|
Macroeconomics (from the Greek prefix makro- meaning "large"
+ economics) is a branch of economics dealing with the performance, structure,
behavior, and decision-making of an economy as a whole. For example, using
interest rates, taxes and government spending to regulate an economy’s
growth and stability. This includes regional, national, and global economies.
Macroeconomists study topics such as GDP, unemployment rates, national income,
price indices, output, consumption, unemployment, inflation, saving,
investment, energy, international trade, and international finance.
Macroeconomics and microeconomics are the two most general fields in economics.
The United Nations Sustainable Development Goal 17 has a target to enhance
global macroeconomic stability through policy coordination and coherence as
part of the 2030 Agenda.
Development:
Main article::
History of macroeconomic thought:
Origins:
Macroeconomics descended from the once divided fields of business cycle theory
and monetary theory. The quantity theory of money was particularly influential
prior to World War II. It took many forms, including the version based on the
work of Irving Fisher: M · V=P · Q {\displaystyle M\cdot V=P\cdot Q}
M\cdot V=P\cdot Q In the typical view of the quantity theory, money velocity
(V) and the quantity of goods produced (Q) would be constant, so any increase
in money supply (M) would lead to a direct increase in price level (P). The
quantity theory of money was a central part of the classical theory of the
economy that prevailed in the early twentieth century.
Austrian School:
Ludwig Von Mises's work Theory of Money and Credit, published in 1912,
was one of the first books from the Austrian School to deal with macroeconomic
topics.
Keynes and his followers:
Macroeconomics, at least in its modern form, began with the publication of John
Maynard Keynes's General Theory of Employment, Interest and Money.[ When
the Great Depression struck, classical economists had difficulty explaining how
goods could go unsold and workers could be left unemployed. In classical
theory, prices and wages would drop until the market cleared, and all goods and
labor were sold. Keynes offered a new theory of economics that explained why
markets might not clear, which would evolve (later in the 20th century) into a
group of macroeconomic schools of thought known as Keynesian economics –
also called Keynesianism or Keynesian theory.
In Keynes's theory, the quantity theory broke down because people and
businesses tend to hold on to their cash in tough economic times – a
phenomenon he described in terms of liquidity preferences. Keynes also
explained how the multiplier effect would magnify a small decrease in
consumption or investment and cause declines throughout the economy. Keynes
also noted the role uncertainty and animal spirits can play in the economy. The
generation following Keynes combined the macroeconomics of the General Theory
with neoclassical microeconomics to create the neoclassical synthesis. By the
1950s, most economists had accepted the synthesis view of the macroeconomy.
Economists like Paul Samuelson, Franco Modigliani, James Tobin, and Robert
Solow developed formal Keynesian models and contributed formal theories of
consumption, investment, and money demand that fleshed out the Keynesian
framework.
Monetarism:
Milton Friedman updated the quantity theory of money to include a role for
money demand. He argued that the role of money in the economy was sufficient to
explain the Great Depression, and that aggregate demand oriented explanations
were not necessary. Friedman also argued that monetary policy was more
effective than fiscal policy; however, Friedman doubted the government's
ability to "fine-tune" the economy with monetary policy. He generally
favored a policy of steady growth in money supply instead of frequent
intervention. Friedman also challenged the Phillips curve relationship between
inflation and unemployment. Friedman and Edmund Phelps (who was not a
monetarist) proposed an "augmented" version of the Phillips curve
that excluded the possibility of a stable, long-run tradeoff between inflation
and unemployment. When the oil shocks of the 1970s created a high unemployment
and high inflation, Friedman and Phelps were vindicated. Monetarism was
particularly influential in the early 1980s. Monetarism fell out of favor when
central banks found it difficult to target money supply instead of interest
rates as monetarists recommended. Monetarism also became politically unpopular
when the central banks created recessions in order to slow inflation.
New classical:
New classical macroeconomics further challenged the Keynesian school. A central
development in new classical thought came when Robert Lucas introduced rational
expectations to macroeconomics. Prior to Lucas, economists had generally used
adaptive expectations where agents were assumed to look at the recent past to
make expectations about the future. Under rational expectations, agents are
assumed to be more sophisticated. A consumer will not simply assume a 2%
inflation rate just because that has been the average the past few years; they
will look at current monetary policy and economic conditions to make an
informed forecast. When new classical economists introduced rational
expectations into their models, they showed that monetary policy could only
have a limited impact. Lucas also made an influential critique of Keynesian
empirical models. He argued that forecasting models based on empirical
relationships would keep producing the same predictions even as the underlying
model generating the data changed. He advocated models based on fundamental
economic theory that would, in principle, be structurally accurate as economies
changed. Following Lucas's critique, new classical economists, led by Edward C.
