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28.2 THE NEOCLASSICAL SYNTHESIS
Within a few years, the General Theory had transformed macroeconomics. Not everybody was converted, and lew agreed with it all. But most discussions became organised around il.
By thc early 1950s a large consensus had emerged, based on an integration of many ol Keynes' ideas and the ideas ol earlier economists. This consensus was called the neoclassical synthesis. To quote Irom Paul Samuelson, in the 1955 edition ol his textbook, Economics, the first modern economics textbook: In recent years, 90 per cent of American economists have stopped being Keynesian economists' or Ami Keynesian economists. Instead, they have worked towards a synthesis of whatever is valuable in older economics and in modern theories ol income determination. The result might be called neo-classical economics and is accepted, in its broad outlines, by all but about live per cent of extreme lelt-wing and right-wing writers.
The neoclassical synthesis was to remain the dominant view lor another twenty years. Progress was astonishing, leading many to call the period from the early 1940s to the early 1970s the golden age ol macroeconomics.
Progress on all fronts
The first order of business after publication of thc General Theory was to formalise mathematically what Keynes meant. While Keynes knew mathematics, he had avoided using it in the General Theory. One result was endless controversies about what Keynes meant and whether there were logical Haws in some ot his arguments.
l he IS-LM model
A number ol formalisations ot Keynes' ideas were offered. The most influential was the IS—LM model developed bv John Hicks and Alvin Hansen in the 1930s and early 1940s. The initial version of the IS—LAI model—which was actually very close to the version presented in Chapter 5 ol this book—was criticised lor emasculating many ol Keynes insights. Expectations played no role and the adjustment of prices and wages was altogether absent. Yet thc IS-LM model provided a basis from which to start building, and as such it was immensely successlul. Discussions became organised around the slopes ol the IS and LM curves, what variables were missing from thc two relations, what equations tor prices and wages should be added to thc model, and so on.
Theories of consumption, investment and money demand
Keynes had emphasised the importance ol consumption and investment behaviour, and the choice between money and other financial assets. Major progress was soon made along all three fronts.
In thc 1950s, Franco Modigliani (then at Carnegie Mellon' and Milton Friedman (then at the Llniversity ol Chicago! independently developed the theory of consumption you saw in Chapter 16. Both insisted on the importance ot expectations in determining currcnt consumption decisions.
EPILOGUE: THE STORY Ol MACROtCONOMICS chapter 28
lames Tobin. who was from Vale University, developed ihe theory of investment based on the relation between thc present value of protils and investment. Thc theory was further developed and tested by Dale lorgenson. trom I larvard University. You saw ibis theory in C hapter 16.
Tobin also developed the theory ol the demand tor money, and more generally thc theory ot thc choice between dillerent assets based on liquidity, return and risk. His work has become the basis not only lor an improved treatment of linancial markets in macroeconomics but also for the theory of tinancc in general.
Growth theory
In parallel with the work on fluctuations, there was a renewed focus on growth. In contrast to the stagnation in the pre-World War II era. most countries in thc 1950s and 1960s were growing last. Even il they experienced fluctuations, their standard ol living was rising rapidly. The growth model developed by MIT's Robert Solow and ANLI's Trevor Swan in 1956, which you saw in Chapters I I and 12, provided a framework to think about the determinants ol growth. It was followed by an explosion ot work on the roles ol saving and technological progress in growth.
Macroeconometric models
All these contributions were integrated in larger and larger macrocconometric models. I he first US macroeconometric model developed by Lawrence Klein at the Liniversity ot Pennsylvania in the earlv 1950s, was an extended If relation, with sixteen equations. Willi the development ol the National Income and Product Accounts (making available better data and thc development ot econometrics and computers, thc models quickly grew in size. The most impressive effort was the construction ol the MPS model (MPS stands lor MIT—Penn-SSRC, for thc two universities and the research institution the Social Science Research Council—involved in its construction ■ developed during the 1960s by a group led by Franco Modigliani. Its structure was an expanded version ol thc IS LM model, plus a Phillips curve mechanism. Hut its components—consumption investment and money demand—all reflected the tremendous theoretical and empirical progress made since Keynes.
Keynesians versus monetarists
With such rapid progress, many macroeconomists who delined themselves as Keynesians came to believe that thc future was bright. The nature ol fluctuations was increasingly well understood, and the development of models allowed lor a better use ol policy The time when thc cconomy could be fine- tuned. and recessions all but eliminated, seemed not lar in the luture.
This optimism was met with scepticism by a small but inllucntial minority, the monetarists. Their intellectual leader was Milton Friedman. While Friedman saw much progress being made—and was himself the father ol one of the major contributions, the theory of consumption—he didn't share in thc general enthusiasm. He believed that thc understanding ol thc cconomy remained very limited. I le questioned the motives ot governments as well as thc notion that they actually knew enough to improve macroeconomic outcomes.
In thc 1960s, debates between Keynesians and monetarists dominated the economic headlines. The debates centred around three issues: I the effectiveness ol monetary policy versus liscal policy, (2) the Phillips curve, and (3 the role of policy.
Monetary policy versus fiscal policy
Keynes had emphasised fiscal rather than monetary policy as the key to fighting recessions. And this had remained thc prevailing wisdom. I he IS curvc, many argued, was quite steep. Changes in thc interest rate had little effect on demand and output. Thus, monetary policy didn't work very well. Fiscal policy, which affects demand directly, could affect output taster and more reliably.

Milton Friedman
Friedman strongly challenged this conclusion. In a ll>63 book, A Monetary History of thc United States, 1867-1960, Friedman and Anna Schwartz painstakingly reviewed the evidence on monetary 
policy and thc relation between money and output in thc United States over a century. Their conclusion wasn't only lhat monetary policy was very poweilul but that movements in money did explain most of thc fluctuations in output. They interpreted the Great Depression as the result ol a major mistake in monetary policy, a decrease in the money supply due to hank failures—a decrease lhat the Fed could have avoided by increasing the monetary base, but hadn't. (We discussed this interpretation in Chapter 23.)
Friedman and Schwartz's challenge was followed by a vigorous debate and by intense research on the respective effects of fiscal policy and monetary policy. In the end, a consensus was in ellcci reached. Both liscal policy and monetary policy clearly had ellects. And il policy-makers cared about not only the level hut also the composition ot output, the best policy was typically a mix of the two.