The second half of the 20^th century was an exciting time for Economics, with developments rapidly succeeding each other as a reaction to the very different economic scenarios the world faced. This development did nothing if not speed up towards the end of the century, when different theories not only succeeded each other, but often coexisted, feeding off the breakthroughs that were being made by the different schools. In this way, the end of the century was curiously reminiscent of the first half, with a return to the two main schools and a whole new focus on mathematics.

Fitting into this retro revival period, Keynesians were also kept busy countering the neo-classicists and monetarists who were intruding onto their sacred ground: macroeconomics and the Phillips curve. This current in economic thought is often overshadowed because of the keen political interest that New Classical Macroeconomics was able to garner, but warrants a much closer look than it is sometimes afforded. Were they able to preserve the monetary illusion? Perhaps not, but they were consistent in their approach: exploring market failure one breakdown at a time.

Main definitions and economists:

–New Keynesian Economics, as a counterattack to New Classical Economics’ theories;

–George Akerlof, the mind behind asymmetric information;

–Gregory Mankiw, whose works marked the beginning of menu costs analysis;

Employment and inflation:

–Menu costs as a way of explaining price stickiness;

–Mankiw’s menu cost model demonstrated how price stickiness originated in menu costs reduces social welfare;

–Layard-Nickell NAIRU model, helps understand how the labour market works from the NKE’s point of view.

–NAIRU, a concept related to the natural rate of unemployment, although with a few subtle differences.

The second half of the 20^th century was an exciting time for Economics, with developments rapidly succeeding each other as a reaction to the very different economic scenarios the world faced. This development did nothing if not speed up towards the end of the century, when different theories not only succeeded each other, but often coexisted, feeding off the breakthroughs that were being made by the different schools. In this way, the end of the century was curiously reminiscent of the first half, with a return to the two main schools and a whole new focus on maths.

We start by looking at New Classical Macroeconomics. Traditionally, macroeconomics had been the realm of the Keynesians, whereas classical precepts had traditionally been applied to microeconomics and aggregated to have a shot at macro. NCM takes and applies this basis to develop a clear and coherent set of principles that aim to explain the major players, unemployment and inflation, from a fully neoclassical perspective.

Main definitions and economists:

–New Classical Macroeconomics, as a development of monetarism and the comeback of neoclassical economics;

–Robert Lucas, who is considered as the core of this doctrine;

–Thomas Sargent, whose works on the application of rational expectations to analyse monetary policies are of paramount importance;

–Rational expectations, the foundations on which NCM is built.

Employment and inflation:

–Phillips curve: NCM’s view, or what is the result when rational expectations are used in the expectations-augmented Phillips curve;

–Natural rate of unemployment, which differ in a very subtle way from the NAIRU measure;

–Business cycles are greatly analysed by NCM’s economists;

–Cahuc’s adjustment costs model helps understand how the labour market works from the NCM’s point of view.

From the conciliatory mood of the 1940s and 1950s, where we saw how Keynesianism and Neoclassicism could fit together, we move away from the Neoclassical Synthesis and back to a determinedly ‘laissez faire’ attitude with Monetarism. This current popularises government intervention as firmly limited to guaranteeing market safeguards and intervening in the financial markets, abandoning fiscal policy. We move, therefore, into an era concerned with financial stability, where inflation becomes a firm target.

Monetarism became popular amongst, famously, US and UK politicians in the 1980s, coinciding with a period of severe stagflation, and is, to this day, a controversial school of Economics, paradoxically known because of its affinity to various legislatures despite being a firm advocate of the separation between politics and economics.

Monetarism:

Monetarism, a doctrine opposed to Keynesianism, from which we must highlight

Milton Friedman, the clear leader of the

Chicago school, specially during the 50s and 60s.

Importance of expectations:

Adaptive expectations, as opposed to money illusion, which was implemented into the

Expectations-augmented Phillips curve, that demonstrated the inefficiency of monetary policies aimed at reducing unemployment. Therefore, in the long run, the

Natural rate of unemployment will persist.