Prescott and Finn E. Kydland, created real business cycle (RB C) models of the
macro economy. RB C models were created by combining fundamental equations from
neo-classical microeconomics. In order to generate macroeconomic fluctuations,
RB C models explained recessions and unemployment with changes in technology
instead of changes in the markets for goods or money. Critics of RB C models
argue that money clearly plays an important role in the economy, and the idea
that technological regress can explain recent recessions is implausible.
However, technological shocks are only the more prominent of a myriad of
possible shocks to the system that can be modeled. Despite questions about the
theory behind RB C models, they have clearly been influential in economic
methodology.
New Keynesian response:
New Keynesian economists responded to the new classical school by adopting
rational expectations and focusing on developing micro-founded models that are
immune to the Lucas critique. Stanley Fischer and John B. Taylor produced early
work in this area by showing that monetary policy could be effective even in
models with rational expectations when contracts locked in wages for workers.
Other new Keynesian economists, including Olivier Blanchard, Julio Rotemberg,
Greg Mankiw, David Romer, and Michael Woodford, expanded on this work and
demonstrated other cases where inflexible prices and wages led to monetary and
fiscal policy having real effects. Like classical models, new classical models
had assumed that prices would be able to adjust perfectly and monetary policy
would only lead to price changes. New Keynesian models investigated sources of
sticky prices and wages due to imperfect competition, which would not adjust,
allowing monetary policy to impact quantities instead of prices. By the late
1990s, economists had reached a rough consensus. The nominal rigidity of new
Keynesian theory was combined with rational expectations and the RBC
methodology to produce dynamic stochastic general equilibrium (DSGE) models.
The fusion of elements from different schools of thought has been dubbed the
new neoclassical synthesis. These models are now used by many central banks and
are a core part of contemporary macroeconomics. New Keynesian economics, which
developed partly in response to new classical economics, strives to provide
microeconomic foundations to Keynesian economics by showing how imperfect
markets can justify demand management.
Macroeconomic models:
Aggregate demand–aggregate supply:
A traditional AS–AD diagram showing a shift in AD and the AS curve
becoming inelastic beyond potential output. The AD-AS model has become the
standard textbook model for explaining the macroeconomy. This model shows the
price level and level of real output given the equilibrium in aggregate demand
and aggregate supply. The aggregate demand curve's downward slope means that
more output is demanded at lower price levels. The downward slope is the result
of three effects: the Pigou or real balance effect, which states that as real
prices fall, real wealth increases, resulting in higher consumer demand of
goods; the Keynes or interest rate effect, which states that as prices fall,
the demand for money decreases, causing interest rates to decline and borrowing
for investment and consumption to increase; and the net export effect, which
states that as prices rise, domestic goods become comparatively more expensive
to foreign consumers, leading to a decline in exports.
In the conventional Keynesian use of the AS-AD model, the aggregate supply
curve is horizontal at low levels of output and becomes inelastic near the
point of potential output, which corresponds with full employment. Since the
economy cannot produce beyond the potential output, any AD expansion will lead
to higher price levels instead of higher output. The AD–AS diagram can
model a variety of macroeconomic phenomena, including inflation. Changes in the
non-price level factors or determinants cause changes in aggregate demand and
shifts of the entire aggregate demand (AD) curve. When demand for goods exceeds
supply there is an inflationary gap where demand-pull inflation occurs and the
AD curve shifts upward to a higher price level. When the economy faces higher
costs, cost-push inflation occurs and the AS curve shifts upward to higher
price levels. The AS–AD diagram is also widely used as a pedagogical tool
to model the effects of various macroeconomic policies.
IS-LM:
The IS–LM model gives the underpinnings of aggregate demand (itself
discussed above). It answers the question "At any given price level, what
is the quantity of goods demanded?". This model shows what combination of
interest rates and output will ensure equilibrium in both the goods and money
markets. The goods market is modeled as giving equality between investment and
public and private saving (IS), and the money market is modeled as giving
equilibrium between the money supply and liquidity preference. The IS curve
consists of the points (combinations of income and interest rate) where
investment, given the interest rate, is equal to public and private saving,
given output The IS curve is downward sloping because output and the interest
rate have an inverse relationship in the goods market: as output increases,
more income is saved, which means interest rates must be lower to spur enough
investment to match saving. The LM curve is upward sloping because the interest
rate and output have a positive relationship in the money market: as income
(identically equal to output) increases, the demand for money increases,
resulting in a rise in the interest rate in order to just offset the incipient
rise in money demand. The IS-LM model is often used to demonstrate the effects
of monetary and fiscal policy] Textbooks frequently use the IS-LM model, but it
does not feature the complexities of most modern macroeconomic models.
