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22
The Goals of
Macroeconomic Policy
When men are employed, they are best contented.
BENJAMIN FRANKLIN
Inflation is repudiation.
CALVIN COOLIDGE
Contents
● Part 1: The Goal of Economic Growth
♦ Productivity Growth: From Little Acorns . . .
♦ The Capacity to Produce: Potential GDP and
the Production Function
♦ The Growth Rate of Potential GDP
♦ Alternative Measures of Economic Growth
♦ What Determines the Growth Rate?
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Contents (continued)
● Part 2: The Costs of Unemployment
♦ The Human Costs of High Unemployment
♦ Counting the Unemployed: the Official
Statistics
♦ Types of Unemployment
♦ How Much Employment is “Full Employment”
♦ Unemployment Insurance: The Invaluable
Cushion
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Contents (continued)
● Part 3: The Costs of Inflation
♦ Inflation: The Myth and the Reality
♦ Inflation as a Redistribution of Income and
Wealth
♦ Real Versus Nominal Interest Rates
♦ Inflation Distorts Measurements
♦ Other Costs of Inflation
♦ The Costs of Low Versus High Inflation
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Contents (continued)
♦ Low Inflation does Not Necessarily Lead to
High Inflation
● Appendix: How Statisticians Measure
Inflation
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Part 1: The Goal of
Economic Growth
The Capacity to Produce:
Potential GDP
● Potential GDP = the real GDP that the
economy could produce if the labor force
and other resources were fully employed
● Production Function = Mathematical
depiction of the relationship between an
economy’s inputs and outputs.
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The Capacity to Produce:
Potential GDP
● The growth rate of potential GDP depends
on:
♦ The growth rate of the labor force
♦ The growth rate of the nation’s capital stock
♦ The rate of technical progress
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
22-1 The Economy’s
Production Function
FIGURE
B
Y1
A
Y0
0
K
L0 Labor input
(hours)
(a)
Y1
Real GDP
Real GDP
M
K1
A
Y0
0
K0
L0 Labor input
(hours)
(b)
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
The Growth Rate of Potential
GDP
● Labor productivity = the amount of output
a worker turns out in an hour (or a week, or
a year) of labor.
● Over long periods of time, the growth rates
of actual and potential GDP are normally
quite similar.
● But the two often diverge sharply over short
periods.
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22-1 Recent Growth Rates
of Real GDP in the U.S.
TABLE
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Alternative Measures of
Economic Growth
● Growth rate of Real GDP
● Growth rate of Real GDP per capita;
● Real GDP per capita = ratio of real GDP to
population.
● Growth rate of Labor productivity
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
Alternative Measures of
Economic Growth
● These last two measures of economic
progress differ only in their denominators:
one divides GDP by population, the other by
hours of work.
● The right measure to use depends on the
purpose.
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?Issue Revisited: Is Faster
Growth Always Better?
● Faster growth may lead to greater pollution,
crowding, and waste production.
● Greater consumption may not necessarily
make people happier.
● Growth may drive people to work longer
hours.
● Faster growth may generate higher inflation,
in some cases.
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
Part 2: The Costs of
Unemployment
The Human Costs of High
Unemployment
● Unemployment rate = the number of
unemployed people, expressed as a
percentage of the labor force
● Unemployment entails a loss in output for
the society as a whole, a loss that can never
be recovered.
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22-2 The Economic Costs
of High Unemployment
TABLE
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
22-2 Actual and Potential
GDP in the United States
FIGURE
9,500
Actual GDP
9,000
8,500
8,000
7,500
Billions of 1996 Dollars
7,000
Potential GDP
6,500
6,000
5,500
5,000
1 98 2 –1983
Recession
4,500
4,000
1 97 4 –1975
Recession
3,500
3,000
1960s
Boom
2,500
2,000
1,500
1957–1958
Recession
1955
1959
1 96 0 –1961
Recession
1963
1967
1971
1975
Year
1979
1983
1987
1991
1995
1999
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The Human Costs of High
Unemployment
● Unemployment is a serious personal
problem for the unemployed.
♦ Income forgone
♦ Psychological distress
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The Human Costs of High
Unemployment
● In good times and bad some groups suffer
more than others from unemployment
♦ Below average unemployment rates:
■Married men
■Well-educated workers
♦ Above average unemployment rates:
■Teenagers
■Nonwhites
■Blue-collar workers
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
22-3 Unemployment
Rates for Selected Groups, 2001
FIGURE
40
35
30.5
Percent
30
25
20
14.7
15
10
6.6
5
0
2.3
2.7
College
Graduates
Married
Men
7.3
8.0
Women
Adults
Blacks
Who Who Did Not
MaintainGraduate from
Families High School
Teenagers
Black
Male
Teenagers
Counting the Unemployed:
The Official Statistics
● The BLS estimates the labor force, the
employed, and the unemployed.
♦ These distinctions cannot deal very well with
the problems of discouraged workers and of
“hidden” or “disguised” unemployment.
♦ Discouraged Worker: An unemployed person
who gives up looking for work and is therefore
no longer counted as part of the labor force.
