Agenda
1. The Practice of Macroeconomics
The Policy and Practice
of Macroeconomics
1-1
The Practice of Macroeconomics
• Macroeconomics is the study of economic
activity and prices in the national economy.
• Macroeconomics is the study of:
1. The structure, dynamic adjustment, and
performance of national economies, and
2. The government policies that affect national
economic performance.
1-3
2. Macroeconomic Policy
1-2
The Practice of Macroeconomics
• The Process: Developing Macro Models
– Macroeconomist explain how the economy works
by using economic theory and models.
• An economic theory is a set of ideas about the
economy, organized in a logical framework.
• Economic models are simplified representations of the
economic phenomenon under consideration.
1-4
1
The Practice of Macroeconomics The Practice of Macroeconomics
• The Process: Developing Macro Models • The Process: Developing Macro Models

– Developing economic models requires 8 steps: – Developing economic models requires 8 steps:

1. Identify an interesting economic question. 5. Empirically test the relationship.

2. Specify the endogenous variables. 6. Evaluate the results.

3. Specify the exogenous variables. 7. Use the model to make further predictions and/or

4. Hypothesize the relationship between them. 8. Use the model to formulate policy.

1-5 1-6

The Practice of Macroeconomics The Practice of Macroeconomics

• The Purpose: Interpreting Macro Data • The Purpose: Interpreting Macro Data

– Macroeconomics focuses on 3 main indicators: 1. Real GDP or Real Gross Domestic Product

1. Real GDP • Measures the output of goods and services produced in

an economy over some specific period of time.
2. The Unemployment Rate
– Business cycles are the recurrent fluctuations in real GDP.
3. Inflation
– Expansions occur when economic activity grows.

– Recessions occur when economic activity declines.

1-7 1-8

2
The Practice of Macroeconomics The Practice of Macroeconomics

Real GDP per Capita Real Gross Domestic Product

Thousands of 2005 Dollars Year-on-Year Percent Change

50 50 16 16

12 12
40 40
8 8

30 30 4 4

0 0
20 20
-4 -4

10 10 -8 -8
50 55 60 65 70 75 80 85 90 95 00 05 10 50 55 60 65 70 75 80 85 90 95 00 05 10
Source: Haver Analytics Source: Bureau of Economic Analysis /Haver Analytics

1-9 1-10

The Practice of Macroeconomics The Practice of Macroeconomics

• The Purpose: Interpreting Macro Data
Civilian Unemployment Rate
Percent

2. The Unemployment Rate 12 12

10 10
• Measures the percentage of the labor force who are
activity looking for work but who do not have jobs 8 8
during a specific period in time.
6 6

4 4

2 2
50 55 60 65 70 75 80 85 90 95 00 05 10
Source: Bureau of Labor Statistics /Haver Analytics

1-11 1-12

3
The Practice of Macroeconomics The Practice of Macroeconomics
• The Purpose: Interpreting Macro Data
Consumer Price Index
Year-on-Year Percent Change

3. Inflation 16 16

12 12
• Measures how rapidly the overall price level is rising.
8 8
• Deflation occurs when the inflation rate is negative.
4 4

• Hyperinflation occurs when the inflation rate is

0 0
exceptionally high.
-4 -4
50 55 60 65 70 75 80 85 90 95 00 05 10
Source: Bureau of Labor Statistics /Haver Analytics

1-13 1-14

Macroeconomic Policy Macroeconomic Policy

• Macroeconomic policies use economic 1. How can poor countries get rich?
models to determine how to produce better
macroeconomic outcomes. a. What determines why rich countries are rich and
why poor countries are poor?

b. Can government policies affect these outcomes?

1-15 1-16

4
Macroeconomic Policy Macroeconomic Policy
2. Is saving too low?
Personal Saving Rate
Percent of Disposable Income

a. Saving plays an important role in how an 12.5 12.5

economy performs both in the short-run and in the 10.0 10.0

long-run.
7.5 7.5

b. Can government policies affect the outcome? 5.0 5.0

2.5 2.5

0.0 0.0
50 55 60 65 70 75 80 85 90 95 00 05 10
Source: Bureau of Economic Analysis /Haver Analytics

1-17 1-18

Macroeconomic Policy Macroeconomic Policy

3. Do government budget deficits matter?
Federal Government Budget Balance
Percent of GDP

– Budget deficits occur when the government 2.5 2.5

spends more than it receives in tax revenues. 0.0 0.0

– Fiscal policy is the government’s decisions about -2.5 -2.5

spending and taxing. -5.0 -5.0

-7.5 -7.5

-10.0 -10.0
50 55 60 65 70 75 80 85 90 95 00 05 10
Source: Office of Management and Budget /Haver Analytics

1-19 1-20

5
Macroeconomic Policy Macroeconomic Policy
4. How costly is it to reduce inflation? 5. Can financial crises be made less likely?

– The primary responsibility for controlling inflation – Financial crises involve large-scale disruptions in
rests with a country’s central bank. the financial system and in financial markets.

– Monetary policy is the central bank’s decisions – Asset prices typical fall sharply during a financial
about the level of short-term interest rates or the crises.
growth of the money supply.

1-21 1-22

Macroeconomic Policy Macroeconomic Policy

6. How active should stabilization policy be?
Standard & Poor's 500 Composite Index
Index Average: 1941-43 = 10

1600 1600
– Stabilization policy is the government policies
used to minimize business cycle fluctuations.
1400 1400
1) Activists advocate the use of policies to eliminate
excessive unemployment whenever it develops.
1200 1200

2) Nonactivists argue that the economy has a self-

1000 1000 correcting mechanism that will quickly return
unemployment to a “normal” level.
800 800
06 07 08 09 10 11
Source: Wall Street Journal /Haver Analytics

1-23 1-24

6
Macroeconomic Policy Macroeconomic Policy
7. Should macro policy follow rules? 8. Are global trade imbalances a danger?

– The debate on stabilization policy is also about the – Trade imbalances are the difference between
question of whether policy should be: exports and imports of goods and services.

1) Discretionary – Trade imbalances also reflect international

borrowing and lending activity.
2) Rules-based

1-25 1-26

Macroeconomic Policy Macroeconomic Policy

• This course will use economic theory and
Current Account Balance
Percent of GDP models to emphasize both:
2 2

0 0
1. The practice of macroeconomics and

-2 -2
2. Macroeconomic policy
-4 -4
in the context of real-world examples.
-6 -6

-8
50 55 60 65 70 75 80 85 90 95 00 05 10
-8 http://www.youtube.com/watch?v=d0nERTFo-Sk
Source: Bureau of Economic Analysis/Haver Analytics

1-27 1-28