Nevertheless, these models still feature similar relationships to those in
IS-LM.
Growth models:
The neoclassical growth model of Robert Solow has become a common textbook
model for explaining economic growth in the long-run. The model begins with a
production function where national output is the product of two inputs: capital
and labor. The Solow model assumes that labor and capital are used at constant
rates without the fluctuations in unemployment and capital utilization commonly
seen in business cycles. An increase in output, or economic growth, can only
occur because of an increase in the capital stock, a larger population, or
technological advancements that lead to higher productivity (total factor
productivity). An increase in the savings rate leads to a temporary increase as
the economy creates more capital, which adds to output. However, eventually the
depreciation rate will limit the expansion of capital: savings will be used up
replacing depreciated capital, and no savings will remain to pay for an
additional expansion in capital. Solow's model suggests that economic growth in
terms of output per capita depends solely on technological advances that
enhance productivity. In the 1980s and 1990s endogenous growth theory arose to
challenge neoclassical growth theory. This group of models explains economic
growth through other factors, such as increasing returns to scale for capital
and learning-by-doing, that are endogenously determined instead of the
exogenous technological improvement used to explain growth in Solow's model.
Basic macroeconomic concepts:
Macroeconomics encompasses a variety of concepts and variables, but there are
three central topics for macroeconomic research. Macroeconomic theories usually
relate the phenomena of output, unemployment, and inflation. Outside of
macroeconomic theory, these topics are also important to all economic agents
including workers, consumers, and producers.
Output and income:
National output is the total amount of everything a country produces in a given
period of time. Everything that is produced and sold generates an equal amount
of income. The total output of the economy is measured GDP per person. The
output and income are usually considered equivalent and the two terms are often
used interchangeably, output changes into income. Output can be measured or it
can be viewed from the production side and measured as the total value of final
goods and services or the sum of all value added in the economy. Macroeconomic
output is usually measured by gross domestic product (GDP) or one of the other
national accounts. Economists interested in long-run increases in output, study
economic growth. Advances in technology, accumulation of machinery and other
capital, and better education and human capital, are all factors that lead to
increase economic output over time. However, output does not always increase
consistently over time. Business cycles can cause short-term drops in output
called recessions. Economists look for macroeconomic policies that prevent
economies from slipping into recessions, and that lead to faster long-term
growth.
Unemployment:
Main article: Unemployment:
The amount of unemployment in an economy is measured by the unemployment rate,
i.e. the percentage of workers without jobs in the labor force. The
unemployment rate in the labor force only includes workers actively looking for
jobs. People who are retired, pursuing education, or discouraged from seeking
work by a lack of job prospects are excluded. Unemployment can be generally
broken down into several types that are related to different causes. Classical
unemployment theory suggests that unemployment occurs when wages are too high
for employers to be willing to hire more workers. Other more modern economic
theories?] suggest that increased wages actually decrease unemployment by
creating more consumer demand. According to these more recent theories,
unemployment results from reduced demand for the goods and services produced
through labor and suggest that only in markets where profit margins are very
low, and in which the market will not bear a price increase of product or
service, will higher wages result in unemployment. Consistent with classical
unemployment theory, frictional unemployment occurs when appropriate job
vacancies exist for a worker, but the length of time needed to search for and
find the job leads to a period of unemployment. Structural unemployment covers
a variety of possible causes of unemployment including a mismatch between
workers' skills and the skills required for open jobs. Large amounts of
structural unemployment commonly occur when an economy shifts to focus on new
industries and workers find their previous set of skills are no longer in
demand. Structural unemployment is similar to frictional unemployment as both
reflect the problem of matching workers with job vacancies, but structural
unemployment also covers the time needed to acquire new skills in addition to
the short-term search process. While some types of unemployment may occur
regardless of the condition of the economy, cyclical unemployment occurs when
growth stagnates. Okun's law represents the empirical relationship between
unemployment and economic growth. The original version of Okun's law states
that a 3% increase in output would lead to a 1% decrease in unemployment.
