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Economics - Essay Example

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Explain and discuss the development of Macroeconomic theory and policy since the 1930’s, clearly highlighting the major areas of controversy and consensus Macroeconomics deals in the lessons related to aggregate prices, income, products and services pertaining to a country’s economy or the global economy…
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Download file to see previous pages... Keynesian economists Before Keynes, the classical school of economic thought prevailed and this school did not develop any integrated macroeconomic theory, there existed mainly postulates which expressed economic ideas. Their key postulates suggested that full employment will prevail in the long run is market forces of demand and supply were permitted to perform freely. Even if unemployment occurs it will be a short run impact. They also suggested that demand will always be equal to output in such a case and equilibrium will continue to exist in the long run. These ideas were proven to be wrong with the advent of the Great Depression of the 30s. The classical laissez-faire doctrine failed to hold. Unemployment (3 percent to 25 percent from 1929 to 1933) began to spread largely in the economies ruled by the free market industrial mechanism leading to fall in Gross National Production (fell by 30 percent) and price level fell by 23 percent (Dwivedi, 2005, p. 13). In an attempt to solve the problem, Keynes developed the modern macroeconomic theory which is associated with employment, growth and stability. According to Keynes, output and employment levels are functions of total resources available in the economy, unemployment is the result of shortfall in aggregate demand as well as economic variations brought about by deficiency in demand. This can be got rid of through government spending. This last aspect was introduced by Keynes as a tool for demand management. Such spending would therefore crowd out private investments and via the multiplier effect it would have favourable impact on income and employment. The time span between the 30s and 90s is known as the period of ‘Keynesian Revolution’ (Dornbusch, 2005, p.443). Keynesian policies were adopted by most nations’ governments in developed economies. However in reality, economic world goes through evolutions from time to time and transits form one system to another. Monetarists In the 1970s Keynesian economic thoughts began to show its loopholes as the fiscal policies did no longer solve the economic problems of developed nations consisting of low growth, high unemployment and inflation levels. Then there was the problem of stagflation in the early 70s. Keynes had theorized that disflation would be brought about with unemployment but the economy witnessed bad performance in both areas. As per Keynes’ suggestion, taxes and interest could be reduced in order to ensure inflow of money into the economy. However that would bring about inflation. A new phase of economists, who were popularised as monetarists, emerged. Monetarism could be known as ‘Counter Revolution’ and this group was directed by Milton Friedman who showed that Keynesian policy failed to forecast gross national output, price, unemployment rate and interest rate. He showed money supply changes could influence inflation levels in future time periods in nonlinear manner. This led to the emergence of a new thought of revolution. Where the role of money was the key idea behind growth and national income’s stability in the short run and determines price level in long run. This shifted the idea of aggregate real output’s demand towards the demand and supply of money at aggregate level. This also brought about a long span of debate between the monetarists and Keynesians centring on “ ...Download file to see next pagesRead More
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