In 1958, A. W. Phillips wrote a paper on Economica (London School of Economics), entitled “The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957”. Analysing data concerning money wages and unemployment rates in the UK, Phillips managed to draw a curve representing the inverse relation between these variables. It must be said that Irving Fisher had already pointed out a relationship between price levels and unemployment in his paper “A Statistical Relation between Unemployment and Price Changes”, 1926 (cleverly renamed later as “I Discovered the Phillips Curve”). The Phillips curve has evolved following other empirical studies, and is widely known nowadays, even though it has also been criticized.

In his article, Phillips drew a curve showing the inverse relation between the rate of change of money wage rates, as a percentage change per year () and the unemployment rate (U).

Two important things must be noted: the point where the curve crosses the abscissa, and the fact that the ordinate seems to work as an asymptote. The importance of the point of crossing must be highlighted (around 5,5%), since it is the rate of unemployment that an economy will have for a zero increase in the money wages. This point will be named, in further developments of the Phillips curve, Natural Rate of Unemployment and Non-Accelerating Inflation Rate of Unemployment (NAIRU). Regarding the asymptote, as the author pointed out, there was no data of higher rates of change in money wage, nor lower unemployment rates. It can be concluded that unemployment cannot be lowered beyond a certain level.

Two years later, Richard G. Lipsey would publish a paper in the same journal deepening the mathematics regarding the curve, as well as expanding Phillips’ research by doing further econometrical tests.

Also in 1960, Paul A. Samuelson and Robert M. Solow, in their “Analytical Aspects of Anti-Inflation Policy”, studied a similar relation, in this case using data from the United States. Although they used inflation (Π) instead of the rate of change in money wages, they came up with similar results. Even though the curve might seem different because of the scale used, the unemployment rate at price stability is the same as at money wage stability (around 5,5%), and there seem to be no way to lower unemployment beyond a certain level (around 1%).

It was in this paper that the Phillips curve was considered a “menu of choice” for the first time. This meant that, concerning policy making, governments would be able to choose between a low rate of unemployment with high inflation, and a higher rate of unemployment with lower inflation. However, as the authors pointed out, this menu had to be used only in the short-run, since certain policies or economic events might change the shape of the curve in the longer run.

In the mid 50s, and until the late 60s, the adaptive expectations hypothesis became popular, especially because of the works by Phillip Cagan and Milton Friedman. This hypothesis would endure almost unquestioned until the late 60s and early 70s, when economist Robert Lucas (among others) brought forward a rational expectations hypothesis, from earlier works by J. F. Muth.

John R. Hicks, in his article “Mr. Keynes and the Classical; a Suggested Interpretation”, published in 1937 in the journal Econometrica, developed a model known as IS-LL, which will later become IS-LM. The purpose of the article was to compare classical economists’ view on the goods and money market, with Keynes’ views.
In a few words, Hicks would assume Keynes’ innovations (possibility of frictional unemployment, the impact of animal spirits on investment, as well as money illusion effects) to take place in the short run, while classical views (such as full employment, perfect competition and the ability of the economy to re-equilibrate itself without government intervention) to be valid on the long run.
Hicks starts with the following assumptions, which we will maintain:

-he considers the short period;

-the quantity of physical equipment is fixed;

-homogeneous labor;

-depreciation can be neglected;

-rate of money wages (w) can be taken as given;

-quantity of money (M) is given;

-price level of goods equals their marginal cost.

(For the sake of simplicity, we will not consider differences between investment and consumption goods, nor the differences on the distribution of income.)

He also defines the following variables, which we will reformulate according to the level of simplicity we are aiming at:

-Y: total income;

-M: money quantity (which is given);

-I: investment;

-S: savings;

-i: rate of interest.

By uniting both classical and Keynesian views, Hicks writes the following three equations:

-M(Y,i) : we see that money quantity depends on both total income and the rate of interest;

-I(i) : investment depends on the rate of interest;

-I=S(Y) : investment must equal savings, which depend on total income.

From these three equations, we can see the relation between total income and the rate of interest in both markets:

-money market: since the money quantity is given, the LL curve (blue) will slope upwards, because an increase in income usually raise the demand for money (people need cash to consume goods) and an increasing rate of interest tend to lower money demand (the explanation of this can be made from two different angles: people will rather save more money since the interest rate is higher, therefore will spend less and demand less cash; or people are less willing to borrow money from banks, to spend it or invest it, because of the higher rate of interest);

-goods market: the IS curve (green) shows the relation between income and interest needed to make savings equal to investment. It slopes downwards because the lower the interest, the more people will invest, and therefore the higher will the total income be.

