The Importance of Macroeconomics

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Chapter 1

• The Importance of Macroeconomics

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Principal Uses of Macroeconomics for Business
Managers

• Understanding the economy
• Realizing how changes in economic variables will
  affect your business
• Understanding how changes in fiscal and monetary
  policy may affect sales and profits.
• To a limited extent, forecasting the future,
  although that probably is impossible. But when a
  major unexpected change does occur, you should be
  able to react quickly and accurately.

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Principal Macroeconomic Goals of any Society

• Full Employment. Provide a job for everyone who
  wants to work.
• Low, Stable Inflation. Economic decisions should
  be based on maximizing producer value or consumer
  utility, not as a hedge against rising prices.
• Rapid growth in productivity and the standard of
  living

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Different Types of Policies Used to Control the
Economy

• Monetary Policy moves affecting the cost and
  availability of credit.
• Fiscal Policy spending programs and tax rates
• Trade Policy regulations affecting free trade
  and quotas and tariffs sometimes try and affect
  the value of the currency.
• Regulatory Policy programs affecting government
  intervention and regulation, but with a minimal
  budget impact.

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Current Core of Macroeconomic Theory

• 1. All major components of aggregate demand
  consumption, investment, and net exports are
  negatively related to the real rate of interest,
  which is the nominal rate minus the expected rate
  of inflation.

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Core Point 2

• In the short run, movements in economic activity
  are dominated by changes in aggregate demand,
  while in the long run, the economy tends to
  return to a steady-state growth path

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Core Point 3

• The long-run growth rate is determined by (a) the
  ratio of investment to GDP, and (b) the degree to
  which fiscal, trade, and regulatory policies
  encourage the spread of free markets and
  technical innovation and invention.

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Core Point 4

• The central bank controls the nominal short-term
  interest rate, but the real long-term interest
  rate affects aggregate demand. Long-term
  interest rates are determined in large part on
  the expected future rate of inflation.

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Core Point 5

• Economic agents have forward-looking
  expectations, which means they base their
  decisions on what they expect to happen in the
  future, as contrasted to simpler extrapolations
  of the past. Of course, their predictions are
  not always accurate, but people learn from past
  mistakes and adjust their expectations
  accordingly.

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Core Point 6

• Changes in monetary policy affect both output and
  prices in the short run, but only prices in the
  long run. There is no long-run tradeoff between
  unemployment and inflation.

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Core Point 7

• Changes in monetary policy affect real output
  with a shorter lag than inflation. Because
  monetary policy is transmitted through a variety
  of methods, and because the lags are variable,
  the short-term impact of monetary policy often
  cannot be predicted accurately

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Core Point 8

• In the short run, wages are based on
  predetermined variables, which means they react
  to changes in the economy only with a substantial
  lag. In the long run, the real wage is equal to
  the marginal productivity of labor, while the
  nominal wage is determined by monetary factors.

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Core Point 9

• Federal government budget deficits can be
  financed either by selling Treasury securities to
  the central bank, which is akin to printing money
  and is inflationary, or by selling them to the
  private sector, which will raise real interest
  rates and hence reduce real growth.

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Core Point 10

• Markets clear and economic agents attempt to
  maximize their utility, subject to short-term
  rigidities and adjustments, liquidity
  constraints, and incorrect expectations.
  Nonetheless, labor markets may not clear for many
  years, leading to extended periods of high
  unemployment even though the rest of the economy
  appears to be in equilibrium.

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An empirical discipline

• Discussions about macroeconomics are often
  influenced by personal opinions, since they
  affect the amount of money that each individual
  has. As a result, what passes for facts is
  often weighted by personal bias.
• As a result, whenever possible, we try and test
  theories to see if they agree with the existing
  facts.

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Different Reactions to Similar Policies

• Similar changes in policies, such as tax cuts,
  Federal reserve easing or tightening, or public
  works spending programs may have far different
  effects on the economy.
• In part, the results depend on the phase of the
  business cycle when these changes are
  implemented.
• Expectations are also important. The impact will
  generally be greater if the policy change was
  unexpected, and smaller if a similar change has
  been made in the recent past.

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Why Economists Disagree

• Difference between positive economics what is
  and normative economics what should be.
• Ceteris paribus conditions often change, so what
  works one time may not work the next time.
• Junk science and spurious econometric
  correlations often dominate the discussion.
• Political biases often confused with facts.