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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
Economic Growth and Fluctuations
•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.
Economic Growth and Fluctuations
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
Economic Growth and Fluctuations
Fluctuations of Real GDP
Around Trend
Real GDP fluctuates
around potential GDP in a
business cycle—a
periodic but irregular upand-down movement in
production.
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
Economic Growth and Fluctuations
Most recent business cycle in the United States
Economic Growth and Fluctuations
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.
Economic Growth and Fluctuations
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
Economic Growth and Fluctuations
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.
Economic Growth and Fluctuations
The Okun Gap
Real 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)
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Tax policy
Social Insurance programs
Immigration
Environmental regulations
Government spending
Technological change
Education policy
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.
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
Source: http://www.bls.gov/news.release/pdf/empsit.pdf
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.
2. Excludes “under-employment” – e.g. it does not tells us
about the number of part-time workers who want fulltime jobs.
Jobs and Unemployment
During the 1930s, the unemployment rate hit 25 percent.
Jobs and Unemployment
Jobs and Unemployment
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.
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 production—a temporary
problem.
• A prolonged spell of unemployment can
bring permanent damage through the loss
of human capital.
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.
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.
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.
Inflation and the Dollar
Why the Exchange Rate Matters
When 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.
Surpluses, Deficits, and Debts
The budget deficit
as a percentage of
GDP increases in
recessions and
shrinks in
expansions
Surpluses, Deficits, and Debts
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.
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.
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 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.
Surpluses, Deficits, and Debts
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.
Macroeconomic Policy Challenges
and 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 selfinterest. 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.
Macroeconomic Policy Challenges
and 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
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