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22>>?2009WorthPublishersMacroeconomics:TheBigPictureAnoverviewofmacroeconomics,thestudyoftheeconomyasawhole,andhowitdiffersfrommicroeconomicsTheimportanceofthebusinesscycleandwhypolicy-makersseektodiminishtheseverityofbusinesscyclesWhatlong-rungrowthisandhowitdeterminesacountry’sstandardoflivingThemeaningofinflationanddeflationandwhypricestabilityispreferredWhatisspecialaboutthemacroeconomicsofanopeneconomy,aneconomythattradesgoods,services,andassetswithothercountriesMacroeconomicsvs.MicroeconomicsLet’sbeginbylookingmorecarefullyatthedifferencebetweenmicroeconomicandmacroeconomicquestions.MICROECONOMICQUESTIONSMACROECONOMICQUESTIONSGotobusinessschoolortakeajob?Howmanypeopleareemployedintheeconomyasawhole?WhatdeterminesthesalaryofferedbyCitibanktoCherieCamajo,anewColumbiaMBA?Whatdeterminestheoverallsalarylevelspaidtoworkersinagivenyear?Macroeconomicsvs.MicroeconomicsMICROECONOMICQUESTIONSMACROECONOMICQUESTIONSWhatdeterminesthecosttoauniversityorcollegeofofferinganewcourse?Whatdeterminestheoveralllevelofpricesintheeconomyasawhole?Whatgovernmentpoliciesshouldbeadoptedtomakeiteasierforlow-incomestudentstoattendcollege?Whatgovernmentpoliciesshouldbeadoptedtopromotefullemploymentandgrowthintheeconomyasawhole?WhatdetermineswhetherCitibankopensanewofficeinShanghai?Whatdeterminestheoveralltradeingoods,servicesandfinancialassetsbetweentheU.S.andtherestoftheworld?Macroeconomicsvs.MicroeconomicsMicroeconomicsfocusesonhowdecisionsaremadebyindividualsandfirmsandtheconsequencesofthosedecisions.Example:Howmuchitwouldcostforauniversityorcollegetoofferanewcourse─thecostoftheinstructor’ssalary,theclassroomfacilities,theclassmaterials,andsoon.Havingdeterminedthecost,theschoolcanthendecidewhetherornottoofferthecoursebyweighingthecostsandbenefits.Macroeconomicsvs.MicroeconomicsMacroeconomicsexaminestheaggregatebehavioroftheeconomy(i.e.howtheactionsofalltheindividualsandfirmsintheeconomyinteracttoproduceaparticularlevelofeconomicperformanceasawhole).Example:Overalllevelofpricesintheeconomy(howhighorhowlowtheyarerelativetopriceslastyear)ratherthanthepriceofaparticulargoodorservice.Macroeconomicsvs.MicroeconomicsInmacroeconomics,thebehaviorofthewholemacroeconomyis,indeed,greaterthanthesumofindividualactionsandmarketoutcomes.Example:Paradoxofthrift:whenfamiliesandbusinessesareworriedaboutthepossibilityofeconomichardtimes,theypreparebycuttingtheirspending.Thisreductioninspendingdepressestheeconomyasconsumersspendlessandbusinessesreactbylayingoffworkers.Asaresult,familiesandbusinessesmayendupworseoffthaniftheyhadn’ttriedtoactresponsiblybycuttingtheirspending.Macroeconomics:TheoryandPolicyInaself-regulatingeconomy,problemssuchasunemploymentareresolvedwithoutgovernmentintervention,throughtheworkingoftheinvisiblehand.AccordingtoKeynesianeconomics,economicslumpsarecausedbyinadequatespendingandtheycanbemitigatedbygovernmentintervention.Monetarypolicyuseschangesinthequantityofmoneytoalterinterestratesandaffectoverallspending.Fiscalpolicyuseschangesingovernmentspendingandtaxestoaffectoverallspending.WhyGeorgeW.BushWasn’tHerbertHooverHerbertHooverdidn’tdomuchtofighttheGreatDepression.Atthetime,conventionalwisdomdictatedthatthegovernmenttakeahands-offapproachtotheeconomy.Leadingeconomists,includingJosephSchumpeter,offeredsimilaradvice.