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In the Long Run

The Twentieth Century was a time of revolution and counterrevolution in macroeconomics. Indeed, the division of economics into the two separate branches of microeconomics and macroeconomics was the result of what is known as the Keynesian Revolution. John Maynard Keynes in 1936 proposed a new way of viewing unemployment and output, though this new way had antecedents in the work of prior economists.

The mainstream view prior to Keynes was that competitive markets were stabilizing, which is a basic message of the model of supply and demand. When there is a shortage, price tends to rise, which eliminates the shortage, and when there is a surplus, price tends to fall, which eliminates the surplus. The self-stabilizing property of competitive markets was assumed to work for the system as a whole, which meant that if an economy experienced some shock (to use the contemporary term) that caused a recession with rising unemployment, the system would correct itself by a series of price changes.

Although competitive markets have stabilizing features, there are other forces in the economy that can be destabilizing. For example, if people spend less, then producers may cut back production. If they cut back production, they will lay off workers. Those workers who are now unemployed may then spend less. So a decrease in spending can cause a further decrease in spending. Keynes de-emphasized the stabilizing aspect of market systems and emphasized the destabilizing forces to arrive at the conclusion that once recession and unemployment occurred, the destabilizing forces might overwhelm the stabilizing forces, keeping the economy permanently stuck in depression.

Obviously the 1930s, a decade-long period of depressed economic activity, made people receptive to the ideas of Keynes. Perhaps the most influential of the Keynesian economists was Paul Samuelson, a brilliant mathematical economist whose introductory textbook became the standard against which all other textbooks were judged. However, by the 1980s a counterrevolution was underway that argued that there were serious problems in the Keynesian view, and that those who had used that view in advising government were responsible for the inflation that was rising in most parts of the world in the 1970s. In future chapters we examine both the Keynesian view and the views of its critics. However, by the 21st century there was some agreement on these controversies.

Economists agree that the economy has both stabilizing and destabilizing forces, but they do not agree on their relative strengths. If you reflect on this statement a bit, you should not be surprised that economists who want government to take an active role in economic affairs usually emphasize the destabilizing forces and those who think government should avoid intervening in economic affairs usually stress the stabilizing forces of markets. Most economists also think that in the long run the stabilizing forces will prevail and that destabilizing forces matter only in the short run. As a result, most economists now argue that the Keynesian analysis does not apply in the long run, and that the pre-Keynesian view of the long run had a great deal of merit. However, when we examine the short run, we must pay attention to the destabilizing forces.

Today macroeconomics textbooks generally start with a discussion of growth, which is a long-term way of looking at change in the economy. They relegate the concerns of Keynes to the short run, to fluctuations around the long-run trend. There are important differences in these two time periods. For example, from a long-term perspective saving is good because it provides funds for investment and hence economic growth. However, some economists worry about saving in the short run. If people suddenly stop spending and start to save, this change may destabilize the economy and lead to unemployment. The remainder of this chapter will look at a variety of ways economists have tried to make sense of the long term and economic growth.

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Copyright Robert Schenk