Brief History of Macroeconomic Thought and Policy

Read this chapter to examine macroeconomic attitudes towards economic policies of the three main schools of economic thought: Classical, Keynesian, and Monetarist. Also, learn about modern day interpretations of the main ideas.

1. The Great Depression and Keynesian Economics

Keynes versus the Classical Tradition

In a nutshell, we can say that Keynes's book shifted the thrust of macroeconomic thought from the concept of aggregate supply to the concept of aggregate demand. Ricardo's focus on the tendency of an economy to reach potential output inevitably stressed the supply side ­– an economy tends to operate at a level of output given by the long-run aggregate supply curve. Keynes, in arguing that what we now call recessionary or inflationary gaps could be created by shifts in aggregate demand, moved the focus of macroeconomic analysis to the demand side. He argued that prices in the short run are quite sticky and suggested that this stickiness would block adjustments to full employment.

Keynes dismissed the notion that the economy would achieve full employment in the long run as irrelevant. "In the long run," he wrote acidly, "we are all dead".

Keynes's work spawned a new school of macroeconomic thought, the Keynesian school. Keynesian economics asserts that changes in aggregate demand can create gaps between the actual and potential levels of output, and that such gaps can be prolonged. Keynesian economists stress the use of fiscal and of monetary policy to close such gaps.