{{Short description|Study of an economy as a whole}} {{distinguish|Microeconomics}} [[File:Circulation in macroeconomics.svg|thumb|250px|Production and national income: Macroeconomics takes a big-picture view of the entire economy, including examining the roles of, and relationships between, firms, households and governments, and the different types of markets, such as the financial market and the labour market.]] {{Macroeconomics sidebar}} '''Macroeconomics''' is a branch of [[economics]] that deals with the performance, structure, behavior, and decision-making of an [[economy]] as a whole.<ref> {{cite news| last1 = Samuelson| first1 = Robert| author1-link = Robert J. Samuelson| title = Goodbye, readers, and good luck — you'll need it| newspaper= [[The Washington Post]] | year = 2020| url = https://www.washingtonpost.com/opinions/2020/09/13/robert-samuelson-goodbye-column/?arc404=true }} This article was an opinion piece expressing despondency in the field shortly before his retirement, but it is still a good summary.</ref><ref>{{Cite web |title=What is macroeconomics? |url=https://www.federalreserve.gov/faqs/what-is-macroeconomics.htm |access-date=2025-12-08 |website=Board of Governors of the Federal Reserve System |language=en}}</ref> This includes regional, national, and [[global economies]].<ref>{{cite book| last1 = O'Sullivan| first1 = Arthur| author1-link = Arthur O'Sullivan (economist)| last2 = Sheffrin| first2 = Steven M. | title = Economics: Principles in Action| publisher = Pearson Prentice Hall| year = 2003| location = Upper Saddle River, New Jersey | page = 57| isbn = 978-0-13-063085-8}}</ref><ref>Steve Williamson, [http://www.econ.yale.edu/smith/econ510a/notes99.pdf Notes on Macroeconomic Theory], 1999</ref> Macroeconomists study aggregate measures of the economy, such as [[output (economics)|output]] or [[gross domestic product]] (GDP), [[national income]], [[unemployment]], [[inflation]], [[Consumption (economics)|consumption]], [[saving]], [[investment (macroeconomics)|investment]], or trade.<ref name=":1">{{Cite web |title=Micro and Macro: The Economic Divide |url=https://www.imf.org/en/publications/fandd/issues/series/back-to-basics/micro-and-macro |access-date=2025-12-08 |website=IMF |language=en}}</ref> Macroeconomics is primarily focused on questions that help to understand aggregate variables in relation to long-run [[economic growth]].<ref>{{Cite book |last=Taylor |first=John B. |url=https://api.pageplace.de/preview/DT0400.9780444594785_A29000711/preview-9780444594785_A29000711.pdf |title=Handbook of Macroeconomics |last2=Uhlig |first2=Harald |publisher=[[Elsevier]] |year=2016 |isbn=978-0-444-59469-3 |edition=Vol 2A |location=Amsterdam |pages=4-5 |access-date=December 8, 2025 |url-status=live |archive-url=https://web.archive.org/web/20251209221603/https://api.pageplace.de/preview/DT0400.9780444594785_A29000711/preview-9780444594785_A29000711.pdf |archive-date=9 Dec 2025}}</ref>
Macroeconomics and [[microeconomics]] are the two most general [[Academic discipline|fields]] in economics.<ref name="blaug1985">{{Citation|author=Blaug, Mark|title=Economic theory in retrospect|year=1985|location=Cambridge|publisher=[[Cambridge University Press]]|isbn=978-0-521-31644-6}}</ref> Given macroeconomists focus on large-scale phenomena, or aggregate variables, they differ significantly from microeconomists who study markets and decision making at a smaller level of analysis, such as firms or consumers. This divide is institutionalized in the field of economics, given the differences in both [[Research method|methods]] and outcomes of interest.<ref name=":1" />
Macroeconomics is further divided into topics based on the time frame of analysis: '''short-term''' fluctuations over the [[business cycle]], '''medium-term''' determinants of aggregate variables, such as unemployment, that are unaffected by short-term shocks, and '''long-term''' economic growth. The field also includes analysis of [[Monetary policy|monetary]] and [[Fiscal policy|fiscal policies]], particularly where they target [[Economic policy|stabilization]] of certain indicators or the rate of economic growth.
Macroeconomics, as a separate field of research and study, is generally recognized to have begun in 1936, when [[John Maynard Keynes]] published his ''[[The General Theory of Employment, Interest and Money]]'', but its intellectual predecessors are much older.<ref name=":1" /> Swedish economist [[Knut Wicksell]] wrote the book ''[[Knut Wicksell|Interest and Prices]]'' (1898), translated into English in 1936, is considered to be the pioneer of macroeconomics, while [[John Maynard Keynes|Keynes]] who introduced [[national income accounting]] and various related concepts can be said to be the founding father of macroeconomics as a formal discipline. Since [[World War II]], various macroeconomic schools of thought like [[Keynesians]], [[monetarists]], [[new classical economics|new classical]] and [[New Keynesian economics|new Keynesian economists]] have made contributions to the development of the [[Mainstream economics|mainstream research]].
==Basic concepts== Macroeconomics encompasses a variety of concepts and variables, but above all, the three central macroeconomic variables are output, unemployment, and inflation.<ref name=Blanchard>Blanchard (2021).</ref>{{rp|39}} Besides, the time horizon varies for different types of macroeconomic topics, and this distinction is crucial for many research and policy debates.<ref name=Blanchard/>{{rp|54}} A further important dimension is that of an economy's openness, economic theory distinguishing sharply between [[closed economies]] and [[open economy|open economies]].<ref name=Blanchard/>{{rp|373}}
It is usual to distinguish between three time horizons in macroeconomics, each having its own focus on, e.g., the determination of output:<ref name=Blanchard/>{{rp|54}} * the short run (e.g., a few years): Focus is on [[business cycle]] fluctuations and changes in [[aggregate demand]], which often drive them. [[Stabilization policy|Stabilization policies]] like [[monetary policy]] or [[fiscal policy]] are relevant in this time frame * the medium run (e.g., a decade): Over the medium run, the economy tends to an output level determined by supply factors like the capital stock, the technology level, and the labor force, and unemployment tends to revert to its structural (or "natural") level. These factors move slowly, so that it is a reasonable approximation to take them as given on a medium-term time scale, though [[labour market policies]] and [[competition policy]] are instruments that may influence the economy's structures and hence also the medium-run equilibrium * the long run (e.g., a couple of decades or more): On this time scale, emphasis is on the determinants of long-run [[economic growth]] like [[capital accumulation|accumulation]] of human and physical capital, technological innovations, and [[demographic change]]s. Potential policies to influence these developments include [[education reform]], incentives to change [[saving rate]]s, or incentives to increase [[R&D]] activities.
