Editing Macroeconomics

{{Short description|Study of an economy as a whole}}
{{distinguish|Microeconomics}}
{{Macroeconomics sidebar}}
[[File:Circulation in macroeconomics.svg|thumb|250px|Production and national income: Macroeconomics takes a big-picture view of the entire economy, including examining the roles of, and relationships between, firms, households and governments, and the different types of markets, such as the financial market and the labour market.]]
'''Macroeconomics''' is a branch of [[economics]] that deals with the performance, structure, behavior, and decision-making of an [[economy]] as a whole.<ref>
{{cite news| last1 = Samuelson| first1 = Robert| author1-link = Robert J. Samuelson| title = Goodbye, readers, and good luck — you'll need it| newspaper= The Washington Post
| year = 2020| url = https://www.washingtonpost.com/opinions/2020/09/13/robert-samuelson-goodbye-column/?arc404=true
}} This article was an opinion piece expressing despondency in the field shortly before his retirement, but it is still a good summary.</ref> This includes regional, national, and [[global economies]].<ref>{{cite book| last1 = O'Sullivan| first1 = Arthur| author1-link = Arthur O'Sullivan (economist)| last2 = Sheffrin| first2 = Steven M.
| title = Economics: Principles in Action| publisher = Pearson Prentice Hall| year = 2003| location = Upper Saddle River, New Jersey | page = 57| isbn = 978-0-13-063085-8}}</ref><ref>Steve Williamson, [http://www.econ.yale.edu/smith/econ510a/notes99.pdf Notes on Macroeconomic Theory], 1999</ref> Macroeconomists study topics such as [[output (economics)|output]]/[[Gross domestic product|GDP]] (gross domestic product) and [[national income]], [[unemployment]] (including [[Unemployment#Measurement|unemployment rates]]), [[price index|price indices]] and [[inflation]], [[Consumption (economics)|consumption]], [[saving]], [[investment (macroeconomics)|investment]], [[Energy economics|energy]], [[international trade]], and [[international finance]].

Macroeconomics and [[microeconomics]] are the two most general fields in economics.<ref name="blaug1985">{{Citation|author=Blaug, Mark|title=Economic theory in retrospect|year=1985|location=Cambridge|publisher=[[Cambridge University Press]]|isbn=978-0-521-31644-6}}</ref> The focus of macroeconomics is often on a country (or larger entities like the whole world) and how its markets interact to produce large-scale phenomena that economists refer to as aggregate variables. In microeconomics the focus of analysis is often a single market, such as whether changes in supply or demand are to blame for price increases in the oil and automotive sectors. 
From introductory classes in "principles of economics" through doctoral studies, the macro/micro divide is institutionalized in the field of economics. Most economists identify as either macro- or micro-economists.

Macroeconomics is traditionally divided into topics along different time frames: the analysis of short-term fluctuations over the [[business cycle]], the determination of structural levels of variables like inflation and unemployment in the medium (i.e. unaffected by short-term deviations) term, and the study of long-term economic growth. It also studies the consequences of policies targeted at mitigating fluctuations like [[fiscal policy|fiscal]] or [[monetary policy]], using taxation and government expenditure or interest rates, respectively, and of policies that can affect living standards in the long term, e.g. by affecting growth rates.

Macroeconomics as a separate field of research and study is generally recognized to start in 1936, when [[John Maynard Keynes]] published his ''[[The General Theory of Employment, Interest and Money]]'', but its intellectual predecessors are much older. Since World War II, various macroeconomic schools of thought like [[Keynesians]], [[monetarists]], [[new classical economics|new classical]] and [[New Keynesian economics|new Keynesian economists]] have made contributions to the development of the [[Mainstream economics|macroeconomic research mainstream]].

==Basic macroeconomic concepts==
Macroeconomics encompasses a variety of concepts and variables, but above all the three central macroeconomic variables are output, unemployment, and inflation.<ref name=Blanchard>Blanchard (2021).</ref>{{rp|39}} Besides, the time horizon varies for different types of macroeconomic topics, and this distinction is crucial for many research and policy debates.<ref name=Blanchard/>{{rp|54}} A further important dimension is that of an economy's openness, economic theory distinguishing sharply between [[closed economies]] and [[open economy|open economies]].<ref name=Blanchard/>{{rp|373}}

[[File:Circulation in macroeconomics.svg|thumb|[[Circular flow of income|Circulation in macroeconomics]]]]

===Time frame===

It is usual to distinguish between three time horizons in macroeconomics, each having its own focus on e.g. the determination of output:<ref name=Blanchard/>{{rp|54}}
* the short run (e.g. a few years): Focus is on [[business cycle]] fluctuations and changes in [[aggregate demand]] which often drive them. [[Stabilization policy|Stabilization policies]] like [[monetary policy]] or [[fiscal policy]] are relevant in this time frame
* the medium run (e.g. a decade): Over the medium run, the economy tends to an output level determined by supply factors like the capital stock, the technology level and the labor force, and unemployment tends to revert to its structural (or "natural") level. These factors move slowly, so that it is a reasonable approximation to take them as given in a medium-term time scale, though [[labour market policies]] and [[competition policy]] are instruments that may influence the economy's structures and hence also the medium-run equilibrium
* the long run (e.g. a couple of decades or more): On this time scale, emphasis is on the determinants of long-run [[economic growth]] like [[capital accumulation|accumulation]] of human and physical capital, technological innovations and [[demographic change]]s. Potential policies to influence these developments are [[education reform]]s, incentives to change [[saving rate]]s or to increase [[R&D]] activities.

===Output and income===
National [[Output (economics)|output]] is the total amount of everything a country produces in a given period of time. Everything that is produced and sold generates an equal amount of income. The total [[net output]] of the economy is usually measured as [[gross domestic product]] (GDP). Adding net [[factor income]]s from abroad to GDP produces [[gross national income]] (GNI), which measures total income of all residents in the economy. In most countries, the difference between GDP and GNI are modest so that GDP can approximately be treated as total income of all the inhabitants as well, but in some countries, e.g. countries with very large [[net foreign assets]] (or debt), the difference may be considerable.<ref name=Blanchard/>{{rp|385}}

Economists interested in long-run increases in output study economic growth. Advances in technology, accumulation of machinery and other [[Capital (economics)|capital]], and better education and [[human capital]], are all factors that lead to increased economic output over time. However, output does not always increase consistently over time. [[Business cycle]]s can cause short-term drops in output called [[recession]]s. Economists look for [[#Macroeconomic policy|macroeconomic policies]] that prevent economies from slipping into either [[recession]]s or [[Overheating (economics)|overheating]] and that lead to higher [[productivity]] levels and [[standards of living]].

===Unemployment===
{{Main|Unemployment}}

[[File:Okuns law differences 1948 to mid 2011.png|thumb|left|A chart using US data showing the relationship between economic growth and unemployment expressed by [[Okun's law]]. The relationship demonstrates cyclical unemployment. High short-run GDP growth leads to a lower unemployment rate.]]