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
Types of Unemployment
● Frictional unemployment is the normal
movement of workers from one job to
another.
● Structural unemployment exists when
workers’ characteristics do not fit with
employers’ requirements.
● Cyclical unemployment occurs when the
level of economic activity declines
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How Much Unemployment is
“Full Employment”?
● It was once thought that 4% was a good
target.
● Events from the early 1990s through 2002
have left economists uncertain of the fullemployment unemployment rate.
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Unemployment Insurance:
The Invaluable Cushion
● Unemployment insurance cushions (but
does not completely prevent) the monetary
loss to some (but not all) unemployed
people.
● Payroll taxes and unemployment benefits
♦ Spread the costs of unemployment over the
entire population
♦ Do not eliminate its basic economic cost
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Part 3: The Costs of
Inflation
Inflation: The Myth and the
Reality
● The costs of inflation are less obvious than
those of unemployment, yet people certainly
fear it.
● Inflation and Real Wages: Inflation does
not typically erode real wages, because
increases in nominal wages compensate for
the rising prices.
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
22-4 Rates of Change of
Wages and Prices in the U.S.
FIGURE
14
14
13
13
12
12
11
11
10
10
9
9
8
8
7
7
6
6
5
5
4
4
3
3
2
Prices
Percentage Change in Prices
Percentage Change in Wages
Wages
2
1
1
0
0
–1
–1
–2
–2
1950
1960
1970
1980
1990
2000
1955
1965
1975
1985
1995
Year
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Reasons for Wages
Amount
to Increase
Higher productivity
2%
Compensation for higher prices
3
Total
5%
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Inflation: The Myth and the
Reality
● The Illusion of Traditional “Fair” Prices:
Inflation does not necessarily lead to unfair
prices.
● The Importance of Relative Prices:
Inflation is not usually to blame when some
goods become more expensive relative to
others.
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TABLE
22-3 Pure Inflation
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TABLE
22-4 Real-World Inflation
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Inflation as a Redistributor
of Income and Wealth
● Because inflation does not proceed evenly,
it redistributes income and wealth in
arbitrary, unfair ways.
● It systematically discriminates against
people on fixed incomes, and it may favor
borrowers at the expense of lenders.
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Real versus Nominal Interest
Rates
● Real rate of interest = percentage increase in
purchasing power that the borrower pays the
lender in exchange for the loan.
● Nominal rate of interest = Real interest rate
+ expected rate of inflation
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Real versus Nominal Interest
Rates
● Inflation that is accurately anticipated need
not redistribute wealth between borrowers
and lenders.
♦ The nominal interest rate will include an
adequate inflation premium, above the real
interest rate.
● If the actual inflation rate turns out to be
different from the expected rate
unanticipated redistribution will occur.
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Inflation Distorts
Measurements
● Confusing Real and Nominal Interest Rates
♦ Hides true economic cost of borrowing money.
■Many Americans viewed the 12% mortgage
interest rates that banks charged in 1980 as
scandalously high while they saw the 7% mortgage
rates of 1998 as a great bargain.
■In truth, however, the real interest rate in 1998
(about 5%) was well above the bargain-basement
real rates in 1980 (about 2%).
Copyright© 2003 Southwestern/Thomson Learning All rights reserved.
Inflation Distorts
Measurements
● Many laws and regulations that were
designed for an inflation-free economy
malfunction when inflation is high.
● These costs of inflation are not purely
redistributive.
● Society as a whole loses when mutually
beneficial transactions are prohibited by
dysfunctional legislation.
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Other Costs of Inflation
● The uncertainty created by inflation may
inhibit long-term contracts.
● Inflation may impose real costs on shoppers,
whose level of information about relative
prices deteriorates.
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The Costs of Low versus
High Inflation
● Inflation creates fewer social problems if
♦ It is low rather than high.
♦ It is steady (and therefore relatively
predictable) rather than variable.
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Low Does Not Necessarily
Lead to High Inflation
● Low inflation does not necessarily lead to
high inflation
♦ Creeping inflation sometimes accelerates, but it
sometimes decelerates.
♦ While creeping inflations have many causes,
galloping inflations have occurred only when
the government has printed incredible amounts
of money.
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Appendix: How
Statisticians Measure
Inflation
Index Numbers for Inflation
● The price index is a measure of the cost of a
basket of goods in a current year, relative to
the cost of the same basket in a base year.
● There is no perfect price index.
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22-5 Results of Student
Expenditure Survey, 1983
TABLE
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The Consumer Price Index
● The Consumer Price Index (CPI), often
known as "the cost of living," is the most
widely cited index.
● Nominal values can be deflated by the CPI
in order to estimate real changes.
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TABLE
22-6 Prices in 2001
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How to Use a Price Index to
“Deflate” Monetary Figures
● The GDP deflator is somewhat different
from the CPI, in that its basket includes all
the components of GDP, not just consumer
goods.
♦ It is usually, although not always, very close to
the CPI.
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22-7 Cost of 1983 Student
Budget in 2001 Prices
TABLE
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