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Chapter 4: A First Look at Macroeconomics

Origins and issues of macroeconomics

Economic growth

Unemployment & inflation

Government budget surpluses/deficits

International trade surpluses and deficits

Macroeconomic policy challenges and tools

Origins and Issues of Macroeconomics

Economists began to study economic growth, inflation, and international payments during the 1750s.

Modern macro dates from the Great Depression, a decade (1929-1939) of high unemployment and stagnant production throughout the world economy.

John Maynard Keynes’ book, The General Theory of Employment, Interest, and Money, began the subject.

Origins and Issues of Macroeconomics

Short-Term Versus Long-Term Goals

Keynes focused on the short-term

on unemployment and lost production.

“In the long run, we’re all dead.”

During the 1970s and 1980s, macroeconomists became more concerned about long-term—inflation and economic growth.

Economic Growth and Fluctuations

Economic growth

•expansion of the economy’s production possibilities• outward shifting Production possibilities frontier (PPF).• results from more resources (land, labor, capital) or improved technology

Real Gross Domestic Product (GDP)

•total market value of all the goods and services produced by domestically located factors of producing during a year, measured using a fixed prices.• inflation alone does not cause an increase in real GDP

Economic Growth is measured by growth in Real GDP

Economic Growth and Fluctuations

•Potential GDP is GDP if economy operates at “full employment”

•Real GDP<Potential GDP below full employment

• A recession occurs when real GDP declines.

Economic Growth and Fluctuations

Business cycles:

• Fluctuations of real GDP around potential• 2 stages

1. A recession: real GDP declining2. An expansion: real GDP rising

• 2 turning points1. Peak2. Trough

Business cycle dates officially determined by NBER

http://www.nber.org/cycles.html

Economic Growth and Fluctuations: 1866-2006

Economic Growth and Fluctuations: 1980-2008

Economic Growth and Fluctuations

How costly are the growth slowdown and the lost output over the business cycle?

To answer that question we measure:

The Lucas wedge

The Okun gap

The Cost of a Productivity Slowdown

The Lucas Wedgeaccumulated loss of output from the productivity growth slowdown of the 1970s

Productivity=RGDP/labor hours

(4.3 percent from 1960s versus actual growth realized).

$72 trillion or 6.5 times the real GDP in 2005.

The Cost of a Recessions

The Okun GapReal GDP minus potential GDP is the output gap (Okun gap)

Okun gap from recessions since 1973 is $3.3 trillion or about 30 percent of real GDP in 2005.

Pain of an Okun gap not equally distributed across society.

A larger Okun gap would be caused by ___ . A larger Lucas wedge would be caused by ______:

A longer r

eces..

.

A shorte

r rec..

.

Slower p

roduct.

..

None of t

he ab...

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1. A longer recession; slower productivity growth

2. A shorter recession; slower productivity growth

3. Slower productivity growth; longer recession

4. None of the above.

Determinants of Economic Growth

Rate of growth in resources (land, labor, capital)–Tax policy–Social Insurance programs–Immigration–Environmental regulations–Government spending –Technological change–Education policy

Which tax would be likely to lead to greater economic growth?

A tax re

bate t...

A tax cr

edit t..

.

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1. A tax rebate to households.

2. A tax credit to business subsidizing the purchase of new capital.

Stricter environmental regulations would likely lead to _____ economic growth.

incre

ased

decrease

d

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1. increased

2. decreased

More generous unemployment insurance benefits would likely lead to ____ economic growth

incre

ased

decrease

d

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20

1. increased

2. decreased

More immigration would lead to ____ economic growth

faste

r

slower

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1. faster

2. slower

Jobs and Unemployment

JobsIn 2008, 145.3 million people in the United States had jobs.

This number is 18 million more than in 1996 and 35 million more than in 1986.

But the pace of job creation fluctuates.

During a recession, the number of jobs shrinks.

19901991 recession: >1 million jobs lost

2001 recession, 2 million jobs lost

2008 recession: 2 million jobs lost in 4th quarter, how many more??

.

Jobs and Unemployment

Unemployment

On an average day in a normal year, 7 million people in the U.S. are unemployed (not employed, but searching for a job).

Labor force statistics:

Civilian Labor force = employed + unemployed (excludes military)

Unemployment rate = unemployed/Civilian labor force

Jobs and Unemployment

The unemployment rate is not a perfect measure of the underutilization of labor. For two reasons:

The unemployment rate

1. Excludes discouraged workers.

• Workers who are discouraged about job prospects and quit searching.