The amount of [[unemployment]] in an economy is measured by the unemployment rate, i.e. the percentage of persons in the [[labor force]] who do not have a job, but who are actively looking for one. People who are retired, pursuing education, or [[discouraged worker|discouraged from seeking work]] by a lack of job prospects are not part of the labor force and consequently not counted as unemployed, either.<ref name=Blanchard/>{{rp|156}}

Unemployment has a short-run cyclical component which depends on the business cycle, and a more permanent structural component, which can be loosely thought of as the average unemployment rate in an economy over extended periods,<ref name=Romer>Romer (2019).</ref> and which is often termed the [[Natural rate of unemployment|natural]]<ref name=Romer/> or structural<ref name=Sørensen>Sørensen and Whitta-Jacobsen (2022).</ref><ref name=Blanchard/>{{rp|167}} rate of unemployment.

[[Unemployment#Cyclical unemployment|Cyclical unemployment]] occurs when growth stagnates. [[Okun's law]] represents the empirical relationship between unemployment and short-run GDP growth.<ref>Dwivedi, 445–46.</ref> The original version of Okun's law states that a 3% increase in output would lead to a 1% decrease in unemployment.<ref>{{Cite web |title=Neely, Christopher J. "Okun's Law: Output and Unemployment. ''Economic Synopses''. Number 4. 2010. |url=http://research.stlouisfed.org/publications/es/10/ES1004.pdf.}}</ref>

The structural or natural rate of unemployment is the level of unemployment that will occur in a medium-run equilibrium, i.e. a situation with a cyclical unemployment rate of zero. There may be several reasons why there is some positive unemployment level even in a cyclically neutral situation, which all have their foundation in some kind of [[market failure]]:<ref name=Romer/>

* [[Search unemployment]] (also called frictional unemployment) occurs when workers and firms are heterogeneous and there is [[imperfect information]], generally causing a time-consuming [[Search and matching theory (economics)|search and matching process]] when filling a job vacancy in a firm, during which the prospective worker will often be unemployed.<ref name=Romer/><ref>Dwivedi, 443.</ref> Sectoral shifts and other reasons for a changed demand from firms for workers with particular skills and characteristics, which occur continually in a changing economy, may also cause more search unemployment because of increased mismatch.<ref name=Mankiw>Mankiw (2022).</ref><ref>{{Cite web |title=Freeman (2008) |url=http://www.dictionaryofeconomics.com/article?id=pde2008_S000311.}}</ref><ref>Dwivedi, 444–45.</ref>
* [[Efficiency wage]] models are labor market models in which firms choose not to lower wages to the level where supply equals demand because the lower wages would lower employees' efficiency levels<ref name=Mankiw/>
* [[Trade unions]], which are important actors in the labor market in some countries, may exercise [[market power]] in order to keep wages over the market-clearing level for the benefice of their members even at the cost of some unemployment
* Legal [[minimum wage]]s may prevent the wage from falling to a market-clearing level, causing unemployment among low-skilled (and low-paid) workers.<ref name=Mankiw/><ref>{{Cite web|last=Pettinger|first=Tejvan|title=Involuntary unemployment|url=https://www.economicshelp.org/blog/glossary/involuntary-unemployment/|access-date=2020-09-21|website=Economics Help|language=en-GB}}</ref> In the case of employers having some [[monopsony power]], however, employment effects may have the opposite sign.<ref>{{Cite journal |last1=Dickens |first1=Richard |last2=Machin |first2=Stephen |last3=Manning |first3=Alan |date=January 1999 |title=The Effects of Minimum Wages on Employment: Theory and Evidence from Britain |url=https://www.journals.uchicago.edu/doi/10.1086/209911 |journal=Journal of Labor Economics |language=en |volume=17 |issue=1 |pages=1–22 |doi=10.1086/209911 |s2cid=7012497 |issn=0734-306X}}</ref>

===Inflation and deflation===
[[File:M2 and Inflation USA.svg|thumb|right|Changes in the ten-year moving averages of price level and growth in money supply (using the measure of M2, the supply of hard currency and money held in most types of bank accounts) in the US from 1880 to 2016. Over the long run, the two series show a clear positive correlation.]]
A general price increase across the entire economy is called [[inflation]]. When prices decrease, there is [[deflation]]. Economists measure these changes in prices with [[price index]]es. Inflation will increase when an economy becomes overheated and grows too quickly. Similarly, a declining economy can lead to decreasing inflation and even in some cases deflation.

[[Central bank]]ers conducting [[monetary policy]] usually have as a main priority to avoid too high inflation, typically by adjusting interest rates. High inflation as well as deflation can lead to increased uncertainty and other negative consequences, in particular when the inflation (or deflation) is unexpected. Consequently, most central banks aim for a positive, but stable and not very high inflation level.<ref name=Blanchard/>

Changes in the inflation level may be the result of several factors. Too much [[aggregate demand]] in the economy will cause an [[Overheating (economics)|overheating]], raising inflation rates via the [[Phillips curve]] because of a tight labor market leading to large wage increases which will be [[Pass-through (economics)|transmitted]] to increases in the price of the products of employers. Too little aggregate demand will have the opposite effect of creating more unemployment and lower wages, thereby decreasing inflation. Aggregate [[supply shock]]s will also affect inflation, e.g. the [[1970s energy crisis|oil crises of the 1970s]] and the [[2021–2023 global energy crisis]]. Changes in inflation may also impact the formation of [[inflation expectations]], creating a self-fulfilling inflationary or deflationary spiral.<ref name=Blanchard/>

The [[monetarist]] [[quantity theory of money]] holds that changes in the price level are directly caused by changes in the [[money supply]].{{sfn|Mankiw|2022|p=98}} Whereas there is empirical evidence that there is a long-run positive correlation between the growth rate of the money stock and the rate of inflation, the quantity theory has proved unreliable in the short- and medium-run time horizon relevant to monetary policy and is abandoned as a practical guideline by most central banks today.<ref name="Graff">{{cite journal |last1=Graff |first1=Michael |title=The quantity theory of money in historical perspective |url=https://www.research-collection.ethz.ch/handle/20.500.11850/124095 |journal=Kof Working Papers |publisher=KOF Swiss Economic Institute, ETH Zurich |access-date=3 September 2023 |date=April 2008|volume=196 |doi=10.3929/ethz-a-005582276 }}</ref>

===Open economy macroeconomics===

[[Open economy]] macroeconomics deals with the consequences of [[international trade]] in [[goods]], [[financial asset]]s and possibly [[factor market]]s like [[labor migration]] and international relocation of firms (physical capital). It explores what determines [[import]], [[export]], the [[balance of trade]] and over longer horizons the accumulation of [[net foreign assets]]. An important topic is the role of [[exchange rate]]s and the pros and cons of maintaining a [[fixed exchange rate]] system or even a [[currency union]] like the [[Economic and Monetary Union of the European Union]], drawing on the research literature on [[optimum currency area]]s.<ref name=Blanchard/>

=== GDP Equation Using Expenditure Approach ===
One way to calculate Gross Domestic Product, or total net output, is the expenditure method. The GDP essentially tells you how big the economy is. The larger the GDP value, the bigger the economy. The expenditure approach involves looking at four main components: Consumer Spending, Government Spending, Investment Spending, and Net Exports.<ref>{{Cite web |title=Calculating GDP With the Expenditure Approach |url=https://www.investopedia.com/ask/answers/070615/how-do-you-calculate-gdp-expenditures-approach.asp |access-date=2025-02-25 |website=Investopedia |language=en}}</ref> Consumer Spending is made up of ordinary consumers spending money on different kinds of products and also investing their money in residential markets. Government Spending involves the government spending money on goods and services and they may assist consumers or businesses with spending as well. For instance, purchasing physical capital for businesses. While transfer payments, which includes things like welfare or social security payments), are things that a government pays, it is not included in the final calculation of the expenditure approach because it is not paying for any final goods and services. Investment spending involves businesses spending money on physical capital/equipment to help with producing goods and services. Lastly, net exports is just exports minus imports. Exports are goods and services that a country is selling to people abroad and imports are goods and services that people from a country are receiving from abroad.

