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A Brief History of Macroeconomic Thought
and Policy in the 20th Century
Read Chapter 17 – pages 350-368
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.
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.
3) Keynesian Economics and the Great
Depression
i) Started with an investment collapse
following the excessive build-up during the
roaring 20’s.
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.
II Keynesian Economics in the 1960’s and
1970’s
A) Expansionary Policy in the 1960’s – Two
Phases.
1) Correcting a Recessionary Gap in the early
1960’s – Kennedy Tax cuts and
expansionary monetary policy.
2) Too much stimulus during the late 1960’s
created an inflationary gap.
B) The 1970’s: Troubles from the supply
side.
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.
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.
4) One of the implications of classical
economics is that policy effects are reduced.
E) Lessons from the 1970’s
1) Short run aggregate supply can shift over
time.
2) Money matters a lot.
3) Policy stabilization is a delicate process.
III An Emerging Consensus: Macroeconomics
for the Twenty-first Century
A) 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.
B) The 1980’s and 1990’s: 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.