While economic theory may seem academic in nature, these seemingly esoteric theories affect everyone on a personal level---especially the branch of economics called macroeconomics. If your mortgage rate goes up or the interest rate for your savings account drops to practically nothing, that's macroeconomics in action. Macroeconomic theory also influences government decisions on issues like public spending and tax cuts.
Economics is basically divided into two fields of study: macroeconomics and microeconomics. Unlike microeconomics, which focuses on the economic behavior of individuals, families and companies, macroeconomics is the study of regional and national economies. More specifically, macroeconomics examines national-level economic factors like gross national product (GDP), unemployment, consumption and foreign trade.
Macroeconomics was developed in the 1930s. Before that time, economists didn't have the regional and national statistics that were needed to study national economies. The severe toll of the Great Depression spurred economists to try to gain a better understanding of large-scale economic factors. One of these economists was Britain's John Maynard Keynes. Keynes argued that the government could stimulate the economy out of a depression by reducing interest rates and investing in infrastructure.
Other schools of thought arose in reaction to Keynesian economics. Monetarism focused on the national supply and demand of money. It theorized that increasing the supply of money or cutting interest rates would lower unemployment, while cutting the supply of money or raising interest rates would prevent inflation. Monetarism advocated less government action than Keynesian economics. Supply-side economics, also known by the nickname of "trickle-down" economics, suggests that tax cuts for the rich spur economic growth, as the rich then have more money to invest.
How is macroeconomics put into practice? The federal government can affect fiscal policy via tax rates and the amount of money spent on public works. The Federal Reserve---the central bank of the U.S.---has power over fiscal policy. The Federal Reserve has the power to create and restrict the money that is available to banks. The Fed also sets interest rates.
Macroeconomic theory has affected the policies of the U.S. government, with different theories put into practice over different eras. Keynesian economics was the basis of Franklin D. Roosevelt's New Deal, which spawned several different government agencies that offered people jobs to build infrastructure, such as highways. Ronald Reagan was influenced by supply-side theories, which encouraged him to make large tax cuts.
- Jupiterimages/Photos.com/Getty Images