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PART 7
Macroeconomic Overview
A First Look at
Macroeconomics
Copyright © 2006 Pearson Education Canada
19
CHAPTER
Objectives
After studying this chapter, you will able to
 Describe the origins and issues of macroeconomics
 Describe the trends and fluctuations in economic growth
 Describe the trends and fluctuations in jobs and
unemployment
 Describe the trends and fluctuations in inflation
 Describe the trends and fluctuations in government and
international deficits
 Identify the macroeconomic policy challenges and
describe the tools available for meeting them
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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 and the nation go into deficit again?
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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-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.
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Growth and Fluctuations
Economic growth is the expansion of the economy’s
production possibilities—an 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 nation’s farms, factories,
shops, and offices, measured in the prices of a single year.
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Growth and Fluctuations
Economic Growth in
Canada
Figure 19.1 shows real
GDP in Canada from 1961
to 2005.
The figure highlights:
 Growth of potential GDP
 Fluctuations of real GDP
around potential GDP
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Growth and Fluctuations
Growth of Potential GDP
Potential GDP is the value
of real GDP when all the
economy’s labour, capital,
land, and entrepreneurial
ability are fully employed.
During the 1970s and early
1980s, the growth of real
GDP per person slowed—a
phenomenon called the
productivity growth
slowdown.
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Growth and Fluctuations
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.
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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 19.2 on the next slide illustrates these features of
the business cycle.
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Growth and Fluctuations
Canada’s most recent business cycle.
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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.
A growth recession occurs when real GDP growth rate
is positive but slows so that real GDP is below potential
GDP.
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Growth and Fluctuations
And the most recession …
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Growth and Fluctuations
and three growth recessions.
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Growth and Fluctuations
Figure 19.3 shows the long-term growth trend and cycles.
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Growth and Fluctuations
Economic Growth
Around the World
Figure 19.4(a) shows
the growth rate of real
GDP per person in
Canada alongside
those of the world’s
three largest
economies.
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Growth and Fluctuations
 During the 1960s,
Japan’s growth rate
was much faster than
the others.
 After the 1970s, all
four growth rates were
similar.
 Canada’s growth rate
has been a bit less
than the U.S. growth
rate.
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Growth and Fluctuations
Figure 19.4(b) compares
Canada’s economic
growth with that in
several countries and
regions from 1980 to
2004.
Asia has been the fastest
growing region in the
global economy.
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Growth and Fluctuations
The Lucas Wedge and Okun Gap
How costly are the productivity slowdown and the lost
output as real GDP fluctuates around potential GDP in
a business cycle?
To answer that question we measure:
 The Lucas wedge
 The Okun gap
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Growth and Fluctuations
The Lucas Wedge
The Lucas wedge is the
accumulated loss of output
from a slowdown in the
growth rate of real GDP
per person.
Figure 19.5(a) shows that
the Canadian Lucas
wedge that arises from the
productivity slowdown of
the 1970s is $11.5 trillion
or 10 year’s GDP at the
2005 level.
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Growth and Fluctuations
The Okun Gap
The Okun gap is the gap
between potential GDP
and actual real GDP and
is another name for the
output gap.
Figure 19.5(b) shows the
Okun gap from recessions
since 1974 is $173 billion
or about 2 months of real
GDP in 2005.
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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 an inferior Canadian health-care
system, fewer child-care services, worse roads, and less
to spend on cleaner air, cleaner lakes, and more trees.
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
The Canadian economy creates about 220,000 additional
jobs a year, on the average.
But the number fluctuates.
Since 2000, the economy created 1.6 additional jobs, but
during the 1991 recession, 260,000 jobs disappeared.
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Jobs and Unemployment
Unemployment
Unemployment is a state in which a person does not
have a job but is available for work, willing to work, and
has made some effort to find work within the previous four
weeks.
The labour force is the total number of people who are
employed and unemployed.
The unemployment rate is the percentage of the people
in the labour force who are unemployed.
A discouraged worker is a person available for work,
willing to work, but who has given up the effort to find
work.
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Jobs and Unemployment
Unemployment in
Canada
Figure 19.6 shows the
unemployment rate in
Canada from 1926 to
2005.
 During the 1930s,
the unemployment
rate hit 20 percent.
 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 not as
high as in the Great
Depression.
 The unemployment
rate is never zero.
Since World War II, it
has averaged 6.7
percent.
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Jobs and Unemployment
Unemployment Around
the World
Figure 19.7 compares the
unemployment rate in
Canada with those in
Japan, Western Europe,
and the United States.
Unemployment is higher
in Canada, on the
average, than in the other
countries shown.
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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
production—a temporary problem.
A prolonged spell of unemployment can bring permanent
damage through the loss of human capital.
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Inflation
Inflation is a process of rising prices.
We measure the inflation rate as the percentage change
in the average level of prices or the price level.
The Consumer Price Index—the CPI—is a common
measure of the price level.
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Inflation
Inflation in Canada
 Was low in the first
half of the 1960s.
 Increased in the
1970s and early
1980s.
 Was lowered in the
1980s and 1990s.
 Kept inside a
target band since
early 1990s.
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Inflation
The inflation rate
fluctuates, but it is
always positive—
the price level has
not fallen during
the years shown
in the figure.
A falling price
level—a negative
inflation rate—is
called deflation.
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Inflation
Inflation Around the
World
Figure 19.9(a) shows the
inflation rate in Canada
compared with other
countries.
 Canadian inflation has
been similar to that in
other industrial countries.
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Inflation
Figure 19.9(b) shows the
inflation rate in industrial
countries has been much
lower than that in
developing countries.
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Inflation
Is Inflation a Problem?
Unpredictable changes in the inflation rate are a problem
because they 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.
Eradicating it is costly because it brings a period of greater
than average unemployment.
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Surpluses and Deficits
Government Budget Surplus and Deficit
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 and Deficits
Figure 19.10(a) shows
the changing surplus
and deficit of the
federal and provincial
governments in
Canada since 1960.
 Persistent federal
deficits during the
1970s through the
1990s and
 Federal surpluses
since 1998.
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Surpluses and Deficits
Provincial governments
had
 Surpluses during the
1960s and 1970s and
 Large deficits in the
early 1990s.
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Surpluses and Deficits
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 is the balance of
exports minus imports, plus net interest paid to and
received from the rest of the world.
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Surpluses and Deficits
Figure 19.10(b) shows
Canada’s current
account balance from
1960 to 2005.
 Persistent current
account deficit most of
the time
 Surpluses during the
past five years
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Macroeconomic Policy Challenges
and Tools
Five widely agreed policy challenges for macroeconomics
are to:
1. Reduce unemployment
2. Boost economic growth
3. Stabilize the business cycle
4. Keep inflation low
5. Reduce government and international deficits
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Macroeconomic Policy Challenges
and Tools
Two broad groups of macroeconomic policy tools are
Fiscal policy—making changes in tax rates and
government spending
Monetary policy—changing interest rates and changing
the amount of money in the economy
The government conducts fiscal policy.
The Bank of Canada conducts monetary policy.
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Copyright © 2006 Pearson Education Canada