The questions asked by the students that what is macroeconomics? so the macroeconomic is defined as one of the major branches of economics which focuses on the aggregate behavior of the economy. In simple words, it presents the birds-eye view of the economy. It gives more focus to major or aggregate issues of time economy like growth rate, gross domestic product, gross national product, inflation, and unemployment, etc.
Macroeconomic deals with the behavior, structure, decision making, and performance of the whole economy. For example, using government spending, money supply, taxes, and interest rate regulate economic stability and growth. The global, national, and regional economies are also its subject.
Microeconomics and macroeconomics are two major and are general fields of economics. The United Nations provides SDGs, Sustainable Development Goals, wherein the 17th goal is to stabilize macroeconomic economic condition through international policy coordination and make it a part of the 2030 agenda.
Origins / Development of Macroeconomics
Macroeconomics descended from the Monetary Theory and Business Cycle Theory. Before World War II the quantity theory of money was influential. It gets modified by time and again and reached the version of Irving Fisher and explained by the below-mentioned equation.
M* V= P* Q
In the above equation, M represents the money supply, V represents the money velocity (how many times a single note or coin changes its hand), P represents the market price level, and Q represents the quantity produced with the country. This theory remained a central part of the classical theory, which remained present in the early 20th century.
The first book of the Austrian School was published in 1912 and Ludwig Von Mises presents his Theory of Money and Credit which deals with macroeconomic concepts.
The modern era of macroeconomics started with the publication of General Theory of Employment, Interest, and Money by John Maynard Keynes. The classical economists had failed in the recession-era of 1929 and were remained failed to describe how to resolve the issue of unsold goods and unemployed workers. As per the classical theory wages of workers and prices of goods would drop to clear the market where all goods and labor were sold. At that time Keynes came into the ground and offered a new theory of economics that provided focus on market failure, which evolved into one of the best macroeconomic schools of thought known as Keynesian economics (sometimes referred to as Keynesian theory or Keynesianism).
Keynes broke down the classical theory of money because in a recession people and businesses tend to hold money instead to invest, which is described as liquidity preference theory. Further, Keynes also introduced the multiplier effect and emphasis on it that how a small investment brings a big change in the economic conditions of the country and vice versa. To create the neoclassical synthesis, Keynes integrated neoclassical microeconomics with the General Theory of macroeconomics. Macroeconomics synthesis was widely accepted by most economists in the 1950s. The big economists of that time namely James Tobin, Robert Solow, Franco Modigliani, and Paul Samuelson developed models based on the provided macroeconomics synthesis of Keynes and contributed to the theories of investment, money demand, and consumption.
The quantity theory of money was updated by Milton Friedman to include the role of money demand. He stated that the Great Recession could easily define by the role of money and termed it as sufficient for the explanation of the Great Recession and termed as not necessary explanations which are based on aggregate demand. He was in favor of monetary policy rather than fiscal policy and said monetary policy was more effective. Although, he remained doubtful on the monetary policy to help the government to fine-tune the economy. He declined frequent interventions in the economy and supported the steady growth in the money supply.
Friedman also challenged the defined relationship between unemployment and inflation (Philip Curve). He along with Edmund Phelps, who is not a monetarist group of economists, presented a modified version of Philip Curve wherein they excluded the possibility of stability and defined long-run relationship (trade-off) inflation and unemployment. The vindication of their modified curve had to been seen during the 1970s oil shock when high inflation and high unemployment prevailed. The concept of monetarism remained influential in the early 1980s but later the central banks found this approach difficult to target money supply while the interest rate approach was found quite easy.
New Classical School
Keynesian school of economics was further challenged by the new classical school of thought in the field of macroeconomics. The major development that the new classical did is to propose a rational expectations model which was presented by Robert Lucas. Before the rational expectations model, economists had followed adaptive expectations where agents make their expectations for the future based on the recent past trend. It is more difficult for agents to used rational expectation as compared to adaptive expectation as the prior one is a more complicated process. In the adaptive expectation economist mostly look at the inflation rate and decide while in the rational expectation model, the economist has to look monetary rate and current economic conditions along with the inflation rate to forecast any event. The new classical showed that monetary policy has only limited impact by introducing rational expectations into their models.
