Business, Community & Government

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.

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

Topics include: The Fed Is Magic • How the Fed Thinks: IS-LM • Finding the Right Inflation Rate • What the IS-LM Curve Really Looks Like


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...

About the Instructor

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.

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Paul Krugman

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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