Macroeconomics

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Macroeconomics
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Macroeconomics

• Macroeconomics is the study of the economy in the
  aggregate.
• The Big Three Macroeconomic Concepts
• Unemployment
• Inflation
• Productivity

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Unemployment

• The unemployment rate is the number of unemployed
  persons who are actively looking for work or are
  on temporary layoff divided by the total labor
  force.
• Labor Force Civilian non-institutional
  population over age 16 minus people not in the
  labor force (students, homemakers, retirees,
  discouraged workers).
• The current unemployment rate is 5.7.

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Definitions
Labor Force Number of Employed Number of
Unemployed Unemployment Rate Number of
Unemployed Labor Force Labor Force
Participation Rate Labor Force
Adult Population
X 100
X 100
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Types of Unemployment

• Frictional Unemployment
• Occurs due to normal turnover in the labor
  market. People changing jobs.
• Structural Unemployment
• Refers to workers who are not employed because
  their skills are not in demand.
• Cyclical Unemployment
• Occurs due to changes in the business cycle.

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Natural Rate of Unemployment

• The natural rate of unemployment is the
  percentage of the labor force that can normally
  be expected to be unemployed for reasons other
  than cyclical fluctuations in real GDP.
• The natural rate of unemployment is related to
  the willingness of workers to voluntarily
  separate from their jobs, job loss, the duration
  of unemployment periods, the rate of change in
  the pattern of demand, and changes in technology.

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Costs of Unemployment

• Loss in productivity is measured by the gap
  between potential GDP and actual GDP.
• A conservative estimate of the cumulative gap
  between actual and potential GDP over the years
  1974-1992 (evaluated in 1987 prices) is
  approximately 1300 billion.
• At 1993 levels, this loss in output would be
  about 3 months worth of production.
• It cannot be made up.

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Inflation

• The inflation rate is the percentage rate of
  increase in the economys average level of
  prices.
• Inflation refers to a sustained rise in the
  average level of prices.
• Inflation does not mean that all prices are
  rising. Some prices may be falling, but on
  average the overall level of prices is rising.

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Inflation

• Creeping inflation is an inflation that proceeds
  for a long time at a moderate and fairly steady
  pace.
• Galloping inflation is an inflation that proceeds
  at an exceptionally high rate, often for only a
  brief period.
• In 1993, Brazil experienced inflation rates of
  2,700

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The Costs of Inflation

• The main cost of inflation is the loss of
  efficiency that results because inflation
  distorts price signals. For example
• People invest in assets designed to protect them
  against inflation, such as real estate, rather
  than in productive investments that enhance the
  growth and efficiency of the economy.

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The Costs of Inflation

• Business collect bills more promptly, using
  resources that could otherwise have been used to
  produce goods and services.
• Individuals reduce money holdings, which is
  inconvenient and misallocates the individuals
  personal resources of time, energy , and leisure.
• In the case of hyperinflation, inflation over
  100, the currency system breaks down and the
  economy reverts to barter.

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Purchasing Power and Inflation

• Inflation erodes the purchasing power of a given
  sum of money.
• Assume you have 10,000 and the price level is 1.
• In current dollars, you have 10,000, and in
  constant dollars you have 10,000.
• Now let the price level rise to 2.
• In current dollars, you still have 10,000, but
  in constant dollars you now have ??? ?
• The rise in the price level has decreased the
  purchasing power of your money.

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Productivity

• Productivity is the average output produced per
  employee or per hour.
• In 2002, productivity was about 44 per
  worker-hour in the United States.
• Growth in productivity is one way to measure
  economic progress.
• If productivity grows by 3 per year, by 2022
  U.S. productivity would rise to 80 per worker-
  hour.

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Productivity and Economic Growth

• Increases in productivity are one source of
  economic growth.
• Other sources of economic growth are increases in
  capital and labor.

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Sources of Economic Growth in the USA
1929-48 1948-73 1973-82 1929-82 Sources
/\L/L 1.42 1.40 1.13 1.34
/\K/K 0.11 0.77 0.69 0.56 Total
Input Growth 1.53 2.17 1.82 1.90 Productivity
Growth 1.01 1.53 -0.27 1.02 Output
Growth 2.54 3.70 1.55 2.92
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Economic Growth 1870-1989
Level of Real GDP/Population Growth/Year Countr
y 1870 1913 1950 1989
1870-1989 Australia 3123 4523 5931
13584 1.2 Canada 1347 3560
6113 17576 2.2 France 1571 2734
4149 13837 1.8 Germany 1300 2606
3339 13989 2.0 Japan 618
1114 1563 15101 2.7 U.K. 2610
4024 5651 13468
1.4 U.S.A. 2247 4854 8611 18317
1.8
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Business Cycles
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Business Cycles

• Business cycles are fluctuations in the level of
  economic activity, alternating between periods of
  recession and prosperity.

