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Modern Macroeconomics
In loving memory of Brian’s parents, Joseph and Margaret Snowdon, and
Howard’s father, Philip M. Vane Modern Macroeconomics
Its Origins, Development and Current State Brian Snowdon
Principal Lecturer in Economics in the Newcastle Business
School, Northumbria University, Newcastle upon Tyne, UK Howard R. Vane
Professor of Economics in the School of Accounting, Finance
and Economics, Liverpool John Moores University, Liverpool, UK Edward Elgar
Cheltenham, UK • Northampton, MA, USA
© Brian Snowdon, Howard R. Vane 2005
All rights reserved. No part of this publication may be reproduced, stored in
a retrieval system or transmitted in any form or by any means, electronic,
mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by
Edward Elgar Publishing Limited Glensanda House Montpellier Parade Cheltenham Glos GL50 1UA UK Edward Elgar Publishing, Inc. 136 West Street Suite 202 Northampton Massachusetts 01060 USA
A catalogue record for this book
is available from the British Library ISBN 1 84376 394 X (cased) 1 84542 208 2 (paperback)
Typeset by Manton Typesetters, Louth, Lincolnshire, UK.
Printed and bound in Great Britain by MPG Books Ltd, Bodmin, Cornwall. Contents List of figures x List of tables xiii Preface xiv Acknowledgements xvii 1
Understanding modern macroeconomics 1 1.1 Macroeconomic issues and ideas 1 1.2
The role of economic theory and controversy 3 1.3
Objectives, instruments and the role of government 7 1.4 The Great Depression 9 1.5
Keynes and the birth of macroeconomics 13 1.6
The rise and fall of the Keynesian consensus 15 1.7
Theoretical schizophrenia and the neoclassical synthesis 21 1.8
Schools of thought in macroeconomics after Keynes 24 1.9
The new political macroeconomics 29 1.10
The renaissance of economic growth research 32 2
Keynes v. the ‘old’ classical model 36 2.1 Introduction 36 2.2 Classical macroeconomics 37 2.3
Employment and output determination 38 2.4 Say’s Law 45 2.5 The quantity theory of money 50 2.6
Keynes’s General Theory 54 2.7
Interpreting the General Theory 57 2.8 Keynes’s main propositions 58 2.9
Keynes’s analysis of the labour market 65 2.10
Keynes’s rejection of Say’s Law 69 2.11
Keynes and the quantity theory of money 69 2.12
Three important interpretations of Keynes 70 2.13
The ‘new’ Keynes scholarship 75 2.14
Causes and consequences of the Great Depression 76 2.15 How to pay for the war 82 2.16
Keynes and international macroeconomics 83 v vi Modern macroeconomics 2.17
Keynes’s legacy and the classical revival 85
Interview with Robert Skidelsky 91 3
The orthodox Keynesian school 101 3.1 Introduction 101 3.2 The orthodox Keynesian school 102 3.3
The IS–LM model for a closed economy 102 3.4
Underemployment equilibrium in the Keynesian model 114 3.5
The IS–LM model for an open economy 123 3.6
The Phillips curve and orthodox Keynesian economics 135 3.7
The central propositions of orthodox Keynesian economics 144
Interview with James Tobin 148 4
The orthodox monetarist school 163 4.1 Introduction 163 4.2
The quantity theory of money approach 165 4.3
The expectations-augmented Phillips curve analysis 174 4.4
The monetary approach to balance of payments theory and exchange rate determination 187 4.5
The orthodox monetarist school and stabilization policy 192
Interview with Milton Friedman 198 5
The new classical school 219 5.1 Introduction 219 5.2
The influence of Robert E. Lucas Jr 220 5.3
The structure of new classical models 223 5.4
Equilibrium business cycle theory 236 5.5
The policy implications of the new classical approach 242 5.6 An assessment 267
Interview with Robert E. Lucas Jr 272 6
The real business cycle school 294 6.1
Introduction: the demise of new classical macroeconomics mark I 294 6.2
The transition from monetary to real equilibrium business cycle theory 295 6.3
Real business cycle theory in historical perspective 297 6.4 Cycles versus random walks 300 6.5 Supply-side shocks 303 6.6
