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

Paul Krugman

Lesson time 10:43 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.


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.

Quite enjoyable - some more theory would have been welcome.

IT was great! More detail would have been a boon to the course

Thank you Mr. Krugman. you have lighted a fire.

Brilliant framework on the whole. Love the encouragement he provides us with to look for answers on things we'd like to know but think it's out of our scope of understanding. Would definitely come back to this course again. Hope Mr. Krugman creates another interesting course like this.


A fellow student

How does this interact with MMT (i.e. interest rates below 0?) This is a reality in many countries today, such as Japan.

Angel G.

The problem persist: Read more about the mathematics behind the IS-LM model and how to use it to solve macroeconomic problems. (workbook page 23). Was anyone able to check the link? It's not taking me to the correct website

Akshay D.

A query for Prof K or others: how do rates get influenced through purchase/sale of T Bills? Not clear. My derived rationale is: If Fed thinks 3 mth Tbill rates are high, they just go out and buy more bills - what does this cause - excess liquidity and money supply and therfore money becomes cheap and rates fall BUT if there is more money out there, would that not rise to inflation and therefore rates would move up? And similarly, if rates are low, they just print more Bills, sell them and soak up some liquidity now that would make money scarce and expensive BUT that would dry up liquidity and would demand for money and therefore rates move up? I hope to resolve my confusion. Thanks.

magda Z.

Don't you think that there was no inflation in the US mainly because the printing of money, out of a thin air was used to buy assets and products from around the world including M&A. I agree with you that the recent 2.2 Trillion QE will create no inflation at all since the money will end up at the bank accounts of the very few who will buy assets around the world. Its time for a new Monetary World Order.. it cant be that certain countries are buying the assets of others out of a thin air.

Ekin Ö.

I have always been wondering why the target on the inflation rate was 2%. It's a relief to learn that the number is arbitrary, and it's funny to learn that it initially comes from New Zealand, and the other central banks just followed suit. :-)

Eugene S.

the infographic on 2:29 is erroneous. The amount of MONEY (dollar bills) actually increases when the Fed buys the treasuries to lower the interest rates.

A fellow student

Read more about the mathematics behind the IS-LM model and how to use it to solve macroeconomic problems. (workbook page 23). Was anyone able to check the link? It's not taking me to the correct website i think.

dara A.

we need to have a LIVE masterclass with Paul discussing today's economic coronavirus climate!!!


If interest rates can't hit zero, why do some countries like Switzerland, Japan, and Denmark have a negative IBOR? Why does the EU have a 0% interest rate?

A fellow student

In the lecture notes, it says that if the economy produces too much, it will widespread increases in the prices of nearly all goods and services as the demand for them outpaces production capabilities. Can anyone explain to me why an increase in supply will lead to an increase in demand? Shouldn't it be like an increase in supply will lead to a decrease in price because of surplus?