Hence, the equation for the expenditure approach to calculating the Gross Domestic Product is

[[Gross domestic product|GDP]] = Consumer Spending(CS) + Government Spending(GS) + Investment Spending(IS) + Net Exports(EXP-IMP).

=== GDP Deflator Equation & Explanation ===
Another concern with measuring a country's economic growth is that even though we see the GDP growing, that does not inherently mean the economy is growing. Most of the increase in GDP may just be due to inflation. To know whether this is the case, we have to calculate the GDP Deflator which adjusts the GDP for inflation.

GDP Deflator = (Nominal GDP/Real GDP) x 100<ref>{{Cite web |title=GDP Deflator {{!}} Formula + Calculator |url=https://www.wallstreetprep.com/knowledge/gdp-deflator/ |access-date=2025-02-25 |website=Wall Street Prep |language=en}}</ref>

Nominal GDP is GDP that includes inflation and Real GDP is GDP adjusted for inflation. To adjust for inflation means that the effect of inflation on the value was removed.

A GDP Deflator of 100 indicates that there is no inflation nor deflation. A GDP Deflator value that is greater than 100 indicates that there is inflation. A GDP Deflator value that is less than 100 indicates that there is deflation.

=== Money Supply & Money Multiplier: Equation & Explanations ===
Two common ways of determining the total money supply in an economy are M1 and M2. M2 consists of M1 plus a few other things. M1 is money that is liquid. Liquid refers to a financial asset being able to easily be converted into cash quickly and without losing a significant amount of value. This obviously includes cash but also things like coins, checking account deposits, etc. M2, however, includes time deposits, saving accounts, and money market mutual funds, which are not as liquid, in its measurement. It is important to know about the money supply as it affects interest rates and can also play a central role in monetary policy.<ref>{{Cite web |title=Deposit Multiplier vs. Money Multiplier: What's the Difference? |url=https://www.investopedia.com/ask/answers/062615/what-difference-between-deposit-multiplier-and-money-multiplier.asp?utm_source=chatgpt.com#toc-deposit-multiplier |access-date=2025-04-30 |website=Investopedia |language=en}}</ref>

The Money Multiplier equation shows how the bank can expand the money supply through taking in deposits and lending money.

The '''Money Supply Reserve Multiplier equation''' is:

'''Money Multiplier''' = 1 / '''Reserve Requirement Ratio'''<ref>{{Cite web |title=What Is the Multiplier Effect? Formula and Example |url=https://www.investopedia.com/terms/m/multipliereffect.asp#toc-money-supply-multiplier-effect |access-date=2025-04-29 |website=Investopedia |language=en}}</ref>

The reserve requirement in this equation represents a proportion of money that the bank is required to keep in case they need to deal with withdrawals from customers. That proportion of money is based on the deposits of money made at the bank. So, if the reserve requirement is .20(20%), then the money multiplier is 5. This means that a $5 deposit would lead to a $25 increase in the money supply. This is because of the cycle of the bank keeping part of the deposit(in our example, 20%) and lending out the rest every time. These new spendable bank deposits are counted in the money supply even though the amount of physical currency did not change. So, while the physical amount of currency would still be $5, the amount of spendable money would be $25.

==Development==
{{main|History of macroeconomic thought}}
[[File:John Maynard Keynes.jpg|thumb|right|[[John Maynard Keynes]] is considered the initiator of macroeconomics when he published his work ''[[The General Theory of Employment, Interest, and Money]]'' in 1936.]]

Macroeconomics as a separate field of research and study is generally recognized to start with the publication of [[John Maynard Keynes]]' ''[[The General Theory of Employment, Interest, and Money]]'' in 1936.<ref name=Dimand/><ref>Snowdon and Vane (2005).</ref><ref name=Blanchard/>{{rp|526}} The terms "macrodynamics" and "macroanalysis" were introduced by [[Ragnar Frisch]] in 1933, and Lawrence Klein in 1946 used the word "macroeconomics" itself in a journal title in 1946.<ref name=Dimand/> but naturally several of the themes which are central to macroeconomic research had been discussed by thoughtful economists and other writers long before 1936.<ref name=Dimand/>

===Before Keynes===
In particular, macroeconomic questions before Keynes were the topic of the two long-standing traditions of [[business cycle|business cycle theory]] and [[monetary theory]]. [[William Stanley Jevons]] was one of the pioneers of the first tradition, whereas the [[quantity theory of money]], labelled the oldest surviving theory in economics, as an example of the second was described already in the 16th century by [[Martín de Azpilcueta]] and later discussed by personalities like [[John Locke]] and [[David Hume]]. In the first decades of the 20th century monetary theory was dominated by the eminent economists [[Alfred Marshall]], [[Knut Wicksell]] and [[Irving Fisher]].<ref name=Dimand>Dimand (2008).</ref>

===Keynes and Keynesian economics===

When the Great Depression struck, the reigning economists had difficulty explaining how goods could go unsold and workers could be left unemployed. In the prevailing [[neoclassical economics]] paradigm, prices and wages would drop until the market cleared, and all goods and labor were sold. Keynes in his main work, the ''General Theory'', initiated what is known as the [[Keynesian Revolution]]. He offered a new interpretation of events and a whole intellectural framework - a novel theory of economics that explained why markets might not clear, which would evolve into a school of thought known as [[Keynesian economics]], also called Keynesianism or Keynesian theory.<ref name=Blanchard/>{{rp|526}}

In Keynes' theory, [[aggregate demand]] - by Keynes called "effective demand" - was key to determining output. Even if Keynes conceded that output might eventually return to a medium-run equilibrium (or "potential") level, the process would be slow at best. Keynes coined the term [[liquidity preference]] (his preferred name for what is also known as [[money demand]]) and explained how monetary policy might affect aggregate demand, at the same time offering clear policy recommendations for an active role of fiscal policy in stabilizing aggregate demand and hence output and employment. In addition, he explained how the [[multiplier effect]] would magnify a small decrease in consumption or investment and cause declines throughout the economy, and noted the role that uncertainty and [[Animal spirits (Keynes)|animal spirits]] can play in the economy.<ref name=Blanchard/>{{rp|526}}

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.<ref name=Blanchard/>{{rp|526}} 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.<ref name=Blanchard/>{{rp|527}}

===Monetarism===
[[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.<ref name=Blanchard/>{{rp|528}}

Friedman also challenged the original simple [[Phillips curve]] relationship between inflation and unemployment. Friedman and [[Edmund Phelps]] (who was not a monetarist) proposed an "augmented" version of the Phillips curve that excluded the possibility of a stable, long-run tradeoff between inflation and unemployment.<ref>{{Cite web|url=http://www.econlib.org/library/Enc/PhillipsCurve.html|title=Phillips Curve: The Concise Encyclopedia of Economics {{!}} Library of Economics and Liberty|website=www.econlib.org|access-date=2018-01-23}}</ref> When the [[1970s energy crisis|oil shocks]] of the 1970s created a high unemployment and high inflation, Friedman and Phelps were vindicated. Monetarism was particularly influential in the early 1980s, but fell out of favor when central banks found the results disappointing when trying to target money supply instead of interest rates as monetarists recommended, concluding that the relationships between money growth, inflation and real GDP growth are too unstable to be useful in practical monetary policy making.<ref>{{cite journal |last1=Williamson |first1=Stephen D. |title=The Role of Central Banks |journal=Canadian Public Policy |date=2020 |volume=46 |issue=2 |pages=198–213 |doi=10.3138/cpp.2019-058 |jstor=26974728 |s2cid=219465676 |issn=0317-0861|doi-access=free }}</ref>

===New classical economics===
[[New classical macroeconomics]] further challenged the Keynesian school. A central development in new classical thought came when [[Robert Lucas, Jr.|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.<ref name=Blanchard/>{{rp|530}} Consumers 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. In the new classical models with rational expectations, monetary policy only had a limited impact.

