MACRO ECONOMICS

ECONOMIC SCHOOLS OF THOUGHT

PRESENTED TO: ZIA ABBASS RIZVI

PRESENTED BY:

Nabeel Danish Bilal Mustafa Summaiya Aidrus Moez Mahboob

THE CLASSICAL SCHOOL OF THOUGHT

he was wary of businessmen and argued against the formation of monopolies. with rent and profit. they could make a combined amount of 48. Smith maintained that. "The History of Astronomy". One example he used was the making of pins. the brewer. Smith believed that when an individual pursues his self-interest. The image of the invisible hand was previously employed by Smith in Theory of Moral Sentiments. The latter. 1776 London edition Value theory was important in classical theory. is actually guided to produce the right amount and variety of goods by a socalled "invisible hand". Smith also believed that a division of labour would effect a great increase in production. usually abbreviated as The Wealth of Nations. Nevertheless. he promotes the good of society more than so if he intends to benefit society: "by pursuing his own interest. One worker could probably make only twenty pins per day. other costs besides wages also enter the price of a commodity. The first page of the Wealth of Nations. The Wealth of Nations expounds that the free market. he argued. but it has its original use in his essay." Self-interested competition in the free market. Classical economics focused on the tendency of markets to move to long-run equilibrium. termed the 'labour theory of value'. would tend to benefit society as a whole by keeping prices low. Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations. while appearing chaotic and unrestrained. . if ten people divided up the eighteen steps required to make a pin. while still building in an incentive for a wide variety of goods and services. An often-quoted passage from The Wealth of Nations is: It is not from the benevolence of the butcher. and never talk to them of our own necessities but of their advantages.Adam Smith (1723 –1790) was a Scottish moral philosopher and a pioneer of political economy. not to their humanity but to their self-love. Other classical economists presented variations on Smith. Smith wrote that the "real price of every thing . Adam Smith is widely cited as the father of modern economics... [the individual] frequently promotes that of the society more effectually than when he intends to promote it. is the toil and trouble of acquiring it" as influenced by its scarcity. but from their regard to their own interest. However. is considered his magnum opus and the first modern work of economics. We address ourselves.000 pins in one day. or the baker that we expect our dinner.

extensive government intervention will hinder the efficient operation of the market in the determination of prices of goods and services and the allocation of resources towards their production. J.Classical Economics Theory: The term classical economics was applied to a school of economic thought that began with Adam Smith's writing of the Wealth of Nations in 1776. a theory generally free of outside intervention. Say's law captures the essence of the classical school of thought. With economic foundations based on the role of markets. The normal economic state of the economy is at full employment. Other important classical economists include David Ricardo who introduced and developed the concepts of comparative advantage and the benefits of an open economy that participates in international trade. unemployment is not an important public policy concern as the unemployment present will be voluntary. The father of the classical school is Adam Smith. and to sustain national defense. The government has a minimal role over the course of the business cycle.B. The classical school of economic thought was the dominant school of thought until the time of the great depression. The statement that supply creates its own demand implies that by producing goods and services. Says presented what is today known as Say's Law: supply creates its own demand. Smith used the concept of the invisible hand to describe the role of the market in the allocation of resources. and emphasizing the role of production in determining income and economic output. In the long run. firms create the jobs and incomes capable of buying those goods and services. Interestingly enough. • • . and left alone the economy will gravitate toward full employment. the invisible hand guides participants in the market towards an outcome that efficiently allocates resources to the production of goods that society desires. This implies that all workers that desire jobs will have them. The government does have an important place in areas such as providing a legal framework. and it was further perpetuated by John Maynard Keynes in his General Theory. and those who are unemployed voluntarily choose to be so. the creator of the term was Marx. However. In the market. preventing abuses of the market. Absent any explicit guidance mechanism. the interaction of demand and supply determines how much of a good will be produced and the price that is charged for that good. the classical school of thought has several important implications: • The government should play a minimal role in determining the condition of the economy.

One of the most important questions early classical economists attempted to answer was how the value or price of a good is determined. One good's price is higher than another's because of the extra labor used in its production. Since the majority input used in production during the eighteenth century was labor. According to Smith. The price of a good reflects the amount of labor used in its creation. the prices of goods are determined by what it costs to produce them. Smith developed a labor-based theory of prices.• Economic analysis should emphasize the study of markets and how they effectively operate. Smith needed to go further and explain why two goods with identical demands would have different prices. Smith described how the interaction of supply and demand in the market determined a good's price. .

