By Daniel Richards, Manzur Rashid, Peter Antonioni

The field of macroeconomics continues to develop and change as new theories are put forward. Building on the work of great macroeconomists like Keynes and Tobin, here are five famous economists who are having a huge impact on macroeconomics.

Robert Solow (1924–)

Robert Solow is best known for his fundamental work on economic growth. In two path-breaking articles in 1956 and 1957, he laid out the basic mathematics for the model of economic growth, and provided empirical evidence on its implications. That model has since become central to all long-run macroeconomic analysis and is widely known as the neoclassical growth model. It’s still the starting point for standard analyses of economic growth.

Solow’s model implies that two things explain why living standards grow over time:

  • Capital stock per person
  • Technology

Of the two factors, Solow’s evidence implied that technology was by far the more important in terms of explaining rising GDP per capita over time.

Another important feature of Solow’s model was that the growth process was stable. This may seem obvious today. But growth requires that both capital and labor inputs steadily increase, and a number of scholars in the 19th and early 20th centuries, including Karl Marx in particular, believed that the process of capital accumulation was destined to produce unstable business cycles, possibly culminating in a gigantic crash. For many the Great Depression was the definitive proof of this view that economic growth is inherently unstable. Solow’s model was an important antidote to this somewhat gloomy view.

Solow also did important work on the economics of natural resources, the environment, and labor markets, the last of which supported the Keynesian model. He was awarded the Nobel Memorial Prize in Economic Sciences in 1987.

Robert Lucas (1937–)

Robert Lucas was at the forefront of a critical reevaluation of macroeconomics that ultimately changed the way macroeconomists model the economy in fundamental ways. Sometimes called the new classical macroeconomics, Lucas and others insisted that macroeconomic models had to be consistent with the rational, optimizing behavior of microeconomic theory. Expectations were no exception to this rationality requirement, and this led to the development of rational expectations models.

Both because it implied that government macroeconomics stabilization efforts were largely ineffective and because it emphasized underlying microeconomic foundations, the new classical paradigm directly challenged the dominant Keynesian approach of that day, and gave support to simple policy rules such as Friedman’s money growth rule. When Keynesians countered with empirical evidence purporting to demonstrate that Keynesian policy rules worked better, Lucas responded with his famous Lucas Critique, arguing that such empirical evidence was misleading because it reflected the policies in effect for the time that the data was collected. It couldn’t be used to predict what would happen with a different policy because if a different policy were enacted, consumers and businessmen would rationally change their policy expectations and therefore their behavior.

Although Keynesian analysis rooted in sticky wages and prices survived, both rational expectations and the Lucas Critique have become permanent parts of macroeconomic modeling, as did the general insistence on microeconomic foundations. It is now recognized that models that do not have these elements are unlikely to describe the macroeconomy accurately.

Lucas made important contributions to economic growth theory showing in particular the critical role of human capital formation, that is, education and training. He was awarded the Nobel Memorial Prize in Economic Sciences in 1995.

Edward Prescott (1940–)

Edward Prescott was a leader in the second round of the new classical macroeconomics that also permanently changed macroeconomic modeling.

One branch of his work focuses on a fundamental inconsistency in discretionary policy-making. Prescott applied this argument to macroeconomic policy in general. Good long-run outcomes require that flexibility be abandoned and policy be committed to a clear rule, possibly a Friedman-type rule that freezes money growth permanently.

A second branch of Prescott’s work pioneered the integration of short-run and long-run analysis in one unified model. An important insight of this analysis is that when real GDP falls, it can be very difficult to determine whether this is a case of real output being below trend or a case in which both actual and potential GDP have fallen. Only the former might warrant government intervention. Prescott built a unified model showing that in an economy described by the neoclassical growth process and with flexible wages and prices, the optimal response of households and businesses to random shocks would generate movements in real GDP that look a lot like the business cycle data of the real world. However, because these reflect optimal behavior, no government intervention is needed.

Although these models capture real GDP movements fairly well, they do much less well in replicating labor market outcomes. You typically need to add sticky wages and prices for this purpose and that opens up an avenue for government policy to improve things. Nevertheless, Prescott’s contribution is a lasting one. The unified modeling approach that he pioneered — now usually referred to as Dynamic Stochastic General Equilibrium modeling — has become standard in macroeconomic analysis.

