ParkinBade Chapter 19

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CHAPTER
A First Look at Macroeconomics
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After studying this chapter you will be able to

• Describe the origins and issues of macroeconomics
• Describe the trends and fluctuations in economic
  growth and explain the benefits and costs of
  economic growth
• Describe the trends and fluctuations in
  unemployment and explain why unemployment is a
  problem
• Describe the trends and fluctuations in inflation
  and the value of the dollar and explain why
  inflation is a problem
• Describe the trends and fluctuations in
  surpluses, deficits, and debts and explain why
  they matter
• Identify the macroeconomic policy challenges and
  list the tools available for meeting them

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What Will Your World Be Like?

• Will tomorrows world be more prosperous than
  today?
• Will jobs be plentiful?
• Will the cost of living be stable?
• Will the governments and the nations deficit
  continue to increase?
• What macroeconomic policy tools does the
  government have to steer the course of the
  economy?

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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.

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Origins and Issues of Macroeconomics

• Short-Term Versus Long-Term Goals
• Keynes focused on the short-termon unemployment
  and lost production.
• In the long run, said Keynes, were all dead.
• During the 1970s and 1980s, macroeconomists
  became more concerned about the
  long-terminflation and economic growth.

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Economic Growth and Fluctuations

• Economic growth is the expansion of the economys
  production possibilitiesan outward shifting PPF.
• We measure economic growth by the increase in
  real GDP.
• Real GDP (real gross domestic product) is the
  value of the total production of all the nations
  farms, factories, shops, and offices, measured in
  the prices of a single year.

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Economic Growth and Fluctuations

• Economic Growth in the United States
• Figure 20.1 shows real GDP in the United States
  from 1960 to 2005.

• The figure highlights
• Growth of potential GDP
• Fluctuations of real GDP around potential GDP

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Economic Growth and Fluctuations

• Growth of Potential GDP
• Potential GDP is the value of production when all
  the economys labor, capital, land, and
  entrepreneurial ability are fully employed.
• During the 1970s, the growth of output per person
  sloweda phenomenon called the productivity
  growth slowdown.

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Economic Growth and Fluctuations

• Fluctuations of Real GDP Around Trend
• Real GDP fluctuates around potential GDP in a
  business cyclea periodic but irregular
  up-and-down movement in production.

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Economic Growth and Fluctuations

• Every business cycle has two phases
• 1. A recession
• 2. An expansion
• and two turning points
• 1. A peak
• 2. A trough
• Figure 20.2 on the next slide illustrates these
  features of the business cycle.

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Economic Growth and Fluctuations

• Most recent business cycle in the United States

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Economic Growth and Fluctuations

• A recession is a period during which real GDP
  decreases for at least two successive quarters.
• An expansion is a period during which real GDP
  increases.

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Economic Growth and Fluctuations

• Figure 20.3 shows the long-term growth trend and
  cycles.

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Economic Growth and Fluctuations

• Economic Growth Around the World
• Figure 20.4(a) compares the growth rate of real
  GDP per person in the United States with that for
  the rest of the world as a whole.

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Economic Growth and Fluctuations

• Figure 20.4(b) compares economic growth in the
  United States with that in other countries and
  regions from 1996 to 2006.
• Among the advanced economies, Japan has grown
  slowest and the newly industrialized Asian
  economies have grown fastest.

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Economic Growth and Fluctuations

• Among the developing economies, Central and South
  America have grown slowest and Asia has grown
  fastest.
• The world has grown a bit faster than the United
  States.

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Economic Growth and Fluctuations

• 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

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Economic Growth and Fluctuations

• The Lucas Wedge
• The Lucas wedge is the accumulated loss of output
  from the productivity growth slowdown of the
  1970s .
• Figure 20.5(a) shows that the Lucas wedge is 72
  trillion or 6.5 times the real GDP in 2005.

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Economic Growth and Fluctuations

• The Okun Gap
• Real GDP minus potential GDP is the output gap.
• A negative output gap is called an Okun gap.
• Figure 20.5(b) shows the Okun gap from recessions
  since 1973 is 3.3 trillion or about 30 percent
  of real GDP in 2005.

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Economic Growth and Fluctuations

• Benefits and Costs of Economic Growth
• The Lucas wedge is a measure of the dollar value
  of lost real GDP if the growth rate slows. This
  cost translates into real goods and services.
• It is a cost in terms of less health care for the
  poor and elderly, less cancer and AIDS research,
  worse roads, and less to spend on clean air, more
  trees, and cleaner lakes.
• But fast growth is also costly. Its main costs is
  forgone current consumption. To sustain growth,
  resources must be allocated to advancing
  technology and accumulating capital rather than
  to current consumption.

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Jobs and Unemployment

• Jobs
• In 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 1990?1991 recession, more than 1
  million jobs were lost and during the 2001
  recession, 2 million jobs disappeared.

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Jobs and Unemployment

• Unemployment
• Not everyone who wants a job can find one.
• On an average day in a normal year, 7 million
  people in the United States are unemployed.
• In a recession, the number is larger. For
  example, in 1990-1991 recession, 9 million people
  were looking for jobs.
• The unemployment rate is the number of unemployed
  people expressed as a percentage of all the
  people who have jobs or are looking for one.

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Jobs and Unemployment

• The unemployment rate is not a perfect measure of
  the underutilization of labor. For two reasons
• The unemployment rate
• 1. Excludes people who are so discouraged that
  they have given up looking for jobs.
• 2. Measures unemployed people rather than
  unemployed labor hours. So it does not tells us
  about the number of part-time workers who want
  full-time jobs.