Lucas also made an [[Lucas critique|influential critique]] of Keynesian empirical models. He argued that forecasting models based on empirical relationships would keep producing the same predictions even as the underlying model generating the data changed. He advocated models based on fundamental economic theory (i.e. having an explicit [[Microfoundations|microeconomic foundation]]) that would, in principle, be structurally accurate as economies changed.<ref name=Blanchard/>{{rp|530}}

Following Lucas's critique, new classical economists, led by [[Edward C. Prescott]] and [[Finn E. Kydland]], created [[real business cycle]] (RBC) models of the macro economy. RBC models were created by combining fundamental equations from neo-classical microeconomics to make quantitative models. In order to generate macroeconomic fluctuations, RBC models explained recessions and unemployment with changes in technology instead of changes in the markets for goods or money. Critics of RBC models argue that technological changes, which typically diffuse slowly throughout the economy, could hardly generate the large short-run output fluctuations that we observe. In addition, there is strong empirical evidence that monetary policy does affect real economic activity, and the idea that technological regress can explain recent recessions seems implausible.<ref name=Blanchard/>{{rp|533}}<ref name=Romer/>{{rp|195}}

Despite criticism of the realism in the RBC models, they have been very influential in [[economic methodology]] by providing the first examples of [[general equilibrium]] models based on [[Microfoundations|microeconomic foundations]] and a specification of underlying shocks that aim to explain the main features of macroeconomic fluctuations, not only qualitatively, but also quantitatively. In this way, they were forerunners of the later DSGE models.<ref name=Romer/>{{rp|194}}

===New Keynesian response===
[[New Keynesian]] economists responded to the new classical school by adopting rational expectations and focusing on developing micro-founded models that were immune to the Lucas critique. 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 (economics)|sticky prices and wages]] due to [[imperfect competition]],<ref>[http://huwdixon.org/SurfingEconomics/chapter4.pdf The role of imperfect competition in new Keynesian economics], Chapter 4 of [http://huwdixon.org/SurfingEconomics/index.html Surfing Economics] by [[Huw Dixon]]</ref> which would not adjust, allowing monetary policy to impact quantities instead of prices. [[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]], [[Janet Yellen]], [[Julio Rotemberg]], [[Greg Mankiw]], [[David Romer]], and [[Michael Woodford (economist)|Michael Woodford]], expanded on this work and demonstrated other cases where various market imperfections caused inflexible prices and wages leading in turn to monetary and fiscal policy having real effects. Other researchers focused on imperferctions in labor markets, developing models of [[efficiency wage]]s or [[Search and matching theory (economics)|search and matching]] (SAM) models, or imperfections in credit markets like [[Ben Bernanke]].<ref name=Blanchard/>{{rp|532–36}}

By the late 1990s, economists had reached a rough consensus.<ref>Blanchard (2009)</ref> The market imperfections and nominal rigidities of new Keynesian theory was combined with rational expectations and the RBC methodology to produce a new and popular type of models called [[dynamic stochastic general equilibrium]] (DSGE) models. The fusion of elements from different schools of thought has been dubbed the [[new neoclassical synthesis]].<ref>{{cite journal |last1=Goodfriend |first1=Marvin |last2=King |first2=Robert G. |title=The New Neoclassical Synthesis and the Role of Monetary Policy |journal=NBER Macroeconomics Annual |date=1997 |volume=12 |pages=231–283 |doi=10.2307/3585232 |jstor=3585232 |url=https://www.jstor.org/stable/3585232 |access-date=8 September 2023}}</ref><ref>{{cite journal |last1=Woodford |first1=Michael |title=Convergence in Macroeconomics: Elements of the New Synthesis |journal=American Economic Journal: Macroeconomics |date=January 2009 |volume=1 |issue=1 |pages=267–279 |doi=10.1257/mac.1.1.267 |url=https://www.aeaweb.org/articles?id=10.1257/mac.1.1.267 |access-date=8 September 2023 |language=en |issn=1945-7707}}</ref> These models are now used by many central banks and are a core part of contemporary macroeconomics.<ref name=Blanchard/>{{rp|535–36}}

===2008 financial crisis===
The [[2008 financial crisis]], which led to the [[Great Recession]], led to major reassessment of macroeconomics, which as a field generally had neglected the potential role of [[financial institution]]s in the economy. After the crisis, macroeconomic researchers have turned their attention in several new directions:

* the financial system and the nature of macrofinancial linkages and frictions, studying leverage, liquidity and complexity problems in the financial sector, the use of [[Macroprudential regulation|macroprudential tools]] and the dangers of an [[Fiscal sustainability|unsustainable]] public debt<ref name=Blanchard/>{{rp|537}}<ref>{{cite journal |last1=Glandon |first1=P. J. |last2=Kuttner |first2=Ken |last3=Mazumder |first3=Sandeep |last4=Stroup |first4=Caleb |title=Macroeconomic Research, Present and Past |journal=Journal of Economic Literature |date=September 2023 |volume=61 |issue=3 |pages=1088–1126 |doi=10.1257/jel.20211609 |url=https://www.aeaweb.org/articles?id=10.1257/jel.20211609 |access-date=8 September 2023 |language=en |issn=0022-0515|url-access=subscription }}</ref>
* increased emphasis on [[Applied economics|empirical work]] as part of the so-called [[credibility revolution]] in economics, using improved methods to distinguish between [[Correlation does not imply causation|correlation and causality]] to improve future policy discussions<ref name=":0">Nakamura and Steinsson (2018) write that macroeconomics struggles with long-term predictions, which is a result of the high complexity of the systems it studies.</ref>
* interest in understanding the importance of [[Heterogeneity in economics|heterogeneity]] among the economic agents, leading among other examples to the construction of heterogeneous agent new Keynesian models ([[HANK model]]s), which may potentially also improve understanding of the impact of macroeconomics on the [[income distribution]]<ref>{{cite web |last1=Guvenen |first1=Fatih |title=Macroeconomics with Heterogeneity: A Practical Guide |url=https://www.nber.org/system/files/working_papers/w17622/w17622.pdf |website=www.nber.org |publisher=National Bureau of Economic Research |access-date=8 September 2023}}</ref>
* understanding the implications of integrating the findings of the increasingly useful [[behavioral economics]] literature into macroeconomics<ref>{{cite web |last1=Ji |first1=Yuemei |last2=De Grauwe |first2=Paul |title=Behavioural economics is also useful in macroeconomics |url=https://cepr.org/voxeu/columns/behavioural-economics-also-useful-macroeconomics |website=CEPR |publisher=Centre for Economic Policy Research |access-date=8 September 2023 |language=en |date=1 November 2017}}</ref> and behavioral finance

