Macroeconomics

Macroeconomics

Macroeconomics is the branch of economics that deals with the economy at large. Macroeconomics is concerned with how the economy of a country works, how the central bank of that country deals with its business cycles, GDP & GNP (Gross Domestic Product and Gross National Product, respectively), fiscal (taxes – government) and monetary (interest rates or money supply – central bank) policies and other related matters.

Introduction to Macroeconomics

Economics is a social science dealing with attempting to reconcile an unlimied amount of human needs with the limited number of world resources available. As such, economics can be subdivided into many disciplines, such as mircoeconomics, macroeconomics, finance, normative economics, financial econometrics and so on. Therefore, the following article covers some of the topics dicussed in macroeconomics, such as stagflation. Stagflation refers to a particularly unpropsperous economy in which high inflation is coupled with stagnant unemployment. As macroeconomics looks at economies as a whole, concetrating on central banking, nationa states, GDP, GNP and large international corporations, so unemployment is naturally an important topic in macroeconomic theory. Moreover, macroeconomic theory predicts business cycles and thus, economic recessions, as well as, economic expansions. Thus, during recessions growth is stagnant or lower, while unemployment is higher. Conversely, expansions correspond to spikes in production and lower unemployment. However, unemployment does not include everyone who is not employed. Hence, students, homemakers or persons who are not actively looking for a job (for example because they have given up), remain excluded from the national statistic for unemployed individuals. Additionally, central banks may attempt to manipulate the economy of a country through money supply. For instance, during an economic recession, a central bank may inject money into the economy, which then increases aggregate demand, which in turn stimulates the economy.

GDP equals consumption plus investment made by firms plus government expenditure plus exports minus imports. Investment in this case does not mean investing in securities or real estate (a house or a condominium is an investment, whereas a car is an expense), but investment of capital made by firms to increase, improve or maintain business operations.

GDP is calculated by adding all that has been produced within the borders of a country during a year. GNP is calculated by subtracting from that number all that was produced during that year by foreigners, and adding to the result all that was earned by the country’s citizens abroad. An important note to keep in mind is not to double and triple count, which is why second hand sales are not usually considered in the GDP computation. GDP does not measure everything; other aspects such as pollution, freedom and safety, and even happiness are important to quality of life as well.

Economics is everywhere, and understanding economics can help you make better decisions and lead a happier life. (Tyler Cowen). Photo: Megan Jorgensen (Elena)

Naturally, unemployment is likewise of interest to macroeconomists. During an economic contraction (recession) firms produce less, because of smaller aggregate demand, and tend to lay workers off. Laid off workers, in turn, lose their ability to purchase goods and services, and thus consumption goes down as well. Okun’s Law states that the country’s unemployment will move ½ of the percentage change of the GDP below or above potential GDP (at full employment).

During an expansion (boom) prices rise because people spend more. The central bank of a country has the responsibility to balance the economy. To achieve that, it can raise or lower the interest rate (which is then followed by commercial banks) or decrease or increase money supply. The bank cannot do both simultaneously.

Purchasing power parity has to do with the exchange rate between states, and refers to the notion that an equivalent basket of goods may be purchased in two countries if the money were exchanged at the agreed on rate. In reality, the equivalency does not always hold. A strong Canadian dollar would increase Canada’s imports, but reduce Canada’s exports, since other countries would no longer find Canadian prices competitive. Paradoxically, a strong currency can decrease a country’s GDP. Canada’s main trading partner is the USA, roughly 80% of total trade. Therefore, Canada’s economic health is greatly influenced by what is going on south of the border.

Macroeconomic Stability

There were two oil shocks, in 1973 and 1979; the following recessions (1974-1975; 1980-1982) have led to questioning about the causal link between oil price and economic slides (Clarida, Gali, & Gertler, 2000).

The authors discuss the pre-Volcker and Volcker-Greenspan eras (post late 1979), and test a New Keynesian model (reaction function). The backward-oriented Keynesian model is insensitive to fluctuation projections, elaborated on later in the manuscript. However, this may be acting through the intermediary of the resulting austere monetary policy. Along these lines, inflation was on the rise in the years preceding the oil crises. Price stickiness refers to prices that are slow motion in alteration. A self-fulfilling fluctuation is the phenomenon of upward trends in real interest rates as a consequence of a build-up of inflation. The anticipation forces downturns the rates South.

In economics, one of the most important concepts is “opportunity cost”- the idea that once you spend your money on something, you can’t spend it again on something else (Malcolm Turnbull. Photo: Megan Jorgensen (Elena)

The authors render that with inflation lag below unity, the projected inflation Lower interest rates boost aggregate (total) demand inducing inflation to climb. The final picture proves the expectation hypothesis, similar to psychological concept of self-fulfilling prophecy, when our preconceptions of strangers make us behave in ways that elicit reactions from others than in turn confirm our initial mental schema.

The contrasting principle is the sunspot generalization effect. Supply shock affect inflation only when the gap is close to unity, theoretical application of the feedback rule. The argument stands that the Federal Reserve has been more tough on inflation in the Volcker-Greenspan epoch.

Reference

    Clarida, R., Gali, J., & Gertler, M. (2000). Monetary policy rules and macroeconomic stability: Evidence and some theory. The Quarterly Journal of Economics, February, 147-180.