ECO302:

Spring 2021
Intermediate Macroeconomic Theory I

Lecture-1: Introduction to Macroeconomics

Charles I. Jones Chapter1

Instructor: Biplob Nandi

East West University
CHAPTER ORGANIZATION

What macroeconomics is and consider some

questions?
What Macroeconomists Do?
How macroeconomics uses models, and why.
WHAT MACROECONOMICS IS ABOUT?
 Macroeconomics: the study of structure and performance of national
economies and government policies that affect economic performance
– studies collections of people and firms, and how their interactions through
markets determine the overall economic activity in a country or region.
– Aggregation: summing individual economic variables to obtain economy
wide totals
– Distinguishes microeconomics (disaggregated) from macroeconomics
(aggregated)
 Microeconomics focuses on the study of individual people, firms, or
markets.
It is important that you keep in mind the fallacy of composition – “what is
true for individuals is also true for groups
CIRCULAR FLOW : INTERACTION AMONG AGENTS
IMPORTANT MACROECONOMIC QUESTIONS TO CONSIDER:

 Why is today’s average American nearly 40 times richer than the average
Bangladeshi?
 What causes recessions? What is “government stimulus” and why might
it help?
 What is the government budget deficit? How does it affect workers,
consumers, businesses, taxpayers, debt dynamics and economic growth?
 Why does the cost of living keep rising?
 Why are so many countries poor? What policies might help them grow
out of poverty?
 What is the trade deficit? How does it affect the country’s well-being?
TOPICS STUDIED IN MACROECONOMICS
 The unemployment rate
– fraction of the labor force that wants work but does
not currently have a job.
 The inflation rate
– rate at which prices are increasing in an economy.
– Deflation: when prices of most goods and services
decline
– Inflation rate: the percentage increase in the level of
prices
– Hyperinflation: an extremely high rate of inflation
 UNEMPLOYMENT RATE

0
1
2
3
4
5
6
7
8
9

1991
1992
Percent

1993
1994
1995
1996
BGD

1997
1998
1999
Source: WDI, World Bank

2000
CHN

2001
2002
2003
2004
IND

2005
2006
2007
2008
IDN
The Unemployment rate among Developing

2009
2010
2011
2012
MYS

2013
2014
2015
2016
2017
VNM

2018
2019
2020
INFLATION RATE
INFLATION RATE
Inflation Rates in selected Developing Countries
Percent
70.00

60.00

50.00

40.00

30.00

20.00

10.00

0.00
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

-10.00

BGD CHN IND IDN MYS VNM

Source: WDI, World Bank

TOPICS STUDIED IN MACROECONOMICS
 Government use of policy to direct or stabilize the economy
– fiscal policy- Changes in fiscal deficit, Sources of financing, etc
– monetary policy- changes in money supply, Bank rate, etc
Budget deficit
– government borrows money to finance spending.
– occurs if (Government spending) > (Tax revenues)
 Fiscal sustainability depends on the new debt creation along with budget deficit.
Moreover, sources of deficit financing and debt services payment are crucial to maintain
effective fiscal policy for economic growth.
 Reducing the income inequality is another part of fiscal policy through the productive
and welfare expenditure

Trade deficits ($17 billion in 2017 In Bangladesh)

– occur when one economy borrows from another.
– This happens on an international level.
 FISCAL POLICY AND KEY COMPONENTS
Public Debt as Percent of GDP
300

250

200

150

100

50

0
1999
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998

2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Bangladesh India Japan Greece United Kingdom United States

Source: Fiscal Monitor Database, IMF, 2019

 FISCAL POLICY AND KEY COMPONENTS
Bangladesh: Historical fiscal Deficit as % of GDP
Japan and USA: Historical fiscal Deficit as % of GDP
16.0

14.0

12.0

10.0

8.0

6.0

4.0

2.0

0.0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

USA Japan
Source: IMF Fiscal Monitor

In general, most of the developed economies have higher public debt to GDP ratio compared
to developing economies along with higher fiscal deficit.
Bangladesh maintains a stable fiscal deficit (below 5% on an average over the last decade)
while total debt services increases with relative lower debt stock due to the higher
proportional increases in the domestic debt. Thus, debt composition is crucial to maintain
stable fiscal policy.
DEBT DYNAMICS OF BANGLADESH
 50

0
100
150
250
300

200
1974
1975
1976
1977
1978
1979
1980

Source : WDI Data Base

M2 as % of GDP

1981
1982
1983
1984
1985
1986
1987
1988
1989

BAN
1990
MONETARY POLICY

1991
1992
1993
1994

IND
1995
1996
1997
1998
1999
2000

Japan
2001
2002
2003
2004
2005
USA
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
 0
2
4
6
8
10
12
14
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

Source: Estimates from WDI Data

1990

BAN
1991
1992
1993
MONETARY POLICY

1994

IND
Velocity of Money(GDP/M2)