Postulate 1: Wage = MPL (marginal product of labor) Assumptions: • • • we are talking about the real wage everyone receives the MPL as their wage – this is a necessary assumption for profit maximization finally we assume diminishing returns to a fixed factor. capital is fixed in the long run We see that the second derivative is negative (the curve is downward sloping). There are several possible causes of this: 1. The first and most prominent reason is that diseconomies of scale set in 2. and can be summarized by 2 postulates. as the pool of available workers shrinks.The Classical School's Labor Market Classical Theory: The Classicalist argued that the aggregate labor market determines total employment.) 3. Long run fixed capital argument – represents fixed plant equipment . in this case. The second could be a skill argument (you are forced to hire less and less productive workers.

Max employment therefore yields max output. At wages below L*. At wages above L*. we have a shortage and the level of labor and output is less. An example would be people eating robots (basically eating that which they produce). Two types of classical unemployment: 1. max employment is the intersection. L*. Here we can see that demand is downward sloping – this is a consequence of profit maximization. as determined by the supply curve. This means that the real wage is same for both producers and consumers. This leads us to our second postulate: Postulate 2: Uwage = MDUwork (surrendered leisure time or marginal disutility of work) If we have voluntary contracting in the economy (no forced labor). Frictional – between jobs . we have a surplus and labor/output are determined by the demand curve.We assume one productive sector making both an output and a consumption good.

Classical view that forces or mechanisms exist to restore a position of full employment. Income that is not spent for consumption purposes is savings (That which is left over from the expenditure screen of consumers). it only influences the general level of prices.Synoptic View: a) All unemployment can be largely construed as voluntary and fits into three categories: 1) 2) 3) Frictional – time lag between jobs Search – idea is that workers may quit existing job to try to find another Money-wage stickiness –real-wage is too high because money-wages don’t adjust and this goes back to the notion that workers refuse to accept money-wage cuts. It will have no effect on the real output and employment of the economy. c) Money is neutral – if we increase the quantity of money. If you didn’t have any interference or government intervention. you would have a tendency to move to full employment (they would still admit there could be lags or leaks in the system). . d) The interest rate functions to clear the loanable funds market. b) The Economic System is self-adjusting to full employment. but it does not affect the real output of the economy. It will have no effect on relative prices. Interest rates should bring savings and investment in conjunction with one another. Savings would then go to capital accumulation. e) Savings drive economic growth.

KEYNESIAN SCHOOL OF THOUGHT .

and Vittorio Orlando of Italy). then took a leave of absence to work for the British Treasury. which also included Virginia Woolf and Bertrand Russell. He resigned because he thought the Treaty of Versailles was overly burdensome for the Germans. Keynes wrote: “The Council of Four paid no attention to these issues [which included making Germany and Austro-Hungary into good neighbors]. He remained there for another year to study under ALFRED MARSHALL and ARTHUR PIGOU.John Maynard Keynes: Keynes was born in Cambridge and attended King’s College. and . politically unstable. where he earned his degree in mathematics in 1905. John Neville Keynes. We now know that Keynes was right. being preoccupied with others—Clemenceau to crush the economic life of his enemy. the President to do nothing that was not just and right” In the 1920s Keynes was a believer in the quantity theory of money (today called MONETARISM). Marshall and Pigou. he returned to Cambridge to resume teaching. While there. In 1923 he wrote Tract on Monetary Reform. President Woodrow Wilson of the United States. and later he published Treatise on Money. The amounts demanded by the Allies were so large. survived by his father. in which he described the workings of India’s monetary system. that a Germany that tried to pay them would stay perpetually poor and. Keynes took a position with the civil service in Britain. Cambridge. he wrote. His writings on the topic were essentially built on the principles he had learned from his mentors. Keynes died on April 21. Lloyd George to do a deal and bring home something which would pass muster for a week. he collected the material for his first book in economics. He worked his way up quickly through the bureaucracy and by 1919 was the Treasury’s principal representative at the peace conference at Versailles. After resigning. Keynes’s book contains an insightful analysis of the Council of Four (Georges Clemenceau of France. 1946. also a renowned economist in his day. Indian Currency and Finance. After leaving Cambridge. Besides its excellent economic analysis of reparations. His major policy view was that the way to stabilize the economy is to stabilize the price level. A prominent journalist and speaker. He returned to Cambridge in 1908 as a lecturer. both on MONETARY POLICY. In 1925 he married the Russian ballet dancer Lydia Lopokova. Keynes was one of the famous Bloomsbury Group of literary greats. whose scholarship on the quantity theory of money led to Keynes’s Tract on Monetary Reform many years later. At the 1944 Bretton Woods Conference. therefore. Keynes was one of the architects of the postwar system of fixed exchange rates (see FOREIGN EXCHANGE). Prime Minister David Lloyd George of Britain. where the International Monetary Fund was established. Keynes wrote it to object to the punitive reparations payments imposed on Germany by the Allied countries after World War I. Keynes became a celebrity before becoming one of the most respected economists of the century when his eloquent book The Economic Consequences of the Peace was published in 1919. He was made a lord in 1942.