Business cycles: main features and stylized facts 304 6.7 Real business cycle theory 307 6.8
The structure of a real business cycle model 309 Contents vii 6.9 Technology shocks 313 6.10
A real business cycle aggregate demand and supply model 315 6.11 Calibrating the model 320 6.12
Real business cycle theory and the neutrality of money 322 6.13
Measuring technology shocks: the Solow residual 325 6.14
Real business cycle theory and the stylized facts 326 6.15
The policy implications of real business cycle theory 330 6.16
Criticisms of real business cycle theory 332 6.17
Great Depressions: a real business cycle view 336 6.18 An assessment 338
Interview with Edward C. Prescott 344 7
The new Keynesian school 357 7.1
The fall and rise of Keynesian economics 357 7.2 A Keynesian resurgence 358 7.3 New Keynesian economics 361 7.4
Core propositions and features of new Keynesian economics 363 7.5 Nominal rigidities 366 7.6
Dornbusch’s overshooting model 376 7.7 Real rigidities 378 7.8
New Keynesian business cycle theory 396 7.9 Hysteresis and the NAIRU 401 7.10
New Keynesian economics and the stylized facts 408 7.11 Policy implications 409 7.12
Keynesian economics without the LM curve 423 7.13
Criticisms of new Keynesian economics 428 7.14
An assessment of new Keynesian economics 431
Interview with N. Gregory Mankiw 433 8
The Post Keynesian school 451 Paul Davidson 8.1 Introduction 451 8.2
The significance of the principle of effective demand 453 8.3 Taxonomy 454 8.4
Keynes’s taxonomic attack on Say’s Law 455 8.5
Can relative price changes induce D2 to fill the gap? 457 8.6
Investment spending, liquidity, and the non-neutrality of money axiom 459 8.7
What type of an economic system is ‘irrational’ enough to use money contracts? 461 8.8
Information, decisions and uncertainty 463 8.9
Classifying decision-making environments 464 viii Modern macroeconomics 8.10
Keynesian uncertainty, money and explicit money contracts 468 8.11 Conclusions 472 9 The Austrian school 474 Roger W. Garrison 9.1 The Mengerian vision 474 9.2
The intertemporal structure of capital 475 9.3 Saving and economic growth 479 9.4 The saving–investment nexus 482 9.5 The market for loanable funds 489 9.6
Full employment and the production possibilities frontier 492 9.7
The capital-based macroeconomic framework 496 9.8
Saving-induced capital restructuring 498 9.9
Keynes’s paradox of thrift revisited 501 9.10
The Austrian theory of the business cycle 503 9.11
A Keynesian downturn in the Austrian framework 509 9.12
Inflation and deflation in the Austrian theory 513 9.13 Policy and reform 515 10
The new political macroeconomics 517 10.1
Introduction: political distortions and macroeconomic performance 517 10.2
Political influences on policy choice 518 10.3 The role of government 521 10.4
Politicians and stabilization policy 523 10.5
Alternative approaches to the ‘political business cycle’: an overview 525 10.6
The Nordhaus opportunistic model 526 10.7 The Hibbs partisan model 532 10.8
The decline and renaissance of opportunistic and partisan models 535 10.9
Rational political business cycles 537 10.10 Rational partisan theory 538 10.11
Opportunistic and partisan behaviour: a synthesis 545 10.12
Politics, time inconsistency, credibility and reputation 546 10.13
Policy implications of politico-economic models: an independent central bank? 549 10.14
The political economy of debt and deficits 554 10.15
Political and economic instability: are they related? 555 10.16
The political economy of economic growth 556 10.17
Political barriers to economic growth 562 10.18 The size of nations 564 Contents ix 10.19 Conclusion 565
Interview with Alberto Alesina 567 11
The renaissance of economic growth research 579 11.1 Introduction 579 11.2 The ‘Great Divergence’ 580 11.3 In praise of economic history 584 11.4 Back to the long run 585 11.5
Why is economic growth so important? 589 11.6
Modern economic growth in historical perspective 593 11.7 The stylized facts of growth 595 11.8