Lucas also criticized the work of Keynes and his empirical models. He argued that the same prediction would be found by empirical relationships based forecasting models even data had changed for the underlying model. He advocated the models which are based on any economic theory and as the economies changed they would be structurally accurate. New classical economists who were led by Finn E. Kydland and Edward C. Prescott proposed RBC (Real Business Cycle) in macroeconomics by following the critique of Lucas. Real business cycle models were created by combining the neo-classical microeconomics fundamental equations. RBC models, to study macroeconomic fluctuations, explained that unemployment and recessions do not occur due to change in the money or good markets but with technological change. Some economists criticized the concept of RBC models and argued that money has a vital role in the economy and that technological change could not explain the recession, so the statement in support of technology is implausible.
New Keynesian Response
By adopting rational expectations and developing micro-founded models that were immune to Lucas’s critique, new Keynesians responded to the new classical school of thought. John B. Taylor and Stanley Fischer are the two who produced early work from the New Keynesian School by proving that the monetary policy could be effective with rational expectations when workers locked in wages of contracts. The other economists from the new Keynesian school of thought including Julio Rotemberg, Olivier Blanchard, Michael Woodford, David Romer, and Greg Mankiw expended the new Keynesian approach where inflexible wages and prices led to real effects of monetary and fiscal policy.
New classical models similar to classical models assumed that the prices can adjust perfectly in the economy and the monetary policy only causes changes in the prices. On the other hand, new Keynesian models due to imperfect competition investigated the sources of sticky wages and prices that would not adjust, allow monetary policy to affect the quantities rather than prices.
Later, economists reached a rough consensus by the late 1990s. Dynamic Stochastic General Equilibrium (DSGE) models were produced combining the new Keynesian theory, rational expectations, and RBC methodology. The mixture of different elements from different schools of thought is called a new neoclassical synthesis. These models are now considered as a core part of contemporary economics and utilized by the many central banks. New Keynesian economics remand successful to provide a microeconomic foundation to Keynesian economics by guiding how to justify demand management in imperfect markets.
Why is Macroeconomics Important?
Macroeconomics is the bird’s eye of any economy that explores the interrelation among different macroeconomic concepts, their determination, and causes of variations. In the below points the importance of macroeconomics has been analyzed carefully.
- Various national challenges, such as overpopulation, inequality, the balance of payments, inflation, underpin the small economies. The analysis of macroeconomics aims to get these problems under control.
- Macroeconomics facilitates the analysis of the causes, consequences, and remedies of general redundancy.
- Macroeconomic analysis is very critical for determining the overall output of the economy in terms of national income. National income data help to predict the degree of fiscal activity and to understand the distribution of income among various classes of people in the economy.
- Macroeconomics helps in assessing the resources, wealth, and capacities of the economy, analyze ways to raise national income by boosting productivity, improve competitiveness, and generate work prospects for the economy in terms of monetary growth.
- Right macro-level economic policies make it easier to manage inflation and deflation (business cycles) and as a result, violent booms and depressions seldom exist.
- Many diverse theories of savings and consumption have been included in macroeconomics as a discipline. It describes the role of savings in investment and the importance of the national economy.
Topics in Macroeconomics
There are many topics in macroeconomics from which few and main topics are hereunder. It is pertinent to mention here that below are some topics and we have no covered all the topics in this list but this list helps you out to clear the theme of macroeconomics.
- Classical Economics
- New Classical Economics
- Keynesian Economics
- Aggregate Demand and Supply Analysis
- IS-LM Analysis
- Inflation / Deflation
- Interest Rate
- Multiplier Effect
- GDP, GNP, NNP etc.
- Ways to measure GDP
- Philip Curve
- Austrian School
- Growth Model
- Income and Output
- Monetary Policy
- Fiscal Policy
- Business Cycles
- Money, Banking
- Government Spending
- Investment, Saving
- Role of the financial system
Major Macroeconomics Concepts
Classical Economics, New Classical Economics, Keynesian Economics, Austrian School, and Monetarism have been discussed in the above section of the development of macroeconomics.