John Maynard Keynes marked a hugely important turning point in the history of Economics. For the first time, Economics had become positive, allowing for differences of opinion. It was firmly a social science, not a collection of observations or ‘natural laws’ condemned to repeat their patterns ad eternum, but could be interfered with and changed. This brought about a chasm in economic thinking: differences of opinion could bring about real differences in the lives of many.

This became all too apparent with the advent of World War II, when economic intervention became all too urgent to help rebuild the lives of all those whose livelihoods had been quashed following a war and a recession that was already 10 years long. The important thing was to decide whether to intervene or leave it to the invisible, all regulating hand.

Keynesianism:

J. M. Keynes, the man who began it all.

Cambridge school, shifting from marginalism to Keynesian ideas.

Keynesianism, its main precursors and ideas.

Neoclassical Synthesis:

Neoclassical Synthesis: how neoclassical economics and Keynesianism reconciled.

John Hicks, the main precursor of the Neoclassical Synthesis.

IS-LL model, which marked the beginning of a new era in macroeconomic analysis.

Phillips curve, which pointed out a relation between unemployment and inflation, starting one of the greatest debates in economic history: can government intervention reduce unemployment?

Modern economics would look nothing like what they do without neoclassical economics which, for instance, implemented rigorous mathematical analysis into economics. Most of what we absolutely take for granted was discovered by the great economists of the time, and they are also responsible for providing enough of a framework to raise a century long controversy with the other great school of the 20^th century.

Neoclassical economics is really the birth of mathematics as an inescapable tool for constructing theories that are internally coherent (that is, explained in and of themselves without requiring casuistic examples), escaping the slightly lackadaisical approach of many classical economists like the great Ricardo. This allowed Economics to develop at a much faster pace, and provided the basis for how Economics is studied and investigated today.

Neoclassical economics also sees the first clear distinctions between branches of Economics, previously grouped together in the ever present “Principles of Economics” manuals. It sees the basis of the modern didactic framework that we still classify Economics under, and is, in short, the first time that Economics looks like something we might recognise today: consistent theories built upon a solid mathematical framework that aim to underpin the casuistics of what goes on around us.

Marginalism:

Marginal Revolution, around 1870, brought the prevailing classical view of value theory to an end.

William S. Jevons, who devised the concept of marginal utility.

Carl Menger, one of the founders of the Austrian school.

Léon Walras and his concept of “tâtonnement” revolutionized the study of general equilibrium.

Main neoclassical economists:

Alfred Marshall, the true founder of the neoclassical school of economics.

Francis Y. Edgeworth, whose mathematical contributions to economics are of great importance.

Arthur C. Pigou, precursor of welfare economics.

Vilfredo Pareto, who specially focused on allocation and efficiency matters.

Irving Fisher, the main American neoclassical economist.

Main neoclassical schools:

Although not included in this Learning Path (in order not to overwhelm you!), it is interesting to learn about the three main schools at the time: Cambridge school, Lausanne school and the Austrian school. Reading about these will help you put into context everything you’ve learned during this Learning Path.

It is the first important school of economic thought, which included some of the best known economists of all times, as we will see. Thanks to these authors, the study of economics became more of a science, instead of just a kind of philosophy. It took place from the late 18th century to the late 19th century. First, we will learn about some relevant previous doctrines, which will help us understand were the theories of classical economists come from.

Previous doctrines:

Mercantilism, main economic doctrine from 1500 to 1750, according to which protectionism had to be in place in order to accumulate gold and precious metals.

Physiocracy, developed exclusively in France from 1750 to 1780, aimed at the study of natural laws in order to understand economics and apply proper economic policies.

Main classical economists:

Adam Smith, considered the father of Classical economics, he wrote “The Wealth of Nations” in 1776, one of the first important books in economics.

David Ricardo, whose works on international trade marked the start of the study of this subject basing it on models.

Robert Malthus, is mainly known for his views on population growth.

John Stuart Mill, studied the determination of prices as a result of supply and demand.

Karl Marx, whose views on theory of value marks a difference with the other classical economists.