===Output and income=== National [[Output (economics)|output]] is the total amount of everything a country produces in a given period of time. Everything that is produced and sold generates an equal amount of income. The total [[net output]] of the economy is usually measured as GDP. Adding net [[factor income]]s from abroad to GDP produces [[gross national income]] (GNI), which measures the total income of all residents in the economy. In most countries, the difference between GDP and GNI is modest so that GDP can be treated as the total income of all inhabitants as well; however, in some countries, e.g., those with very large [[net foreign assets]] (or debt), the difference may be considerable.<ref name=Blanchard/>{{rp|385}}
Advances in technology, accumulation of machinery and other [[Capital (economics)|capital]], and better education and [[human capital]], are all factors that lead to increased economic output over time. However, output does not always increase consistently over time. [[Business cycle]]s can cause short-term drops in output called [[recession]]s. Economists look for [[#Macroeconomic policy|macroeconomic policies]] that prevent economies from slipping into either [[recession]]s or [[Overheating (economics)|overheating]] and that lead to higher [[productivity]] levels and [[standards of living]].
===Unemployment=== {{Main|Unemployment}}
[[File:Okuns law differences 1948 to mid 2011.png|thumb|left|A chart using US data showing the relationship between economic growth and unemployment expressed by [[Okun's law]]. The relationship demonstrates cyclical unemployment. High short-run GDP growth leads to a lower unemployment rate.]]
The amount of [[unemployment]] in an economy is measured by the unemployment rate, i.e., the percentage of persons in the [[labor force]] who do not have a job, but who are actively looking for one. People who are retired, pursuing education, or [[discouraged worker|discouraged from seeking work]] due to a lack of job prospects are not part of the labor force and, consequently, are not counted as unemployed either.<ref name=Blanchard/>{{rp|156}}
Unemployment has a short-run cyclical component which depends on the business cycle, and a more permanent structural component, which can be loosely thought of as the average unemployment rate in an economy over extended periods,<ref name=Romer>Romer (2019).</ref> and which is often termed the [[Natural rate of unemployment|natural]]<ref name=Romer/> or structural<ref name=Sørensen>Sørensen and Whitta-Jacobsen (2022).</ref><ref name=Blanchard/>{{rp|167}} rate of unemployment.
[[Unemployment#Cyclical unemployment|Cyclical unemployment]] occurs when growth stagnates. [[Okun's law]] represents the empirical relationship between unemployment and short-run GDP growth.<ref>Dwivedi, 445–46.</ref> The original version of Okun's law states that a 3% increase in output would lead to a 1% decrease in unemployment.<ref>{{Cite web |title=Neely, Christopher J. "Okun's Law: Output and Unemployment. ''Economic Synopses''. Number 4. 2010. |url=http://research.stlouisfed.org/publications/es/10/ES1004.pdf.}}</ref>
The structural or [[natural rate of unemployment]] is the level of unemployment that will occur in a medium-run equilibrium, i.e., a situation with a cyclical unemployment rate of zero. There may be several reasons why there is some positive unemployment level even in a cyclically neutral situation, which all have their foundation in some [[market failure]]:<ref name=Romer/>
* [[Search unemployment]] (also called frictional unemployment) occurs when workers and firms are heterogeneous, and there is [[imperfect information]], generally causing a time-consuming [[Search and matching theory (economics)|search and matching process]] when filling a job vacancy in a firm, during which the prospective worker will often be unemployed.<ref name=Romer/><ref>Dwivedi, 443.</ref> Sectoral shifts and other reasons for a changed demand from firms for workers with particular skills and characteristics, which occur continually in a changing economy, may also cause more search unemployment because of increased mismatch.<ref name=Mankiw>Mankiw (2022).</ref><ref>{{Cite web |title=Freeman (2008) |url=http://www.dictionaryofeconomics.com/article?id=pde2008_S000311.}}</ref><ref>Dwivedi, 444–45.</ref> * [[Efficiency wage]] models are labor market models in which firms choose not to lower wages to the level where supply equals demand because the lower wages would lower employees' efficiency levels<ref name=Mankiw/> * [[Trade unions]], which are important actors in the labor market in some countries, may exercise [[market power]] to keep wages over the market-clearing level for the benefit of their members, even at the cost of some unemployment * Legal [[minimum wage]]s may prevent the wage from falling to a market-clearing level, causing unemployment among low-skilled (and low-paid) workers.<ref name=Mankiw/><ref>{{Cite web|last=Pettinger|first=Tejvan|title=Involuntary unemployment|url=https://www.economicshelp.org/blog/glossary/involuntary-unemployment/|access-date=2020-09-21|website=Economics Help|language=en-GB}}</ref> In the case of employers having some [[monopsony power]], however, employment effects may have the opposite sign.<ref>{{Cite journal |last1=Dickens |first1=Richard |last2=Machin |first2=Stephen |last3=Manning |first3=Alan |date=January 1999 |title=The Effects of Minimum Wages on Employment: Theory and Evidence from Britain |url=https://www.journals.uchicago.edu/doi/10.1086/209911 |journal=Journal of Labor Economics |language=en |volume=17 |issue=1 |pages=1–22 |doi=10.1086/209911 |s2cid=7012497 |issn=0734-306X}}</ref>
===Inflation and deflation=== [[File:M2 and Inflation USA.svg|thumb|right|Changes in the ten-year moving averages of price level and growth in money supply (using the measure of M2, the supply of hard currency and money held in most types of bank accounts) in the US from 1880 to 2016. Over the long run, the two series show a clear positive correlation.]] A general price increase across the entire economy is called [[inflation]]. When prices decrease, there is [[deflation]]. Economists measure these changes in prices with [[price index]]es. Inflation will rise when an economy overheats and grows too quickly. Similarly, a declining economy can lead to decreasing inflation and, in some cases, deflation.