. thought Keynes. Keynes investigated other causes of Britain’s economic woes. they did not let it go. It was Keynes. balanced budgets were standard practice with the government. Keynes was a relatively strong advocate of free markets. while having its roots in The General Theory. in large part. Economists still argue about what Keynes thought caused high unemployment. “apart from the necessity of central controls to bring about an adjustment between the propensity to consume and the inducement to invest. and critiqued. Yet the fact that Keynes is the wellspring for so many outstanding economists is testament to the magnitude and influence of his ideas. INVESTMENT. reaching levels as high as 20 percent. there is no more reason to socialise economic life than there was before” (p. however. But Keynes actually wanted wages not to fall. the market mechanism could then operate freely. in what proportions the factors of production will be combined to produce it. PAUL SAMUELSON. WALTER HELLER. Some think he attributed it to wages that take a long time to fall. William Nordhaus. The study of econometrics was created. not ADAM SMITH. JAMES TOBIN. His ideas have been endlessly revised. to empirically explain Keynes’s macroeconomic models.” Keynes believed that once full employment had been achieved by FISCAL POLICY measures. and because it showed (or purported to show) that full employment could be maintained only with the help of government spending. and aggregate demand. consumption.that to do that the government’s central bank must lower INTEREST RATES when prices tend to rise and raise them when prices tend to fall. It was pathbreaking in several ways. Keynesian economics today. “There is no objection to be raised against the classical analysis of the manner in which private self-interest will determine what in particular is produced. Charles Schultze. who said.S. Keynes’s General Theory revolutionized the way economists think about economics.” continued Keynes. Why shouldn’t government. ROBERT SOLOW. Of course. and The General Theory of Employment. once policymakers had taken deficit spending to heart. as UNEMPLOYMENT in Britain dragged on during the interwar period. Little of Keynes’s original work survives in modern economic theory. he argued. Keynes’s conclusion initially met with opposition. Interest and Money was the result. A general cut in wages. and how the value of the final product will be distributed between them. is chiefly the product of work by subsequent economists including JOHN HICKS. and in fact advocated in the General Theory that wages be kept stable. This would offset any benefits to output that the lower price of labor might have contributed. and government spending. Keynes’s ideas took a dramatic change. and ARTHUR OKUN. in particular because it introduced the notion of aggregate demand as the sum of consumption. Contrary to some of his critics’ assertions. would decrease income. fill the shoes of business by investing in public works and hiring the unemployed? The General Theory advocated deficit spending during economic downturns to maintain full employment. government put people back to work on public works projects. 379). But the idea soon took hold and the U. “Thus. Alan Blinder. At the time. expanded.

KEYNESIAN ECONOMICS serves as a sort of yardstick that can define virtually all economists who came after him. almost all were controversial. .So influential was John Maynard Keynes in the middle third of the twentieth century that an entire school of modern thought bears his name. Many of his ideas were revolutionary.