2. Excludes “under-employment”

–part-time workers who want full-time jobs.

Jobs and Unemployment

During the 1930s, the unemployment rate hit 25 percent.

Jobs and Unemployment

Inflation

We measure the price level as the average of the prices that people pay for all the goods and services that they buy.

Consumer Price Index (CPI) is a common measure of the price level.

Inflation rate:percentage change in the price level.

Inflation occurs when the price level is rising persistently.

Deflation occurs when inflation is negative and prices are falling.

Inflation

Hyperinflation

The most serious type of inflation is hyperinflation -- an inflation rate that exceeds 50 percent a month.

Why Inflation is a Problem

Inflation is a problem for many reasons, but the main one is that once it takes hold, it is unpredictable.

Unpredictable inflation is a problem because it

Redistributes income and wealth

Borrowers and lendersTaxes

Diverts resources from production toward forecasting inflation & contracts to deal with inflation

If inflation is higher than borrowers and lenders expected, borrowers will ____ and lenders will _____.

Win; lo

se

Win; w

in

Lose

; win

Lose

; lose

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1. Win; lose

2. Win; win

3. Lose; win

4. Lose; lose

Value of the dollar

The Value of the Dollar

in terms of other currencies is called the exchange rate —a measure of how much your dollar will buy in other parts of the world.

An example is the number of pesos that 1 U.S. dollar will buy (pesos/dollar)

Value of the dollar

Depreciation

value of the dollar decreases relative to other currencies.

Appreciation

Value of the dollar increasesincreases relative to other currencies.

A weighted average of the foreign exchange value of the U.S. dollar against a subset of the broad index currencies that circulate widely outside the country of issue. Major currencies index includes the Euro Area, Canada, Japan, United Kingdom, Switzerland, Australia, and Sweden.

Value of the Dollar

Why the Exchange Rate MattersWhen the U.S. dollar appreciates,

U.S. consumers pay less for imported goods more imports and less demand for domestic goods.

Foreign consumers pay more for U.S. exports fewer exports and less demand for domestic goods.

When the U.S. dollar depreciates, the opposite occurs.

When the dollar appreciates relative to other currencies, the cost of U.S. exports to other countries ______ and the cost of U.S. imports from other countries _____.

Rises;

rises.

Rises;

falls.

Falls

; falls

.

Falls

; rise

s.

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1. Rises; rises.

2. Rises; falls.

3. Falls; falls.

4. Falls; rises.

Government Surpluses, Deficits, and Debts

Government Budget Balance

If a government collects more in taxes than it spends, it has a government budget surplus.

If a government spends more than it collects in taxes, it has a government budget deficit.

Deficits Bring Debts

A debt is the amount that is owed.

When a government or a nation has a deficit, its debt grows.

A government’s or a nation’s debt equals the sum of all past deficits minus past surpluses.

A government’s debt is called national debt.

If the U.S. debt grows from 2008 to 2009, the government must have experienced a budget deficit.

True

False

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2. False

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Surpluses, Deficits, and Debts

The budget deficit as a percentage of GDP increases in recessions and shrinks in expansions

Surpluses, Deficits, and Debts

Surpluses, Deficits, and Debts

During the 1980s expansion, a large deficit appeared but it almost disappeared during the 1990–1991 recession.

The current account deficit in 2005 was 6.3 percent of GDP.

International Surpluses, Deficits, and Debts

International Surplus and Deficit

Trade surplus: imports > exports

Trade deficit: exports> imports

The balance on the current account equals U.S. exports minus U.S. imports but adds interest received and substracts interest paid to rest of the world.

Current account surplus: net lender to rest of world

Curernt account deficit: net borrower from rest of world

International Surpluses, Deficits, and Debts

Until 1986, the United States was a net lender to the world.

But with increased deficits, the United States is now a net borrower from the world.

U.S. borrowing from the rest of the world rises as imports ____ or exports _____.

Rise; r

ise

Rise; fa

ll

Fall;

fall

Fall;

rise

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1. Rise; rise

2. Rise; fall

3. Fall; fall

4. Fall; rise

Macroeconomic Policy Challenges and Tools

Two broad groups of macroeconomic policy tools are

Fiscal policy

changes in tax rates and government spending

Conducted by government

Monetary policy

changing interest rates and the amount of money in the economy

Conducted by Federal Reserve