Historical Perspectives on Macroeconomics: Sixty Years After the General Theory
Mainstream economics accepts a simplification, the equation of exchange :. The previous equation presents the difficulty that the associated data are not available for all transactions. With the development of national income and product accounts , emphasis shifted to national-income or final-product transactions, rather than gross transactions.
Economists may therefore work where. In one empirical formulation, velocity was taken to be "the ratio of net national product in current prices to the money stock". Thus far, the theory is not particularly controversial, as the equation of exchange is an identity. A theory requires that assumptions be made about the causal relationships among the four variables in this one equation.
There are debates about the extent to which each of these variables is dependent upon the others. The quantity theory postulates that the primary causal effect is an effect of M on P. Economists Alfred Marshall , A. Pigou , and John Maynard Keynes before he developed his own, eponymous school of thought associated with Cambridge University , took a slightly different approach to the quantity theory, focusing on money demand instead of money supply.
They argued that a certain portion of the money supply will not be used for transactions; instead, it will be held for the convenience and security of having cash on hand. The Cambridge economists also thought wealth would play a role, but wealth is often omitted for simplicity. The Cambridge equation is thus:.
The Cambridge version of the quantity theory led to both Keynes's attack on the quantity theory and the Monetarist revival of the theory. The plus signs indicate that a change in the money supply is hypothesized to change nominal expenditures and the price level in the same direction for other variables held constant.
Friedman described the empirical regularity of substantial changes in the quantity of money and in the level of prices as perhaps the most-evidenced economic phenomenon on record. An application of the quantity-theory approach aimed at removing monetary policy as a source of macroeconomic instability was to target a constant, low growth rate of the money supply.
As financial intermediation grew in complexity and sophistication in the s and s, it became more so. To mitigate this problem, some central banks , including the U. Federal Reserve , which had targeted the money supply, reverted to targeting interest rates. Starting with New Zealand, more and more central banks started to communicate inflation targets as the primary guidance for the public. Reasons were that interest targeting turned out to be a less effective tool in low-interest phases and it did not cope with the public uncertainty about future inflation rates to expect.
The communication of inflation targets helps to anchor the public inflation expectations, it makes central banks more accountable for their actions, and it reduces economic uncertainty among the participants in the economy.
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Knut Wicksell criticized the quantity theory of money, citing the notion of a "pure credit economy". Keynes had originally been a proponent of the theory, but he presented an alternative in the General Theory. Keynes argued that the price level was not strictly determined by the money supply. Changes in the money supply could have effects on real variables like output. Ludwig von Mises agreed that there was a core of truth in the quantity theory, but criticized its focus on the supply of money without adequately explaining the demand for money.
He said the theory "fails to explain the mechanism of variations in the value of money". From Wikipedia, the free encyclopedia. Theory in monetary economics. This article has multiple issues. Please help improve it or discuss these issues on the talk page. Learn how and when to remove these template messages. Some of this article's listed sources may not be reliable. Please help this article by looking for better, more reliable sources. Unreliable citations may be challenged or deleted. April Learn how and when to remove this template message. This article relies too much on references to primary sources.
Please improve this by adding secondary or tertiary sources. Further information: Cambridge equation. Classical dichotomy Cumulative process Demand for money Equation of exchange Income velocity of money Liquidity preference Modern Monetary Theory " Monetae cudendae ratio " Monetarism Monetary inflation Monetary policy Neutrality of money. The Economic History Review. Johnson, R. Archived from the original PDF on July 17, Retrieved June 17, First published by the Institute of Economic Affairs, London, Archived from the original PDF on Retrieved Reprinted in M.
Friedman The Optimum Quantity of Money , 51 - p. The Theory of New Classical Macroeconomics. A Positive Critique. Contributions to Economics. Macroeconomics: Theories and Policies. Macmillan Publishing Company: New York, Retrieved 28 December February, "Archived copy".
Archived from the original on December 8, Retrieved November 1, Hafer and David C. Interest and Prices PDF. This audio file was created from a revision of the article " Quantity theory of money " dated , and does not reflect subsequent edits to the article. Audio help.
Historical Perspectives on Macroeconomics
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Namespaces Article Talk. Views Read Edit View history. The Bible BCE and Hammurabi 's Code BCE both explain economic remediations for cyclic sixty-year recurring great depressions, via fiftieth-year Jubilee biblical debt and wealth resets [ citation needed ]. Thirty major debt forgiveness events are recorded in history including the debt forgiveness given to most european nations in the s to There were great increases in productivity , industrial production and real per capita product throughout the period from to that included the Long Depression and two other recessions.
Both the Long and Great Depressions were characterized by overcapacity and market saturation. Over the period since the Industrial Revolution, technological progress has had a much larger effect on the economy than any fluctuations in credit or debt, the primary exception being the Great Depression, which caused a multi-year steep economic decline. See: Productivity improving technologies historical.