Proximate v. fundamental sources of growth 596 11.9 The Harrod–Domar model 598 11.10
The Solow neoclassical growth model 602 11.11
Accounting for the sources of economic growth 612 11.12 The convergence debate 614 11.13 Beyond the Solow model 622 11.14
Endogenous growth: constant returns to capital accumulation 625 11.15
Endogenous growth: the economics of ideas 627 11.16
An augmented Solow model: a neoclassical revival? 632 11.17
Focusing on the fundamental causes of growth 633 11.18
Institutions and economic growth 635 11.19 Trade and economic growth 647 11.20 Geography and growth 652 11.21
Growth in history: in search of a unified theory 654 11.22
The ideal conditions for growth and development: rediscovering old truths 657
Interview with Robert M. Solow 660
Interview with Paul M. Romer 673 12
Conclusions and reflections 695 12.1 Introduction 695 12.2
Twentieth-century developments in macroeconomics: evolution or revolution? 696 12.3
Is there a consensus on key macroeconomic issues? 703 Bibliography 708 Author index 791 Subject index 803 Figures 1.1
Unemployment in the US and UK economies over the course of the twentieth century 2 1.2
Inflation in the US and UK economies over the course of the twentieth century 3 2.1
The aggregate production function (a) and the marginal product of labour (b) 40 2.2
Output and employment determination in the classical model 43 2.3
The classical interest rate mechanism and Say’s Law 48 2.4
The determination of the price level in the classical model 53 2.5
The determination of output and employment 64 2.6
Keynes and involuntary unemployment 67 2.7
Aggregate demand failure in the US economy, 1929–33 78 3.1
Demand for speculative balances 105 3.2 The generalized IS–LM model 105 3.3 Expansionary fiscal policy 107 3.4 Expansionary monetary policy 108 3.5
The government budget constraint and bond-financed fiscal expansion 111 3.6
The general case with the Keynes effect 115 3.7 The liquidity trap case 117 3.8
The interest-inelastic investment case 119 3.9
The Mundell–Fleming/Keynesian model 127 3.10
Fiscal expansion under imperfect capital mobility 128 3.11
Monetary expansion under imperfect capital mobility 129 3.12
Fiscal expansion under (a) and (b) imperfect and (c) perfect capital mobility 131 3.13
Monetary expansion under (a) imperfect and (b) perfect capital mobility 134 3.14 The Phillips curve 136 3.15
The relationship between wage change and excess demand for labour 138 3.16
The relationship between excess demand for labour and unemployment 139 3.17
The relationship between excess demand for labour, vacancy and unemployment rates 141 x Figures xi 3.18
The link between the Keynesian model and wage and price inflation 143 4.1
The evolution of orthodox monetarism 164 4.2 The classical case 172 4.3 The Keynesian case 172 4.4
The expectations-augmented Phillips curve 177 4.5
The trade-off between inflation and unemployment 179 4.6
The output–employment costs of reducing inflation 183 5.1
The structure of new classical models 224 5.2
The welfare implications of equilibrium in a competitive market 231 5.3
The effects of anticipated and unanticipated changes in the
money supply on the level of output and the price level 243 5.4
Consistent and optimal equilibrium 253 5.5
Game played between the monetary authorities and wage negotiators 255 5.6
The relationship between average inflation and central bank independence 261 5.7
The evolution of new classical macroeconomics 269 6.1
The path of output in the ‘trend-reverting’ case 302 6.2
The path of output where shocks have a permanent influence 302 6.3
Output and employment fluctuations due to a technology shock 314 6.4
The IS–LM model with flexible prices 315 6.5
The real business cycle aggregate demand and supply model 316 6.6
The impact of a technology shock 318 6.7
The impact of a government expenditure shock 319 6.8
The impact of temporary and permanent technology shocks in the real business cycle model 320 6.9
The annual growth rates of technology and output in the USA, 1955–85 327 6.10