Income and the rate of interest are therefore determined where the IS and LL curves intersect (point P).

This model (more precisely, the IS-LM) is used nowadays to show the effect of diverse economic policies on a closed economy, and served as a starting point for the later Mundell-Fleming model, which helps understand their effects on an open economy.

John R. Hicks was a British economist (1904-1989), professor at the London School of Economics, Cambridge University and University of Oxford. He took special interest on issues concerning microeconomics, growth, economic fluctuations and monetary theory. In his most famous work “Value and Capital”, 1939, Hicks referred to aggregation problems, interest rate, etc. It was also in this book where he developed further the comparative statics, the analysis in economics when describing two possible outcomes. His book “The Social Framework: an Introduction to Economics”, 1942, is a veritable treatise on structural analysis by means of social accounting.

However, Hicks is mainly known for the development of a general equilibrium model, based on J. M. Keynes’ “General Theory”, in which he analyzed four markets: goods, labor, credit and money, called the IS-LM model. This model, firstly named IS-LL, appeared in his article “Mr. Keynes and the Classics: a Suggested Interpretation”, published in 1937 in the journal Econometrica.

He was awarded the Nobel Prize in Economics in 1972, along with Kenneth Joseph Arrow, for his contributions to general equilibrium theory and welfare economics.

Neoclassical synthesis (NCS) refers to an economic doctrine that appeared in the U.S. in the early 1940s, and would remain the dominant paradigm until the late 1960s, when monetarism took over. It was Paul Samuelson, in his book “Economics”, 1955, who gave this doctrine its sense of synthesis, since it can be described as Keynesian in the short run and neoclassical in the long run. This is, policy makers will be able to adjust the economy (especially using fiscal policies, seen by NCS’ economists as far more effective than monetary policy) in the short run, but considering also that equilibrium will be reached in the long run without the need for public intervention. Theoretical and empirical studies by NCS’ economists are mainly based on the IS-LM model and the Phillips curve.

The IS-LM model was first developed by John Hicks in 1937 and Hansen expanded and popularized it in 1949. It is built on the premises put forward by J. M. Keynes in his “General theory”, 1936, and gives fiscal policy a higher degree of efectiveness (IS-LM policies effects, NCS view).

The Phillips curve, derived from an empirical study, gave a relationship between unemployment and inflation, which was not explicit in Keynes’ analysis. The validity of this relationship has been highly criticized by different schools of economic thought, such as monetarism, the New Classical Macroeconomics and the New Keynesian Economics.

Other renowned NCS’ economists are Modigliani, for his analysis of consumption under an intertemporal utility maximization frame, known as the life-cycle hypothesis; Jorgenson, for his work on the investment function; and Tobin and Baumol, for their studies on the demand and supply of money.

The NCS as a macroeconomic mainstream started struggling in the late 1960s, following a high inflation episode in the U.S., which could not be explained using the theoretical framework of this doctrine. Not long after, in the mid-1970s, stagflation in the U.S. meant the rise of monetarism and the subsequent fall of the NCS.

This school of economic thought, which focuses on macroeconomics, is mainly based on interpretations of John Maynard Keynes’ most important book, the “General Theory of Employment, Interest and Money”, 1936.

Keynes’ main thesis was that unemployment during the Great Depressionwas the result of a decreasing demand, and that the solution was to revive the economic system through public investment. A Keynesian policy would be one that promotes, for example, public works such as building dams or highways.

Supporters of Keynesianism, or Keynesian economics, believe that although businesses and private sector entities working on a liberal environment function in an efficient way, sometimes market failures may appear. For this, they support a certain degree of implication by the public sector in order to prevent these failures and restore the economy if they appear, through fiscal and monetary policies. However, they will give more credit to the former, the latter being more supported by Monetarists.

Keynesianism was the main economic doctrine from 1936 until the advent of Monetarism, with which it coexisted until the stagflation of the seventies.

Joan Robinson, Nicholas Kaldor and John R. Hicks, are just some of the great disciples of Keynes, and therefore Keynesian economists, mainly from the Cambridge School in its not neoclassical meaning, to name a few.

Name given to British economist Alfred Marshall and his followers, who were also part of the neoclassical school of economics, such as Arthur C. Pigou and Francis Y. Edgeworth, which fully assimilated the concepts and methods of marginalism.