Changes in the inflation rate may result from several factors. Too much [[aggregate demand]] in the economy will cause an [[Overheating (economics)|overheating]], raising inflation rates via the [[Phillips curve]] because of a tight labor market leading to large wage increases which will be [[Pass-through (economics)|transmitted]] to increases in the price of the products of employers. Too little aggregate demand will have the opposite effect of creating more unemployment and lower wages, thereby decreasing inflation. Aggregate [[supply shock]]s will also affect inflation, e.g., the [[1970s energy crisis|oil crises of the 1970s]] and the [[2021–2023 global energy crisis]]. Changes in inflation may also impact the formation of [[inflation expectations]], creating a self-fulfilling inflationary or deflationary spiral.<ref name=Blanchard/>
The [[monetarist]] [[quantity theory of money]] holds that changes in the price level are directly caused by changes in the [[money supply]].{{sfn|Mankiw|2022|p=98}} [[Central bank]]ers conducting [[monetary policy]] usually have as a main priority to avoid too high inflation, typically by adjusting interest rates. High inflation, as well as deflation, can lead to increased uncertainty and other negative consequences, particularly when inflation (or deflation) is unexpected. Consequently, most central banks aim for a positive, but stable and not very high inflation level.<ref name="Blanchard" />
Whereas there is empirical evidence that there is a long-run positive [[correlation]] between the growth rate of the money stock and the rate of inflation, the quantity theory has proved unreliable in the short- and medium-run time horizon relevant to monetary policy and is abandoned as a practical guideline by most central banks today.<ref name="Graff">{{cite journal |last1=Graff |first1=Michael |title=The quantity theory of money in historical perspective |url=https://www.research-collection.ethz.ch/handle/20.500.11850/124095 |journal=Kof Working Papers |publisher=KOF Swiss Economic Institute, ETH Zurich |access-date=3 September 2023 |date=April 2008|volume=196 |doi=10.3929/ethz-a-005582276 }}</ref>
=== GDP Measurement ===
==== Equation Using Expenditure Approach ==== One way to capture GDP, or total net output, is the expenditure method. The expenditure approach requires aggregating four main components of spending: [[consumer spending]] (CS) [[government spending]] (GS), [[Investment (macroeconomics)|investment]] (IS), and [[Balance of trade|net exports]] (EXP-IMP).<ref>{{Cite web |title=Calculating GDP With the Expenditure Approach |url=https://www.investopedia.com/ask/answers/070615/how-do-you-calculate-gdp-expenditures-approach.asp |access-date=2025-02-25 |website=Investopedia |language=en}}</ref> CS is composed of household purchases of goods and services, including investments in residential housing. GS is government spending on goods and services, particularly in areas such as [[education]], the [[Military budget|military]], and other [[Infrastructure|public infrastructure]]. While transfer payments, which include things like [[Welfare spending|welfare]] or [[Social Security (United States)|social security payments]], are paid by the government, they are not included in the final calculation of the expenditure approach because they are not a [[Final good|final good or service]]. IS is all spending by businesses on physical [[Capital goods|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:
<math>GDP = CS + GS + IS + (EXP-IMP)</math>
==== GDP Deflator ==== 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 [[Real and nominal value|inflation adjustment]]<nowiki/>for a given year.
<math>GDP^{adj} = (GDP^{ nom} /GDP^{ real}) \cdot 100</math><ref>{{Cite web |title=GDP Deflator {{!}} Formula + Calculator |url=https://www.wallstreetprep.com/knowledge/gdp-deflator/ |access-date=2025-02-25 |website=Wall Street Prep |language=en}}</ref>
Where the term <math>GDP^{ nom} </math> captures [[nominal GDP]], or the standard measure of the total value of goods and services in a given year at that year's prices.<ref>{{Cite web |title=Nominal gross domestic product (GDP) |url=https://www.oecd.org/en/data/indicators/nominal-gross-domestic-product-gdp.html |access-date=2025-12-08 |website=OECD |language=en}}</ref> <math>GDP^{ real} </math> captures [[Real gross domestic product|real GDP]], or the inflation-adjusted measure of all goods and services produced in the economy.<ref>{{Cite web |date=2025-09-25 |title=Real Gross Domestic Product |url=https://fred.stlouisfed.org/series/GDPC1 |access-date=2025-12-08 |website=fred.stlouisfed.org |language=en}}</ref>
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 === Two common ways of determining the [[Money supply|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 capital|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 fund|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.<ref>{{Cite web |title=Deposit Multiplier vs. Money Multiplier: What's the Difference? |url=https://www.investopedia.com/ask/answers/062615/what-difference-between-deposit-multiplier-and-money-multiplier.asp |access-date=2025-04-30 |website=Investopedia |language=en}}</ref>
The [[Money multiplier|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|reserve requirement ratio]]'''<ref>{{Cite web |title=What Is the Multiplier Effect? Formula and Example |url=https://www.investopedia.com/terms/m/multipliereffect.asp#toc-money-supply-multiplier-effect |access-date=2025-04-29 |website=Investopedia |language=en}}</ref>
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===
[[Open economy]] macroeconomics deals with the consequences of [[international trade]] in [[goods]], [[financial asset]]s, and possibly [[factor market]]s 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 rate]]s 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 area]]s.<ref name="Blanchard" />
==History== {{main|History of macroeconomic thought}}
[[File:John Maynard Keynes.jpg|thumb|right|[[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.<ref name=Dimand/><ref>Snowdon and Vane (2005).</ref><ref name=Blanchard/>{{rp|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.<ref name=Dimand/> But naturally, several of the themes which are central to macroeconomic research had been discussed by thoughtful economists and other writers long before 1936.<ref name=Dimand/>
===Before Keynes=== In particular, macroeconomic questions before Keynes were the topic of the two long-standing traditions of [[business cycle|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]].<ref name=Dimand>Dimand (2008).</ref>
===Keynes and Keynesian economics===
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.<ref name=Blanchard/>{{rp|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 (Keynes)|animal spirits]] can play.<ref name=Blanchard/>{{rp|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.<ref name=Blanchard/>{{rp|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.<ref name=Blanchard/>{{rp|527}}
===Monetarism=== [[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.<ref name=Blanchard/>{{rp|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.<ref>{{Cite web|url=https://www.econlib.org/library/Enc/PhillipsCurve.html|title=Phillips Curve: The Concise Encyclopedia of Economics {{!}} Library of Economics and Liberty|website=www.econlib.org|access-date=2018-01-23}}</ref> When the [[1970s energy crisis|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.<ref>{{cite journal |last1=Williamson |first1=Stephen D. |title=The Role of Central Banks |journal=Canadian Public Policy |date=2020 |volume=46 |issue=2 |pages=198–213 |doi=10.3138/cpp.2019-058 |jstor=26974728 |s2cid=219465676 |issn=0317-0861|doi-access=free }}</ref>