Supply shocks and the price level 329 7.1
Nominal wage contracts, rational expectations and monetary policy 368 7.2
Price adjustment under monopolistic competition 373 7.3 Menu costs v. price adjustment 374 7.4 Near rationality 375 7.5
The efficiency wage and the Solow condition 386 7.6
Involuntary unemployment in the efficiency wage model 387 7.7 The shirking model 391 7.8
The impact of an aggregate demand shock in the new Keynesian model 397 xii Modern macroeconomics 7.9
The risk-based aggregate supply curve 400 7.10
Standardized unemployment rates for North America (USA
and Canada) and OECD Europe, 1972–98 402 7.11
The ‘natural rate’ view of the relationship between actual
unemployment and equilibrium unemployment 404 7.12
The hysteresis view of a ‘time-varying’ NAIRU 406 7.13
Bank of England inflation report fan chart for February 2004:
forecast of CPI inflation at constant nominal interest rates of 4.0 per cent 417 7.14
UK inflation and inflation expectations, October 1991– October 2003 418 7.15
Derivation of the AD curve 425 7.16
Adjusting to long-run equilibrium in the AD–IA model 427 9.1
The intertemporal structure of production 476 9.2
A possible temporal pattern of consumable output 480 9.3
Intertemporal capital restructuring 481 9.4
Time discount and derived demand 488 9.5 The loanable funds market 490 9.6
The production possibilities frontier 495 9.7
A capital-based macroeconomic framework 496 9.8 Saving-induced economic growth 498 9.9 A saving-induced recession 502 9.10 A policy-induced boom and bust 505 9.11
An investment-led collapse into recession 511 10.1 Influences on policy choice 520 10.2 A politico-economic model 524 10.3
The Nordhaus political business cycle model 529 10.4
The long-run solution in the Nordhaus model 530 10.5 The Hibbs partisan model 533 10.6
How inequality may adversely affect growth 561 11.1
The impact on per capita income of differential growth rates 591 11.2 The great divergence 591 11.3
The neoclassical aggregate production function 605 11.4 The Solow growth model 608 11.5 Technological progress 610 11.6 Transition dynamics 618 11.7 Conditional convergence 619 11.8
Proximate and fundamental sources of growth 634 Tables 1.1 The Great Depression 12 1.2
Growth of per capita GDP, world and major regions, 1820– 1998 18 1.3
Growth rates (GDP), 1820–1998 18 1.4
Unemployment rates, 1964–2002 19 1.5 Inflation rates, 1964–2002 20 2.1
US GDP, prices and unemployment: 1929–33 78 2.2
Keynes and the international economic system, 1944 85 2.3
Most-cited macroeconomists: 1920–30 86 2.4
Most-cited macroeconomists: 1931–5 86 2.5
Most-cited macroeconomists: 1936–9 87 2.6
Most-cited macroeconomists: 1940–44 87 5.1 Citation counts: 1966–97 221 5.2
Central bank independence and economic performance 260 6.1
The ‘stylized facts’ of the business cycle 306 7.1
NAIRU estimates for the G7 countries and the euro area 402 7.2
Evidence on reasons for price stickiness 428 10.1
Politico-economic models of aggregate fluctuations 526 10.2
Partisan influence on macroeconomic outcomes, USA, 1948– 2001 534 10.3
Rates of growth of GDP in real terms 543 10.4
Alternative politico-economic models 547 10.5
Selected indicators of governance: 20 sub-Saharan African countries 559 11.1
Level and rate of growth of GDP per capita: world and major regions, 0–1998 AD 581 11.2
Three indicators of living standards: 40 countries 583 11.3
The cumulative impact of differential growth rates 590 11.4 A tale of two Koreas 639 11.5
Growth rates of per capita GDP (%): the two Koreas 640 12.1
Some areas of agreement and disagreement in macroeconomics 702 xiii Preface
Over the last ten years we have collaborated in co-writing and/or editing five
books on macroeconomics. The first of this series of books, A Modern Guide
to Macroeconomics: An Introduction to Competing Schools of Thought, was
published by Edward Elgar in 1994, while our most recent joint venture, An
Encyclopedia of Macroeconomics, was published by Edward Elgar in 2002.
