When asked to list the five books that have most influenced his writings, the acclaimed British novelist Ian McEwan put a book called “What Science Offers the Humanities” on the top of his list. He goes on to suggest that science is “a matter of beauty”, to be admired just as we admire our favourite painting, song, or novel. He’s right. Science is beauty, and I would add, economics is a science.
Macroeconomics was born exactly 80 years ago this year, in 1936.
John Maynard Keynes (pronounced “Canes”) published The General Theory of Employment, Interest and Money in 1936, and it was arguably one of the most influential books of the 20th century.
Macroeconomics was born almost out of necessity. Keynes purposed a new theory of the overall level of employment that sought to explain the sharp rise of joblessness during the late 1920s, and its stubborn persistence in the following years. But even if it was motivated by real life challenges, this was a book about theory, with the good professor from Cambridge University in the United Kingdom clearly stating in the opening sentences of the book’s preface:
This book is chiefly addressed to my fellow economists. I hope that it will be intelligible to others. But its main purpose is to deal with difficult questions of theory, and only in the second place with the applications of this theory to practice. for if orthodox economics is at fault, the error is to be found not in the superstructure, which has been erected with great care for logical consistency, but in a lack of clearness and of generality in the premises. Thus I cannot achieve my object of persuading economists to re-examine critically certain of their basic assumptions except by a highly abstract argument and also by much controversy. I wish there could have been less of the latter. But I have thought it important, not only to explain my own point of view, but also to show in what respects it departs from the prevailing theory. Those, who are strongly wedded to what I shall call ‘the classical theory’, will fluctuate, I expect, between a belief that I am quite wrong and a belief that I am saying nothing new.
In other words, move aside Dude, I’m starting a revolution. Keynes targets the hapless Arthur C. Pigou, who makes a cameo appearance as the stand-in for the classical theory in the famous Chapter 2 of The General Theory.
The classical model assumes a market for labour services that works like any other perfectly competitive market. The price of labour—the wage rate—will move up or down to clear any excess supply, or alleviate any excess demand. Unemployment doesn’t really exist, or if it does it is fleeting and transitory, reflecting frictions as workers move between jobs, needing time to gather information and find them. If unemployment persists, it must be because workers are for some reason refusing to take a cut in wages. There is an excess supply of labour—that is, unemployment—because the wage rate is too high.
Keynes objects to this blame-the-victim argument: “the contention that the unemployment which characterizes a depression is due to a refusal by labour to accept a reduction of money-wages is not clearly supported by the facts” (Keynes 1936, page 9). The classical theory does not work, and we need something new, a new set of assumptions and logic that explains the facts.
There are two parts in today’s lecture. In the first we talk about the birth of macro-economics, and show that the high and persistent unemployment of the 1930s which motivated The General Theory, also characterizes what some of the rich countries have been through in the past eight or nine years. In the second, we begin our discussion of some of the basic vocabulary of macroeconomics, particularly the measurement of the macro-economy with national income accounting. Your prime objective is to fully understanding the meaning, the uses, and the abuses of “Gross Domestic Product.”