===New classical economics=== [[New classical macroeconomics]] further challenged the Keynesian school. A central development in new classical thought came with [[Robert Lucas, Jr.|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.<ref name=Blanchard/>{{rp|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 [[Lucas critique|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 [[Microfoundations|microeconomic foundation]]) that would, in principle, be structurally accurate as economies changed.<ref name=Blanchard/>{{rp|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.<ref name=Blanchard/>{{rp|533}}<ref name=Romer/>{{rp|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 [[Microfoundations|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.<ref name=Romer/>{{rp|194}}
===New Keynesian response=== [[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 (economics)|sticky prices and wages]] due to [[imperfect competition]],<ref>[https://huwdixon.org/SurfingEconomics/chapter4.pdf The role of imperfect competition in new Keynesian economics], Chapter 4 of [https://huwdixon.org/SurfingEconomics/index.html Surfing Economics] by [[Huw Dixon]]</ref> 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 (economist)|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 wage]]s or [[Search and matching theory (economics)|search and matching]] (SAM) models, or imperfections in credit markets like [[Ben Bernanke]].<ref name=Blanchard/>{{rp|532–36}}
By the late 1990s, economists had reached a rough consensus.<ref>Blanchard (2009)</ref> 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]].<ref>{{cite journal |last1=Goodfriend |first1=Marvin |last2=King |first2=Robert G. |title=The New Neoclassical Synthesis and the Role of Monetary Policy |journal=NBER Macroeconomics Annual |date=1997 |volume=12 |pages=231–283 |doi=10.2307/3585232 |jstor=3585232 |url=https://www.jstor.org/stable/3585232 |access-date=8 September 2023}}</ref><ref>{{cite journal |last1=Woodford |first1=Michael |title=Convergence in Macroeconomics: Elements of the New Synthesis |journal=American Economic Journal: Macroeconomics |date=January 2009 |volume=1 |issue=1 |pages=267–279 |doi=10.1257/mac.1.1.267 |url=https://www.aeaweb.org/articles?id=10.1257/mac.1.1.267 |access-date=8 September 2023 |language=en |issn=1945-7707}}</ref> These models are now used by many central banks and are a core part of contemporary macroeconomics.<ref name=Blanchard/>{{rp|535–36}}
===2008 financial crisis=== 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 institution]]s 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 regulation|macroprudential tools]] and the dangers of an [[Fiscal sustainability|unsustainable]] public debt,<ref name=Blanchard/>{{rp|537}}<ref>{{cite journal |last1=Glandon |first1=P. J. |last2=Kuttner |first2=Ken |last3=Mazumder |first3=Sandeep |last4=Stroup |first4=Caleb |title=Macroeconomic Research, Present and Past |journal=Journal of Economic Literature |date=September 2023 |volume=61 |issue=3 |pages=1088–1126 |doi=10.1257/jel.20211609 |url=https://www.aeaweb.org/articles?id=10.1257/jel.20211609 |access-date=8 September 2023 |language=en |issn=0022-0515|url-access=subscription }}</ref> * increased emphasis on [[Applied economics|empirical work]] as part of the so-called [[credibility revolution]] in economics, using improved methods to distinguish between [[Correlation does not imply causation|correlation and causality]] to improve future policy discussions,<ref name=":0">Nakamura and Steinsson (2018) write that macroeconomics struggles with long-term predictions, which is a result of the high complexity of the systems it studies.</ref> * interest in understanding the importance of [[Heterogeneity in economics|heterogeneity]] among the economic agents, leading among other examples to the construction of heterogeneous agent new Keynesian models ([[HANK model]]s), which may potentially also improve understanding of the impact of macroeconomics on the [[income distribution]],<ref>{{cite web |last1=Guvenen |first1=Fatih |title=Macroeconomics with Heterogeneity: A Practical Guide |url=https://www.nber.org/system/files/working_papers/w17622/w17622.pdf |website=www.nber.org |publisher=National Bureau of Economic Research |access-date=8 September 2023}}</ref> * understanding the implications of integrating the findings of the increasingly useful [[behavioral economics]] literature into macroeconomics<ref>{{cite web |last1=Ji |first1=Yuemei |last2=De Grauwe |first2=Paul |title=Behavioural economics is also useful in macroeconomics |url=https://cepr.org/voxeu/columns/behavioural-economics-also-useful-macroeconomics |website=CEPR |publisher=Centre for Economic Policy Research |access-date=8 September 2023 |language=en |date=1 November 2017}}</ref> and behavioral finance.
=== Growth models === Research in the economics of the determinants behind long-run [[economic growth]] has followed its own course.<ref>{{cite book |last1=Howitt |first1=Peter |last2=Weil |first2=David N. |chapter=Economic Growth |chapter-url=https://link.springer.com/referenceworkentry/10.1057/978-1-349-95121-5_2314-1 |title=The New Palgrave Dictionary of Economics |publisher=Palgrave Macmillan UK |pages=1–11 |language=en |doi=10.1057/978-1-349-95121-5_2314-1 |date=2016|isbn=978-1-349-95121-5 }}</ref> The [[Harrod-Domar]] model from the 1940s attempted to build a long-run growth model inspired by Keynesian demand-driven considerations.<ref>{{cite book |last1=Eltis |first1=Walter |chapter=Harrod–Domar Growth Model |chapter-url=https://link.springer.com/referenceworkentry/10.1057/978-1-349-95121-5_1267-1 |title=The New Palgrave Dictionary of Economics |publisher=Palgrave Macmillan UK |pages=1–5 |language=en |doi=10.1057/978-1-349-95121-5_1267-1 |date=2016|isbn=978-1-349-95121-5 }}</ref> 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.<ref>{{Cite web|last=Banton|first=Caroline|title=The Neoclassical Growth Theory Explained|url=https://www.investopedia.com/terms/n/neoclassical-growth-theory.asp|access-date=2020-09-21|website=Investopedia|language=en}}</ref> The model operates with a [[production function]] where national output is the product of two inputs: capital and labor. The Solow model assumes that labor and capital are used at constant rates without the fluctuations in unemployment and capital utilization commonly seen in business cycles.{{sfn|Solow|2002|pp=518–19}} In this model, increases in output, i.e., economic growth, can only occur because of an increase in the capital stock, a larger population, or technological advancements that lead to higher productivity ([[total factor productivity]]). An increase in the savings rate leads to a temporary increase in output as the economy builds more capital. However, eventually the depreciation rate will limit capital expansion: savings will be used to replace depreciated capital, leaving none to pay for additional expansion. Solow's model suggests that economic growth, measured by output per capita, depends solely on technological advances that enhance productivity.{{sfn|Solow|2002|p=519}} The Solow model can be interpreted as a special case of the more general [[Ramsey–Cass–Koopmans model|Ramsey growth model]], where households' savings rates are not constant as in the Solow model, but derived from an explicit intertemporal [[utility function]].
In the 1980s and 1990s, [[endogenous growth theory]] arose to challenge the neoclassical growth theory of Ramsey and Solow. This group of models explains economic growth through factors such as increasing returns to scale in capital and [[Learning-by-doing (economics)|learning-by-doing]] that are endogenously determined, rather than the exogenous technological improvement used to explain growth in Solow's model.{{sfn|Blaug|2002|pp=202–03}} Another type of endogenous growth model endogenizes technological progress by explicitly modelling [[research and development]] activities of profit-maximizing firms.<ref name=Sørensen/>{{rp|280–308}}
==== Climate change in macroeconomics ==== [[File:Diagram of natural resource flows-en.svg|thumb|Natural resources flow through the economy and end up as waste and pollution.]]
