Macroeconomics studies the causes of fluctuations in broad economic phenomena. The most important of these are unemployment and inflation, which is a general rise in the prices of all goods, or a relative decline in the value of currency.
The previous section, "The Balance of Saving," illustrates the view held by most economists that the balance of trade as a macroeconomic variable. We see the trade balance as depending on economy-wide relationships between saving and investment rather than on the competitiveness of individual industries.
Macroeconomic theories developed in response to puzzling episodes in economic history. The most important of these was the Great Depression of the 1930's, which in the United States produced unemployment rates over 10 percent for nearly a decade, with a peak unemployment rate of over 25 percent of the labor force. It was a time of great poverty and misery, even though we clearly had the productive capacity to achieve affluence.
If you are looking for ironclad theoretical reasoning backed by overwhelming empirical evidence, then stay away from macroeconomics. If you make a thorough study of the field, you will find competing doctrines and dogmas, imprecise data, and the inability to conduct repeatable experiments.
To see why macroeconomics is difficult, consider the argument made near the very beginning of this book against the likelihood of a persistent labor shortage. In that section, I pointed out that it would be natural for wages to adjust upward, leading to an increase in labor supply and a reduction in labor demand, which would eliminate the shortage.
This same argument holds in reverse. When there is unemployment, meaning an excess supply of labor, a drop in wages should reduce supply and increase demand, eliminating the unemployment. Many macroeconomists, from John Maynard Keynes to Milton Friedman, believe that this process of downward adjustment of wages works slowly and painfully. If instead the level of demand for output can be maintained so that there is less need for downward wage adjustment, the economy will have an easier time remaining at full employment.
Why does aggregate demand sometimes fall short of the level needed to maintain full employment? My beliefs about this issue are influenced to an unusual degree by Charles Kindleberger, who was not considered a macroeconomist.
Kindleberger was an economic historian, who wrote extensively on the Depression and on historical episodes of speculative frenzy. He noted that these episodes, such as the Dutch Tulip Mania in the 1620's and 1630's or the South Sea Bubble in England in roughly 1710-1720, had common elements. A country achieved wealth as a result of the combination of winning a war and encountering a new market opportunity. Kindleberger called this process "displacement." Displacement resulted in early speculators achieving riches, leading masses of people to join in, resulting in overspeculation. This was followed by a panic, a crash, and an economic recession. This model of fluctuations was laid out by Kindleberger in his book Manias, Panics, and Crashes.
I got involved with the commercialization of the Internet very early, in 1994. I saw its resemblance to the Kindleberger model as early as August of 1995, when Netscape Communications became the first Internet company to sell stock to the general public. The response to Netscape's initial public offering was overwhelming, and this paved the way for many other "dotcoms" to turn their founders into millionaires, even though almost none of the businesses made profits.
Most of the articles in this section are about the Internet Bubble and its aftermath. I believe that the stock market crash of 2000-2001 created conditions that were conducive to another Great Depression. However, several factors cushioned the fall.
In contrast with 1929-1933, the Federal Reserve made a conscious effort to avoid a monetary contraction and thus avoided deflation.
The Bush Administration's populist economic policies, which expanded the government Budget deficit beyond what would have taken place naturally with the Depression, represented in the short run--and I should emphasize only in the short run--a textbook application of Keynesian fiscal stimulus.
Compared with the 1930's, there were fewer impediments to the necessary labor market adjustments. There was no rise in unionism and no attempt by the government to encourage business cartels to keep prices artificially high.
As you read the sections in this chapter, I would caution you not to become too attached to the theories and explanations that you find. Given all of the controversy that exists within the profession about macroeconomics, and one economist's views should be taken with a grain of salt. Moreover, as the economy evolves over time, a macroeconomic model that is accurate for one era may prove erroneous in another. This chapter can by no means provide a definitive account of macroeconomics.