Download Lecture 4

Economics
THIRD EDITION
By John B. Taylor
Stanford University
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1
Chapter 17 (Macro 4)
Macroeconomics: The
Big Picture
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2
Overview
• This chapter introduces the major themes and
components of modern macroeconomics. It
defines macroeconomics in terms of economic
growth and economic fluctuations. It summarizes
the recent historical record of a few key
macroeconomic variables and emphasizes a set of
key facts about economic growth and economic
fluctuations. An overview of the major sources of
macroeconomic theory is provided to explain
these facts. Finally, the role of economic policy is
introduced with a brief discussion of fiscal and
monetary policy.
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Teaching Objectives
1. Explain how economic growth and economic
fluctuations occur together, but make clear the
difference between the two.
2. Provide an account of the important facts about
economic growth and economic fluctuations.
3. Introduce major theoretical perspectives on both
economic growth (Solow model) and economic
fluctuations (Keynes, monetarism, and rational
expectations).
4. Introduce the role that economic policy can play
in promoting economic growth and reducing
economic fluctuations.
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1. Economic Output Over Time
• 1a. Real GDP is the starting point for studying
macroeconomics. Figure 17.1 distinguishes
economic growth trends from business cycles, or
fluctuations.
1b. Economic growth can be measured in terms of
individual benefit by using real GDP per capita
values, providing an indicator of average wellbeing in an economy.
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Figure 17.1 (Macro 4)
Economic Growth and Fluctuations
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1. Economic Output Over Time
• 1c. The growth record of the United States
over the past 40 years is based on real GDP
growth of 3 percent and per capita growth
of 1.7 percent. However, these growth rates
cover two distinct periods. The first period
(1955-1975) growth rate was about 3.25
percent, compared to the second period
(1975-1994) rate of 2.5 percent. Explaining
this growth slowdown has been a major
challenge for economists.
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Figure 17.2
(Macro 4)
Visualizing Economic Growth
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Economic fluctuations
• 1d. Economic fluctuations define the parts of a
business cycle (see Figures 17.2 and 17.2).
• Note the irregular duration and variable depth and
peak of cycles. This may be related to particular
administrations or events. It is important to point
out that economic fluctuations differ from cycles
in physical sciences.
• The aftermath of a recession, a recovery, is
gradual, and the effect of an improvement in the
economy is usually delayed.
• A comparison between the 1990-1991 recession
and the Great Depression of the 1930s is made in
Figure 17.4.
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Economic Fluctuations:
Recession / Expansion
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Figure 17.3 (Macro 4)
The Phases of Business Cycles
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Figure 17.4
(Macro 4)
Growth and
Fluctuations
Throughout
the Twentieth
Century
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2. Jobs, Inflation, and Interest Rates
• 2a. Job creation, or the net increase in
employment, along with measures of labor
productivity, are two of several variables used to
describe an economy's performance.
• Figure 17.5 illustrates employment growth over
the last 40 years. Labor productivity has increased
at about 1.3 percent per year when measured in
real GDP per hour. But again there are two periods
of productivity growth, reflecting the productivity
slowdown of the last 20 years: 2 percent for the
period from the mid-1950s to the mid-1970s,
compared to 0.7 percent since. Small differences
make for large differences over long periods of
time.
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Figure 17.5
(Macro 4)
The Unemployment Rate
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Unemployment
• 2b. The unemployment rate rises in a recession
and falls in a recovery but with a delay, as shown
in Figure 17.6. The contrast in the magnitude
between recent rates and the Great Depression is
provided by Figure 17.7. The labor force
participation rate, although rising gradually over
the last 40 years, also varies over the business
cycle as workers are discouraged from further job
search or decide to retire early, causing the rate to
fall in a recession.
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Figure 17.6
(Macro 4)
Unemployment During the Great Depression
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Inflation
• Inflation is closely linked to the business cycle, as
seen from the shaded areas in Figure 17.8.
• There is a long-term positive trend to inflation
over the last 40 years, even though disinflation has
been a feature of the last decade.
• Inflation has never been zero during the period
and is expected to remain positive on average in
the future.
• The cost of inflation is the uncertainty about how
to determine prices and anticipate future changes
in prices. Inflation has not been low or stable, both
desirable goals.
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Figure 17.7
(Macro 4)
The Ups and Downs in Inflation
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Interest rates
• Interest rates are also linked to business cycles.
• Interest rates, such as mortgage and savings
deposit rates, along with the federal funds rate, are
affected by the performance of the economy, as
shown in Figure 17.8.
• Real interest rates, the difference between nominal
interest rates and expected inflation, provide a way
of explaining the close relationship between
inflation and interest rates.
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Figure 17.8
(Macro 4)
The Ups and Downs in Interest Rates
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3. Macroeconomic Theory and Policy
• 3a. Economic growth theory and economic
fluctuations theory are the long- and shortterm parts of macroeconomic theory,
respectively. The trend line of Figure 19.1 is
potential GDP, or the long-run tendency of
GDP, and is an average-level GDP that
reflects the long-term growth rate, the slope
of the trend line.
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Aggregate Supply
• 3b. The term aggregate supply is used to describe
potential GDP in the short-run setting of economic
fluctuations. Aggregate supply is determined by
the available labor, capital, and technology.
• 3b.1 The concept of the aggregate production
function is used to relate real GDP to the inputs:
labor, capital, and technology. Because of this
long-term relationship between inputs and output,
any slowdown in economic growth must be due to
a slowdown in the growth of one or more of the
inputs.
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Economic policies
• 3c. Policy for long-term economic growth
(sometimes called supply side policy)
attempts to increase potential GDP, or
aggregate supply.
• Fiscal and monetary policy are other tools
to improve economy.
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Fiscal policy
• 3c.1 Fiscal policy can affect aggregate
supply through the use of tax changes or
changes in spending or borrowing. These
incentives alter labor, capital, and
technology inputs to the production
function.
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Monetary policy
• 3c.2 Monetary policy is concerned primarily with
the control of the money supply in order to control
inflation. A low and stable rate of inflation is
desirable because it reduces the uncertainty
associated with determining prices and future
inflation when inflation is high or variable.
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Final thoughts
• 3d.1 Changes in aggregate demand are central to
the explanation of economic fluctuations, whether
due to fluctuations in business spending (Keynes)
or the money supply (monetarists).
3d.2 The potential of macroeconomic policy, both
fiscal and monetary, to alter the size of economic
fluctuations parallels the potential of policy to
affect economic growth. These details are pursued
in subsequent chapters.
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