Macroeconomics

Introduction

John Maynard Keynes popularly known as the father of economics laid down the Keynesian principle of economics in the mid of 20th century through which he tried to explain the causes of the Great Depression. Keynes's theory brought a paradigm shift to economics by negating the self-adjusting mechanism that markets were assumed to be following. Keynes proposed the idea that when the great depression hit the world people started holding their money and as a result it brought a halt to economic activity (Darrat, 2009, p. 879).

Keynes's theory is followed to date in various forms. Keynesian style of macroeconomics requires government intervention when the private sector is unable to perform well. The public sector usually intervenes through changes in the monetary policy to stabilize the market's performance.

Approaches used by Keynesian theorists

Majority of US economists and theorists have used Keynesian way of economy by adding their personal interventions to it. The primary approach is simple: no capitalist economy can function at its best without government intervention. Government's intervention, in the otherwise free market economy, considerably raises the level at which it performs.

Keynesian theorists support economic growth through equal distribution of wealth. They believe that the poor have a tendency to spend money rather than save it, when they are given some money (Eichengreen, 2005, p. 2-8). This leads to economic growth. Another approach is that government intervention does not necessarily guarantee that the economic cycle will not experience any wiggle at all but it certainly impedes a major depression.

Monetary theories and long run macroeconomic stability

According to Federal Reserve Act monetary policy changes have two basic objectives to realize: promotion of maximum sustainable output and employment generation, and promotion of stable prices. Long run macroeconomic stability can be attained through maintaining a balance between expansionary and contractionary stance of monetary policy or in other words deciding upon the tradeoff between sustainable price stability and full employment (Garrett, 2009, p. 5).

The future course of action for the economic activity is determined by the monetary policy stance taken by the government. The monetary policy has to be designed to achieve sustainable growth in the long run. Monetary policy can contribute to the long run macroeconomic stability by ensuring price stability. Lower level of prices facilitates low inflation. A decrease in interest rate leads to higher investment as cost of borrowing declines. This also increases purchasing power of consumers leading to an increase in production.

According to Meltzer, Keynes's monetary theory proposed three equations for increasing investment to promote long run economic stability. Keynes says that to promote neutrality in the economy in the long run the following equation has to be satisfied:

Here p represents aggregate price level, E is aggregate earnings or aggregate money income, O is the real output and S is saving per unit of real output. Monetary theory supports that easier financial conditions will lead to economic growth in the long run. Consequently, your interest rates for the long term will fall and prices will rise. For example, investment increases when you ...