ABSTRACT
Prior to the Great Depression the vast majority of economists sub scribed to a classical economic theory when analyzing the macro economy. Classical economists profess a laissez faire philosophy centered on the idea that while economies go through unfortunate periods of downturn-indeed, many such downturns occurred in Europe and the United States during the nineteenth century-they will eventually self correct. Classical economists of this time believed that government policies to “fine tune” the economy were counter productive and, in contrast, they taught that the government’s pri mary role was to maintain a balanced budget and allow the “invisible hand” of markets-which Adam Smith made popular in the late eighteenth century-to work. The Great Depression led to a profound shift in economists’ thinking about macroeconomic issues. As economies worldwide found their self correcting mechanisms stalled during the 1930s, many thinkers began to question the wisdom of the classical theory. New theories, propagated by John Maynard Keynes and his 1936 book The General Theory of Employment, Interest and Money, pre sented a theoretical justification for activist fiscal and monetary policy during times of recession. Keynesians argued for increases in govern ment spending and tax cuts to counteract the decline in aggregate demand that occurs during recessions due to decreases in household consumption and business investment. Keynesian theories remained popular, and the subject of much academic research and debate, for many years following the Great Depression. However in the 1970s,
as the U.S. economy suffered from a different type of affliction-one centered on the supply side rather than the demand side-Keynesian theories experienced decline in popularity. This eventually led to widespread agreement among economists in recent years that the usefulness of discretionary fiscal policy was outdated and that mone tary policy was the more effective and appropriate way to attempt to deal with economic downturns. Debates over how to promote a healthy economy are once again in style, after decades when it seemed the debates were over. The market meltdown of 2008 ended a long string of years in which monetary policy reigned supreme. The Keynesians have made a resurgence in the economic policy debate; however, not without seri ous critics. Which macroeconomic policy tools will be in vogue in the next 20 years? That’s an interesting question without a clear answer.