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Business Cycles

• Business cycles are comprised of four phases
• Recession
• Rate of growth in GDP falls, unemployment
  increases, excess capacity increases,
  inflationary pressures decrease, and profits
  fall.
• Trough/Bottom
• Expansion
• Rate of growth in GDP rises, unemployment
  decreases, excess capacity decreases,
  inflationary pressures build, and profits rise.
• Peak

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Natural GDP
Natural GDP
GDP
GDP
Actual Real GDP
Actual Real GDP
Expansion
Recession
0
0
Time
Time
Unemp Rate
Infl Rate
Inflation Rises
Actual Unemp
Inflation Rate
Natural Rate of Un
Inflation Slows
0
0
t0 t1 t2
t0 t1 t2
Time
Time
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Graphs Description

• Left Graphs
• In the upper frame, the black line shows the
  steady growth of natural real GDP or the amount
  the economy can produce at a constant rate of
  inflation.
• The red line shows the actual growth of GDP.
• When actual GDP is below (above) natural GDP,
  inflation falls (rises).

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Graphs Description

• Right Graphs
• In the upper frame, the black line shows the
  steady growth of natural real GDP or the amount
  the economy can produce at a constant rate of
  inflation.
• The red line shows the actual growth of GDP.
• When actual GDP is below (above) natural GDP,
  unemployment rises (falls).

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A Brief History of Business Cycles The USA
Expansions 19454-19484 13 19501-19532 14 1954
3-19573 13 19582-19601 8 19611-19693 35 19
711-19734 12 19752-19801 20 19803-19813
5 19824-19903 32 19913-20011 38
Recessions 19491-19494 4 19533-19542
4 19574-19591 2 19602-19604
3 19694-19704 5 19741-19751
5 19802-19802 1 19814-19823
4 19903-19912 4 20011-20014 3
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Business Cycles Selected Facts

• In the period from 1854 to 2004, there have been
  32 full cycles, averaging 53 months in length
  (from trough to trough).
• Expansions averaged 35 months
• Contractions averaged 18 months
• In the period from 1945 to the present, there
  have been 10 full cycles, averaging 61 months in
  length.
• Since WWII, expansions have been 43 longer while
  contractions have been 39 shorter.
• Expansions averaged 53 months
• Contractions averaged 10.5 months

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Business Cycles Selected Facts

• Consumer spending cycles are not as extreme as
  those of GDP.
• People realize that recessions are temporary so
  declines in income are offset by increased use of
  savings.
• In nine of the ten recessions since World War II,
  consumer spending either rose or declined by
  smaller percentages than GDP.
• The one exception was the recession of 1990-91,
  when consumer spending declined slightly more
  than GDP.

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Business Cycles Selected Facts

• Investment has the most extreme cyclical
  movements of all the components of GDP.
• This is due to the fact that investment spending
  is determined in part by the availability of
  profits, which have extreme cyclical swings.
• It is also because capital investment can be
  deferred.

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Taming Business Cycles

• Stabilization Policy

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Business Cycles and Government

• The governments response to the cyclical nature
  of business is to engage in economic
  stabilization measures.
• Monetary policy
• Change in the rate of growth in the money supply.
• Fiscal policy
• Change government spending and taxes.

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Economic Stabilization Goals

• Price Stability
• Maintenance of an unchanged general level of
  prices over time.
• Full Employment
• Full utilization of all available labor and
  capital.
• Economic Growth
• Growth of real output over time.

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Economic Stabilization Laws

• The Federal Reserve Act (1913)
• Establish a central bank, furnish elastic
  currency, provide a lender of last resort,
  supervise the banking system.
• The 1946 Employment Act
• Formulate and execute policy to promote maximum
  employment, production and purchasing power.

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Economic Stabilization Laws

• The 1978 Humphrey-Hawkins Act
• Provide employment and price objectives as well
  as money growth targets.
• The 1980 Monetary Control Act
• Deregulate the banking system.

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THE PRESIDENT
CONGRESS
FEDERAL AGENCIES
FEDERAL RESERVE
BUDGET
TAXES
SPENDING
MONETARY POLICY
FISCAL POLICY
REGULATORY POLICY
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Economic Stabilization The Authorities

• The Congress
• House of Representatives
• Elected every 2 years 435 Members
• Senate
• Elected every 6 years 50 Members
• The President of the United States
• Elected every 4 years
• The Federal Reserve

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Stabilization Authorities Congress

• Congress implements the nations fiscal policy.
• Congress produces the governments annual budget.
• Congress determines spending levels for the
  government.
• Congress enacts tax laws for the nation.

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Stabilization Authorities President

• The President and his staff prepare an annual
  economic report that reviews the state of the
  economy.
• The President submits an annual budget, but
  Congress has fiscal authority.
• The President must influence members of Congress
  to adopt his budget priorities.

