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Challenges, Responses, and Extensions
  -- A Historical View

The first two sections of this web site attempt to lay out the basic structure of the classical and Keynesian approaches to macroeconomics.  Given this background, you should be prepared to consider the evolution of thinking in macroeconomics.  That is what we take up here.

Markets and Prices

Early economics focused on understanding markets and prices, elements of what is now known as microeconomics. 

The Great Depression

The Great Depression gave rise to macroeconomics.  The distinction between microeconomics and macroeconomics became much clearer when the U.S. unemployment rate hit 25% in 1932.  In particular, the Great Depression presented an overwhelming challenge to what came to be known as the Classical Model.  The unemployment rate reached levels thoroughly inconsistent with any notion of equilibrium in the labor market and remained above 10% for the entire decade of the 1930's.

The Era of Business Cycles Begins

In 1946,  Arthur F. Burns and Wesley C. Mitchell published Measuring Business Cycles. This volume marked the first comprehensive study of business cycles.   In the same year, John Maynard Keynes (1883 to 1946) passed from this earth.

The Keynesian Heyday

The election of John Kennedy in 1960 opened the way for the academic Keynesians to bring their ideas to actual government policies, marking the beginning of the Keynesian heyday.

The Phillips Curve, first appearing in print in 1958, suggested the possibility of a stable tradeoff between inflation and unemployment.  Critics of stabilization policy based on a stable Phillips curve introduced the concept of the natural rate of unemployment.


Throughout the Keynesian heyday, the primary counterpart was monetarism, led by Milton Friedman.

New Classical Economics

The emergence of new classical economics in the 1970s can be traced to two sources.  First, John Muth's introduction of rational expectations was beginning to be recognized as a major theoretical advance.  Second, the oil shocks of the decade (1973 Oil Crisis, Wikipedia. 1979 Energy Crisis, Wikipedia) were clear candidates for interpretation as supply shocks.

Merely compiling lists of criticisms of the Keynesian models is not enough.  You need a model of your own to enter the race.  The real business cycles models show that business cycles can arise even without nominal rigidities or, indeed, even without nominal variables.

Supply-side economics.  Economic theory or political strategy?

New Keynesian Economics

The new Keynesian economics responded to rational expectations and other criticism.

The IS/MP Model.  reconcile rate of interest vs. level of prices.  More practical representation of monetary policy.

Taylor rules both describe what central banks have done and provide a prescription for their behavior in the future.

Open Economy Macro

Macroeconomists used to distinguish between closed economy macro (no economic connection to other countries) and open economy macro (including imports, exports, and financial flows).  Closed-economy macro no longer of widespread interest.  Even though the models considered to this point often do not include an international sector, ...  index



Comments?  Questions?  macro-at-econmodel-dot-com  Copyright 2006 William R. Parke