Money and Finance in the Macro-economic Process

The historic terrain of macro-economic theory is the explanation of the levels and fluctuations of overall economic activity. Macro-economists have been especially interested in the effects of alternative fiscal, financial, and monetary policies. With the publication of J. M. Keynes’s General Theory in 1936 and the mathematical formalizations of his theory by J. R. Hicks (1937) and others, the language of macro-economic theory became systems of simultaneous equations. These are general equilibrium systems of interdependence in the sense that the relationships describe an entire national economy, not just a particular industry or sector. The systems are usually not completely closed; they depend on exogenous parameters including instruments controlled by policy-makers. Seeking definite relationships of economic outcomes to policies and other exogenous variables, qualitative and quantitative, these models sacrifice detail and generality, limiting the number of variables and equations by aggregations over agents, commodities, assets, and time. Theoretical macro-economic models of one brand or another are very influential. They guide the architects of econometric forecasting models. They shape the thinking of policy-makers and their advisers about “the way the world works.” They color the views of journalists, managers, teachers, housewives, politicians, and voters. Almost everyone thinks about the economy, tries to understand it, and has opinions how to improve its performance. Anyone who does so uses a model, even if it is vague and informal.