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Jobs and Unemployment

• Unemployment in in United States
• Figure 20.6 shows the unemployment rate from 1926
  to 2006.

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Jobs and Unemployment

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

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Jobs and Unemployment

• The lowest rate occurred during World War II at
  1.2 percent.

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Jobs and Unemployment
During recent recessions, the unemployment rate
increased but was not as high as in the Great
Depression.
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Jobs and Unemployment
The unemployment rate is never zero. Since World
War II, it has averaged 5 percent.
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Jobs and Unemployment

• Unemployment Around the World
• Figure 20.7 compares the unemployment rate in the
  United States with those in Japan, Western
  Europe, and Canada.
• The U.S. unemployment rate has been lower than
  that in Western Europe and Canada but higher than
  that in Japan.

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Jobs and Unemployment

• The cycle in unemployment in Canada is similar to
  that in the United States.
• The cycle in unemployment in Western European is
  out of phase with that in the United States.
• Unemployment in Japan has drifted upwards since
  the mid-1990s.

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Jobs and Unemployment

• Why Unemployment Is a Problem
• Unemployment is a serious economic, social, and
  personal problem for two main reasons
• Lost production and incomes
• Lost human capital
• The loss of a job brings an immediate loss of
  income and productiona temporary problem.
• A prolonged spell of unemployment can bring
  permanent damage through the loss of human
  capital.

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Inflation and the Dollar

• We measure the level of pricesthe price level
  as the average of the prices that people pay for
  all the goods and services that they buy.
• The Consumer Price Indexthe CPIis a common
  measure of the price level.
• We measure the inflation rate as the percentage
  change in the price level.
• Inflation arises when the price level is rising
  persistently.
• If the price level is falling, inflation is
  negative and we have deflation.

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Inflation and the Dollar
Inflation in the United States

• Was low in the 1960s.
• Increased in the 1970s and early 1980s.
• Fell during the 1980s and 1990s.
• Increased after 2002.

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Inflation and the Dollar

• Inflation Around the World
• Figure 20.9(a) shows the inflation rate in the
  United States compared with that in other
  industrial countries.
• U.S. inflation is similar to that in other
  industrial countries.

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Inflation and the Dollar

• Figure 20.9(b) shows the inflation rate in
  industrial countries has been much lower than
  that in developing countries.

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Inflation and the Dollar

• Hyperinflation
• The most serious type of inflation is
  hyperinflationan 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

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Inflation and the Dollar

• Unpredictable changes in the inflation rate
  redistribute income in arbitrary ways between
  employers and workers and between borrowers and
  lenders.
• A high inflation rate is a problem because it
  diverts resources from productive activities to
  inflation forecasting.
• From a social perspective, this waste of
  resources is a cost of inflation.
• Eradicating inflation is costly because it brings
  a period of greater than average unemployment.

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Inflation and the Dollar

• The Value of the Dollar
• The value of the U.S. dollar in terms of other
  currencies is called the exchange ratea 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.

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Surpluses, Deficits, and Debts

• Figure 20.10 shows the U.S. dollar exchange rate.
• 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.

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Inflation and the Dollar

• Why the Exchange Rate Matters
• When the U.S. dollar appreciates, U.S. consumers
  pay less for imported goods.
• But the higher dollar makes it harder for U.S.
  producers to complete in foreign markets. A
  higher dollar hurts U.S producers.
• When the U.S. dollar depreciates, U.S. consumers
  pay more for imported goods. So a lower dollar
  hurts consumers.
• But the lower dollar makers it easier for U.S.
  producers to complete in foreign markets.

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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.

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Surpluses, Deficits, and Debts

• Figure 20.11(a) shows the U.S. federal government
  budget balance from 1960 to 2005.
• The budget deficit as a percentage of GDP
  increases in recessions and shrinks in expansions
• In 1998, a budget surplus emerged, but the budget
  deficit reappeared in 2001.

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Surpluses, Deficits, and Debts

• International Surplus and Deficit
• If a nation imports more than it exports, it has
  an international deficit.
• If a nation exports more than it imports, it has
  an international 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.

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Surpluses, Deficits, and Debts

• Figure 20.11(b) shows the U.S. current account
  balance from 1960 to 2005.
• During the 1980s expansion, a large deficit
  appeared but it almost disappeared during the
  19901991 recession.
• The current account deficit in 2005 was 6.3
  percent of GDP.

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Surpluses, Deficits, and Debts

• Deficits Bring Debts
• A debt is the amount that is owed.
• When a government or a nation has a deficit, its
  debt grows.
• A governments or a nations debt equals the sum
  of all past deficits minus past surpluses.
• A governments debt is called national debt.

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Surpluses, Deficits, and Debts

• Figure 20.12(a) shows the U.S. government debt
  from 1945 to 2005.
• Budget surpluses and rapid economic growth shrink
  the debt.
• Budget deficits and slower economic growth
  swelled the debt.

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Surpluses, Deficits, and Debts

• Figure 20.12(b) shows the U.S. international debt
  from 1975 to 2005.
• 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.

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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.

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Macroeconomic Policy Challengesand Tools

• 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

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Macroeconomic Policy Challengesand Tools

• Two broad groups of macroeconomic policy tools
  are
• Fiscal policymaking changes in tax rates and
  government spending
• Monetary policychanging interest rates and
  changing the amount of money in the economy
• The government conducts fiscal policy.
• The Federal Reserve (the Fed) conducts monetary
  policy.

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THE END