sionA course in macroeconomics teaches the student the role of the government in dealing with business cycles. If economic thought had stopped with the classical economists, there would be no need for a course in macroeconomics. As mentioned, the classical economists believed that there was only a minimal role for the government in the economy. The natural economic condition was at full employment, and the government should not interfere with the efficient operation of markets which yield that outcome. Economic recessions, even depressions, were temporary in nature. Left alone, the economy would return to a level consistent with potential output. And so the world of economic thought went until the Great Depression of the 1930s. For many industrialized nations, output plummeted and unemployment rates soared during the 1930s. In the United States, unemployment reached 25% and output dropped by over 30% from the level reached in 1929. The classical argument that falling prices and interest rates would restore economic prosperity never occurred (1). The economy remained stuck. With high unemployment, there was not enough consumer income to stimulate consumption and aggregate demand. With falling demand for output, business investment sank. High tariffs prevented an export-driven growth stimulus (2). (1) Flexible and falling prices, wages, and interest rates could offset an economic slowdown in several ways. In a business downturn, a decrease in labor demand and layoffs lead to a decrease in wages. Lower wages reduce the relative price of employing labor relative to capital and create an offsetting increase in the demand for labor. If prices fall further than wages, then purchasing power increases. Furthermore, with falling prices, the value of wealth holdings also increases - both effects contribute to increased consumption, offsetting the initial decrease in aggregate demand that caused the economic downturn in the first place.Lower intere...