There were frequent crises in Europe and America in the 19th and first half of the 20th century, specifically the period — This period started from the end of the Napoleonic wars in , which was immediately followed by the Post-Napoleonic depression in the United Kingdom —30 , and culminated in the Great Depression of —39, which led into World War II. See Financial crisis: 19th century for listing and details.
The first of these crises not associated with a war was the Panic of In this period, the economic cycle — at least the problem of depressions — was twice declared dead. The first declaration was in the late s, when the Phillips curve was seen as being able to steer the economy. However, this was followed by stagflation in the s, which discredited the theory. The second declaration was in the early s, following the stability and growth in the s and s in what came to be known as The Great Moderation. Notably, in , Robert Lucas , in his presidential address to the American Economic Association , declared that the "central problem of depression-prevention [has] been solved, for all practical purposes.
Various regions have experienced prolonged depressions , most dramatically the economic crisis in former Eastern Bloc countries following the end of the Soviet Union in For several of these countries the period — has been an ongoing depression, with real income still lower than in In , economists Arthur F. Burns and Wesley C. Mitchell provided the now standard definition of business cycles in their book Measuring Business Cycles : .
Business cycles are a type of fluctuation found in the aggregate economic activity of nations that organize their work mainly in business enterprises: a cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions, and revivals which merge into the expansion phase of the next cycle; in duration, business cycles vary from more than one year to ten or twelve years; they are not divisible into shorter cycles of similar characteristics with amplitudes approximating their own.
According to A. Burns: . Business cycles are not merely fluctuations in aggregate economic activity. The critical feature that distinguishes them from the commercial convulsions of earlier centuries or from the seasonal and other short term variations of our own age is that the fluctuations are widely diffused over the economy — its industry, its commercial dealings, and its tangles of finance.
The economy of the western world is a system of closely interrelated parts.
He who would understand business cycles must master the workings of an economic system organized largely in a network of free enterprises searching for profit. The problem of how business cycles come about is therefore inseparable from the problem of how a capitalist economy functions. An expansion is the period from a trough to a peak, and a recession as the period from a peak to a trough. The NBER identifies a recession as "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production".
There is often a close timing relationship between the upper turning points of the business cycle, commodity prices and freight rates, which is shown to be particularly tight in the grand peak years of , , and Recent research employing spectral analysis has confirmed the presence of Kondratiev waves in the world GDP dynamics at an acceptable level of statistical significance.
In recent years economic theory has moved towards the study of economic fluctuation rather than a "business cycle"  — though some economists use the phrase 'business cycle' as a convenient shorthand. For example, Milton Friedman said that calling the business cycle a "cycle" is a misnomer , because of its non-cyclical nature.
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Friedman believed that for the most part, excluding very large supply shocks, business declines are more of a monetary phenomenon. The explanation of fluctuations in aggregate economic activity is one of the primary concerns of macroeconomics. The main framework for explaining such fluctuations is Keynesian economics.
In the Keynesian view, business cycles reflect the possibility that the economy may reach short-run equilibrium at levels below or above full employment. If the economy is operating with less than full employment, i. Beside the Keynesian explanation there are a number of alternative theories of business cycles, largely associated with particular schools or theorists in heterodox economics. A common alternative within mainstream economics is real business cycle theory.
Nowadays other notable theories are credit-based explanations such as debt deflation and the financial instability hypothesis. The latter two gained interest for being able to explain the subprime mortgage crisis and financial crises. Within mainstream economics, the debate over external exogenous versus internal endogenous being the causes of the economic cycles, with the classical school now neo-classical arguing for exogenous causes and the underconsumptionist now Keynesian school arguing for endogenous causes. These may also broadly be classed as "supply-side" and "demand-side" explanations: supply-side explanations may be styled, following Say's law , as arguing that " supply creates its own demand ", while demand-side explanations argue that effective demand may fall short of supply, yielding a recession or depression.
This debate has important policy consequences: proponents of exogenous causes of crises such as neoclassicals largely argue for minimal government policy or regulation laissez faire , as absent these external shocks, the market functions, while proponents of endogenous causes of crises such as Keynesians largely argue for larger government policy and regulation, as absent regulation, the market will move from crisis to crisis.
This division is not absolute — some classicals including Say argued for government policy to mitigate the damage of economic cycles, despite believing in external causes, while Austrian School economists argue against government involvement as only worsening crises, despite believing in internal causes. The view of the economic cycle as caused exogenously dates to Say's law , and much debate on endogeneity or exogeneity of causes of the economic cycle is framed in terms of refuting or supporting Say's law; this is also referred to as the " general glut " supply in relation to demand debate.
