- The first point to note is that the infamous economist, John Maynard Keynes, is important because he was responsible for diving macroeconomic field of inquiry.
- The second is that the macroeconomic field of inquiry concerns four main economic aggregates; unemployment, inflation, productivity and GDP rates (growth).
Short term vs Long Run
Short-term analysis = divergence between actual level of output and potential level of output, so basically studying output gap. Fluctuations and study of it are called business cycle and these are two part of the short-term.
Long term analysis: Path followed by the potential output in a period of 10 years or more. What drives economic growth?
Stable business cycles v Growth...
- Stable business cycles are preferred because it is predictible, better confidence levels and less resources will be wasted (particularly unemployment). Both Classicists and Keynesians agree stable is better than unstable, where they differ is the policies which should be implemented.
What is the method of macroeconomics?
- Economists do not agree on policies because different schools approach economics on different ideologies. They differ even on the fundamentals such as out of the four main study points which is the most important and which is the least.
- Two main schools of economics exist and those are Neo-Classical economists, then of course you have Keynesians and the other Heterodox economics (such as post-Keynesian - they follow Keynesian but differentiate from neo-classicalism, marxism, Austrian, Sraffian, complexity theory, evolutionary economics etc).
- Note there is a difference between Keynesian and post-Keynesian.
Main features of the Neoclassical of macroeconomic methodology
- Macroeconomics can be found as aggregation of microeconomics based on 2 assumption as seen below.
- Methodological individualism - understanding of economy as being composed of self-interest individuals who are rational who want to maximize utility subject to resource constraints. This is why macroeconomics is micro founded.
- Existence of general equilibrium - Individuals are rational and self-interested so markets will always end up at an equilibrium where demand = supply (link to invisible hand theory). When all the markets are in equilibrium the whole economy is in what they call a "general equilibrium". This is demonstrated mathematically by Leon Walrus by beginning of 20th century - he identified a price vector (list of prices) and proved its mathematical existence.
- The primary concern regarding the analysis is market exchange - i.e. the consequence of assumptions that markets are self-regulating.
- Legitimacy of the assumption, neglect of the role of structures and mechanisms (i.e. governments) - the assumptions do not hold - perhaps individuals are not rational and self-interest, markets are perfectly competitive etc. methodological individualism fails to recognize that consumers may be affected by external features
- Trade-off between static efficiency and dynamic changes? - their study is focused upon static analysis even though we know things do not change they evolve. Conflict between static and dynamic goals and this is not recognized by neo-classical economics.
Main features of Keynesian methodology
- Macroeconomics is not aggregation of microeconomics.
- You need a separate theory for macro which has its own method, providing a holistic approach
- Introduction of uncertainty in analysis - economic agents are uncertain about the future and this affects behavior. Existence of uncertainty is why individual behavior cannot be used and aggregated.
- Expectations that people have and it is on basis of this economic agents make decisions. Investment decisions of firms are also based on expectations.
- Focus is on long-term and that it is affected by the short-term and expectations of people. He said business cycle affects long-term economic growth as it affects things like investment levels, confidence etc.