During the course of co-writing and editing the Encyclopedia of Macroeco-
nomics a number of eminent economists, who contributed to the project,
asked if we had any plans to write a second edition of the Modern Guide to
Macroeconomics, a book which has received widespread critical acclaim and
been translated into French (Ediscience, 1997), Chinese (Commercial Press,
1998), Italian (Etas Libri, 1998), and Polish (Polish Scientific Publishers,
1998). Initially we intended to produce a second edition of the Modern Guide
to Macroeconomics involving amendments to each chapter, as well as updat-
ing the data and references. However, as the project unfolded we decided that
the Modern Guide to Macroeconomics required an extensive rewrite, not only
involving major amendments to each chapter, but also requiring the addition
of two new chapters surveying the burgeoning literature on the ‘new political
macroeconomics’ and the ‘new growth’ literature. As a result of these exten-
sive changes we decided that the current book was sufficiently different to
warrant a new title, which reflects its theme and contents. In writing Modern
Macroeconomics: Its Origins, Development and Current State we have also
been kindly aided by two eminent scholars in their respective fields, Profes-
sor Paul Davidson who contributed Chapter 8 on the Post Keynesian school
and Professor Roger Garrison who contributed Chapter 9 on the Austrian school.
The main aim of our new book, as reflected in its title, is to consider the
origins, development and current state of modern macroeconomics in a manner
appropriate for intermediate undergraduates taking courses in macroeconom-
ics. As such we have assumed that such students will already have a firm grasp
of basic economic principles and be familiar with introductory macroeconomic
theories and models as developed, for example, in textbooks such as those by
Abel and Bernanke (2001), Blanchard (2003), or Mankiw (2003). This book
should, however, also prove useful to students taking other undergraduate
economics courses, most notably in the history of economic thought, as well as
economic history. For the benefit of intermediate undergraduates we have xiv Preface xv
marked with an asterisk those references in the bibliography that are particu-
larly recommended for further reading. In providing extensive referencing the
book should also prove to be a useful introductory guide to the research
literature for postgraduate students in their preliminary year of study.
While the book is written so as to allow students on a range of degree
courses to read individual chapters in isolation, according to their interests
and needs, in line with the Modern Guide to Macroeconomics the book
follows a structured direction tracing the origins and development of modern
macroeconomics in historical perspective. In a book of this nature it is obvi-
ously impossible to cover every area. We have therefore aimed to highlight
what we consider to have been the major issues that emerged following the
birth of macroeconomics in the 1930s.