Through the distribution of the monetary policy. Cecil Pigou. known as Say's law. including John Stuart Mill. states that “supply creates its own demand. Keynes firmly objects to its main theory--adjustments in prices would automatically make demand tend to the full employment level. A central tenet of the classical view. they advocated abolishing minimum wages. Neo-classical theory supports that the two main costs that shift demand and supply are labor and money. until they see other wages falling and a general fall of prices. unions. and not enough consumption. First. This would in turn reduce business sales revenues and expected profits. To Keynes. He also argued that to boost employment.Y. and is therefore indisputable. Keynes argued that the second. he argued that it is not real but nominal wages that are set in negotiations between employers and workers. A second and stronger claim. consumption. so that the aggregate demand for goods would drop. Wages and spending During the Great Depression. as opposed to a barter relationship. If there were more labor than demand for it. nominal wage cuts would be difficult to put into effect because of laws and wage contracts.Keynes and the Classics Keynes sought to distinguish his theories from "classical economics. increasing labor-market flexibility. Keynes sought to develop a theory that would explain determinants of saving. However. real wages had to go down: nominal wages would have to fall more than prices. then interest rates would fall until people either cut their savings rate or started borrowing. to Keynes. However. the determination of wages is more complicated. strong form of Say's Law only holds if increases in individual savings exactly match an increase in aggregate investment. unlike Keynes." by which he meant the economic theories of David Ricardo and his followers. F. the interaction of aggregate demand and aggregate supply determines the level of output and employment in the economy. that the "costs of output are always covered in the aggregate by the sale-proceeds resulting from demand" depends on how consumption and saving are linked to production and investment. the classical theory defined economic collapse as simply a lost incentive to produce. Investment in new plants and equipment—perhaps . even without unions. Alfred Marshall. people will resist nominal wage reductions.” Say's Law can be interpreted in two ways. If there was too much saving. First. and long-term contracts. Edgeworth. Even classical economists admitted that these exist. In particular. doing so would reduce consumer demand. Because of what he considered the failure of the “Classical Theory” in the 1930s. and A. the claim that the total value of output is equal to the sum of income earned in production is a result of a national income accounting identity. investment and production. In that theory. wages would fall until hiring began again. Mass unemployment was caused only by high and rigid real wages. demand and supply can be adjusted. however. First.

and if saving does not immediately fall in step.already discouraged by previous excesses—would then become more risky.e. or pessimistic business expectations. perhaps due to falling consumer demand. This could make the economy spiral downward as those who had money would simply wait as falling prices made it more valuable—rather than spending. less likely. shows this process. (For simplicity. To Keynes. the economy would decline. other sources of the demand for or supply of funds are ignored here. saving beyond planned investment. Second. Instead of raising business expectations. over-investment in earlier years. people would start to expect them to fall. the resulting excess of saving causes interest-rate cuts. wage cuts could make matters much worse. if wages and prices were falling. Further. Excessive saving results if investment falls. . As Irving Fisher argued in 1933. The classical economists argued that interest rates would fall due to the excess supply of "loanable funds". Excessive saving Classics on Saving and Investment. encouraging recession or even depression.) Assume that fixed investment in capital goods falls from "old I" to "new I". deflation (falling prices) can make a depression deeper as falling prices and wages made pre-existing nominal debts more valuable in real terms. abolishing the excess supply: so again we have saving (S) equal to investment. i. was a serious problem. adapted from the only graph in The General Theory. The first diagram. excessive saving. in his Debt-Deflation Theory of Great Depressions. The interest-rate (i) fall prevents that of production and employment.

especially in the short run. since planned fixed investment in plant and equipment is mostly based on long-term expectations of future profitability. because of fear of capital losses on assets besides money. So S and I are drawn as steep (inelastic) in the graph. the equilibrium suggested by the new I line and the old S line cannot be reached. bond-holders. (In this trap. The graph below summarizes his argument. a large interest-rate fall is needed to close the saving/investment gap. that spending does not rise much as interest rates fall. Instead.Keynes had a complex argument against this laissez-faire response.) Even economists who reject this liquidity trap now realize that nominal interest rates cannot fall below zero (or slightly higher). this negative interest rate is not necessary to Keynes's argument. saving does not fall much as interest rates fall. Keynes suggested that there may be a "liquidity trap" setting a floor under which interest rates cannot fall. Third. assuming again that fixed investment falls. In the diagram. (This is not drawn in the graph. the supply of and the demand for the stock of money determine interest rates in the short run. Given the inelasticity of both demand and supply. fear capital losses on their bonds and thus try to sell them to attain money (liquidity). this requires a negative interest rate at equilibrium (where the new I line would intersect the old S line).) Neither changes quickly in response to excessive saving to allow fast interest-rate adjustment. First. Second. As drawn. Keynes on Saving and Investment. since the income and substitution effects of falling rates go in conflicting directions. Finally. . However. Some see this latter kind of liquidity trap as prevailing in Japan in the 1990s. fearing rises in interest rates (because rates are so low). Keynes argued that saving and investment are not the main determinants of interest rates. so that excess saving persists.