Inflation and deflation:
A general price increase across the entire economy is called inflation. When
prices decrease, there is deflation. Economists measure these changes in prices
with price indexes. Inflation can occur when an economy becomes overheated and
grows too quickly. Similarly, a declining economy can lead to deflation.
Central bankers, who manage a country's money supply, try to avoid changes in
price level by using monetary policy. Raising interest rates or reducing the
supply of money in an economy will reduce inflation. Inflation can lead to
increased uncertainty and other negative consequences. Deflation can lower
economic output. Central bankers try to stabilize prices to protect economies
from the negative consequences of price changes. Changes in price level may be
the result of several factors. The quantity theory of money holds that changes
in price level are directly related to changes in the money supply. Most
economists believe that this relationship explains long-run changes in the
price level. Short-run fluctuations may also be related to monetary factors,
but changes in aggregate demand and aggregate supply can also influence price
level. For example, a decrease in demand due to a recession can lead to lower
price levels and deflation. A negative supply shock, such as an oil crisis,
lowers aggregate supply and can cause inflation.
Macroeconomic policy:
Macroeconomic policy is usually implemented through two sets of tools: fiscal
and monetary policy. Both forms of policy are used to stabilize the economy,
which can mean boosting the economy to the level of GDP consistent with full
employment. Macroeconomic policy focuses on limiting the effects of the
business cycle to achieve the economic goals of price stability, full
employment, and growth.
Monetary policy:
Further information: Monetary policy:
Central banks implement monetary policy by controlling the money supply through
several mechanisms. Typically, central banks take action by issuing money to
buy bonds (or other assets), which boosts the supply of money and lowers
interest rates, or, in the case of contractionary monetary policy, banks sell
bonds and take money out of circulation. Usually policy is not implemented by
directly targeting the supply of money. Central banks continuously shift the
money supply to maintain a targeted fixed interest rate. Some of them allow the
interest rate to fluctuate and focus on targeting inflation rates instead.
Central banks generally try to achieve high output without letting loose
monetary policy that create large amounts of inflation. Conventional monetary
policy can be ineffective in situations such as a liquidity trap. When interest
rates and inflation are near zero, the central bank cannot loosen monetary
policy through conventional means. An example of intervention strategy under
different conditions Central banks can use unconventional monetary policy such
as quantitative easing to help increase output. Instead of buying government
bonds, central banks can implement quantitative easing by buying not only
government bonds, but also other assets such as corporate bonds, stocks, and
other securities. This allows lower interest rates for a broader class of
assets beyond government bonds. In another example of unconventional monetary
policy, the United States Federal Reserve recently made an attempt at such a
policy with Operation Twist. Unable to lower current interest rates, the
Federal Reserve lowered long-term interest rates by buying long-term bonds and
selling short-term bonds to create a flat yield curve.
Fiscal policy:
Further information: Fiscal policy:
Fiscal policy is the use of government's revenue and expenditure as instruments
to influence the economy. Examples of such tools are expenditure, taxes, debt.
For example, if the economy is producing less than potential output, government
spending can be used to employ idle resources and boost output. Government
spending does not have to make up for the entire output gap. There is a
multiplier effect that boosts the impact of government spending. For instance,
when the government pays for a bridge, the project not only adds the value of
the bridge to output, but also allows the bridge workers to increase their
consumption and investment, which helps to close the output gap. The effects of
fiscal policy can be limited by crowding out. When the government takes on
spending projects, it limits the amount of resources available for the private
sector to use. Crowding out occurs when government spending simply replaces
private sector output instead of adding additional output to the economy.
Crowding out also occurs when government spending raises interest rates, which
limits investment. Defenders of fiscal stimulus argue that crowding out is not
a concern when the economy is depressed, plenty of resources are left idle, and
interest rates are low. Fiscal policy can be implemented through automatic
stabilizers. Automatic stabilizers do not suffer from the policy lags of
discretionary fiscal policy. Automatic stabilizers use conventional fiscal
mechanisms but take effect as soon as the economy takes a downturn: spending on
unemployment benefits automatically increases when unemployment rises and, in a
progressive income tax system, the effective tax rate automatically falls when
incomes decline.
Comparison:
Economists usually favor monetary over fiscal policy because it has two major
advantages. First, monetary policy is generally implemented by independent
central banks instead of the political institutions that control fiscal policy.
Independent central banks are less likely to make decisions based on political
motives. Second, monetary policy suffers shorter inside lags and outside lags
than fiscal policy. Central banks can quickly make and implement decisions
while the discretionary fiscal policy may take time to pass and even longer to
carry out.
|
|
