Macroeconomics is the analysis of the aggregate activity of a nation's economy. Topics in the study of macroeconomics include inflation, unemployment, and fiscal policy. The purpose of this discipline is to understand how societies can more effectively achieve goals such as economic growth, economic security, and full employment.
Development of Macroeconomics
Macroeconomics is a relatively new field of study, gaining attention during the 1930s; with the term first being used by the Norwegian nobel prize-winning economist Ragnar Frisch although naturally the principles upon which it is founded have been in existence far longer. During the 1930s it became possible for the first time to collect increasingly detailed economic data on national income, balance of trade and the current account; allowing for a more precise analysis of the entire national economy.
The Great Depression
The Great Depression of 1929 was a powerful influence behind the development of macroeconomics, since it highlighted the major flaws in applying microeconomic theory to the national economy. According to microeconomic, or "market-clearing" theory, the large amount of unemployment following the Great Depression should have been adjusted by the "invisible hand" of the markets, whereby workers revised their wage expectations downwards to the point where firms were willing to employ more workers. However, due to the unemployment and poverty, the demand for goods and services dropped, so firms did not require workers. In addition to this, workers were unwilling to accept substantially lower wages to do the same jobs as before, preventing the wage rate dropping to an appropriate level. In response to this situation, the British economist John Maynard Keynes wrote The General Theory of Employment, Interest and Money in which he outlined the limitations of Microeconomics and put forward many founding macroeconomic principals such as aggregate demand, and thus can be considered the "father" of Macroeconomics. Since then many of Keynes' original theories have been subject to intense scrutiny and critique, notably by monetarists such as Milton Friedman who claim government intervention to correct market failure is inefficient, and private firms motivated by profits and price competitiveness are far better at ironing out market failures.
Typically, governments use fiscal and monetary policy to stabilize the economy and prevent events such as the Great Depression from happening. Fiscal policy involves government taxation and spending to reduce or increase aggregate demand and Monetary policy seeks achieves the same using the manipulation of Interest rates.
Schools of Thought
Since the 1930s, two main schools of macroeconomic thought have developed, although within these other sub-groups exist. The two schools are:
- Monetarism- advocated by economists such as Milton Friedman and Anna Schwartz, monetarism rejects Keynes' demand management and government intervention proposals, stating that these create distortions in the market and force out the more efficient private firms. Rather, monetarism seeks to understand changes in the economy through the lens of the money supply.
- Keynesian- this school stems from the original work of John Maynard Keynes, and uses the principal of aggregate demand to explain unemployment and changing levels of economic growth. Keynesian economists usually advocate demand management or fiscal policy as a means of correcting market failure.
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