Until the Keynesian revolution in mainstream economics in the wake of the Great Depression , classical and neoclassical explanations exogenous causes were the mainstream explanation of economic cycles; following the Keynesian revolution, neoclassical macroeconomics was largely rejected. There has been some resurgence of neoclassical approaches in the form of real business cycle RBC theory. The debate between Keynesians and neo-classical advocates was reawakened following the recession of Mainstream economists working in the neoclassical tradition, as opposed to the Keynesian tradition, have usually viewed the departures of the harmonic working of the market economy as due to exogenous influences, such as the State or its regulations, labor unions, business monopolies, or shocks due to technology or natural causes.
The 19th-century school of underconsumptionism also posited endogenous causes for the business cycle, notably the paradox of thrift , and today this previously heterodox school has entered the mainstream in the form of Keynesian economics via the Keynesian revolution. According to Keynesian economics , fluctuations in aggregate demand cause the economy to come to short run equilibrium at levels that are different from the full employment rate of output.
These fluctuations express themselves as the observed business cycles. Keynesian models do not necessarily imply periodic business cycles. However, simple Keynesian models involving the interaction of the Keynesian multiplier and accelerator give rise to cyclical responses to initial shocks.
Paul Samuelson 's "oscillator model"  is supposed to account for business cycles thanks to the multiplier and the accelerator. The amplitude of the variations in economic output depends on the level of the investment, for investment determines the level of aggregate output multiplier , and is determined by aggregate demand accelerator. In the Keynesian tradition, Richard Goodwin  accounts for cycles in output by the distribution of income between business profits and workers' wages.
The fluctuations in wages are almost the same as in the level of employment wage cycle lags one period behind the employment cycle , for when the economy is at high employment, workers are able to demand rises in wages, whereas in periods of high unemployment, wages tend to fall. According to Goodwin, when unemployment and business profits rise, the output rises. One alternative theory is that the primary cause of economic cycles is due to the credit cycle : the net expansion of credit increase in private credit, equivalently debt, as a percentage of GDP yields economic expansions, while the net contraction causes recessions, and if it persists, depressions.
In particular, the bursting of speculative bubbles is seen as the proximate cause of depressions, and this theory places finance and banks at the center of the business cycle. A primary theory in this vein is the debt deflation theory of Irving Fisher , which he proposed to explain the Great Depression. A more recent complementary theory is the Financial Instability Hypothesis of Hyman Minsky , and the credit theory of economic cycles is often associated with Post-Keynesian economics such as Steve Keen.
Post-Keynesian economist Hyman Minsky has proposed an explanation of cycles founded on fluctuations in credit, interest rates and financial frailty, called the Financial Instability Hypothesis. In an expansion period, interest rates are low and companies easily borrow money from banks to invest. Banks are not reluctant to grant them loans, because expanding economic activity allows business increasing cash flows and therefore they will be able to easily pay back the loans.
This process leads to firms becoming excessively indebted, so that they stop investing, and the economy goes into recession. Within mainstream economics, Keynesian views have been challenged by real business cycle models in which fluctuations are due to technology shocks. This theory is most associated with Finn E. Kydland and Edward C.
Prescott , and more generally the Chicago school of economics freshwater economics. They consider that economic crisis and fluctuations cannot stem from a monetary shock, only from an external shock, such as an innovation. This theory explains the nature and causes of economic cycles from the viewpoint of life-cycle of marketable goods. Vernon stated that some countries specialize in the production and export of technologically new products, while others specialize in the production of already known products.
The most developed countries are able to invest large amounts of money in the technological innovations and produce new products, thus obtaining a dynamic comparative advantage over developing countries. Recent research by Georgiy Revyakin proves initial Vernon theory and shows that economic cycles in developed countries overrun economic cycles in developing countries.
In case of Kondratiev waves such products correlate with fundamental discoveries implemented in production inventions which form the technological paradigm : Richard Arkwright's machines, steam engines, industrial use of electricity, computer invention, etc. Simultaneous technological updates by all economic agents as a result, cycle formation would be determined by highly competitive market conditions: in case if a manufacturing technology at an enterprise does not meet the current technological environment, — such company loses its competitiveness and eventually goes bankrupt.
Another set of models tries to derive the business cycle from political decisions. The partisan business cycle suggests that cycles result from the successive elections of administrations with different policy regimes.
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Regime A adopts expansionary policies, resulting in growth and inflation, but is voted out of office when inflation becomes unacceptably high. The replacement, Regime B, adopts contractionary policies reducing inflation and growth, and the downwards swing of the cycle. It is voted out of office when unemployment is too high, being replaced by Party A. The political business cycle is an alternative theory stating that when an administration of any hue is elected, it initially adopts a contractionary policy to reduce inflation and gain a reputation for economic competence.
It then adopts an expansionary policy in the lead up to the next election, hoping to achieve simultaneously low inflation and unemployment on election day. He did not see this theory as applying under fascism , which would use direct force to destroy labor's power. In recent years, proponents of the "electoral business cycle" theory [ who? For Marx, the economy based on production of commodities to be sold in the market is intrinsically prone to crisis.