Aggregate Demand and Supply Analysis
The aggregate demand shows the demand of the whole economy while aggregate supply shows the supply to the whole economy. The curve of the aggregate demand curve is downward sloping from left to right while the aggregate supply curve is upward sloping from left to right, where both the curves intersect each other known as the equilibrium point. This point shows the price and quantity demanded in the economy.
IS Curve shows the combination of output (GDP) and interest rate where investment equals savings. This curve shows the equilibrium in the product market and downward sloping from left to right.
LM Curve shows the combination of interest rate and output (GDP) where the money supply is equal to money demand. This curve shows equilibrium in the money market and upward sloping from left to right.
The equilibrium takes place at the point in the economy when both of these curves intersect each other.
Inflation / Deflation
Inflation: A steady rise in the general prices of goods and services in the economy. Inflation is the measure of the increase in the cost of goods in a particular economy due to which purchasing power is reduced. To see the economic conditions of a country then, it is important to see the Inflation of the economy and the unemployment rate in the country.
Deflation: A general decline in the prices of goods and services in the economy. It occurs after the inflation is zero.
It is the rate at which the lender gives loans to borrowers.
The change in the final income of the country by adding or withdrawing funds from the economy.
The number of people who are seeking jobs and can do the job but failed to found in the economy for a certain period. Unemployment is defined as a situation where working age is jobless, has no work, and is looking for paid employment. The labor force is actively in search of a job and does not get suitable jobs. It is one of the major problems around the globe. The rate of unemployment is measured by the percentage of the labor force that is unemployed and looking for jobs. The people who do not search for a job are not included in this term. The natural rate of unemployment is not the same, it fluctuates with the changes in the economy.
GDP, GNP, etc.
GDP: the total value of goods and services produced either by locals or foreigners within the borders of the country.
GNP: the total value of goods and services produced by the nationals either living in the country or abroad.
NNP: it is calculated by subtracting the depreciation from GNP.
Ways to measure GDP
There are 3 ways to measure GDP that is the income approach, expense approach, and output approach.
It gives the inverse relationship between unemployment and inflation.
There are many growth models in macroeconomics i.e. basic growth model, Harrod-Domar Growth Model, and Neo-Classical Growth Models (Solow growth model, Meade model, Kaldor model).
The policy issued by the central banks to control the economy through interest rate and money supply and get desired results.
The policy issued by the government to get desired results by controlling the economy through taxes and government spending and.
There are 6 stages of business cycles, starts from expansion, peak, recession, depression, trough, and recovery.
Money is used as the medium of exchange, store of value, and unit of the account while banking is a network through which the central bank control money supply in the economy.
The government made spending to launch different mega projects keeping given the condition of the economy. Government spending is a tool used by federal governments to hold control of the economy.
People save some money from their income and store it in the banks. Later, the banks lend the same money to businesses with some interest rates and businesses invest this money in the economy termed as an investment.
Role of the financial system
The role of the financial system is to control the economy and move it in the best possible direction. Monetary and fiscal policies are used for this purpose.
Objectives of Macroeconomic Policies
The current policymakers establish the clear policy goals of objectives by following Keynes and used under noted major macroeconomic objectives.
- Sustainable development and economic growth: the advanced economies take this concept as the national income growth in real terms, which can be sustainable in the future without having a significant adverse effect on other macroeconomic variables. On the other hand, in developing economies, this concept is taken to increase access to education, access to health, and attain a civilized living standard.
- Stables prices: this concept is taken as to average increase in the price by a small amount. Most economists termed a 2 percent or less than 2 percent increase in prices as stable prices.
- Full employment: it is the state in the economy when all the labor force has been fully employed in different sectors of the economy.
- Balance of payments: This means that the import and exports of a country should be equal.
- Environmental protection: The macroeconomic policies used to protect the environment from overuse and misuse. The economists declared the environment as an asset for the economy which needs to be protected.
- Equal distribution of Income: Equal distribution of income means the gap between rich and poor should be minimizing but still have enough gap to support the work environment.
All the economists do not agree on these objectives, nor do they agree on which instrument should be used to attain certain objectives. But all the policies and preferences have to be changed/prioritize as per the desired results.