Following the introductory chapter on understanding macroeconomics,
Chapter 2 considers the debate between Keynes and the old classical model
before tracing the development of the orthodox Keynesian school (Chapter
3), the orthodox monetarist school (Chapter 4), the new classical school
(Chapter 5), the real business cycle school (Chapter 6), the new Keynesian
school (Chapter 7), the Post Keynesian school (Chapter 8) and the Austrian
school (Chapter 9). Readers familiar with a Modern Guide to Macroeconom-
ics will recognize our chosen approach, namely to discuss the central tenets
underlying, and the policy implications of, these main competing schools of
thought in macroeconomics as they evolved in historical perspective. In
doing so we have taken the opportunity to include in Chapters 2–7 more
recent references and, more importantly, to assess the impact these schools
have had on the current state of macroeconomics. We have also introduced
much new material compared to the equivalently titled chapters in a Modern
Guide to Macroeconomics. To give two examples: in Chapter 2, section 2.14,
we have introduced a discussion of the causes and consequences of the Great
Depression, while in Chapter 3, section 3.5, we discuss the effectiveness of
fiscal and monetary policy for stabilization purposes when the Keynesian IS–
LM model is extended to an open economy. In this book the Post Keynesian
and Austrian schools command individual chapters (each written by leading
scholars in the area), rather than the single chapter approach used in the
Modern Guide to Macroeconomics. Furthermore, to reflect important devel-
opments that have taken place in macroeconomics over the final decades of
the twentieth century we have introduced two entirely new chapters. In Chap-
ter 10 we consider what has come to be known as the ‘new political
macroeconomics’, while in Chapter 11 we discuss the renaissance of research
into the area of ‘economic growth’. It is hoped that these changes will be
welcomed by reviewers and readers alike.
In line with the Modern Guide to Macroeconomics, to help bring the
subject matter alive and capture the imagination of the reader, we have xvi Modern macroeconomics
included at the end of certain chapters interviews with world-renowned scholars
who are experts in their field of study. We are extremely grateful to (listed in
the order in which the interviews appear in the book): Robert Skidelsky (a
leading authority on Keynes and the interwar period); the late James Tobin
(the 1981 Nobel Memorial Laureate, who was one of America’s most promi-
nent and distinguished Keynesian economists); Milton Friedman (the 1976
Nobel Memorial Laureate, who is widely recognized as the founding father
of monetarism); Robert E. Lucas Jr (the 1995 Nobel Memorial Laureate, who
is widely acknowledged as the leading figure in the development of new
classical macroeconomics); Edward Prescott (widely acknowledged as a lead-
ing advocate of the real business cycle approach to economic fluctuations);
Greg Mankiw (a leading exponent of the new Keynesian school of macroeco-
nomics); Alberto Alesina (a leading contributor to the literature on the new
political macroeconomics); and Robert Solow (the 1987 Nobel Memorial
Laureate) and Paul Romer, who have made very influential contributions to
the field of economic growth. Their illuminating and contrasting answers
demonstrate that modern macroeconomics is both an exciting and controver-
sial subject. As an aside the reader may wonder why we have not included
interviews at the end of Chapter 8 on the Post Keynesian school and Chapter
9 on the Austrian school. The reason for this is that these two chapters have
been written by Paul Davidson, a leading world authority on Post Keynesian
economics, and Roger Garrison, a leading world authority on Austrian eco-
nomics – the two people we would have chosen to interview if they hadn’t
kindly agreed to write Chapters 8 and 9 respectively.
Thus, for the potential reviewer or prospective buyer it should be clear that
this book is far more than a second edition of the Modern Guide to Macr-
oeconomics. It is a new book which we hope successfully conveys the
importance of the issues under discussion. As Keynes recognized, the ideas
of economists are more powerful than is commonly understood. In this book
we have attempted to show why this is the case by tracing the development
and interaction of key events and ideas as they occurred during the twentieth
century and into the new millennium. Brian Snowdon Howard R. Vane Acknowledgements
The authors would like to thank the following who have kindly given their
permission to reproduce previously published material, namely:
The NIESR to reproduce Figures 1.1 and 1.2 from the article by A. Britton,
‘Macroeconomics and History’, in the National Institute Economic Review, January 2002.
The Ohio State University Press to reproduce Figure 5.6 and Table 5.2
from the article by A. Alesina and L.H. Summers, ‘Central Bank Independ-
ence and Macroeconomic Performance: Some Comparative Evidence’, Journal
of Money, Credit and Banking, May 1993.
