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aid by the government they are not included in the final calculation of the expenditure approach because they are not a final good or service is is all spending by businesses on physical capital or equipment as well as labor in the service of goods and service production finally net exports capture a country s trade balance total exports are goods and services a country sells abroad and imports are goods and services purchased domestically from abroad represented as an equation gdp is g d p c s g s i s e x p i m p displaystyle gdp cs gs is exp imp gdp deflator edit macroeconomists are also interested in measuring gdp independent of inflation because inflation reflects relative changes in prices the expenditure method may misattribute increased spending on goods and services to growth when it is driven by relative price changes rather than by a change in total quantity to parse out these effects the gdp deflator is a measurement of the relative difference in real vs nominal gdp giving us the size of inflation adjustment for a given year g d p a d j g d p n o m g d p r e a l 100 displaystyle gdp adj gdp nom gdp real cdot 100 22 where the term g d p n o m displaystyle gdp nom captures nominal gdp or the standard measure of the total value of goods and services in a given year at that year s prices 23 g d p r e a l displaystyle gdp real captures real gdp or the inflation adjusted measure of all goods and services produced in the economy 24 a gdp deflator of 100 indicates neither inflation nor deflation when the value exceeds 100 it indicates price inflation in the economy conversely a gdp deflator below 100 indicates deflation measuring the supply of money edit two common ways of determining the total money supply in an economy are m1 and m2 m2 consists of m1 plus a few other things m1 is money that is liquid liquid refers to a financial asset that can be quickly converted into cash without significant loss of value this obviously includes cash coins checking account deposits and similar items m2 however includes time deposits saving accounts and money market mutual funds which are not as liquid in its measurement it is important to understand the money supply as it affects interest rates and plays a central role in monetary policy 25 the money multiplier equation shows how a bank can expand the money supply by taking in deposits and making loans the money supply reserve multiplier equation is money multiplier 1 reserve requirement ratio 26 the reserve requirement in this equation represents the proportion of deposits that the bank must keep in reserve to meet customer withdrawals that proportion of money is based on the deposits made at the bank so if the reserve requirement is 20 20 then the money multiplier is five this means that a 5 deposit would lead to a 25 increase in the money supply this is because of the cycle in which the bank keeps a portion of the deposit in our example 20 and lends out the remainder each time these new spendable bank deposits are counted in the money supply even though the amount of physical currency did not change so while the physical amount of currency would still be 5 the amount of spendable money would be 25 open economies edit open economy macroeconomics deals with the consequences of international trade in goods financial assets and possibly factor markets such as labor migration and the international relocation of firms physical capital it explores what determines import export the balance of trade and over longer horizons the accumulation of net foreign assets an important topic is the role of exchange rates and the pros and cons of maintaining a fixed exchange rate system or even a currency union like the economic and monetary union of the european union drawing on the research literature on optimum currency areas 8 history edit main article history of macroeconomic thought john maynard keynes is considered the initiator of macroeconomics when he published his work the general theory of employment interest and money in 1936 macroeconomics as a separate field of research and study is generally recognized to have begun with the publication of john maynard keynes s the general theory of employment interest and money in 1936 27 28 8 526 the terms macrodynamics and macroanalysis were introduced by ragnar frisch in 1933 and lawrence klein in 1946 used the word macroeconomics itself in a journal title in 1946 27 but naturally several of the themes which are central to macroeconomic research had been discussed by thoughtful economists and other writers long before 1936 27 before keynes edit in particular macroeconomic questions before keynes were the topic of the two long standing traditions of business cycle theory and monetary theory william stanley jevons was one of the pioneers of the first tradition whereas the quantity theory of money labelled the oldest surviving theory in economics as an example of the second was described already in the 16th century by martín de azpilcueta and later discussed by personalities like john locke and david hume in the first decades of the 20th century monetary theory was dominated by the eminent economists alfred marshall knut wicksell and irving fisher 27 keynes and keynesian economics edit when the great depression struck the reigning economists had difficulty explaining how goods could go unsold and workers could be left unemployed in the prevailing neoclassical economics paradigm prices and wages would fall until the market cleared with all goods and labor sold keynes in his main work the general theory initiated what is known as the keynesian revolution he offered a new interpretation of events and a whole intellectual framework a novel theory of economics that explained why markets might not clear which would evolve into a school of thought known as keynesian economics also called keynesianism or keynesian theory 8 526 in keynes theory aggregate demand by keynes called effective demand was key to determining output even if keynes conceded that output might eventually return to a medium run equilibrium or potential level the process would be slow at best keynes coined the term liquidity preference his preferred name for what is also known as money demand and explained how monetary policy might affect aggregate demand at the same time offering clear policy recommendations for an active role of fiscal policy in stabilizing aggregate demand and hence output and employment in addition he explained how the multiplier effect would magnify a small decrease in consumption or investment causing declines throughout the economy and noted the role that uncertainty and animal spirits can play 8 526 the generation following keynes combined the macroeconomics of the general theory with neoclassical microeconomics to create the neoclassical synthesis by the 1950s most economists had accepted the synthesis view of the macroeconomy 8 526 economists like paul samuelson franco modigliani james tobin and robert solow developed formal keynesian models and contributed formal theories of consumption investment and money demand that fleshed out the keynesian framework 8 527 austrian perspective edit friedrich hayek building on ludwig von mises earlier the theory of money and credit following the austrian school developed a rival theory of the business cycle critiquing keynes a treatise on money hayek did not directly rebut the general theory instead refined capital theory however keynes framework dominated the