=== Growth models ===
Research in the economics of the determinants behind long-run [[economic growth]] has followed its own course.<ref>{{cite book |last1=Howitt |first1=Peter |last2=Weil |first2=David N. |chapter=Economic Growth |chapter-url=https://link.springer.com/referenceworkentry/10.1057/978-1-349-95121-5_2314-1 |title=The New Palgrave Dictionary of Economics |publisher=Palgrave Macmillan UK |pages=1–11 |language=en |doi=10.1057/978-1-349-95121-5_2314-1 |date=2016|isbn=978-1-349-95121-5 }}</ref> The [[Harrod-Domar]] model from the 1940s attempted to build a long-run growth model inspired by Keynesian demand-driven considerations.<ref>{{cite book |last1=Eltis |first1=Walter |chapter=Harrod–Domar Growth Model |chapter-url=https://link.springer.com/referenceworkentry/10.1057/978-1-349-95121-5_1267-1 |title=The New Palgrave Dictionary of Economics |publisher=Palgrave Macmillan UK |pages=1–5 |language=en |doi=10.1057/978-1-349-95121-5_1267-1 |date=2016|isbn=978-1-349-95121-5 }}</ref> The [[Solow–Swan model]] worked out by [[Robert Solow]] and, independently, [[Trevor Swan]] in the 1950s achieved more long-lasting success, however, and is still today a common textbook model for explaining economic growth in the long-run.<ref>{{Cite web|last=Banton|first=Caroline|title=The Neoclassical Growth Theory Explained|url=https://www.investopedia.com/terms/n/neoclassical-growth-theory.asp|access-date=2020-09-21|website=Investopedia|language=en}}</ref> The model operates with a [[production function]] where national output is the product of two inputs: capital and labor. The Solow model assumes that labor and capital are used at constant rates without the fluctuations in unemployment and capital utilization commonly seen in business cycles.{{sfn|Solow|2002|pp=518–19}} In this model, increases in output, i.e. economic growth, can only occur because of an increase in the capital stock, a larger population, or technological advancements that lead to higher productivity ([[total factor productivity]]). An increase in the savings rate leads to a temporary increase as the economy creates more capital, which adds to output. However, eventually the depreciation rate will limit the expansion of capital: savings will be used up replacing depreciated capital, and no savings will remain to pay for an additional expansion in capital. Solow's model suggests that economic growth in terms of output per capita depends solely on technological advances that enhance productivity.{{sfn|Solow|2002|p=519}} The Solow model can be interpreted as a special case of the more general [[Ramsey–Cass–Koopmans model|Ramsey growth model]], where households' savings rates are not constant as in the Solow model, but derived from an explicit intertemporal [[utility function]].

In the 1980s and 1990s [[endogenous growth theory]] arose to challenge the neoclassical growth theory of Ramsey and Solow. This group of models explains economic growth through factors such as increasing returns to scale for capital and [[Learning-by-doing (economics)|learning-by-doing]] that are endogenously determined instead of the exogenous technological improvement used to explain growth in Solow's model.{{sfn|Blaug|2002|pp=202–03}} Another type of endogenous growth models endogenized the process of technological progress by modelling [[research and development]] activities by profit-maximizing firms explicitly within the growth models themselves.<ref name=Sørensen/>{{rp|280–308}}

==== Environmental and climate issues ====
[[File:Diagram of natural resource flows-en.svg|thumb|Natural resources flow through the economy and end up as waste and pollution.]]

Since the 1970s, various environmental problems have been integrated into growth and other macroeconomic models to study their implications more thoroughly. During the oil crises of the 1970s when scarcity problems of natural resources were high on the public agenda, economists like [[Joseph Stiglitz]] and [[Robert Solow]] introduced [[non-renewable resource]]s into neoclassical growth models to study the possibilities of maintaining growth in living standards under these conditions.<ref name=Sørensen/>{{rp|201–39}} More recently, the issue of [[climate change]] and the possibilities of a [[sustainable development]] are examined in so-called [[Integrated assessment modelling|integrated assessment models]], pioneered by [[William Nordhaus]].<ref>{{cite book |last1=Hassler |first1=J. |last2=Krusell |first2=P. |last3=Smith |first3=A. A. |chapter=Chapter 24 - Environmental Macroeconomics |chapter-url=https://www.sciencedirect.com/science/article/abs/pii/S1574004816300076 |title=Handbook of Macroeconomics |publisher=Elsevier |access-date=9 September 2023 |pages=1893–2008 |date=1 January 2016|volume=2 |doi=10.1016/bs.hesmac.2016.04.007 |isbn=9780444594877 }}</ref> In macroeconomic models in [[environmental economics]], the economic system is dependant upon the environment. In this case, the [[circular flow of income]] diagram may be replaced by a more complex flow diagram reflecting the input of solar energy, which sustains natural inputs and [[ecosystem services|environmental services]] which are then used as units of [[Production (economics)|production]]. Once consumed, natural inputs pass out of the economy as pollution and waste. The potential of an environment to provide services and materials is referred to as an "environment's source function", and this function is depleted as resources are consumed or pollution contaminates the resources. The "sink function" describes an environment's ability to absorb and render harmless waste and pollution: when waste output exceeds the limit of the sink function, long-term damage occurs.<ref name=Harris2006>Harris J. (2006). ''Environmental and Natural Resource Economics: A Contemporary Approach''. Houghton Mifflin Company.</ref>{{rp|8}}  In 2024 a new approach was proposed which would institutionalize Inclusion, Sustainability and Resilience in Domestic Economic Governance.<ref>{{cite book |last= Samans|first= Richard |date=2024 |title= Human-Centred Economics: The Living Standards of Nations (open access) |url=https://richardsamans.net/book-human-centred-economics/ |location= |publisher= Palgrave Macmillan in association with the ILO|access-date=22 April 2025}}</ref>

==Macroeconomic policy==

The division into various time frames of macroeconomic research leads to a parallel division of macroeconomic policies into short-run policies aimed at mitigating the harmful consequences of business cycles (known as [[stabilization policy]]) and medium- and long-run policies targeted at improving the structural levels of macroeconomic variables.<ref name=Sørensen/>{{rp|18}}

Stabilization policy is usually implemented through two sets of tools: fiscal and monetary policy. Both forms of policy are used to [[Stabilization policy|stabilize the economy]], i.e. limiting the effects of the business cycle by conducting expansive policy when the economy is in a [[recession]] or contractive policy in the case of [[Overheating (economics)|overheating]].<ref name=Blanchard/><ref name="Mayer, 495">Mayer, 495.</ref>

Structural policies may be labor market policies which aim to change the structural unemployment rate or policies which affect long-run propensities to save, invest, or engage in education or research and development.<ref name=Sørensen/>{{rp|19}}

===Monetary policy===
{{Further|Monetary policy}}

[[Central bank]]s conduct monetary policy mainly by adjusting short-term [[interest rates]].<ref name=RBA>{{cite web |last1=Baker |first1=Nick |last2=Rafter |first2=Sally |title=An International Perspective on Monetary Policy Implementation Systems {{!}} Bulletin – June 2022 |url=https://www.rba.gov.au/publications/bulletin/2022/jun/an-international-perspective-on-monetary-policy-implementation-systems.html |publisher=Reserve Bank of Australia |access-date=13 August 2023 |language=en-AU |date=16 June 2022}}</ref> The actual method through which the interest rate is changed differs from central bank to central bank, but typically the implementation happens either directly via administratively changing the central bank's own offered interest rates or indirectly via [[open market operations]].<ref>{{cite book |title=MC Compendium Monetary policy frameworks and central bank market operations |date=October 2019 |publisher=Bank for International Settlements |isbn=978-92-9259-298-1 |url=https://www.bis.org/publ/mc_compendium.pdf}}</ref>

