Dynamic Macroeconomics

1.1 The Nature and Evolution of Macroeconomics
The subject matter of macroeconomics is usually divided into two distinct
areas: (1) the analysis of long-run economic growth, which is the main focus
of Smith [1776] and other classical economists, and (2) the analysis of
aggregate fluctuations, which is the main focus of Hume [1752], subsequent
monetary and other business cycle theorists, and, of course, Keynes [1936].
1.1.1 Pre-Keynesian Macroeconomics
Macroeconomics did not exist as a separate field of economics before the
publication of the General Theory in 1936. However, at least three important
theoretical streams foreshadowed it.
One was the analysis of long-run economic growth, an important concern
of classical economists, such as Smith, Malthus, Ricardo, and Mill. The
classical economists sought to explain economic growth in terms of
population growth; the accumulation of capital; and the increase in the
efficiency of production, as determined by the division of labor and technical
progress. These factors interacted with the availability of land, a factor of
production that was assumed to be in fixed supply. The classical theory of
economic growth, focusing on the production and distribution of income, is
essentially macroeconomic in nature.
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The second stream of pre-Keynesian macroeconomics is monetary
theory. Monetary theory was quite advanced even before the emergence of

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classical economics. Hume [1752] provides important examples of advanced
monetary analysis more than 20 years before Smith. By the early twentieth
century, monetary theory had established the quantity theory of money, the
classical dichotomy between real and nominal variables, and some monetary
explanations of the business cycle. The quantity theory of money suggests that
increases in the money supply lead, at least eventually, to equiproportional
increases in the general level of prices. The classical dichotomy suggests
that, at least in the long run, real variables are determined purely by
nonmonetary factors.
Monetary theories of the business cycle attribute the business cycle to the
short-term real effects of monetary factors interacting with the gradual
adjustment of wages and prices (Hume [1752], Thornton [1802]), with
misperceptions between changes in relative prices and the price level (Mill,
[1833, 1848]) and with temporary deviations of the interest rate from its
equilibrium value (Fisher [1896], Wicksell [1898], von Mises [1912]).
Various monetary schools of thought had evolved by the latter part of the
nineteenth century and still existed in the early part of the twentieth century.
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The third stream foreshadowing macroeconomics consists of various
types of real business cycle theories. Apart from the dominant monetary
theories, there were alternative theories that attempt to explain aggregate
fluctuations in terms of overinvestment, underconsumption, excess
indebtedness, psychology, technology, or harvest and agricultural cycles.
These theories are also essentially macroeconomic in nature.
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The term “macroeconomics” predates the General Theory and has to be
credited to Frisch [1933, p. 2], who defines it as follows:
When we approach the study of business cycles with the intention of carrying through an analysis
that is truly dynamic and determinate, we are naturally led to distinguish between two types of
analyses: the micro-dynamic and the macro-dynamic types. …The macro-dynamic analysis … tries
to give an account of the fluctuations of the whole economic system taken in its entirety.
In any event, the General Theory, as codified in the IS-LM framework of
Hicks [1937], and later by Modigliani [1944], Samuelson [1948], Hansen
[1949], Patinkin [1956], and others, eventually prevailed over previous
approaches during the 1940s and the 1950s and was pivotal in the
establishment of macroeconomics as a separate field of economics.
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Macroeconomics gradually integrated the three theoretical streams
mentioned above and experienced explosive growth during the rest of the
twentieth century. In its evolution over the years, macroeconomics has
displayed continuity but also significant controversies, changes of direction,
and outright scientific revolutions.
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