The OECD to reproduce Tables 1.2 and 11.1 from the book by A. Maddison,
The World Economy: A Millennial Perspective, copyright 2001, OECD.
Palgrave Macmillan to reproduce Tables 2.3–2.6 from the book by P.
Deutscher, R.G. Hawtrey and the Development of Macroeconomics, 1990, Macmillan.
Pearson Education, Inc. publishing as Pearson Addison Wesley to reproduce
Table 6.1 from the book by A.B. Abel and B.S. Bernanke, Macroeconomics, 4th
edn., p. 288, copyright 2001, Pearson Education.
The International Honor Society in Economics to reproduce the interview
with Greg Mankiw which appears as part of a fuller article by the authors,
‘New Keynesian Economics Today: The Empire Strikes Back’, in The Ameri-
can Economist, Spring 1995.
MCB University Press to reproduce the interview with Milton Friedman
which appears as part of a fuller article by the authors, ‘Modern Macroeco-
nomics and Its Evolution from a Monetarist Perspective: An Interview with
Professor Milton Friedman’, in the Journal of Economic Studies, 1997.
Routledge to reproduce the interview with Robert E. Lucas Jr which ap-
pears as part of a fuller article by the authors, ‘Transforming Macroeconomics:
An Interview with Robert E. Lucas Jr.’, in the Journal of Economic Method- ology, June 1998.
The International Honor Society on Economics to reproduce the interview
with Alberto Alesina which appears as part of a fuller article by the authors,
‘The New Political Macroeconomics’, in The American Economist, Spring 1999.
NTC Economic and Financial Publishing, Washington, DC, USA and
Henley-on Thames, UK to reproduce the interview with James Tobin which xvii xviii Modern macroeconomics
appears as part of a fuller article by the authors, ‘James Tobin, 1918–2002:
An “Unreconstructed Old Keynesian” Who Wouldn’t Quit’, in World Eco-
nomics, July–September 2002.
The authors also wish to thank Professor Paul Romer for permission to use
their interview with him, the copyright on which is held by Professor Romer. 1. Understanding modern macroeconomics
Economic knowledge is historically determined … what we know today about the
economic system is not something we discovered this morning but is the sum of
all our insights, discoveries and false starts in the past. Without Pigou there would
be no Keynes; without Keynes no Friedman; without Friedman no Lucas; without
Lucas no … (Blaug, 1991a, pp. x–xi) 1.1
Macroeconomics Issues and Ideas
Macroeconomics is concerned with the structure, performance and behaviour
of the economy as a whole. The prime concern of macroeconomists is to
analyse and attempt to understand the underlying determinants of the main
aggregate trends in the economy with respect to the total output of goods and
services (GDP), unemployment, inflation and international transactions. In
particular, macroeconomic analysis seeks to explain the cause and impact of
short-run fluctuations in GDP (the business cycle), and the major determi-
nants of the long-run path of GDP (economic growth). Obviously the subject
matter of macroeconomics is of crucial importance because in one way or
another macroeconomic events have an important influence on the lives and
welfare of all of us. It is difficult to overstate just how important satisfactory
macroeconomic performance is for the well-being of the citizens of any
country. An economy that has successful macroeconomic management should
experience low unemployment and inflation, and steady and sustained eco-
nomic growth. In contrast, in a country where there is macroeconomic
mismanagement, we will observe an adverse impact on the living standards
and employment opportunities of the citizens of that country. In extreme
circumstances the consequences of macroeconomic instability have been dev-
astating. For example, the catastrophic political and economic consequences
of failing to maintain macroeconomic stability among the major industrial
nations during the period 1918–33 ignited a chain of events that contributed
to the outbreak of the Second World War, with disastrous consequences for
both humanity and the world economy.
Because macroeconomic performance and policies are closely connected,
the major macroeconomic issues are also the subject of constant media atten-
tion and inevitably play a central role in political debate. The influence of the 1