Macroeconomics is the branch of economics dealing with performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes, and government spending to regulate an economy’s growth and stability. This includes regional, national, and global economies.
Macroeconomists study topics such as: GDP (Gross Domestic Product), unemployment (including unemployment rates), national income, price indices, output, consumption, inflation, saving, investment, energy, international trade, and international finance.
In the following, I will follow the structure of Macroeconomics by Gregory Mankiw, widely regarded one of the best textbooks on intermediate level macroeconomic studies. My aim is to present these topics in a concise and digestible way, while still maintaining the key concepts and ideas.
Macroeconomics in its modern form began with the publication of General Theory of Employment, Interest and Money by John Maynard Keynes. When the Great Depression struck, classical economists had difficulty in explaining how goods could go unsold and workers could be left unemployed. In classical theory, prices and wages would drop until the market cleared, and all goods and labor were sold. Keynes offered a new theory of economics that explained why markets might not clear, which would evolve into a group of macroeconomic schools of thought known as Keynesian economics – also called Keynesianism or Keynesian Theory.
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. 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.
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 not necessary. 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 money supply instead of frequent intervention.
New classical macroeconomics further challenged the Keynesian school. A central development in new classical thought came when Robert Lucas introduced rational expectations to macroeconomics. Prior to Lucas, economists had generally used adaptive expectations where agents were assumed to look at the recent past to make expectations about the future. Under rational expectations, agents are assumed to be more sophisticated. A consumer 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. When new classical economists introduced rational expectations into their models, they showed that monetary policy could only have a limited impact.
New Keynesian economists responded to the new classical school by adopting rational expectations and focusing on developing micro-founded models. Stanley Fischer and John B. Taylor produced early work in this area by showing that monetary policy could be effective even in models with rational expectations when contracts locked in wages for workers. Other new Keynesian economists, including Olivier Blanchard, Julio Rotemberg, Greg Mankiw, David Romer, and Michael Woodford, expanded on this work and demonstrated other cases where inflexible prices and wages led to monetary and fiscal policy having real effects.
Like classical models, new classical models had assumed that prices would be able to adjust perfectly and monetary policy would only lead to price changes. New Keynesian models investigated sources of sticky prices and wages due to imperfect competition, which would not adjust, allowing monetary policy to impact quantities instead of prices.
By the late 1990s, economists had reached a rough consensus. The nominal rigidity of new Keynesian theory was combined with rational expectations to produce dynamic stochastic general equilibrium (DSGE) models. The fusion of elements from different schools of thought has been dubbed the new neoclassical synthesis. These models are now used by many central banks and are a core part of contemporary macroeconomics.