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Topic 9

Macroeconomics
Concerns &
Macroeconomic Policies
Business Cycle
 GDP rises and falls over short spans of time
 At any point in time, it may be above or
below its long run trend
 These fluctuations define the business
cycle
 Periodic movements in output, prices, and
employment
 Business cycles are not created equal.
Duration

Severity
Phases of the Business Cycle

Peak: The highest level of
economic activity in a
particular cycle Expansion: A
rising level of
business activity
Real GDP

Contraction: A
Trough: The lowest
noticeable drop in the
level of business activity
level of business activity
in a particular cycle

Time
Macroeconomic Concerns
 Aggregate Price Level
 Aggregate Output
 Total Employment
 Rest of the World
Inflation and Prices
 Price level:
level a measure of the behavior
of all prices in the economy
 Price level is a yardstick -- a tool for
comparison of prices over time.
 Inflation:
Inflation the rate of change in the price
level
Percentage change in GDP deflator, 1959 - 1994

12.0

10.0
Inflation Rate

8.0

6.0

4.0

2.0

0.0
1959 1963 1967 1971 1975 1979 1983 1987 1991
Year
Aggregate Output (GDP)
Gross Domestic Product
(GDP) is the dollar value of all
final goods and services
produced.
Unemployment
The unemployment rate refers to
the percentage of people in the
labor force who can’t find a job.

Labor Force:
Force people who
are actively seeking or
are currently holding a
job
Unemployment Rate, 1959 - 1994

10.0
9.0
8.0
Unemployment Rate

7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
1959 1963 1967 1971 1975 1979 1983 1987 1991
Year
Recession
A recession is a period in which real
GDP declines for at least two
consecutive quarters. Most
recessions are marked by falling
output and rising unemployment.
Depression:
Depression a prolonged and deep
recession
 Great Depression: 1929-1933
Great Depression (1929-1933)

30

20
Unemployment
10

0

-10
GDP Growth
-20
1929 1930 1931 1932 1933

1929 3.2
1930 -9.4 8.9
1931 -8.6 16.3
1932 -13.4 24.1
1933 -2.1 25.2
The Recession of 1980-1982

10
8 Unemployment
6
4
2
0
-2 GDP Growth
-4
1979 1980 1981 1982
Defining Unemployment
Employed:
Any person 16 years old or older,
(1) who works for pay, either for someone else or
in their own business, for one or more hours
a week,
(2) who works without pay for 15 hours a week in
a family business, or
(3) who has a job but has been temporarily
absent, with or without pay.
Defining Unemployment
Unemployed:
Unemployed
A person 16 years or older who is not
working, is available for work, and has
made specific efforts to find work during
the previous four weeks.
Labor force:
force
The number of people employed plus the
number of unemployed.
Defining Unemployment
 Labor Force = Employed + Unemployed
 Population = Labor Force + Not in
Labor Force
 Unemployment Rate = Unemployed
Labor Force
 Labor Force Participation Rate =

Labor Force
Population
•New Entrants: 11%
Unemployment
•Re-entrants: 26%
Pool •Job Leavers: 12%
Entrants •Job Losers: 63%

5% Unemployment

•Job Finders
•Discouraged
Workers
•Labor Force
Leavers
Types of Unemployment

Cyclical
 due to business cycle movements in GDP
Frictional
 due to job search activities (in-between jobs)
Structural
 due to changes in economic institutions
 geographic displacement, technological change,
discrimination
Macroeconomic Policies

 Expansionary policies
 Monetary and fiscal policies that are used to
try to increase the equilibrium level of income
and output in the economy
 Contractionary policies
 Monetary and fiscal policies that are used to
try to lower aggregate demand for output in
the economy to a level that can be achieved
with full employment of resources
Expansionary Policies
 Automatic stabilizers
 Forces within the economy that naturally tend to
counteract recessions and inflation
 Social Security system

 Unemployment compensation

 Progressive tax structure

 Fiscal drag
 The slowing effect on the economy that results from a
budget surplus (T > G)
 Fiscal stimulus
 The activating effect on the economy that results from
a budget deficit (G > T)
Expansionary Policies
 Monetary policy
 Increase in the money supply  lower
interest rates  increases the level of
aggregate expenditures during periods of
high unemployment
 Buying govt bonds in open market operations
 Reducing the reserve requirements

 Lowering the discount rate
Expansionary Policies
 Discretionary fiscal policy
 Tax financing
 When taxation is used to finance increased government spending,
caution must be used so as not to tax funds that would otherwise be
used for consumption or investment
 The object here should be to design a tax to absorb idle funds
 Debt financing
 Borrowing is a more desirable method of raising funds for government
spending than taxation when the purpose is to increase aggregate
expenditure and total output
 The source of the borrowing has a direct bearing on the effect of this policy
 Crowding Out - Occurs when deficit spending by the government forces
private investment spending to contract
 Financing by creating money
Debt Financing
 Ricardian Equivalence Theorem
 Proposition that it makes no difference whether
government spending is financed by taxes or by a
deficit
 In either case, the transfer of resources from the
private sector to the government leads to having
no net effect on the aggregate economy
 Based on rational expectations, individuals realize
that deficits must be paid off in the future and
therefore taxes will rise to pay off the debt
 They will reduce spending just as they would

if taxes were increased
Financing by Creating Money
 The Treasury sells bonds to the Fed (or to the public) to
finance government spending
 When the Treasury (or public) spends this money to
make purchases, the result is an increase in the money
supply
 This method of financing government spending is
referred to as either:
 Printing money
 Because it increases the money supply
 Monetizing the debt
 Because government debt issued to finance government spending has
been removed from the hands of the public and has been replaced by
deposits that will increase the money supply
Methods of Increasing Government
Spending
 Increase government spending and
hold taxes constant
 Hold government spending constant
and decrease taxes (tax rebate plan)
 Increase government spending and
increase taxes proportionally
 Balanced-budget multiplier (x1)
Discretionary Government Spending

 Discretionary government spending
 Transfer payments eg unemployment benefits,
subsidies, etc (consumption goods)
 Public works (capital goods)
 Problems with discretionary government
spending
 Difficult to end a government spending
programme
 Problems balancing when the programme is
needed and when it can begin
Recession and Deflation

 Disinflation
 A slowdown in the rate of inflation
 Deflation
 A persistent decline in the level of
prices
Inflation and Types of Inflation
 Inflation
 A persistent increase in the level of prices
 Demand-pull inflation
 Inflation that occurs when the total demand for goods
and services exceeds the available supply of goods and
services in the short run
 Cost-push inflation
 Inflation characterized by a spiral of wage and benefit
cost increases and price increases
 Stagflation
 Higher unemployment and inflation occurring at the
same time
Measures to Reduce Total Spending
 Automatic stabilizers
 Monetary policy
 Use of measures to reduce the money supply
 Other measures
 Credit restraints
 Limited borrowing for stock market purchases
 Tightened restrictions on housing credit
 Restrained consumer credit
 Encouragement to save instead of spend
 Voluntary or mandatory price and wage controls
 Government surplus
 Hold taxes and decrease spending
 Increase taxes and hold or decrease spending
 Decrease taxes and decrease spending
 Borrowing
Hyperinflation in Latin America

 Hyperinflation
 Inflation that feeds on itself to go out of control,
creating severe distortions in an economy and
rendering currency almost worthless
 Central and South America
 Bolivia experienced a 11,750% inflation rate in 1985
 Argentina has experienced inflation rates as high as
3,030% in 1989
 Inflation rates in Venezuela have ranged from 31% in
1992 to 61% in 1994