Brief History of Macroeconomic Thought and Policy
1. The Great Depression and Keynesian Economics
Case in Point: Early Views on Stickiness
Although David Ricardo's focus on the long run emerged as the dominant approach to macroeconomic thought, not all of his contemporaries agreed with his perspective. Many 18th- and 19th-century economists developed theoretical arguments suggesting that changes in aggregate demand could affect the real level of economic activity in the short run. Like the new Keynesians, they based their arguments on the concept of price stickiness.
Henry Thornton's 1802 book, An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, argued that a reduction in the money supply could, because of wage stickiness, produce a short-run slump in output:"The tendency, however, of a very great and sudden reduction of the accustomed number of bank notes, is to create an unusual and temporary distress, and a fall of price arising from that distress. But a fall arising from temporary distress, will be attended probably with no correspondent fall in the rate of wages; for the fall of price, and the distress, will be understood to be temporary, and the rate of wages, we know, is not so variable as the price of goods. There is reason, therefore, to fear that the unnatural and extraordinary low price arising from the sort of distress of which we now speak, would occasion much discouragement of the fabrication of manufactures".
A half-century earlier, David Hume had noted that an increase in the quantity of money would boost output in the short run, again because of the stickiness of prices. In an essay titled "Of Money," published in 1752, Hume described the process through which an increased money supply could boost output:
"At first, no alteration is perceived; by degrees the price rises, first of one commodity, then of another, till the whole at least reaches a just proportion with the new quantity of (money) which is in the kingdom. In my opinion, it is only in this interval or intermediate situation … that the encreasing quantity of gold and silver is favourable to industry".
Hume's argument implies sticky prices; some prices are slower to respond to the increase in the money supply than others.
Economists of the 18th and 19th century are generally lumped together as adherents to the classical school, but their views were anything but uniform. Many developed an analytical framework that was quite similar to the essential elements of new Keynesian economists today. Economist Thomas Humphrey, at the Federal Reserve Bank of Richmond, marvels at the insights shown by early economists: "When you read these old guys, you find out first that they didn't speak with one voice. There was no single body of thought to which everyone subscribed. And second, you find out how much they knew. You could take Henry Thornton's 1802 book as a textbook in any money course today".