post war macroeconomics hayek received the 1974 nobel memorial prize in economic sciences in part for his work on capital and business cycle theory 29 monetarism edit milton friedman updated the quantity theory of money to include a role for money demand he argued that the role of money in the economy was sufficient to explain the great depression and that aggregate demand oriented explanations were unnecessary friedman also argued that monetary policy was more effective than fiscal policy however friedman doubted the government s ability to fine tune the economy with monetary policy he generally favored a policy of steady growth in the money supply rather than frequent intervention 8 528 friedman also challenged the original simple phillips curve relationship between inflation and unemployment friedman and edmund phelps who was not a monetarist proposed an augmented version of the phillips curve that excluded the possibility of a stable long run tradeoff between inflation and unemployment 30 when the oil shocks of the 1970s created a high unemployment and high inflation friedman and phelps were vindicated monetarism was particularly influential in the early 1980s but fell out of favor when central banks found the results disappointing when trying to target money supply instead of interest rates as monetarists recommended concluding that the relationships between money growth inflation and real gdp growth are too unstable to be useful in practical monetary policy making 31 new classical economics edit new classical macroeconomics further challenged the keynesian school a central development in new classical thought came with robert lucas s introduction of rational expectations into macroeconomics before lucas economists had generally used adaptive expectations in which agents were assumed to look at the recent past to form expectations about the future under rational expectations agents are assumed to be more sophisticated 8 530 consumers will not simply assume a 2 inflation rate just because that has been the average the past few years they will look at current monetary policy and economic conditions to make an informed forecast in the new classical models with rational expectations monetary policy only had a limited impact lucas also made an influential critique of keynesian empirical models he argued that forecasting models based on empirical relationships would continue to produce the same predictions even as the underlying data generating model changed he advocated models based on fundamental economic theory i e having an explicit microeconomic foundation that would in principle be structurally accurate as economies changed 8 530 following lucas s critique new classical economists led by edward c prescott and finn e kydland developed real business cycle rbc models of the macroeconomy rbc models were created by combining fundamental equations from neo classical microeconomics to make quantitative models to generate macroeconomic fluctuations rbc models explained recessions and unemployment as changes in technology rather than in the markets for goods or money critics of rbc models argue that technological changes which typically diffuse slowly throughout the economy could hardly generate the large short run output fluctuations that we observe in addition there is strong empirical evidence that monetary policy does affect real economic activity and the idea that technological regress can explain recent recessions seems implausible 8 533 9 195 despite criticism of the realism in the rbc models they have been very influential in economic methodology by providing the first examples of general equilibrium models based on microeconomic foundations and a specification of underlying shocks that aim to explain the main features of macroeconomic fluctuations not only qualitatively but also quantitatively in this way they were forerunners of the later dsge models 9 194 new keynesian response edit new keynesian economists responded to the new classical school by adopting rational expectations and focusing on developing microfounded models immune to the lucas critique like classical models new classical models assumed that prices would adjust perfectly and that monetary policy would only lead to price changes new keynesian models investigated sources of sticky prices and wages due to imperfect competition 32 which would not adjust allowing monetary policy to impact quantities instead of prices stanley fischer and john b taylor produced early work in this area by showing that monetary policy could be effective even in rational expectations models when contracts locked in workers wages other new keynesian economists including olivier blanchard janet yellen julio rotemberg greg mankiw david romer and michael woodford expanded on this work and demonstrated other cases where various market imperfections caused inflexible prices and wages leading in turn to monetary and fiscal policy having real effects other researchers focused on imperfections in labor markets developing models of efficiency wages or search and matching sam models or imperfections in credit markets like ben bernanke 8 532 36 by the late 1990s economists had reached a rough consensus 33 the market imperfections and nominal rigidities of new keynesian theory were combined with rational expectations and the rbc methodology to produce a new and popular type of models called dynamic stochastic general equilibrium dsge models the fusion of elements from different schools of thought has been dubbed the new neoclassical synthesis 34 35 these models are now used by many central banks and are a core part of contemporary macroeconomics 8 535 36 2008 financial crisis edit the 2008 financial crisis and the subsequent great recession were the first events to lead to a major reassessment of macroeconomics this field had generally neglected the specific role of financial institutions in the economy after the crisis macroeconomic researchers have turned their attention to several new directions the financial system and the nature of macro financial linkages and frictions studying leverage liquidity and complexity problems in the financial sector the use of macroprudential tools and the dangers of an unsustainable public debt 8 537 36 increased emphasis on empirical work as part of the so called credibility revolution in economics using improved methods to distinguish between correlation and causality to improve future policy discussions 37 interest in understanding the importance of heterogeneity among the economic agents leading among other examples to the construction of heterogeneous agent new keynesian models hank models which may potentially also improve understanding of the impact of macroeconomics on the income distribution 38 understanding the implications of integrating the findings of the increasingly useful behavioral economics literature into macroeconomics 39 and behavioral finance growth models edit research in the economics of the determinants behind long run economic growth has followed its own course 40 the harrod domar model from the 1940s attempted to build a long run growth model inspired by keynesian demand driven considerations 41 the solow swan model worked out by robert solow and independently trevor swan in the 1950s achieved more long lasting success however and is still today a common textbook model for explaining economic growth in the long run 42 the model operates with a production function ...
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