In the heterodox Marxian view, profit is the major engine of the market economy, but business capital profitability has a tendency to fall that recurrently creates crises in which mass unemployment occurs, businesses fail, remaining capital is centralized and concentrated and profitability is recovered. In the long run, these crises tend to be more severe and the system will eventually fail. Some Marxist authors such as Rosa Luxemburg viewed the lack of purchasing power of workers as a cause of a tendency of supply to be larger than demand, creating crisis, in a model that has similarities with the Keynesian one.
Indeed, a number of modern authors have tried to combine Marx's and Keynes's views. Henryk Grossman  reviewed the debates and the counteracting tendencies and Paul Mattick subsequently emphasized the basic differences between the Marxian and the Keynesian perspective. While Keynes saw capitalism as a system worth maintaining and susceptible to efficient regulation, Marx viewed capitalism as a historically doomed system that cannot be put under societal control.
The American mathematician and economist Richard M. Goodwin formalised a Marxist model of business cycles known as the Goodwin Model in which recession was caused by increased bargaining power of workers a result of high employment in boom periods pushing up the wage share of national income, suppressing profits and leading to a breakdown in capital accumulation. Later theorists applying variants of the Goodwin model have identified both short and long period profit-led growth and distribution cycles in the United States and elsewhere.
This cycle is due to the periodic breakdown of the social structure of accumulation, a set of institutions which secure and stabilise capital accumulation. Economists of the heterodox Austrian School argue that business cycles are caused by excessive issuance of credit by banks in fractional reserve banking systems.
According to Austrian economists, excessive issuance of bank credit may be exacerbated if central bank monetary policy sets interest rates too low, and the resulting expansion of the money supply causes a "boom" in which resources are misallocated or "malinvested" because of artificially low interest rates.
The General Theory of Employment, Interest, and Money by John Maynard Keynes
Eventually, the boom cannot be sustained and is followed by a "bust" in which the malinvestments are liquidated sold for less than their original cost and the money supply contracts. One of the criticisms of the Austrian business cycle theory is based on the observation that the United States suffered recurrent economic crises in the 19th century, notably the Panic of , which occurred prior to the establishment of a U.
Adherents of the Austrian School, such as the historian Thomas Woods , argue that these earlier financial crises were prompted by government and bankers' efforts to expand credit despite restraints imposed by the prevailing gold standard, and are thus consistent with Austrian Business Cycle Theory.
The Austrian explanation of the business cycle differs significantly from the mainstream understanding of business cycles and is generally rejected by mainstream economists. Mainstream economists generally do not support Austrian school explanations for business cycles, on both theoretical as well as real-world empirical grounds. The slope of the yield curve is one of the most powerful predictors of future economic growth, inflation, and recessions.
Louis Fed. An inverted yield curve is often a harbinger of recession.
A positively sloped yield curve is often a harbinger of inflationary growth. Work by Arturo Estrella and Tobias Adrian has established the predictive power of an inverted yield curve to signal a recession. Their models show that when the difference between short-term interest rates they use 3-month T-bills and long-term interest rates year Treasury bonds at the end of a federal reserve tightening cycle is negative or less than 93 basis points positive that a rise in unemployment usually occurs.
All the recessions in the United States since up through have been preceded by an inverted yield curve year vs. Over the same time frame, every occurrence of an inverted yield curve has been followed by recession as declared by the NBER business cycle dating committee. Estrella and others have postulated that the yield curve affects the business cycle via the balance sheet of banks or bank-like financial institutions. When the yield curve is upward sloping, banks can profitably take-in short term deposits and make long-term loans so they are eager to supply credit to borrowers.
This eventually leads to a credit bubble. Henry George claimed land price fluctuations were the primary cause of most business cycles. Many social indicators, such as mental health, crimes, and suicides, worsen during economic recessions though general mortality tends to fall, and it is in expansions when it tends to increase. Since the s, following the Keynesian revolution , most governments of developed nations have seen the mitigation of the business cycle as part of the responsibility of government, under the rubric of stabilization policy.
Since in the Keynesian view, recessions are caused by inadequate aggregate demand, when a recession occurs the government should increase the amount of aggregate demand and bring the economy back into equilibrium. This the government can do in two ways, firstly by increasing the money supply expansionary monetary policy and secondly by increasing government spending or cutting taxes expansionary fiscal policy. By contrast, some economists, notably New classical economist Robert Lucas , argue that the welfare cost of business cycles are very small to negligible, and that governments should focus on long-term growth instead of stabilization.
However, even according to Keynesian theory , managing economic policy to smooth out the cycle is a difficult task in a society with a complex economy. Some theorists, notably those who believe in Marxian economics , believe that this difficulty is insurmountable.