History of macroeconomic thought

Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.

The generation of economists that followed Keynes synthesized his macroeconomic framework with neoclassical microeconomics, a development that became known as the neoclassical synthesis. While early Keynesian theory did not provide a detailed explanation of price level dynamics or inflation, later Keynesian economists incorporated the Phillips curve to describe the relationship between unemployment and changes in prices.

Within the Keynesian tradition, some economists criticized the synthesis approach of combining Keynes's insights with an equilibrium framework, instead advocating disequilibrium models. In parallel, monetarist economists—most prominently Milton Friedman—adopted elements of Keynesian analysis, such as the importance of demand for money, but argued that Keynesian theory underestimated the influence of the money supply on inflation.

In the 1970s, Keynesian models came under further criticism from Robert Lucas and other proponents of new classical macroeconomics. They emphasized the role of rational expectations, contending that Keynesian frameworks which ignored forward-looking behavior were theoretically inconsistent. Lucas also introduced the Lucas critique, arguing that Keynesian empirical models lacked stability compared to models explicitly grounded in microeconomic foundations.

The new classical school culminated in real business cycle theory (RBC). Like early classical economic models, RBC models assumed that markets clear and that business cycles are driven by changes in technology and supply, not demand. New Keynesians tried to address many of the criticisms leveled by Lucas and other new classical economists against Neo-Keynesians. New Keynesians adopted rational expectations and built models with microfoundations of sticky prices that suggested recessions could still be explained by demand factors because rigidities stop prices from falling to a market-clearing level, leaving a surplus of goods and labor. The new neoclassical synthesis combined elements of both new classical and new Keynesian macroeconomics into a consensus. Other economists avoided the new classical and new Keynesian debate on short-term dynamics and developed the new growth theories of long-run economic growth. The Great Recession led to a retrospective on the state of the field and some popular attention turned toward heterodox economics.