Since the 1970s, various environmental problems have been integrated into macroeconomic models, particularly growth models, to study the implications of resource scarcity and global climate change for aggregate economic outcomes. The earliest work tackling the former question of scarcity was presented in [[William Stanley Jevons|William Jevons]]'s 1865 book, ''[[The Coal Question]]'', in which he postulates a paradox whereby productivity improvements may accelerate scarcity in a growing economy.
During the oil crises of the 1970s, when scarcity problems of natural resources were high on the public agenda, economists like [[Joseph Stiglitz]] and [[Robert Solow]] introduced [[non-renewable resource]]s into neoclassical growth models to study the possibilities of maintaining growth in living standards under these conditions.<ref name="Sørensen" />{{rp|201–39}} In 2006, economist [[Nicholas Stern, Baron Stern of Brentford|Nicholas Stern]] published the first comprehensive analysis of the global damages to the economy as a result of projected climate change scenarios in [[Stern Review|The Stern Review.]]<ref>{{Cite web |title=The Economics of Climate Change: The Stern Review |url=https://www.lse.ac.uk/granthaminstitute/publication/the-economics-of-climate-change-the-stern-review/ |access-date=2025-12-08 |website=Grantham Research Institute on climate change and the environment |language=en-GB}}</ref> This paper was the first to develop a model to assess the impact of slow, on-set climate change on GDP. More recently, the issue of [[climate change]] and the possibilities of a [[sustainable development]] are examined in so-called [[Integrated assessment modelling|integrated assessment models]] (IAMs), pioneered by [[William Nordhaus]].<ref>{{cite book |last1=Hassler |first1=J. |last2=Krusell |first2=P. |last3=Smith |first3=A. A. |chapter=Chapter 24 - Environmental Macroeconomics |chapter-url=https://www.sciencedirect.com/science/article/abs/pii/S1574004816300076 |title=Handbook of Macroeconomics |publisher=Elsevier |access-date=9 September 2023 |pages=1893–2008 |date=1 January 2016|volume=2 |doi=10.1016/bs.hesmac.2016.04.007 |isbn=9780444594877 }}</ref> The use of IAMs is now widespread in [[climate economics]], and is used to get both disaggregated, regional assessment of damages, or global damages, under different policy scenarios.
More theoretically, macroeconomic models in [[environmental economics]] model a system in which production takes natural resources such as land, water, or energy as inputs. In this case, one example of an integrated model would replace the [[circular flow of income]] diagram may be replaced by a more complex flow diagram reflecting the input of solar energy, which sustains natural inputs and [[ecosystem services|environmental services]] which are then used as units of [[Production (economics)|production]], such as the early work of [[Herman Daly]].<ref>{{Cite web |last=Daly |first=Herman |date=2022-12-20 |title=Ecological Economics by Herman Daly |url=https://www.localfutures.org/ecological-economics/ |access-date=2025-12-08 |website=Local Futures |language=en-US}}</ref> Once consumed, natural inputs pass out of the economy as pollution and waste. The potential of an environment to provide services and materials is referred to as an "environment's source function", and this function is depleted as resources are consumed or pollution contaminates the resources. The "sink function" describes an environment's ability to absorb and render harmless waste and pollution; when waste output exceeds the sink's capacity, long-term damage occurs.<ref name="Harris2006">Harris J. (2006). ''Environmental and Natural Resource Economics: A Contemporary Approach''. Houghton Mifflin Company.</ref>{{rp|8}}
Many methods for national accounting that include [[Environmental good|environmental goods and services]] as components of economic output remain under discussion.<ref>{{cite book |last= Samans|first= Richard |date=2024 |title= Human-Centred Economics: The Living Standards of Nations (open access) |url=https://richardsamans.net/book-human-centred-economics/ |location= |publisher= Palgrave Macmillan in association with the ILO|access-date=22 April 2025}}</ref>
=== Heterodox macroeconomics === Other branches of macroeconomics that resist mainstream macroeconomic theories are broadly classified as [[heterodox macroeconomics]]. This discipline includes the aforementioned [[ecological economics]], modern monetary theory, [[Marxian economics]], and other schools of thought that build on theoretical traditions beyond neoclassical or Keynesian works. For example, heterodox economists see the driver of economic instability as price flexibility rather than [[Nominal rigidity|price stickiness]], and therefore develop models with different assumptions and structures.<ref>{{Cite book |last=Dean |first=Erik |last2=Elardo |first2=Justin |last3=Green |first3=Mitch |last4=Wilson |first4=Benjamin |last5=Berger |first5=Sebastian |last6=Dadzie |first6=Richard |others=Adapted from OpenStax Principles of Economics |title=Principles of Economics: Scarcity and Social Provisioning |edition=3rd |chapter=12.3 – A Heterodox Macroeconomic Perspective |chapter-url=https://openoregon.pressbooks.pub/socialprovisioning3/chapter/12-3-a-heterodox-macroeconomic-perspective/ |language=en}}</ref>
==Macroeconomic policy==
The division into various time frames of macroeconomic research leads to a parallel division of macroeconomic policies into short-run policies aimed at mitigating the harmful consequences of business cycles (known as [[stabilization policy]]) and medium- and long-run policies targeted at improving the structural levels of macroeconomic variables.<ref name=Sørensen/>{{rp|18}}
Stabilization policy is usually implemented through two sets of tools: fiscal and monetary policy. Both forms of policy are used to [[Stabilization policy|stabilize the economy]], i.e. limiting the effects of the business cycle by conducting expansive policy when the economy is in a [[recession]] or contractive policy in the case of [[Overheating (economics)|overheating]].<ref name=Blanchard/><ref name="Mayer, 495">Mayer, 495.</ref>