“Remedialmeasureswhichworkthroughmoneyandcredit.Policiesofthisclassareparticularlyapttoproduceadditionaltroubleforthefuture.”UnderPresidentGeorgeW.Bush:The2004EconomicReportofthePresidentstated“StrongfiscalpolicyactionsbythisAdministrationandtheCongress,togetherwiththeFederalReserve’ssimulativemonetarypolicy,”thereportdeclared,“havesoftenedtheimpactoftherecessionandhavealsoputtheeconomyonanupwardtrajectory.”TheboosttotheeconomygivenbyfiscalpolicyandtheFederalReserve’sinterestratecutsreducedtheseverityanddurationofthe2001recession.Growth,Interrupted,1988-2008TheBusinessCycleThebusinesscycleistheshort-runalternationbetweeneconomicdownturnsandeconomicupturns.Adepressionisaverydeepandprolongeddownturn.Recessionsareperiodsofeconomicdownturnswhenoutputandemploymentarefalling.Expansions,sometimescalledrecoveries,areperiodsofeconomicupturnswhenoutputandemploymentarerising.TheBusinessCycleThepointatwhichtheeconomyturnsfromexpansiontorecessionisabusiness-cyclepeak.Thepointatwhichtheeconomyturnsfromrecessiontoexpansionisabusiness-cycletrough.TheBusinessCycleTheBusinessCycleTheBusinessCycleWhathappensduringabusinesscycle,andwhatcanbedoneaboutit?TheeffectsofrecessionsandexpansionsonunemploymentTheeffectsonaggregateoutputThepossibleroleofgovernmentpolicyDefiningRecessionsandExpansions

Inmanycountries,economistsadopttherulethatarecessionisaperiodofatleast6months,ortwoquarters,duringwhichaggregateoutputfalls.

sometimestoostrictIntheU.S.,thetaskofdeterminingwhenarecessionbeginsandendsisassignedtoanindependentpanelofexpertsattheNationalBureauofEconomicResearch(NBER).Theylookatanumberofeconomicindicators,withthemainfocusonemploymentandproduction,butultimatelythepanelmakesajudgmentcall.

sometimescontroversialTheU.S.UnemploymentRateTamingtheBusinessCyclePolicyeffortsundertakentoreducetheseverityofrecessionsarecalledstabilizationpolicy.Onetypeofstabilizationpolicyismonetarypolicy:changesinthequantityofmoneyortheinterestrate.Thesecondtypeofstabilizationpolicyisfiscalpolicy:changesintaxpolicyorgovernmentspending,orboth.GlobalComparison:InternationalBusinessCyclesComparingRecessionsInparticular,somerecessionshavebeenmuchworsethanothers.Comparingthreehistoricalrecessions:Terribleslumpof1929–19331981–1982recession—generallyconsideredtheworsteconomicslumpsincetheGreatDepressionRelativelymild2001recessionTheserecessionsdifferedinduration:thefirstlasted43months;thesecond,16months;thethird,only8months.Evenmoreimportant,however,theydifferedgreatlyindepth.ComparingRecessionsComparingRecessionsThe1929–1933recessionhittheeconomyvastlyharderthaneitherofthepost–WorldWarIIrecessions.The1981–1982recessiondideventuallyreduceindustrialproductionbyabout10%,althoughproductionthenstagedarapidrecovery.In2001,thedeclineinindustrialproductionwasverymodest.ByGreatDepressionstandards,oreventhoseofthe1980s,the2001recessionwasverymild.Long-RunEconomicGrowthLong-runeconomicgrowthisthesustainedupwardtrendintheeconomy’soutputovertime.Acountrycanachieveapermanentincreaseinthestandardoflivingofitscitizensonlythroughlong-rungrowth.Acentralconcernofmacroeconomicsiswhatdetermineslong-runeconomicgrowth.Long-RunEconomicGrowthIn1905,wefindthatlifeformanyAmericanswasstartlinglyprimitivebytoday’sstandards.Americanshavebecomeabletoaffordmanymorematerialgoodsovertimethankstolong-runeconomicgrowth.Long-RunEconomicGrowthRealGDPpercapita(2000dollars)190019101920193019401950196019701980199020002007Year$40,00030,00020,00010,000WhenDidLong-RunGrowthStart?Long-rungrowthisarelativelymodernphenomenon.From1000to1800,realaggregateoutputaroundtheworldgrewlessthan0.2%peryear,withpopulationrisingataboutthesamerate.Economicstagnationmeantunchanginglivingstandards.Forexample,informationonpricesandwagesfromsuchsourcesasmonasteryrecordsshowsthatworkersinEnglandweren’tsignificantlybetteroffintheearlyeighteenthcenturythantheyhadbeenfivecenturiesearlier.However,long-runeconomicgrowthhasincreasedsignificantlysince1800.Inthelast50yearsorso,realGDPpercapitahasgrownabout3.5%peryear.ATaleofTwoColoniesOneofthemostinformativecontrastsinlong-rungrowthisbetweenCanadaandArgentina.Economichistoriansbelievethattheaveragelevelofpercapitaincomewasaboutthesameinthetwocountriesaslateasthe1930s.AfterWorldWarII,however,Argentina’seconomyperformedpoorly,largelyduetopoliticalinstabilityandbadmacroeconomicpolicies.Meanwhile,Canadamadesteadyprogress.ThankstothefactthatCanadahasachievedsustainedlong-rungrowthsince1930,butArgentinahasnot,CanadatodayhasalmostashighastandardoflivingastheUnitedStates—andisaboutthreetimesasrichasArgentina.InflationandDeflationArisingaggregatepricelevelisinflation.Afallingaggregatepricelevelisdeflation.Theinflationrateistheannualpercentchangeintheaggregatepricelevel.Theeconomyhaspricestabilitywhentheaggregatepricelevelischangingonlyslowly.InflationandDeflation2004006008001,0001,200%PercentincreaseHourlyearningsRoastcoffeeEggsWhitebreadGasoline431%220%508%595%1,052%AFast(Food)MeasureofInflationMcDonald’sopenedin1954:Hamburgerscostonly15cents─25centswithfries.TodayahamburgeratatypicalMcDonald’scostsfivetimesasmuch─between$0.70and$0.80.Isthistooexpensive?No.Infact,aburgeris,comparedwithotherconsumergoods,abetterbargainthanitwasin1954.Burgerpriceshaverisenabout400%,from$0.15toabout$0.75,overthelasthalfcentury.Buttheoverallconsumerpriceindexhasincreasedmorethan600%.IfMcDonald’shadmatchedtheoverallpricelevelincrease,ahamburgerwouldnowcostbetween90centsand$1.00.InternationalImbalancesAnopeneconomyisaneconomythattradesgoodsandserviceswithothercountries.Acountryrunsatradedeficitwhenthevalueofgoodsandservicesboughtfromforeignersismorethanthevalueofgoodsandservicesitsellstothem.Itrunsatradesurpluswhenthevalueofgoodsandservicesboughtfromforeignersislessthanthevalueofthegoodsandservicesitsellstothem.InternationalImbalancesExports,imports(billions)$2,5002,0001,5001,0005000UnitedStatesGermanyChinaSaudiArabiaExportsImportsEstonia’sMiraculousTradeDeficitTheSovietUnionbrokeupinto15independentcountriesin1991.Manyofthesecountriesexperiencedhardeconomictimesintheyearsthatfollowed.ThesmallnationofEstonia,however,thrived.EconomistsroutinelytalkofanEstonianeconomic“miracle.”Youmightthinkthatsuchasuccessfuleconomywouldrunabigtradesurplus,exportingmuchmorethanitimports.Infact,Estoniarunstradedeficitsthataresmallindollartermsbecauseit’sasmallcountry(just1.3millionpeople),butarelargecomparedwiththesizeoftheeconomy.Infact,relativetothesizeofitseconomy,Estonia'stradedeficitin2007wasalmostthreetimesthatoftheUnitedStates.Estonia’sMiraculousTradeDeficitWhydoesEstoniarunsuchlargetradedeficits?Becauseit’ssosuccessful!Thesuccessoftheeconomyhasledtohighratesofinvestment,muchofitbycompaniesbasedinotherEuropeancountries.Aswe’vejustsuggested,tradedeficitsarehighwheninvestmentspendingishighcomparedwithsavings.Macroeconomicsisthestudyofthebehavioroftheeconomyasawhole.Macroeconomicsdiffersfrommicroeconomicsinthetypeofquestionsittriestoanswerandinitsstrongpolicyfocus.Keynesianeconomics,whichemergedduringtheGreatDepression,advocatestheuseofmonetarypolicyandfiscalpolicytofighteconomicslumps.PriortotheGreatDepression,theeconomywasthoughttobeself-regulating.Onekeyconcernofmacroeconomicsisthebusinesscycle,theshort-runalternationbetweenrecessions,periodsoffallingemploymentandoutpu