Active fiscal policy Keynes's ideas influenced Franklin D. It thus means insufficient demand for business output. In sum. This in turn lowers people's incomes and saving. removed uncertainty. Whereas the classical economists assumed that the level of output and income was constant and given at any one time (except for short-lived deviations). Thus. a recession does so. there is a fourth element to Keynes's critique. the interest-rate change is small. in the depths of the Depression. that is policies which acted against the tide of the business cycle: deficit spending when a nation's economy suffers from recession or when recovery is long-delayed and unemployment is persistently high and the suppression of inflation in boom times by either increasing taxes or cutting back on government outlays. Rather than prices adjusting to attain equilibrium. Keynes saw this as the key variable that adjusted to equate saving and investment.Even if this "trap" does not exist. such as fixed investment. Roosevelt adopted some aspects of Keynesian economics. excessive saving corresponds to an unwanted accumulation of inventories. the United States suffered from recession yet again following fiscal contraction. Rather than seeing unbalanced government budgets as wrong. in the 1960s. This pile-up of unsold goods and materials encourages businesses to decrease both production and employment. and forced the rebuilding of destroyed capital. especially after 1937. This accelerator effect would shift the I line to the left again. which provided a kick to the world economy. the desired demand for factories and equipment (not to mention housing) will fall.S. Keynes advocated what has been called countercyclical fiscal policies. or what classical economists called a general glut. Saving involves not spending all of one's income. the fall in income did most of the job by ending excessive saving and allowing the loanable funds market to attain equilibrium." . we are all dead. to Keynes there is interaction between excess supplies in different markets. a recession undermines the business incentive to engage in fixed investment. During his presidency. Keynes's theory suggested that active government policy could be effective in managing the economy. This recreates the problem of excessive saving and encourages the recession to continue. Keynesian ideas became almost official in social-democratic Europe after the war and in the U. With falling incomes and demand for products. because "in the long run. But to many the true success of Keynesian policy can be seen at the onset of World War II. For Keynes. causing a leftward shift in the S line in the diagram. He argued that governments should solve problems in the short run rather than waiting for market forces to do it in the long run. Instead of interest-rate adjustment solving the problem. when. the main story is one of quantity adjustment allowing recessions and possible attainment of underemployment equilibrium. a change not shown in the diagram above. unless it is balanced by other sources of demand. as unemployment in labor markets encourages excessive saving—and vice-versa. Roosevelt's view that insufficient buying-power caused the Depression. Finally. Thus in the diagram.

tends to exacerbate the negative effects of the business cycle.This contrasted with the classical and neoclassical economic analysis of fiscal policy. and engaging in deficit spending on labor-intensive infrastructure projects to stimulate employment and stabilize wages during economic downturns. by cutting wages. A Keynesian economist might point out that classical and neoclassical theory does not explain why firms acting as "special interests" to influence government policy are assumed to produce a negative outcome. and removing income and profits from the economy through cuts in spending and/or increased taxes during downturns. Thus. crowding out is minimal.] An example of a countercyclical policy is raising taxes to cool the economy and to prevent inflation when there is abundant demand-side growth. but government imposes its will by force. Deficit spending is not Keynesianism. there must be significant slack in the labor market before fiscal expansion is justified. spurring business optimism. Second. Second. The Keynesian response is that such fiscal policy is only appropriate when unemployment is persistently high. creating persistent supply-side or classical unemployment. a government deficit increases the stock of government bonds. In that case. or "NAIRU". raising cash flow and profitability. busting unions. above what is now termed the Non-Accelerating Inflation Rate of Unemployment. decreasing happiness. unless labor unions or the government "meddle" in the free market. argues that one should cut taxes when there are budget surpluses. Fiscal stimulus (deficit spending) could actuate production. hurting profitability. less likely. This effect is . and cut spending or. Classical economics. reducing their market price and encouraging high interest rates. making it more expensive for business to finance fixed investment. as the stimulus occurs. education. e.[citation needed] Keynesian economists believe that adding to profits and incomes during boom cycles through tax cuts. government spending on such things as basic research. and infrastructure could help the long-term growth of potential output. Finally. and deregulating business. Their solution is to increase labormarket flexibility. efforts to stimulate the economy would be self-defeating. free trade increases net happiness. public health. raising the amount of saving. Both conservative and some neoliberal economists question this assumption. private investment can be "crowded in": fiscal stimulus raises the market for business output. increase taxes during economic downturns. That is. while firms that respond to the free market do net good. while those same firms acting with the same motivations outside of the government are supposed to produce positive outcomes. Therefore firms that manipulate the government do net harm. gross domestic product rises. on the other hand. But to these schools. In Keynes' theory. Libertarians counter that because both parties consent.g. there was no reason to believe that this stimulation would outrun the side-effects that "crowd out" private investment: first. it would increase the demand for labor and raise wages.. helping to finance the increase in fixed investment. government outlays need not always be wasteful: government investment in public goods that will not be provided by profit-seekers will encourage the private sector's growth. To Keynes. Keynesianism recommends counter-cyclical policies to smooth out fluctuations in the business cycle. this accelerator effect meant that government and business could be complements rather than substitutes in this situation. Further.