Structural policies may include labour market policies that aim to change the structural unemployment rate, or policies that affect long-run propensities to save, invest, or engage in education, research, and development.<ref name=Sørensen/>{{rp|19}}
===Monetary policy=== {{Further|Monetary policy}}
[[Central bank]]s conduct monetary policy mainly by adjusting short-term [[interest rates]].<ref name=RBA>{{cite web |last1=Baker |first1=Nick |last2=Rafter |first2=Sally |title=An International Perspective on Monetary Policy Implementation Systems {{!}} Bulletin – June 2022 |url=https://www.rba.gov.au/publications/bulletin/2022/jun/an-international-perspective-on-monetary-policy-implementation-systems.html |publisher=Reserve Bank of Australia |access-date=13 August 2023 |language=en-AU |date=16 June 2022}}</ref> The actual method through which the interest rate is changed differs from central bank to central bank, but typically the implementation happens either directly via administratively changing the central bank's own offered interest rates or indirectly via [[open market operations]].<ref>{{cite book |title=MC Compendium Monetary policy frameworks and central bank market operations |date=October 2019 |publisher=Bank for International Settlements |isbn=978-92-9259-298-1 |url=https://www.bis.org/publ/mc_compendium.pdf}}</ref>
Via the [[monetary transmission mechanism]], interest rate changes affect [[investment (macroeconomics)|investment]], [[Consumption (economics)|consumption]], [[asset prices]] like listed companies' shares prices and [[Real estate appraisal|house prices]], and through [[exchange rate]] reactions [[export]] and [[import]]. In this way, [[aggregate demand]], [[employment]], and ultimately inflation are affected.<ref name="Fed goals II">{{cite web |title=Federal Reserve Board - Monetary Policy: What Are Its Goals? How Does It Work? |url=https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm |website=Board of Governors of the Federal Reserve System |access-date=13 August 2023 |language=en |date=29 July 2021}}</ref> Expansionary monetary policy lowers interest rates, increasing economic activity, whereas contractionary monetary policy raises interest rates. In a fixed exchange rate system, interest rate decisions, together with direct intervention by central banks in exchange rate dynamics, are major tools for controlling the exchange rate.<ref name=nationalbanken>{{cite web |title=Fixed exchange rate policy |url=https://www.nationalbanken.dk/en/frequently-asked-questions/fixed-exchange-rate-policy |website=Nationalbanken |access-date=13 August 2023 |language=en}}</ref>
In developed countries, most central banks follow [[inflation targeting]], focusing on keeping medium-term inflation close to an explicit target, say 2%, or within an explicit range. This includes the [[Federal Reserve]] and the [[European Central Bank]], which are generally considered to follow a strategy very close to inflation targeting, even though they do not officially label themselves as inflation targeters.<ref name=Holdingline>{{cite web |title=Inflation Targeting: Holding the Line |url=https://www.imf.org/external/pubs/ft/fandd/basics/72-inflation-targeting.htm |website=International Monetary Fund |access-date=12 August 2023}}</ref> In practice, an official inflation targeting often leaves room for the central bank to also help stabilize [[Output (economics)|output]] and employment, a strategy known as "flexible inflation targeting".<ref>{{cite web |last1=Ingves |first1=Stefan |title=Flexible inflation targeting in theory and practice |url=https://www.bis.org/review/r110517c.pdf |website=www.bis.org |publisher=Bank of International Settlements |date=12 May 2011 |access-date=5 September 2023}}</ref> Most [[emerging economies]] focus their monetary policy on maintaining a [[fixed exchange rate]] regime, aligning their currency with one or more foreign currencies, typically the [[US dollar]] or the [[euro]].<ref name=IMF>{{cite book |last1=Department |first1=International Monetary Fund Monetary and Capital Markets |title=Annual Report on Exchange Arrangements and Exchange Restrictions 2022 |date=26 July 2023 |publisher=International Monetary Fund |isbn=979-8-4002-3526-9 |url=https://www.elibrary.imf.org/display/book/9798400235269/9798400235269.xml?code=imf.org |access-date=12 August 2023 |language=en }}</ref>
Conventional monetary policy can be ineffective in situations such as a [[liquidity trap]]. When nominal interest rates are near zero, central banks cannot loosen monetary policy through conventional means. In that situation, they may use unconventional monetary policy such as [[quantitative easing]] to help stabilize output. Quantity easing can be implemented by buying not only government bonds, but also other assets such as corporate bonds, stocks, and other securities. This allows lower interest rates for a broader class of assets beyond government bonds. A similar strategy is to lower long-term interest rates by buying long-term bonds and selling short-term bonds to create a flat [[yield curve]], known in the US as [[Operation Twist]].<ref>{{cite web |last1=Hancock |first1=Diana |last2=Passmore |first2=Wayne |title=How the Federal Reserve's Large-Scale Asset Purchases (LSAPs) Influence Mortgage-Backed Securities (MBS) Yields and U.S. Mortgage Rates |url=https://www.federalreserve.gov/pubs/feds/2014/201412/201412pap.pdf |website=www.federalreserve.gov |publisher=Federal Reserve |access-date=5 September 2023 |date=2014}}</ref>
===Fiscal policy=== {{Further|Fiscal policy}}
Fiscal policy is the use of the government's revenue ([[tax]]es) and [[Government spending|expenditure]] as instruments to influence the economy.
For example, if the economy is producing less than [[potential output]], government spending can be used to employ idle resources and boost output, or taxes could be lowered to boost private consumption, which has a similar effect. Government spending or tax cuts do not have to make up for the entire [[output gap]]. There is a [[Fiscal multiplier|multiplier effect]] that affects the impact of government spending. For instance, when the government pays for a bridge, the project not only adds the bridge's value to output but also enables bridge workers to increase their consumption and investment, helping close the output gap.
