fuels the criticism further.

New Keynesian reacted to the critique by the new classical. They incorporated the rational expectation and generated a model that was immune to Lucas critique. Various Keynes followers developed various models. These models claimed that rigid pricing and remuneration leads to actual effects of both monitory and fiscal policies. The fact is found through the investigation of sticky prices and wages. The theories were prominent in the 1970s.