The people who receive this money then spend most on consumption goods and save the rest. Under conditions such as the Great Depression. "Multiplier effect" and interest rates Two aspects of Keynes' model had implications for policy: First. In the classical model. the supply of funds (saving) determined the amount of fixed business investment. so that the multiplier process tapers off and allows the attainment of an equilibrium. Postwar Keynesianism After Keynes. To Keynes. But during more "normal" times. A government could stimulate a great deal of new production with a modest outlay if: 1. monetary expansion can stimulate the economy. governments prepared good quality economic statistics on an ongoing basis and had a theory that told them what to do. That is. which in turn allows a further increase consumer spending. the amount of investment was determined independently by long-term profit expectations and. Keynes's policy ideas were widely accepted. and is therefore one reason fiscal conservatives advocate a much smaller government. the amount of savings determined the amount that was available to invest. For the first time. The latter opens the possibility of regulating the economy through money supply changes. to a lesser extent. increases total spending by a multiple of that increase. This process continues. there is the "Keynesian multiplier". such as an increase in government outlays. In the post-WWII years. . the economy would behave as classical or neoclassical theory predicted. mostly by encouraging construction of new housing. Keynes re-analyzed the effect of the interest rate on investment. This extra spending allows businesses to hire more people and pay them. At each step. 2.especially pronounced when the government controls a large fraction of the economy. Keynes argued that this approach would be relatively ineffective compared to fiscal policy. In this era of new liberalism and social democracy. Exogenous increases in spending. first developed by Richard F. since all savings was placed in banks. via monetary policy. Kahn in 1931. most western capitalist countries enjoyed low. and all business investors in need of borrowed funds went to banks. the increase in spending is smaller than in the previous step. Keynesian analysis was combined with neoclassical economics to produce what is generally termed the "neoclassical synthesis" which dominates mainstream macroeconomic thought. Though it was widely held that there was no strong automatic tendency to full employment. Second. stable unemployment and modest inflation. the interest rate. many believed that if government policy were used to ensure it. This story is modified and moderated if we move beyond a "closed economy" and bring in the role of taxation: the rise in imports and tax payments at each step reduces the amount of induced consumer spending and the size of the multiplier effect.

that an increase in the money supply would raise output and employment—and then use the Phillips curve to predict an increase in inflation. and decreased unemployment. the government budget. utilized also as a critique of the notably high unemployment and potentially disappointing GNP growth rates associated with the latter two theories by the mid-1980s. one strategy. During this time. and the rise throughout the 1970s of ideas based upon more classical analysis. moderate degrees of government demand leading industrial development. the IS-LM model is nearly as influential as Keynes' original analysis in determining actual policy and economics education.e. This encouraged a much more static vision of macroeconomics than that described above. and reached a peak in the "go go" 1960s. Thus. the economist could use the IS-LM model to predict. At the same time Keynesians began during the period to reorganize their thinking (some becoming associated with New Keynesian economics). and the economic problems of the 1970s. with the oil shock of 1973. and use of fiscal and monetary counter-cyclical policies continued. many economies experienced high and rising unemployment. . contradicting the Phillips curve's prediction. not a higher inflation rate. It relates aggregate demand and employment to three exogenous quantities. and its overall rate kept lower and steadier by such potential policies as Martin Weitzman's share economy). supply-side economics[citation needed] and new classical economics. including monetarism. This stagflation meant that the simultaneous application of expansionary (anti-recession) and contractionary (antiinflation) policies appeared to be necessary. Keynes had only predicted that falling unemployment would cause a higher price. This model was very popular with economists after World War II because it could be understood in terms of general equilibrium theory. coupled with high and rising inflation. where it seemed to many Keynesians that prosperity was now permanent. which was more of an empirical observation than a theory. This curve. the amount of money in circulation. for example. a clear impossibility. modern liberal economics began to fall out of favor. and the state of business expectations. However. implied increased inflation. This dilemma led to the end of the Keynesian near-consensus of the 1960s. The second main part of a Keynesian policy-maker's theoretical apparatus was the Phillips curve. i.. was to emphasize low unemployment and maximal economic growth at the cost of somewhat higher inflation (its consequences kept in check by indexing and other methods. Through the 1950s. indicated that increased employment.It was with John Hicks that Keynesian economics produced a clear model which policymakers could use to attempt to understand and control economic activity. This model.