The effects of fiscal policy can be limited by partial or full [[Crowding out (economics)|crowding out]]. When the government undertakes spending projects, it limits the resources available to the [[private sector]]. Full crowding out occurs in the extreme case when government spending replaces private-sector output rather than adding to the economy's output. A crowding-out effect may also occur if government spending raises interest rates, thereby limiting investment.<ref>{{cite journal |last1=Arestis |first1=Philip |last2=Sawyer |first2=Malcolm |title=Reinventing fiscal policy |journal=Levy Economics Institute of Bard College |date=2003 |issue=Working Paper, No. 381 |url=https://www.econstor.eu/bitstream/10419/31523/1/503961485.pdf |access-date=7 December 2018}}</ref>
Some fiscal policy is implemented through [[automatic stabilizers]] without any active decisions by politicians. Automatic stabilizers do not suffer from the policy lags of [[Discretionary policy|discretionary fiscal policy]]. Automatic stabilizers use conventional fiscal mechanisms, but take effect as soon as the economy takes a downturn: spending on unemployment benefits automatically increases when unemployment rises, and [[tax revenue]] decreases, which shelters private income and consumption from part of the fall in market income.<ref name=Sørensen/>{{rp|657}}
===Comparison of fiscal and monetary policy ===
There is a consensus that both monetary and fiscal instruments may affect demand and activity in the short run (i.e., over the business cycle).<ref name=Sørensen/>{{rp|657}} Economists usually favor monetary over fiscal policy to mitigate moderate fluctuations, however, because it has two major advantages.{{Citation needed|date=December 2025}} First, monetary policy is generally implemented by independent central banks instead of the political institutions that control fiscal policy. Independent central banks are less likely to be subject to political pressure to pursue overly expansionary policies. Second, monetary policy may suffer shorter [[inside lag]]s and [[outside lag]]s than fiscal policy.<ref name=" Mayer, 495"/> There are some exceptions, however: Firstly, in the case of a major shock, monetary stabilization policy may not be sufficient and should be supplemented by active fiscal stabilization.<ref name=Sørensen/>{{rp|659}} Secondly, in the case of a very low interest level, the economy may be in a [[liquidity trap]] in which monetary policy becomes ineffective, which makes fiscal policy the more potent tool to stabilize the economy.<ref name=Blanchard/> Thirdly, in regimes where monetary policy is tied to fulfilling other targets, in particular [[fixed exchange rate]] regimes, the central bank cannot simultaneously adjust its interest rates to mitigate domestic business cycle fluctuations, making fiscal policy the only usable tool for such countries.<ref name=nationalbanken/>
==Macroeconomic models== {{Further|Macroeconomic model}}
Macroeconomic teaching, research, and informed debates normally evolve around formal ([[diagrammatic]] or [[equation]]al) [[macroeconomic model]]s to clarify assumptions and show their consequences precisely. Models include simple theoretical models, often containing only a few equations, used in teaching and research to highlight key basic principles, and larger applied quantitative models used by e.g. governments, central banks, think tanks and international organisations to predict effects of changes in economic policy or other [[exogenous factor]]s or as a basis for making [[economic forecasting]].<ref>{{cite book |last1=Watson |first1=Mark W. |chapter=Macroeconomic Forecasting |chapter-url=https://link.springer.com/referenceworkentry/10.1057/978-1-349-95121-5_2434-1 |title=The New Palgrave Dictionary of Economics |publisher=Palgrave Macmillan UK |access-date=9 September 2023 |pages=1–3 |language=en |doi=10.1057/978-1-349-95121-5_2434-1 |date=2016|isbn=978-1-349-95121-5 }}</ref>
Well-known specific theoretical models include short-term models like the [[Keynesian cross]], the [[IS–LM model]] and the [[Mundell–Fleming model]], medium-term models like the [[AD–AS model]], building upon a [[Phillips curve]], and long-term growth models like the [[Solow–Swan model|Solow–Swan]] model, the [[Ramsey–Cass–Koopmans model]] and [[Peter Diamond]]'s [[overlapping generations model]]. Quantitative models include early [[large-scale macroeconometric model]], the new classical [[Real business-cycle theory|real business cycle models]], microfounded [[computable general equilibrium]] (CGE) models used for medium-term (structural) questions like international trade or tax reforms, [[Dynamic stochastic general equilibrium]] (DSGE) models used to analyze business cycles, not least in many central banks, or [[Integrated assessment modelling|integrated assessment]] models like [[DICE model|DICE]].
===Specific models=== ====IS–LM model====
[[File:Islm.svg|thumb|In this example of a traditional IS–LM chart, the IS curve moves to the right, causing higher interest rates (i) and expansion in the "real" economy (real GDP, or Y).]]
The [[IS–LM]] model, invented by [[John Hicks]] in 1936, gives the underpinnings of aggregate demand (itself discussed below). It answers the question "At any given price level, what is the quantity of goods demanded?" The graphic model shows combinations of interest rates and output that ensure equilibrium in both the goods and money markets under the model's assumptions.{{sfn|Durlauf|Hester|2008}} The goods market is modeled as giving equality between investment and public and private saving (IS), and the money market is modeled as giving equilibrium between the [[money supply]] and [[liquidity preference]] (equivalent to money demand).{{sfn|Peston|2002|pp=386–87}}
The IS curve consists of the points (combinations of income and interest rate) at which, for a given interest rate, investment equals public and private saving, given output.{{sfn|Peston|2002|p=387}} The IS curve is downward sloping because output and the interest rate have an inverse relationship in the goods market: as output increases, more income is saved, which means interest rates must be lower to spur enough investment to match saving.{{sfn|Peston|2002|p=387}}
The traditional LM curve is upward-sloping because the interest rate and output are positively related in the money market. As income (identical to output in a closed economy) increases, the demand for money rises, leading to a higher interest rate to offset the incipient rise in money demand.{{sfn|Peston|2002|pp=387–88}}
The IS-LM model is often used in elementary textbooks to demonstrate the effects of monetary and fiscal policy, though it ignores many complexities of most modern macroeconomic models.{{sfn|Durlauf|Hester|2008}} A problem related to the LM curve is that modern central banks largely ignore the money supply in determining policy, contrary to the model's basic assumptions.<ref name=Romer/>{{rp|262}} In some modern textbooks, consequently, the traditional IS-LM model has been modified by replacing the traditional LM curve with an assumption that the central bank determines the interest rate of the economy directly.<ref name=Romer/>{{rp|194}}<ref name=Blanchard/>{{rp|113}}
====AD-AS model====
[[File:AS + AD graph.svg|thumb|A traditional AD–AS diagram showing a shift in AD, and the AS curve becoming inelastic beyond potential output]]
The [[AD–AS model]] is a common textbook model for explaining the macroeconomy.{{sfn|Healey|2002|p=12}} The original version of the model shows the price level and level of real output given the equilibrium in [[aggregate demand]] and [[aggregate supply]]. The aggregate demand curve's downward slope means that more output is demanded at lower price levels.{{sfn|Healey|2002|p=13}} The downward slope can be explained as the result of three effects: the [[Pigou effect|Pigou or real balance effect]], which states that as real prices fall, real wealth increases, resulting in higher consumer demand of goods; the [[Keynes effect|Keynes or interest rate effect]], which states that as prices fall, the demand for money decreases, causing interest rates to decline and borrowing for investment and consumption to increase; and the net export effect, which states that as prices rise, domestic goods become comparatively more expensive to foreign consumers, leading to a decline in exports.{{sfn|Healey|2002|p=13}}
In many representations of the AD–AS model, the aggregate supply curve is horizontal at low levels of output; it becomes inelastic near the point of [[potential output]], which corresponds with [[full employment]].{{sfn|Healey|2002|p=12}} Since the economy cannot produce beyond the potential output, any AD expansion will lead to higher price levels instead of higher output.
