Chapter 4: A First Look at Macroeconomics –Origins and issues of macroeconomics –Trends and fluctuations in economic growth –Benefits and costs of economic

Chapter 4: A First Look at Macroeconomics

– Origins and issues of macroeconomics– Trends and fluctuations in economic growth– Benefits and costs of economic growth– Trends and fluctuations in unemployment &

inflation and associated problems– Trends and fluctuations in surpluses, deficits, and

debts and why they matter– Identify the macroeconomic policy challenges

and list the tools available for meeting them

What Will Your World Be Like?

Will tomorrow’s world be more prosperous than today?

Will jobs be plentiful?

Will the cost of living be stable?

Will the government’s and the nation’s deficit continue to increase?

What macroeconomic policy tools does the government have to steer the course of the economy?

Origins and Issues of Macroeconomics

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

Modern macroeconomics 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,” said Keynes, “we’re all dead.”

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

Economic Growth and Fluctuations

Economic growth

• the 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


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

•Real GDP<Potential GDP economy is operating below full employment

• A recession occurs when real GDP declines.


Growth of Potential GDP

During the 1970s, the growth of output per person slowed—a phenomenon called the productivity growth slowdown.

Fluctuations of Real GDP Around Trend

Real GDP fluctuates around potential GDP in a business cycle


Fluctuations of Real GDP Around Trend

Real GDP fluctuates around potential GDP in a business cycle—a periodic but irregular up-and-down movement in production.


Every business cycle has two phases:

1. A recession

2. An expansion

and two turning points:

1. A peak

2. A trough


Most recent business cycle in the United States


A recession is a period during which real GDP decreases for at least two successive quarters

NBER officially designates beginning and ending of recession -- above definition is not exact.

An expansion is a period during which real GDP increases.


The Lucas Wedge and Okun Gap

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 Lucas Wedge

the accumulated loss of output from the productivity growth slowdown of the 1970s

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

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


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.


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

Jobs and Unemployment

JobsIn 2006, 143 million people in the United States had jobs.

This number is 16 million more than in 1996 and 33 million more than in 1986.

But the pace of job creation fluctuates.

During the recession, the number of jobs shrinks.

During the 19901991 recession, more than 1 million jobs were lost and during the 2001 recession, 2 million jobs disappeared.


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

Source: http://www.bls.gov/news.release/pdf/empsit.pdf


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

The unemployment rate

1. Excludes discouraged workers.

2. Excludes “under-employment” – e.g. it does not tells us about the number of part-time workers who want full-time jobs.


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


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Unemployment Around the World

The U.S. unemployment rate has been lower than that in Western Europe and Canada but higher than that in Japan.

Inflation and the Dollar

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.

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Was low in the 1960s.

Increased in the 1970s and early 1980s.

Fell during the 1980s and 1990s.

Increased after 2002.

Inflation in the United States

Inflation Around the World

U.S. inflation is similar to that in other industrial countries.

Inflation Around the World

The inflation rate in industrial countries has been much lower than that in developing countries.

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

Diverts resources from production

Costs of Inflation

Unpredictable changes in the inflation rate redistribute income in arbitrary ways

• Employers and workers• Borrowers and lenders• Taxpayers and government

•High inflation diverts resources from productive activities to inflation forecasting

• High inflation makes contracts more complicated. Eradicating inflation is costly because it brings a period of greater than average unemployment.

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

When value of the dollar decreases, the U.S. dollar depreciates against other currencies.

When value of the dollar increases, the U.S. dollar appreciates against other currencies.


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.

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.


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


International Surplus and Deficit

If a nation imports more than it exports, it has a trade deficit.

If a nation exports more than it imports, it has a trade surplus.

The balance on the current account equals U.S. exports minus U.S. imports but also takes into account interest payments paid to and received from the rest of the world.


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.


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.



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.

Macroeconomic Policy Challengesand Tools

Classical and Keynesian Views

Economists’ views fall into two broad schools:

Classical view: The economy behaves best if the government leaves people free to pursue their own self-interest. Attempts by the government to improve macroeconomic performance will not succeed.

Keynesian view: The economy behaves badly if left alone and that government action is needed to achieve and maintain full employment.


Five widely agreed policy challenges for macroeconomics are to:

1. Boost economic growth

2. Keep inflation low

3. Stabilize the business cycle

4. Reduce unemployment

5. Reduce government and international deficits


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

Documents

Chapter 4: A First Look at Macroeconomics –Origins and issues of macroeconomics –Trends and fluctuations in economic growth –Benefits and costs of economic