The Four Basic Truths of Macroeconomics

“The Four Basic Truths of Macroeconomics” talks about four theories of macroeconomics that
the author believes is crucial to understand in macroeconomics:
i. Negative demand shock causes loss in output and unemployment
A demand shock is a sudden increase or decrease in the aggregate demand in an economy
for a number of reasons. A negative demand shock is when the economy suffers a decrease
in the aggregate demand mostly due to the fact that the public wants to save more than
spend. This tends to be temporary and occurs in times of crisis, like a global pandemic, a
terrorist attack, natural disaster or a stock market crash. However, there may be examples
of a negative demand shock due to the technological developments which may cause
products that were in high demand to become obsolete, therefore drastically reducing the
demand, and sometimes even reaching to the point of zero demand, for example, the
demand of desktop computers, which has drastically decreased in a few years since the
development of more portable computers.
In the case of negative demand shocks, people are saving more than they are spending. The
traditional Keynesian model talks about how for an economy to thrive, the investment must
be greater than the savings. However, since a negative demand shock does not just come
about and the reasons behind it offer the population to be more careful about the risk they
are willing to take since they do not know how long the situation is going to last. So, with
the decreasing spending of the public, the businesses also suffer a loss as opposed to the
profit they would have in case of a normal economy. This in turn, causes businesses to let
go of employees, which drives a hike in the unemployment, and with this, there is also a
loss in output.

ii. Central banks can offset demand shocks

Negative demand shocks are often the result of uncontrollable circumstances, however, the
central bank can create positive demand shocks to offset the negative demand shock.
Positive demand shocks are demand shocks where there is a drastic increase in the
aggregate demand of the economy, which induces a rise in spending. While negative
 demand shocks reduce spending and increase savings, positive demand shocks does the
opposite, i.e., increase spending and lesser savings. Positive demand shocks can be factors
like tax exemption or tax cuts, cutting down interest rates and the government giving
stimulus checks.
Taking the example of the pandemic in the United States of America. Unemployment in the
USA in June of 2020 was 11.1% (Monthly unemployment rate in the United States from June
2020 to June 2021, 2021). As the Federal Reserve set up various lending programs as part of
the CARES Act during the midst of the pandemic, the prominent out of which is the
Paycheck Protection Program Liquidity Facility (PPPLF), which gives banks loans so that they
can in turn, lend money to small businesses as a part of the Paycheck Protection Program. In
June of 2021, the unemployment had decreased to a 5.9%, after the implementation of
various programs by the Federal Reserve (Monthly unemployment rate in the United States
from June 2020 to June 2021, 2021). At the end of the second quarter of 2020, the real GDP
of the USA was at an approximate negative thirty percent, which has risen to an
approximate five percent at the end of the first quarter of 2021 (Gross Domestic Product,
First Quarter 2021 (Advance Estimate), 2021)

iii. Increase in money supply causes inflation to hike

Inflation can occur when the money supply surpasses economic growth in otherwise normal
economic conditions. Factors other than the money supply can effect inflation, or the pace
at which the average price of goods or services rises over time.
When the supply of money exceeds the economic output, there is a drop in overall or
aggregate demand, to which the government can respond with a policy that is counter to
the economy's trajectory. Policy would result in the anticipated expansion of output (and
employment), but it would also result in increased prices because it comprises of an
increase in the money supply. Increased demand will then put pressure on input costs,
particularly labor, as an economy approaches maximum capacity. Workers then spend their
extra money on more products and services, driving up prices and wages and pushing
 generic inflation higher—the opposite of what policymakers want to happen. (Mathai,
2020)

iv. Non-monetary shocks can create recession

Recessions are both evident and ambiguous in their character and causes. Recessions are
essentially a series of corporate failures that occur at the same time. Companies are forced
to reduce funding, reduce production, avoid losses, and, in most cases, lay off workers.
These are only some of the caused behind why recession occurs.
Recessions can occur as a result of monetary shock, when the central bank might change its
monetary policy changing interest rate or the Federal Reserve and the banking industry can
take this process to extremes, stimulating riskier asset price bubbles, by increasing the
supply of money and credit in the economy.
However, it does occur as a result of non-monetary shock as well. Shocks like negative
demand shock, due to falling real wages, failing consumer confidence, deflation, natural
disasters, pandemic, etc. Let’s take an example of the COVID-19 pandemic, which has
resulted in a lockdown and the lockdown in itself has created a recession, the World Bank
estimates that COVID-19 has pushed an additional 88 to 115 million people into extreme
poverty in 2020 (Marchisio, 2021) and as per the Asian Development Bank, has hit almost
every sector of the Nepali economy, shaving up to 0.13 per cent off the gross domestic
product and resulting in up to 15,880 people jobless (COVID-19 and its effect on Nepal).
Recession might also occur as a result of supply side shock like the rising price of oil that
could cause a recession in the economy. After the World War II, the Arab members of
Organization of the Petroleum Exporting Countries, quadrupled the price of petroleum and
banned the export of oil to the United States, Japan, and Western Europe, and with the
declining value of the US dollars, it led to a recession and a high amount of inflation.
(Pettinger, 2019)
I agree with every point that the author has mentioned and do believe these are important
macroeconomic facts.
The Pandemic Opportunity

References
COVID-19 and its effect on Nepal. (n.d.). Retrieved from World Trade Organization:
https://www.wto.org/english/tratop_e/covid19_e/sawdf_nepal_e.pdf

Gross Domestic Product, First Quarter 2021 (Advance Estimate). (2021, April 29). Retrieved from bea:
https://www.bea.gov/news/2021/gross-domestic-product-first-quarter-2021-advance-estimate

Marchisio, M. (2021, March 2). What impact will the COVID-19 pandemic and the global economic
downturn have on world food security? Retrieved from International Fund for Agricultural
Development: https://www.ifad.org/en/web/latest/-/what-impact-will-the-covid-19-pandemic-
and-the-global-economic-downturn-have-on-world-food-security-

Mathai, K. (2020). Monetary Policy: Stabilizing Prices and Output. IMF- Finance and Development.
Retrieved from https://www.imf.org/external/pubs/ft/fandd/basics/monpol.htm

Monthly unemployment rate in the United States from June 2020 to June 2021. (2021). Retrieved from
Statista: https://www.statista.com/statistics/273909/seasonally-adjusted-monthly-
unemployment-rate-in-the-us/

Pettinger, T. (2019). Causes of recessions. EconomicsHelp. Retrieved from

https://www.economicshelp.org/macroeconomics/economic-growth/cause-recession2/