S. A series of major bailouts followed. President Obama unveiled a plan for extensive domestic spending to combat recession. prompting a bank run. when the IMF forced it to close 16 banks simultaneously. and quoted Josef Ackermann. Prominent Keynesian economists included Paul Krugman.S.. Peru. Keynesian thinking was reflected in U. Macro economist James K. Robert Reich and Joseph Stiglitz.The recent revival of Keynes In the wake of the financial crisis of 2007-2008 the free-market consensus began to attract negative comment even by mainstream opinion formers from the economic right. free-market guru Martin Wolf. There had been extensive . In October. but later encouraged skepticism about a fiscal stimulus.. D. In a speech on January 8 2009. in accordance with Keynesian economic thought. further reflecting Keynesian thinking. in November 2008. IMF and United Nations economists and political leaders such as British Prime Minister Gordon Brown advocated a coordinated international approach to fiscal stimulus." Shortly afterward economist Robert Shiller began advocating robust government intervention to tackle the financial crisis. In March 2008. The plan was signed by the President on 17 February 2009.C. government was to nationalize the two firms which oversaw most of the U. Timothy F. sub prime mortgage market—Fannie Mae and Freddie Mac. announced the death of the dream of global free-market capitalism. the British Chancellor of the Exchequer referred to Keynes as he announced plans for substantial fiscal stimuli to head off the worst effects of recession. Geithner and Christina Romer to principal economic positions in his administration. starting on September 7 with the announcement that the U. The President of the World Bank. as saying "I no longer believe in the market's self-healing power. which he had helped to create at Bretton Woods in 1944. The works on Keynes of Hyman Minsky. This is in stark contrast to the scope given to Indonesia during its financial crisis of 1997. and which many argued should be reformed at a "new Bretton Woods". advocated that all developed country pledge 0. by the U.S.7 percent of its stimulus package to a vulnerability fund for assisting developing countries. and in coordinated reductions of interest rates by many countries in November and December 2008. Galbraith used the 25th Annual Milton Friedman Distinguished Lecture to launch a sweeping attack against the consensus for monetarist economics and argued that Keynesian economics were far more relevant for tackling the emerging crises. President Barack Obama's appointing Lawrence Summers. Robert Zoellick. Similar policies have been announced in other European countries. Much discussion reflected Keynes's advocacy of international coordination of fiscal or monetary stimulus. Greg Mankiw argued that Keynes was the economist who provided the greatest single insight into the crisis.This was evident at the G20 and APEC meetings in Washington. and of international economic institutions such as the International Monetary Fund and World Bank. and by China.S. chief economics commentator at the Financial Times. specifically citing Keynes. chief executive of Deutsche Bank. and Lima. Robert Skidelsky. and Donald Markwellwere widely cited.

the governor of the People's Bank of China revived Keynes's idea of a centrally managed global reserve currency. Dr Zhou proposed a gradual move towards adopting IMF Special Drawing Rights (SDRs) as a centrally managed global reserve currency . In a speech delivered in March 2009 entitled Reform the International Monetary System. adequacy. Zhou Xiaochuan. He argued that national currencies were unsuitable for use as global reserve currencies as a result of the Triffin dilemma . Dr Zhou argued that it was unfortunate that Keynes's Bancor proposal was not accepted at Bretton Woods in the 1940s.debate in Congress concerning the necessity. A renewed interest in Keynesian ideas was not limited to western countries. which saw it being cut from $819 to $787 billion during its passage through the Senate. and likely effects of the package.the difficulty faced by reserve currency issuers in trying to simultaneously achieve their domestic monetary policy goals and meet other countries' demand for reserve currency.

Sign up to vote on this title
UsefulNot useful