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.

3. Macroeconomics for the 21st Century


  1. Discuss how the Fed incorporated a strong inflation constraint and lags into its policies from the 1980s onwards.
  2. Describe the fiscal policies that were undertaken from the 1980s onwards and their rationales.
  3. Discuss the challenges that events from the 1980s onwards raised for the monetarist and new classical schools of thought.
  4. Summarize the views and policy approaches of the new Keynesian school of economic thought.

Following the recession that ended in 1982, the last two decades of the 20th century and the early years of the 21st century have sometimes been referred to as the Great Moderation. Yes, there were recessions, but they were fairly mild and short-lived. Prematurely, economists began to pat themselves on the backs for having tamed the business cycle. There was a sense that macroeconomic theory and policy had helped with this improved performance. The ideas associated with macroeconomic theory and policy incorporated elements of Keynesian economics, monetarism, and new classical economics. All three schools of macroeconomic thought contributed to the development of a new school of macroeconomic thought: the new Keynesian school.

New Keynesian economics is a body of macroeconomic thought that stresses the stickiness of prices and the need for activist stabilization policies through the manipulation of aggregate demand to keep the economy operating close to its potential output. It incorporates monetarist ideas about the importance of monetary policy and new classical ideas about the importance of aggregate supply, both in the long and in the short run.

Another "new" element in new Keynesian economic thought is the greater use of microeconomic analysis to explain macroeconomic phenomena, particularly the analysis of price and wage stickiness. We saw in the chapter that introduced the model of aggregate demand and aggregate supply, for example, that sticky prices and wages may be a response to the preferences of consumers and of firms. That idea emerged from research by economists of the new Keynesian school.

New Keynesian ideas guide macroeconomic policy; they are the basis for the model of aggregate demand and aggregate supply with which we have been working. To see how the new Keynesian school has come to dominate macroeconomic policy, we shall review the major macroeconomic events and policies of the 1980s, 1990s, and early 2000s.