In modern textbooks, the AD–AS model is often presented slightly differently, however, in a diagram showing not the price level, but the inflation rate along the vertical axis,<ref name=Romer/>{{rp|263}}<ref name=Mankiw/>{{rp|399–428}}<ref name=Sørensen/>{{rp|595}} making it easier to relate the diagram to real-world policy discussions.<ref name=Sørensen/>{{rp|vii}} In this framework, the AD curve is downward sloping because higher inflation will cause the central bank, which is assumed to follow an [[inflation target]], to raise the interest rate, which will dampen economic activity, hence reducing output. The AS curve is upward-sloping, consistent with a standard modern [[Phillips curve]] view, in which higher economic activity lowers unemployment, leading to higher wage growth and, in turn, higher inflation.<ref name=Romer/>{{rp|263}}
==See also== {{Portal|Business and economics}} * [[Microeconomics]] * [[Business cycle accounting]] * [[Economic development]] * [[Growth accounting]]
==References== {{reflist|30em}}
==Further reading== {{Library resources box |by=no |onlinebooks=no |others=no |about=yes |label=Macroeconomics }} * Blanchard, Olivier. (2009). "[https://www.nber.org/papers/w14259 The State of Macro]." ''Annual Review of Economics'' 1(1): 209–228. *{{cite book |last1=Blanchard |first1=Olivier |title=Macroeconomics |date=2021 |publisher=Pearson |location=Harlow, England |isbn=978-0-134-89789-9 |edition=Eighth, global}} * {{cite book |last=Blaug |first=Mark |editor1-last=Snowdon |editor1-first=Brian |editor2-last=Vane |editor2-first=Howard |chapter=Endogenous growth theory |title=An Encyclopedia of Macroeconomics |url=https://archive.org/details/encyclopediaofma00bria |url-access=registration |publisher=Edward Elgar Publishing |location=Northampton, Massachusetts |year=2002 |isbn=978-1-84542-180-9 }} * {{cite book |last1=Campante |first1=Filipe |last2=Sturzenegger |first2=Federico |last3=Velasco |first3=Andrés |title=Advanced Macroeconomics: An Easy Guide |year=2021 |publisher=LSE Press |isbn=9781909890695 |url=https://doi.org/10.31389/lsepress.ame}} * {{cite book |first1=Robert W. |year=2008 |last1=Dimand |chapter=Macroeconomics, origins and history of |chapter-url=https://link.springer.com/referenceworkentry/10.1057/978-1-349-95121-5_2333-1 |title=The New Palgrave Dictionary of Economics |pages=236–44 |publisher=Palgrave Macmillan UK |editor1-first=Steven N. |editor1-last=Durlauf |editor2-first=Lawrence E. |editor2-last=Blume |doi=10.1057/9780230226203.1009|isbn=978-0-333-78676-5 }} * {{cite book |last1=Durlauf |first1=Steven N. |last2=Hester |first2=Donald D. |chapter=IS–LM |title=The New Palgrave Dictionary of Economics |pages=585–91 |edition=2nd |editor1-first=Steven N. |editor1-last=Durlauf |editor2-first=Lawrence E. |editor2-last=Blume |publisher=Palgrave Macmillan |year=2008 |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde2008_I000303 |doi=10.1057/9780230226203.0855 |isbn=978-0-333-78676-5 }} * {{cite book |first=Ray |last=Fair |title=Macroeconomic Modeling: The Cowles Commission Approach |publisher=MIT Press |isbn=9780262380904 |year=2025 |url=https://doi.org/10.7551/mitpress/15639.001.0001}} * {{cite book |last=Healey |first=Nigel M. |editor1-last=Snowdon |editor1-first=Brian |editor2-last=Vane |editor2-first=Howard |chapter=AD-AS model |title=An Encyclopedia of Macroeconomics |url=https://archive.org/details/encyclopediaofma00bria |url-access=registration |publisher=Edward Elgar Publishing |location=Northampton, Massachusetts |year=2002 |isbn=978-1-84542-180-9 |pages=[https://archive.org/details/encyclopediaofma00bria/page/11 11–18] }} * {{cite book |last=Levi |first=Maurice |title=The Macroeconomic Environment of Business (Core Concepts and Curious Connections) |publisher=World Scientific Publishing |location=New Jersey |year=2014 |isbn=978-981-4304-34-4 }} * {{cite book |last1=Mankiw |first1=Nicholas Gregory |title=Macroeconomics |date=2022 |publisher=Worth Publishers, Macmillan Learning |location=New York, NY |isbn=978-1-319-26390-4 |edition=Eleventh, international}} * {{cite book |last=Mayer |first=Thomas |editor1-last=Snowdon |editor1-first=Brian |editor2-last=Vane |editor2-first=Howard R. |chapter=Monetary policy: role of |title=An Encyclopedia of Macroeconomics |url=https://archive.org/details/encyclopediaofma00bria |url-access=registration |publisher=Edward Elgar Publishing |location=Northampton, Massachusetts |year=2002 |isbn=978-1-84542-180-9 |pages=[https://archive.org/details/encyclopediaofma00bria/page/495 495–99] }} * Nakamura, Emi and Jón Steinsson. (2018). "[https://www.aeaweb.org/articles?id=10.1257/jep.32.3.59 Identification in Macroeconomics.]" ''Journal of Economic Perspectives'' 32(3): 59–86. *{{cite book|last=Peston|first=Maurice|title=An Encyclopedia of Macroeconomics|url=https://archive.org/details/encyclopediaofma00bria|url-access=registration|chapter=IS-LM model: closed economy|editor1-last=Snowdon|editor1-first=Brian|editor2-last=Vane|editor2-first=Howard R.|year=2002|publisher=Edward Elgar|isbn=9781840643879}} * {{cite book |last1=Romer |first1=David |title=Advanced macroeconomics |date=2019 |publisher=McGraw-Hill |location=New York, NY |isbn=978-1-260-18521-8 |edition=Fifth}} * {{cite book |last=Solow |first=Robert |editor1-last=Snowdon |editor1-first=Brian |editor2-last=Vane |editor2-first=Howard |chapter=Neoclassical growth model |title=An Encyclopedia of Macroeconomics |url=https://archive.org/details/encyclopediaofma00bria |url-access=registration |publisher=Edward Elgar Publishing |location=Northampton, Massachusetts |year=2002 |isbn=1840643870}} * Snowdon, Brian, and Howard R. Vane, ed. (2002). ''An Encyclopedia of Macroeconomics'', [https://web.archive.org/web/20110722004651/http://www.e-elgar.co.uk/bookentry_mainUS.lasso?id=2106 Description] & scroll to Contents-preview [https://books.google.com/books?id=OJM2mqWI-cYC links.] * {{cite book |last1=Snowdon |first1=Brian |last2=Vane |first2=Howard R. |title=Modern Macroeconomics: Its Origins, Development And Current State |publisher=Edward Elgar Publishing |isbn=1845421809 |year=2005 }} * {{cite book |last1=Sørensen |first1=Peter Birch |last2=Whitta-Jacobsen |first2=Hans Jørgen |title=Introducing advanced macroeconomics: growth and business cycles |date=2022 |publisher=Oxford University Press |location=Oxford, United Kingdom New York, NY |isbn=978-0-19-885049-6 |edition=Third}} * {{cite book |first=David |last=Warsh |title=Knowledge and the Wealth of Nations |publisher=Norton |isbn=978-0-393-05996-0 |year=2006 |url-access=registration |url=https://archive.org/details/knowledgewealtho00wars }}
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[[Category:Macroeconomics| ]]