They are also considered to be part of the Cambridge school, although in other terms not relating to neoclassical economics, the group of economists which in one way or another collaborated with J. M. Keynes in the thirties and forties, partly in connection with the problems of war. These include Post-Keynesian economists Joan Robinson and Nicholas Kaldor, extending the group to the Neo-Keynesians John R. Hicks, Paul A. Samuelson and James Tobin.

Keynes was a British economist (1883-1946), son of the economist and methodologist John Neville Keynes. J. M. Keynes first gained notoriety with his work during the Versailles Peace Conference, when he cleverly proposed in his book “The Economic Consequences of the Peace”, 1919, not to punish Germany to avoid future retaliation. Later, during the Great Depression, he fought the conservative views advocating for a restoration of the gold standard in the famous pamphlet “The Economic Consequences of Mr. Churchill”. After a series of papers on monetary issues, he published in 1936 the most important of his works, the “General Theory of Employment, Interest and Money”, which was the foundation of the then called New Economic Science, or Keynesianism. Keynes’ main thesis was that unemployment during the Great Depression was the result of the decrease in effective demand. Therefore, to achieve full employment, it was necessary to revive the economic system through public investment. In the last years of his life, J. M. Keynes participated in the negotiations of Bretton Woods, in 1944, leading to the creation of the International Monetary Fund.

At the Bretton Woods conference, where he was part of the British delegation, he raised the idea that the IMF should be constituted as a true worldwide central bank, capable of issuing paper currency for international payments, for which he proposed the name “bancor”. Most of the ideas mentioned in the “Keynes Plan” were not followed through, since they competed with the U.S. proposals specified in the “White Plan”.

Great disciples of Keynes, part of the Cambridge School, were Joan Robinson, Nicholas Kaldor and John R. Hicks, to name a few.

Irving Fisher was an American economist (1867-1947), professor of Political Economy at Yale University, known for his contributions to quantitative economics (works such as “The Nature of Capital and Income”, 1906, and “The Purchasing Power of Money”, 1911) and especially the development of index numbers. He also addressed interest rates, in his opinion governed by two interacting forces: the impatience of individuals in terms of exchanging future income for current income, and the principle of yield paid by doing so. In his “Appreciation and interest”, 1896, Fisher showed the relation between the nominal interest rate (i), the real interest rate (r) and inflation (Π) using an equation, known nowadays as the Fisher equation:

i ≈ r + Π

Although this relation derived from earlier works by Jacob de Haas, Irving Fisher’s formula is an easier way to represent this relation.

In the early autumn of 1929, shortly before the famous Black Thursday, Irving Fisher said, “stock prices have reached what looks like a permanently high plateau.” After the stock Crash, he lost his credibility, being this the reason why his work was not taken seriously until decades later.

Predecessor of monetarism, and following the works of bullionists, David Hume, the School of Salamanca and John Stuart Mill, he showed that prices vary depending on the volume of money in circulation, being this variation as shown by the equation of exchange, which he first depicted in his book “The Purchasing Power of Money“.

Pareto was an economist and sociologist of Italian origin, born in Paris (1848-1923), who taught at the University of Lausanne, as well as previously did his mentor, Léon Walras. They both were part of the Lausanne School, which is considered, along with the Austrian School, as the birthplace of marginalism and neoclassical economics.

His chief works were “Course of Political Economy”, 1896-97, and “Manual of Political Economy”, 1906. Among Pareto’s contributions, we can highlight the graphical development of Edgeworth box, as well as an improvement on the way indifference curves are drawn, and studies on the personal distribution of income.

In his studies of the late nineteenth century, Pareto found some regularity in the personal distribution of income in different countries. From that regularity, he determined a series of economic and sociological conclusions, which became known afterwards as Pareto’s Laws. He also studied some regularities in businesses, where concentration was the explanation for the fact that many companies get 80% of their revenue from only 20% of its products.

Nowadays, however, he is mostly known for the Pareto optimal, a notion widely used in game theory and welfare economics.

Pigou was a British economist (1877-1959), disciple of Alfred Marshall, whom he succeeded as a professor at Cambridge. Pigou is remembered above all as a precursor of welfare economics, for his books “Wealth and Welfare”, 1912, and “The Economics of Welfare”, 1920, in which he used measures of national income and its distribution in order to understand how wealth and welfare are related. He is also remembered for making a distinction between different degrees of price discrimination.

Being part of the Cambridge school, Pigou used common tools derived from neoclassical economics, such as marginalism, amongst others.