Business, Politics & Society

Understanding Macroeconomics: The Fed and IS-LM (Wonkish)

Paul Krugman

Lesson time 11:45 min

Learn how the Federal Reserve works to keep the economy healthy, and about the theoretical framework it uses to inform its decisions.

Paul Krugman
Teaches Economics and Society
Nobel Prize-winning economist Paul Krugman teaches you the economic theories that drive history, policy, and help explain the world around you.
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What Is Macroeconomics? Macroeconomics is the study of economies as a whole. This means interrelatedness of multiple industries, markets, the unemployment rate, inflation, and general economic output of an entire economy, such as that of a country or of the globe as a whole. (“Macro” comes from the Greek prefix meaning “large.”) The History of Macroeconomics The study of macroeconomics is not new, but most modern interpretations are heavily influenced by the British economist John Maynard Keynes and his book The General Theory of Employment, Interest, and Money (1936). During the 1930s, the Great Depression hit the United States. Many economists believed that the market would provide full employment if workers were desperate to work and therefore flexible in their wages; the same economists also believed that goods would sell—as long as the market drove down the down the price. None of this was indeed happening and it left many economists perplexed by the situation. Keynes explained that the prosperity of whole economies could decline even if their capacity to produce was undiminished. Even productive economies could get caught in a trap where a lack of spending could cause businesses to cut back on production. The cuts in production would then lead businesses to reduce the number of workers they employed. The reduction in employment opportunities would then lead families to cut back on spending, worsening the original problem. Keynes postured that aggregate demand, which is the overall total demand for goods and services in an economy, would dictate overall economic activity, and if an economy did not create enough demand it would lead to high levels of unemployment and inflation. Keynes argued that during times of recession or depression, certain governmental measures could increase demand and help fuel the overall economy. This came to be known as Keynesian economics. Macroeconomics vs. Microeconomics Macroeconomics focuses on the overall quilt of an economy—how various industries, markets, and businesses are affected and shaped by overarching economic, fiscal, and monetary policies. On the other side of the spectrum is microeconomics, which focuses on the behaviours of businesses and individuals within a specific market. Microeconomics are often affected by governmental policies, which are influenced by macroeconomics. The 4 Main Principles of Macroeconomics Macroeconomists—the people who study macroeconomics—look at a variety of broad economic factors in order to determine how the economy is performing as a whole. Four of these factors stick out as the most important: 1) Unemployment The unemployment rate is the percentage of people who are willing and able to work but who cannot find gainful employment. People who are unemployed are not actively contributing to the economy and, if the unemployment rate is high enough, this can cause an economic slowdown. Some macroeconomists include people who have given up lo...

Think like an economist

For Nobel Prize-winner Paul Krugman, economics is not a set of answers—it’s a way of understanding the world. In his economics MasterClass, Paul teaches you the principles that shape political and social issues, including access to health care, the tax debate, globalization, and political polarization. Heighten your ability to read between the lines and decipher the underlying economics at play.


Students give MasterClass an average rating of 4.7 out of 5 stars.

Thank you, I always found it hard to understand economics. This really helped.

Really interesting and useful lesson by the life.

I like his style and I am now reading some economics, in my seventh decade.

Great overview of economics and economic theory in an easily digestible manner for novices. This was enjoyable to watch.


Nicholas S.

I don't understand something. Economize means to spend less right? So at 4:57, when Paul mentioned "The higher the interest rates, the more people will economize on those. The lower the interest rates, the more they will be willing to sit on cash." Correct me if I am wrong, but doesn't "economize" on the money people gonna hold on hand means to spend less? In essence, doesn't this mean exactly the same if people are willing to sit on the cash?

Sel B.

That invented wealth is actually the future prospects of our children. Stand in the corner.

Thibault H.

Would have loved to hear more about why you think negative interest rates are an economic anomality that go away with time. Japan struggles with them since decades. Europe doesn't seem to be able to shake them off either. And even the Fed has historically low interest rates for such a well-performing economy. Would have loved more insight on this! Otherwise a great video.

Mark R.

So Banks provide money out of thin air. Who owns the banks? How do they fit in with the economy? Are the people dumped with a load of 'national debt'? Is it actually possible to pay off the 'debt' of money that comes out of thin air?

A fellow student

Even though the inflation rate is like "officially claimed" 5%, my salary does not increase 5% correspondingly. I even got more work load for the same salary level. I don't know whether I am typical. If anyone has got 5-10% salary increase in the past 5 years, please let me know.

A fellow student

We are not seeing any inflation? 2 small bags of Lay's chips were $1 a year before, and now they are $1.34. Also all the candy bars inflated from $1 to $1.35. The pattern is consistent in the grocery store. From 2018 to 2019, the inflation is around 30-35%.


Hello, Under the "Learn More" Section there is a link referring to "the mathematics behind the IS-LM model" which does not seem to work. I am directed to a site "macroeconomicanalysis" which is a site for the stock market. Could you please help me? Thank you

Tapan P.

I liked the point about '08- how, since there is a cap, you can actually be stuck at an unemployment level. This is where the other boundaries of economics comes in, with blooming production and investment money into innovation.


Hello, there is a problem in the hyperlink "the mathematics behind the IS-LM model" (in the Learn More section). Can you help me on that?

RJane @.

I always wonder where the money comes from and goes to. Now, I know how the federal government controls money of the country. Thank you, Paul!