Much of Prescott’s work has been done collaboratively with his colleague, Finn Kydland. Both shared the Nobel Memorial Prize in Economic Sciences in 2004.

Robert Barro (1944–)

Robert Barro, like Robert Lucas and Edward Prescott, is one of the intellectual heavyweights behind the new classical revolution rooted in optimizing, forward-looking behavior and rational expectations of what the future — including future economic policy — would bring.

Barro has contributed to many areas of macroeconomics, including important work on the empirical determinants of economic growth. However, he is probably most famous for his work that resurrected and built on much older work by the 19th century classical economist, David Ricardo. The Barro-Ricardian insight was that the government budget constraint must imply budget balance in the long run.

Debts today must be paid off at some time in the future. As a result, a tax cut leading to a budget deficit today means higher taxes in the future to pay off the new debt the deficit creates. Hence, there’s no difference between financing government expenditures with taxes or with debt. The two are ultimately equivalent.

Combined with rational expectations, this Ricardian Equivalence implies that tax cuts (and spending increases) will not raise aggregate demand. Rational, forward-looking consumers will foresee the future tax increases that the resulting deficit implies. They will, therefore, cut back on spending now in order to have the extra funds needed to pay those future higher taxes. This argument is a direct challenge to the Keynesian view that fiscal policy can be used to counter recessions.

Barro’s work with David Gordon built on Kydland and Prescott’s work on time inconsistency. They applied that model explicitly to discretionary monetary policy. They showed that when inflation is expected to be low, policy-makers always have an incentive to increase it a bit and thereby reduce unemployment, as indicated by the expectations-augmented Phillips Curve. A public that has rational expectations, however, will learn to foresee this and so will begin to expect high inflation. Once this happens, the incentive to raise inflation still higher disappears because the costs of more inflation increase dramatically when it’s already at a high rate.

The result of discretionary monetary policy then is an equilibrium with no reduction in unemployment and with the public expecting and the policy-makers setting inflation at a high rate even though everyone would be better off if it were low. That is, allowing the monetary authorities discretion leads to an upward inflation bias. The economy’s long-run equilibrium is at the natural rate of unemployment with more inflation than there would otherwise be. A strict policy rule that commits the authorities to a low inflation policy would be better.

Janet Yellen (1946–)

Sadly, like many areas of business and academia, macroeconomics has a dearth of women at the top. With the new generation of talented female scholars coming through, there’s reason to hope that this situation will change in the years to come. Janet Yellen’s career is a sign that change may already be happening. She’s managed to reach the very top of macroeconomic policy-making. Currently, she’s the Chair of the Federal Reserve. Previously, she served as head of the Council of Economic Advisors under President Bill Clinton.

Having overall responsibility for monetary policy in the United States makes her one of the most powerful people in the world — certainly the most powerful economist. Monetary policy determines a nation’s inflation rate in the long run, and in the short run has a strong influence on unemployment and output. The U.S. is still the largest economy by far, and so the Fed’s decisions reverberate throughout the world economy.

Although Yellen has given much of her life to public service, she also has had a distinguished academic career with important contributions to both microeconomics and macroeconomics. In the former field, her paper on product-bundling (written with W.J. Adams) is a pioneering piece on why firms often sell separate goods bundled together, such as the standard bundle of networks in a cable television package, or the bundling of options in a specific model by car dealers. Yellen and Adams show that this allows firms to separate consumers into different groups to whom they effectively offer different prices and so earn greater profits. This insight is central to all modern work on price discrimination.

Because of her deep microeconomics understanding, Yellen was perhaps better able than many Keynesians to respond to the new classical demand that macroeconomic analysis have solid microeconomic foundations. In a series of papers with George Akerlof, Yellen developed the model of efficiency wages. In this model, firms pay wages higher than the going market rate in order to minimize turnover and motivate more consistent effort. Yellen and Akerlof show that when this model is combined with small price adjustment costs (or with a small amount of “irrationality”), even anticipated shocks to aggregate demand can have large effects on real GDP and unemployment.

Such models are essential ingredients of the New Keynesian macroeconomics. The New Keynesian analysis preserves the main conclusions of Keynes while taking seriously new classical insights such as rational expectations. By the way, George Akerlof is not only Janet Yellen’s colleague but also her husband (and a co-winner of the 2001 Nobel Memorial Prize in Economic Sciences).