Via the [[monetary transmission mechanism]], interest rate changes affect [[investment (macroeconomics)|investment]], [[Consumption (economics)|consumption]], [[asset prices]] like listed companies' shares prices and [[Real estate appraisal|house prices]], and through [[exchange rate]] reactions [[export]] and [[import]]. In this way [[aggregate demand]], [[employment]] and ultimately inflation is affected.<ref name="Fed goals II">{{cite web |title=Federal Reserve Board - Monetary Policy: What Are Its Goals? How Does It Work? |url=https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm |website=Board of Governors of the Federal Reserve System |access-date=13 August 2023 |language=en |date=29 July 2021}}</ref> Expansionary monetary policy lowers interest rates, increasing economic activity, whereas contractionary monetary policy raises interest rates. In the case of a fixed exchange rate system, interest rate decisions together with direct intervention by central banks on exchange rate dynamics are major tools to control the exchange rate.<ref name=nationalbanken>{{cite web |title=Fixed exchange rate policy |url=https://www.nationalbanken.dk/en/frequently-asked-questions/fixed-exchange-rate-policy |website=Nationalbanken |access-date=13 August 2023 |language=en}}</ref>

In developed countries, most central banks follow [[inflation targeting]], focusing on keeping medium-term inflation close to an explicit target, say 2%, or within an explicit range. This includes the [[Federal Reserve]] and the [[European Central Bank]], which are generally considered to follow a strategy very close to inflation targeting, even though they do not officially label themselves as inflation targeters.<ref name=Holdingline>{{cite web |title=Inflation Targeting: Holding the Line |url=https://www.imf.org/external/pubs/ft/fandd/basics/72-inflation-targeting.htm |website=International Monetary Fund |access-date=12 August 2023}}</ref> In practice, an official inflation targeting often leaves room for the central bank to also help stabilize [[Output (economics)|output]] and employment, a strategy known as "flexible inflation targeting".<ref>{{cite web |last1=Ingves |first1=Stefan |title=Flexible inflation targeting in theory and practice |url=https://www.bis.org/review/r110517c.pdf |website=www.bis.org |publisher=Bank of International Settlements |date=12 May 2011 |access-date=5 September 2023}}</ref> Most [[emerging economies]] focus their monetary policy on maintaining a [[fixed exchange rate]] regime, aligning their currency with one or more foreign currencies, typically the [[US dollar]] or the [[euro]].<ref name=IMF>{{cite book |last1=Department |first1=International Monetary Fund Monetary and Capital Markets |title=Annual Report on Exchange Arrangements and Exchange Restrictions 2022 |date=26 July 2023 |publisher=International Monetary Fund |isbn=979-8-4002-3526-9 |url=https://www.elibrary.imf.org/display/book/9798400235269/9798400235269.xml?code=imf.org |access-date=12 August 2023 |language=en }}</ref>

Conventional monetary policy can be ineffective in situations such as a [[liquidity trap]]. When nominal interest rates are near zero, central banks cannot loosen monetary policy through conventional means. In that situation, they may use unconventional monetary policy such as [[quantitative easing]] to help stabilize output. Quantity easing can be implemented by buying not only government bonds, but also other assets such as corporate bonds, stocks, and other securities. This allows lower interest rates for a broader class of assets beyond government bonds. A similar strategy is to lower long-term interest rates by buying long-term bonds and selling short-term bonds to create a flat [[yield curve]], known in the US as [[Operation Twist]].<ref>{{cite web |last1=Hancock |first1=Diana |last2=Passmore |first2=Wayne |title=How the Federal Reserve's Large-Scale Asset Purchases (LSAPs) Influence Mortgage-Backed Securities (MBS) Yields and U.S. Mortgage Rates |url=https://www.federalreserve.gov/pubs/feds/2014/201412/201412pap.pdf |website=www.federalreserve.gov |publisher=Federal Reserve |access-date=5 September 2023 |date=2014}}</ref>

===Fiscal policy===
{{Further|Fiscal policy}}

Fiscal policy is the use of government's revenue ([[tax]]es) and [[Government spending|expenditure]] as instruments to influence the economy.

For example, if the economy is producing less than [[potential output]], government spending can be used to employ idle resources and boost output, or taxes could be lowered to boost private consumption which has a similar effect. Government spending or tax cuts do not have to make up for the entire [[output gap]]. There is a [[Fiscal multiplier|multiplier effect]] that affects the impact of government spending. For instance, when the government pays for a bridge, the project not only adds the value of the bridge to output, but also allows the bridge workers to increase their consumption and investment, which helps to close the output gap.

The effects of fiscal policy can be limited by partial or full [[Crowding out (economics)|crowding out]]. When the government takes on spending projects, it limits the amount of resources available for the [[private sector]] to use. Full crowding out occurs in the extreme case when government spending simply replaces private sector output instead of adding additional output to the economy. A crowding out effect may also occur if government spending should lead to higher interest rates, which would limit investment.<ref>{{cite journal |last1=Arestis |first1=Philip |last2=Sawyer |first2=Malcolm |title=Reinventing fiscal policy |journal=Levy Economics Institute of Bard College |date=2003 |issue=Working Paper, No. 381 |url=https://www.econstor.eu/bitstream/10419/31523/1/503961485.pdf |access-date=7 December 2018}}</ref>

Some fiscal policy is implemented through [[automatic stabilizers]] without any active decisions by politicians. Automatic stabilizers do not suffer from the policy lags of [[Discretionary policy|discretionary fiscal policy]]. Automatic stabilizers use conventional fiscal mechanisms, but take effect as soon as the economy takes a downturn: spending on unemployment benefits automatically increases when unemployment rises, and [[tax revenue]]s decrease, which shelters private income and consumption from part of the fall in market income.<ref name=Sørensen/>{{rp|657}}

===Comparison of fiscal and monetary policy ===

There is a general consensus that both monetary and fiscal instruments may affect demand and activity in the short run (i.e. over the business cycle).<ref name=Sørensen/>{{rp|657}} Economists usually favor monetary over fiscal policy to mitigate moderate fluctuations, however, because it has two major advantages. First, monetary policy is generally implemented by independent central banks instead of the political institutions that control fiscal policy. Independent central banks are less likely to be subject to political pressures for overly expansionary policies. Second, monetary policy may suffer shorter [[inside lag]]s and [[outside lag]]s than fiscal policy.<ref name=" Mayer, 495"/> There are some exceptions, however: Firstly, in the case of a major shock, monetary stabilization policy may not be sufficient and should be supplemented by active fiscal stabilization.<ref name=Sørensen/>{{rp|659}} Secondly, in the case of a very low interest level, the economy may be in a [[liquidity trap]] in which monetary policy becomes ineffective, which makes fiscal policy the more potent tool to stabilize the economy.<ref name=Blanchard/> Thirdly, in regimes where monetary policy is tied to fulfilling other targets, in particular [[fixed exchange rate]] regimes, the central bank cannot simultaneously adjust its interest rates to mitigate domestic business cycle fluctuations, making fiscal policy the only usable tool for such countries.<ref name=nationalbanken/>