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THE FEDERAL RESERVE SYSTEM
Board of Governors (7 appointed
members) Determines reserve requirements and
approves changes in the discount
rate. Supervisory and regu- latory
responsibilities over member banks and holding
companies. Oversight of Federal Reserve Banks.
Federal Reserve Banks (12 District
Banks) Handle reserve balances for
banks. Furnish currency. Collect, clear ,
transfer funds. Handle U.S. government debt and
cash balances. Establish discount rate and
furnish loans at discount window.
Federal Open Market Committee (12
members) Meets 8 times a year in Washington,
D.C. Formulates monetary policy
directives implemented through open market
operations.
Reserve Requirements
Discount Rates
Open Market Operations
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ORGANIZATION OF THE FEDERAL RESERVE SYSTEM
Board of Governors (7 members appointed by the
President)
Supervise
Serve
Federal Open Market Committee (12
voting members BOG, President of NY Fed,
4 other Fed Bank Presidents)
12 Federal Reserve Banks and 25 Branch
Banks (Reserve Bank Presidents appointed by Board
of Directors)
Serve
Open Market Operations
State-Chartered Member Banks and Bank Holding
Companies
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Economic Stabilization Policies

• Economic policies used by the federal government
  to counter the cyclical fluctuations in economic
  activity.
• Monetary policy
• Conducted by the Federal Reserve
• Uses changes in the rate of growth of the money
  supply to cause changes in the level of economic
  activity.
• Fiscal policy
• Implemented by the Congress and the President
• Uses changes in taxes and spending to cause
  changes in the level of economic activity

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Control of the Money Supply

• The Fed controls the money supply with...
• Open Market Operations
• Purchases and sales of government securities by
  the Fed on the open market.
• Discount Window Operations
• Loans made by the Fed to banks.
• Changes in the reserve requirement on bank
  deposits.

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Thinking Like an Economist
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A Guide to Business Cycle Theories

• Questions to be Answered
• What is the primary source of economic
  disturbance in the macroeconomy?
• How fast do expectations adjust to changing
  circumstances?
• Are other frictions in the market clearing
  process important?
• Are policy lags highly variable and unpredictable?

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Early Keynesian Model

• The main source of economic disturbance is
  thought to come from fluctuations in aggregate
  demand.
• Changes in autonomous consumption
• Changes in investment spending
• Changes in liquidity preference/money demand
• Expectations adjust relatively slowly.
• Policy lags can be anticipated and taken into
  account in advance of policy responses.
• No additional frictions included in the model.

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Monetarist Model

• The main source of disturbance is from the demand
  side, specifically from erratic stop-and-go
  policies of the central bank (Fed) as it changes
  the rate of growth in the money supply.
• Expectations adjust relatively slowly.
• Policy lags are thought to be long and variable
  and, most importantly, unpredictable.
• As a result, policies that are intended to be
  countercyclical can end up being procyclical.
• No additional frictions are considered important.

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New Classical Model

• Fluctuations in the macroeconomy are primarily
  from unexpected changes in the money supply.
• Expectations adjust very quickly. Expectations
  are said to be rational.
• People use all the information available
  including educated guesses about the future when
  making decisions.
• Policy lags are not thought to be important
• No other frictions are important.

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New Keynesian Model

• The main source of disturbances comes from
  fluctuations in aggregate demand.
• Changes in autonomous consumption
• Changes in investment spending
• Changes in liquidity preference
• Expectations adjust rapidly.
• Policy lags are not a major problem.
• The market-clearing process is characterized by a
  number of frictions that result in an observed
  stickiness in wages and prices that slow down
  the economys return to full employment.

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Real Business Cycle Model

• Fluctuations from the demand side are relatively
  unimportant in their impact on output and
  unemployment. The main source of business cycles
  comes from the real side of the economy, the
  supply side.
• Random fluctuations in capital, primarily from
  uneven technological change, cause business
  cycles.
• Expectations adjust rapidly.
• Policy lags are not significant.
• No other frictions are important.

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Modeling the Aggregate Economy

• Aggregate Demand
• Aggregate demand is a schedule relating the total
  demand for all goods and services in an economy
  to the general price level in that economy.
• Aggregate Supply
• Aggregate supply is a schedule relating the total
  supply of all goods and services in an economy to
  the general price level.

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Aggregate Demand Determinants
Consumption Investment Government Net
Exports Money Financial Assets
Nonfinancial Markets Financial Markets
Aggregate Demand
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Aggregate Supply Determinants
Labor Costs Capital Costs Materials
Cost Productivity Capacity Expectations
Profit Margins Production Costs
Aggregate Supply
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Aggregate Demand and Supply Determinants
Consumption Investment Government Net
Exports Money Financial Assets Labor
Costs Capital Costs Materials Cost Productivity Ca
pacity Expectations
Nonfinancial Markets Financial Markets Profit
Margins Production Costs
Aggregate Demand Aggregate Supply
Price Level Real Output