1995
1996
1997
1998
1999
2000

Japan
2001
2002
2003
2004
2005
USA

2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
EXTERNAL POSITIONS OF BANGLADESH
TOPICS STUDIED IN MACROECONOMICS
Long-run economic growth
– Figure in the next slide: Output of United States
since 1869
– Note decline in output in recessions; increase in
output in some wars
– Two main sources of growth
• Population growth
• Increases in average labor productivity
LONG-RUN ECONOMIC GROWTH
BANGLADESH GDP (CONSTANT 2010 US$)

1400
1288

1200

1000

800

600 525

400 354

200

0
1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Source: WDI World Bank

 LONG-RUN GROWTH CONTRIBUTORS
TFP, Labor and Capital Productivity Index

2
1.8
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

TFP Labor productivity Capital productivity

Base year =2010
Source: APO Productivity Data Base
TOPICS STUDIED IN MACROECONOMICS
Business cycles - Short-run contractions and expansions in economic
activity
– Downward phase is called a recession
– Upward phase is called recovery
WHAT MACROECONOMISTS DO

Macroeconomic forecasting
– Relatively few economists make forecasts
– Forecasting is very difficult
Macroeconomic analysis
– Private and public sector economists—analyze current conditions
– Does having many economists ensure good macroeconomic policies
WHAT MACROECONOMISTS DO

Macroeconomic research
– Goal: to make general statements about how the economy works
– Theoretical and empirical research are necessary for forecasting
and economic
analysis
– Economic theory: a set of ideas about the economy, organized in a
logical framework
– Economic model: a simplified description of some aspect of the
economy
– Usefulness of economic theory or models depends on
reasonableness of assumptions,
possibility of being applied to real problems, empirically testable
implications,
theoretical results consistent with real-world data
 BANGLADESH: MACROECONOMIC FORECASTING

Table-1: Real Sector Projections

Fiscal Year FY18 FY19 FY20 FY21 FY22 FY23 FY24 FY25 FY30 FY31 FY35 FY41 Avg(21-41)

Real Sector Indicators: ( As % of GDP or Otherwise indicated)

Real GDP growth 7.86 8.15 5.20 6.20 8.29 8.32 8.37 8.51 8.91 9.00 9.36 9.90 8.92
Inflation( CPI Base, % Change) 5.78 5.48 5.50 5.40 5.30 5.12 4.94 4.76 4.51 4.46 4.26 3.96 4.52
ICOR 3.97 3.87 4.00 4.08 4.16 4.24 4.32 4.40 4.56 4.57 4.64 4.73 4.52
Population Growth 1.43 1.41 1.39 1.34 1.24 1.22 1.19 1.18 1.04 1.03 0.93 0.78 1.03
( As % of GDP or Otherwise indicated)
Gross National Savings 27.42 29.50 26.43 27.24 30.81 31.75 32.66 33.93 37.23 37.81 40.24 43.76 37.40
Gross Investment 31.23 31.57 28.25 30.00 34.49 35.28 36.16 37.44 40.60 41.15 43.41 46.88 40.70
Public Investment (Including PPP) 7.97 8.03 6.75 7.50 8.59 8.68 8.86 9.24 9.64 9.72 10.04 10.52 9.60
Private Investment (Including PPP) 23.26 23.54 21.50 22.50 24.00 25.60 27.30 28.20 30.96 31.43 33.37 36.36 30.97
Foreign Direct Investment(FDI) 0.71 0.88 0.52 0.85 1.35 1.90 2.50 3.00 3.00 3.00 3.00 3.00 2.74
Domestic Investment 22.55 22.66 20.98 21.65 22.65 23.70 24.80 25.20 27.96 28.43 30.37 33.36 28.22
Consumption 77.17 74.98 78.44 78.50 75.65 73.69 71.66 70.28 66.12 65.33 62.05 57.47 65.85
GNI Per Capita USD 1702 1909 2004 2170 2353 2578 2827 3104 5012 5532 8295 15762 6734
Population in million 165.1 167.5 169.8 172.1 174.2 176.3 178.4 180.5 190.6 192.6 200.1 210.3
Population growth 1.43 1.41 1.39 1.34 1.24 1.22 1.19 1.18 1.04 1.03 0.93 0.78 1.03
Source:GED, Bangladesh Perspective Plan’s Projections
WHAT MACROECONOMISTS DO

Developing and Testing an Economic Model

• Models simplify the complicated real world into its most relevant
elements.
• A model is useful if it has good predictive power.
• Macroeconomists have a general approach to study questions of
interest:
– Step 1: State the research question
– Step 2: Make provisional assumptions
– Step 3: Work out the implications of the theory
– Step 4: Conduct an empirical analysis to compare the implications of
the
theory with the data
– Step 5: Evaluate the results of your comparisons
WHAT MACROECONOMISTS DO
Parts of an economic model
• Parameter
– an input that is fixed over time, except when the model builder
changes it for
an experiment.
• Exogenous variable
– an input that can change over time, but determined ahead of time
by the
model builder.
– exogenous = “outside of the model”
• Endogenous variable
– an outcome of the model—something that is explained by the
model.
– endogenous = “within the model”
WHAT MACROECONOMISTS DO