==Macroeconomic models==
{{Further|Macroeconomic model}}

Macroeconomic teaching, research and informed debates normally evolve around formal ([[diagrammatic]] or [[equation]]al) [[macroeconomic model]]s to clarify assumptions and show their consequences in a precise way. Models include simple theoretical models, often containing only a few equations, used in teaching and research to highlight key basic principles, and larger applied quantitative models used by e.g. governments, central banks, think tanks and international organisations to predict effects of changes in economic policy or other [[exogenous factor]]s or as a basis for making [[economic forecasting]].<ref>{{cite book |last1=Watson |first1=Mark W. |chapter=Macroeconomic Forecasting |chapter-url=https://link.springer.com/referenceworkentry/10.1057/978-1-349-95121-5_2434-1 |title=The New Palgrave Dictionary of Economics |publisher=Palgrave Macmillan UK |access-date=9 September 2023 |pages=1–3 |language=en |doi=10.1057/978-1-349-95121-5_2434-1 |date=2016|isbn=978-1-349-95121-5 }}</ref>

Well-known specific theoretical models include short-term models like the [[Keynesian cross]], the [[IS–LM model]] and the [[Mundell–Fleming model]], medium-term models like the [[AD–AS model]], building upon a [[Phillips curve]], and long-term growth models like the [[Solow–Swan model|Solow–Swan]] model, the [[Ramsey–Cass–Koopmans model]] and [[Peter Diamond]]'s [[overlapping generations model]]. Quantitative models include early [[large-scale macroeconometric model]], the new classical [[Real business-cycle theory|real business cycle models]], microfounded [[computable general equilibrium]] (CGE) models used for medium-term (structural) questions like international trade or tax reforms, [[Dynamic stochastic general equilibrium]] (DSGE) models used to analyze business cycles, not least in many central banks, or [[Integrated assessment modelling|integrated assessment]] models like [[DICE model|DICE]].

===Specific models===
====IS–LM model====

[[File:Islm.svg|thumb|In this example of a traditional IS–LM chart, the IS curve moves to the right, causing higher interest rates (i) and expansion in the "real" economy (real GDP, or Y).]]

The [[IS–LM]] model, invented by [[John Hicks]] in 1936, gives the underpinnings of aggregate demand (itself discussed below). It answers the question "At any given price level, what is the quantity of goods demanded?" The graphic model shows combinations of interest rates and output that ensure equilibrium in both the goods and money markets under the model's assumptions.{{sfn|Durlauf|Hester|2008}} The goods market is modeled as giving equality between investment and public and private saving (IS), and the money market is modeled as giving equilibrium between the [[money supply]] and [[liquidity preference]] (equivalent to money demand).{{sfn|Peston|2002|pp=386–87}}

The IS curve consists of the points (combinations of income and interest rate) where investment, given the interest rate, is equal to public and private saving, given output.{{sfn|Peston|2002|p=387}} The IS curve is downward sloping because output and the interest rate have an inverse relationship in the goods market: as output increases, more income is saved, which means interest rates must be lower to spur enough investment to match saving.{{sfn|Peston|2002|p=387}}

The traditional LM curve is upward sloping because the interest rate and output have a positive relationship in the money market: as income (identically equal to output in a closed economy) increases, the demand for money increases, resulting in a rise in the interest rate in order to just offset the incipient rise in money demand.{{sfn|Peston|2002|pp=387–88}}

The IS-LM model is often used in elementary textbooks to demonstrate the effects of monetary and fiscal policy, though it ignores many complexities of most modern macroeconomic models.{{sfn|Durlauf|Hester|2008}} A problem related to the LM curve is that modern central banks largely ignore the money supply in determining policy, contrary to the model's basic assumptions.<ref name=Romer/>{{rp|262}} In some modern textbooks, consequently, the traditional IS-LM model has been modified by replacing the traditional LM curve with an assumption that the central bank simply determines the interest rate of the economy directly.<ref name=Romer/>{{rp|194}}<ref name=Blanchard/>{{rp|113}}

====AD-AS model====

[[File:AS + AD graph.svg|thumb|A traditional AD–AS diagram showing a shift in AD, and the AS curve becoming inelastic beyond potential output]]

The [[AD–AS model]] is a common textbook model for explaining the macroeconomy.{{sfn|Healey|2002|p=12}} The original version of the model shows the price level and level of real output given the equilibrium in [[aggregate demand]] and [[aggregate supply]]. The aggregate demand curve's downward slope means that more output is demanded at lower price levels.{{sfn|Healey|2002|p=13}} The downward slope can be explained as the result of three effects: the [[Pigou effect|Pigou or real balance effect]], which states that as real prices fall, real wealth increases, resulting in higher consumer demand of goods; the [[Keynes effect|Keynes or interest rate effect]], which states that as prices fall, the demand for money decreases, causing interest rates to decline and borrowing for investment and consumption to increase; and the net export effect, which states that as prices rise, domestic goods become comparatively more expensive to foreign consumers, leading to a decline in exports.{{sfn|Healey|2002|p=13}}

In many representations of the AD–AS model, the aggregate supply curve is horizontal at low levels of output and becomes inelastic near the point of [[potential output]], which corresponds with [[full employment]].{{sfn|Healey|2002|p=12}} Since the economy cannot produce beyond the potential output, any AD expansion will lead to higher price levels instead of higher output.

In modern textbooks, the AD–AS model is often presented slightly differently, however, in a diagram showing not the price level, but the inflation rate along the vertical axis,<ref name=Romer/>{{rp|263}}<ref name=Mankiw/>{{rp|399–428}}<ref name=Sørensen/>{{rp|595}} making it easier to relate the diagram to real-world policy discussions.<ref name=Sørensen/>{{rp|vii}} In this framework, the AD curve is downward sloping because higher inflation will cause the central bank, which is assumed to follow an [[inflation target]], to raise the interest rate which will dampen economic activity, hence reducing output. The AS curve is upward sloping following a standard modern [[Phillips curve]] thought, in which a higher level of economic activity lowers unemployment, leading to higher wage growth and in turn higher inflation.<ref name=Romer/>{{rp|263}}

== Real-life applications and data ==
{{Rewrite section|date=May 2025}}

=== Trump's proposed tariff policy in Feb 2025 ===
In early February 2025, United States of America President Donald Trump stated that he would be imposing a 25% tariff on imported goods from Mexico and Canada and a 10% tariff on imported goods from China for US consumers.<ref name="pbs.org">{{Cite web |date=2025-02-02 |title=Analysis: The potential economic effects of Trump's tariffs and trade war, in 9 charts |url=https://www.pbs.org/newshour/economy/analysis-the-potential-economic-effects-of-trumps-tariffs-and-trade-war-in-9-charts |access-date=2025-02-25 |website=PBS News |language=en-us}}</ref> A tariff in this case is a tax on imported goods and services. US consumers will be less likely to buy imports from those three countries due to the higher price they would have to pay. This was projected to reduce US imports by 15% and generate federal revenue of $100 billion.<ref>{{Cite web |date=2025-02-02 |title=Analysis: The potential economic effects of Trump's tariffs and trade war, in 9 charts |url=https://www.pbs.org/newshour/economy/analysis-the-potential-economic-effects-of-trumps-tariffs-and-trade-war-in-9-charts |access-date=2025-02-27 |website=PBS News |language=en-us}}</ref>

While imports from Mexico and Canada are important to the US, the US does not rely as much on Canadian and Mexican imports compared to Mexico's and Canada's economies being highly reliant on their exports to the USA. There would be higher production and grocery costs for the US but Mexico would have its economy reduced by 16% as the US takes in 80% of their car exports and 60% of their petroleum exports. In addition, Canada would have its economy reduced by similar amounts as the US takes in 70% of all of their exports.<ref name="pbs.org"/>

In relation to the expenditure approach to calculating GDP, (Exports - Imports) would reduce significantly due to reduced exports, which means a negative net exports and a lower GDP. {{citation needed|date=May 2025}}

=== GDP deflator data ===
When looking at data presented by the Bureau of Economic Analysis, with a base year of 2017, we see that the GDP deflator has been trending upwards since then.<ref>{{Cite web |title=BEA Interactive Data Application |url=https://apps.bea.gov/iTable/?reqid=19&step=3&isuri=1&1921=survey&1903=11&_gl=1*o5p0nu*_ga*MTAyOTMzODIxOS4xNzQwMDYyMjU5*_ga_J4698JNNFT*MTc0MDA2MjI1OS4xLjAuMTc0MDA2MjI2MC41OS4wLjA. |access-date=2025-02-25 |website=apps.bea.gov}}</ref> The base year serves as the standard year to which we can compare whether GDP increased or decreased. The base year's prices are used when calculating Real GDP for a specific year. For instance, calculating 2020's GDP Deflator would be equivalent to 2020's Nominal GDP/2020's Real GDP (using 2017 prices). The GDP Deflator has risen from 100 to 126.22 in 2024 Q4.

==See also==
{{Portal|Business and economics}}
* [[Microeconomics]]
* [[Business cycle accounting]]
* [[Economic development]]
* [[Growth accounting]]

==Notes==
{{reflist|30em}}

==References==
{{Library resources box
|by=no
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|others=no
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|label=Macroeconomics }}
* Blanchard, Olivier. (2009). "[https://www.nber.org/papers/w14259 The State of Macro]." ''Annual Review of Economics'' 1(1): 209–228.
*{{cite book |last1=Blanchard |first1=Olivier |title=Macroeconomics |date=2021 |publisher=Pearson |location=Harlow, England |isbn=978-0-134-89789-9 |edition=Eighth, global}}
* {{cite book |last=Blaug |first=Mark |editor1-last=Snowdon |editor1-first=Brian |editor2-last=Vane |editor2-first=Howard |chapter=Endogenous growth theory |title=An Encyclopedia of Macroeconomics |url=https://archive.org/details/encyclopediaofma00bria |url-access=registration |publisher=Edward Elgar Publishing |location=Northampton, Massachusetts |year=2002 |isbn=978-1-84542-180-9 }}
* {{cite book |first1=Robert W. |year=2008 |last1=Dimand |chapter=Macroeconomics, origins and history of |chapter-url=https://link.springer.com/referenceworkentry/10.1057/978-1-349-95121-5_2333-1 |title=The New Palgrave Dictionary of Economics |pages=236–44 |publisher=Palgrave Macmillan UK |editor1-first=Steven N. |editor1-last=Durlauf |editor2-first=Lawrence E. |editor2-last=Blume |doi=10.1057/9780230226203.1009|isbn=978-0-333-78676-5 }}
* {{cite book |last1=Durlauf |first1=Steven N. |last2=Hester |first2=Donald D. |chapter=IS–LM |title=The New Palgrave Dictionary of Economics |pages=585–91 |edition=2nd |editor1-first=Steven N. |editor1-last=Durlauf |editor2-first=Lawrence E. |editor2-last=Blume |publisher=Palgrave Macmillan |year=2008 |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde2008_I000303 |doi=10.1057/9780230226203.0855 |isbn=978-0-333-78676-5 }}
* {{cite book |last=Dwivedi |first=D.N. |title=Macroeconomics: theory and policy |publisher=Tata McGraw-Hill |location=New Delhi |year=2001 |isbn=978-0-07-058841-7 }}
* {{cite book |first=Manfred |last=Gärtner |title=Macroeconomics |publisher=Pearson Education Limited |isbn=978-0-273-70460-7 |year=2006 }}
* {{cite book |last=Healey |first=Nigel M. |editor1-last=Snowdon |editor1-first=Brian |editor2-last=Vane |editor2-first=Howard |chapter=AD-AS model |title=An Encyclopedia of Macroeconomics |url=https://archive.org/details/encyclopediaofma00bria |url-access=registration |publisher=Edward Elgar Publishing |location=Northampton, Massachusetts |year=2002 |isbn=978-1-84542-180-9 |pages=[https://archive.org/details/encyclopediaofma00bria/page/11 11–18] }}
* {{cite book |last=Levi |first=Maurice |title=The Macroeconomic Environment of Business (Core Concepts and Curious Connections) |publisher=World Scientific Publishing |location=New Jersey |year=2014 |isbn=978-981-4304-34-4 }}
* {{cite book |last1=Mankiw |first1=Nicholas Gregory |title=Macroeconomics |date=2022 |publisher=Worth Publishers, Macmillan Learning |location=New York, NY |isbn=978-1-319-26390-4 |edition=Eleventh, international}}
* {{cite book |last=Mayer |first=Thomas |editor1-last=Snowdon |editor1-first=Brian |editor2-last=Vane |editor2-first=Howard R. |chapter=Monetary policy: role of |title=An Encyclopedia of Macroeconomics |url=https://archive.org/details/encyclopediaofma00bria |url-access=registration |publisher=Edward Elgar Publishing |location=Northampton, Massachusetts |year=2002 |isbn=978-1-84542-180-9 |pages=[https://archive.org/details/encyclopediaofma00bria/page/495 495–99] }}
* Nakamura, Emi and Jón Steinsson. (2018). "[https://www.aeaweb.org/articles?id=10.1257/jep.32.3.59 Identification in Macroeconomics.]" ''Journal of Economic Perspectives'' 32(3): 59–86.
*{{cite book|last=Peston|first=Maurice|title=An Encyclopedia of Macroeconomics|url=https://archive.org/details/encyclopediaofma00bria|url-access=registration|chapter=IS-LM model: closed economy|editor1-last=Snowdon|editor1-first=Brian|editor2-last=Vane|editor2-first=Howard R.|year=2002|publisher=Edward Elgar|isbn=9781840643879}}
* {{cite book |last1=Romer |first1=David |title=Advanced macroeconomics |date=2019 |publisher=McGraw-Hill |location=New York, NY |isbn=978-1-260-18521-8 |edition=Fifth}}
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* Snowdon, Brian, and Howard R. Vane, ed. (2002). ''An Encyclopedia of Macroeconomics'', [https://web.archive.org/web/20110722004651/http://www.e-elgar.co.uk/bookentry_mainUS.lasso?id=2106 Description] & scroll to Contents-preview [https://books.google.com/books?id=OJM2mqWI-cYC links.]
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==Further reading==
*[https://direct.mit.edu/books/oa-monograph/5894/Macroeconomic-ModelingThe-Cowles-Commission Macroeconomic Modeling: The Cowles Commission Approach by Ray C. Fair]

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[[Category:Macroeconomics| ]]