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3 (2) Macro Big Picture

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Chapter

 21  
Macroeconomics:  The  Big  Picture  
• What  a  business  cycle  is  and  why  policy  
makers  seek  to  diminish  the  severity  of  
business  cycles  
• Other  
WHAT  YOU   § How  long-­‐run  economic  growth  
WILL  LEARN   determines  a  country’s  standard  of  living  
§ The  meaning  of  infla=on  and  defla=on  
IN  THIS   and  why  price  stability  is  preferred  
CHAPTER   § The  importance  of  open  economy  
macroeconomics  and  how  economies  
interact  through  trade  deficits  and  trade  
surpluses  
ECONOMICS  IN  ACTION  
FENDING  OFF  DEPRESSION  
 
• In  2008,  the  world  economy  experienced  a  severe  financial  
crisis  that  was  all  too  reminiscent  of  the  early  days  of  the  
Great  Depression.  
• In  the  spring  of  2009,  the  economic  historians  Barry  
Eichengreen  and  Kevin  O’Rourke,  reviewing  the  available  
data,  pointed  out  that  “globally,  we  are  tracking  or  even  
doing  worse  than  the  Great  Depression.”    
• But  the  worst  did  not  come  to  pass.  Why?  
• At  least  part  of  the  answer  is  that  policy  makers  responded  
very  differently.    
• During  the  Great  Depression,  it  was  widely  argued  that  the  
slump  should  simply  be  allowed  to  run  its  course.  
ECONOMICS  IN  ACTION  
Fending  off  Depression  
• In  the  early  1930s,  some  countries’  monetary  authoriTes  actually  raised  
interest  rates  in  the  face  of  the  slump,  while  governments  cut  spending  
and  raised  taxes—acTons  that  deepened  the  recession.  
• In  the  aVermath  of  the  2008  crisis,  by  contrast,  interest  rates  were  
slashed,  and  a  number  of  countries,  the  United  States  included,  used  
temporary  increases  in  spending  and  reducTons  in  taxes  in  an  aYempt  
to  sustain  spending.    CONTROVERSY!  
The  Business  Cycle  
• The  business  cycle  is  the  short-­‐run  alternaTon  between  
economic  downturns  and  economic  upturns.  
   
• A  depression  is  a  very  deep  and  prolonged  downturn.  
 
• Recessions  are  periods  of  economic  downturns  when  
output  and  employment  are  falling.  
 
• Expansions,  someTmes  called  recoveries,  are  periods  of  
economic  upturns  when  output  and  employment  are  rising.  
The  Business  Cycle  
• The  point  at  which  the  economy  turns  from  expansion  to  
recession  is  a  business-­‐cycle  peak.  
 
• The  point  at  which  the  economy  turns  from  recession  to  
expansion  is  a  business-­‐cycle  trough.  
The  Business  Cycle  
The  Business  Cycle  

Real  
A  business  cycle  
GDP  
peak  
Recession  
Depression  
peak  

trough  
Prosperity  

Recovery   Expansion  

Time  
ContracTon   Expansion   (year)  
23/08/15   8  
The  Business  Cycle  
Growth,  Interrupted,  1988-­‐2010  
The  Business  Cycle  

• What  happens  during  a  business  cycle,  and  what  can  be  


done  about  it?    
§ The  effects  of  recessions  and  expansions  on  unemployment  
§ The  effects  on  aggregate  output  
§ The  possible  role  of  government  policy  
The  U.S.  Unemployment  Rate  
FOR  INQUIRING  MINDS  
Defining  Recessions  and  Expansions    
 
• In  many  countries,  economists  adopt  the  rule  that  a  
recession  is  a  period  of  at  least  6  months,  or  two  quarters,  
during  which  aggregate  output  falls.  
   à  someTmes  too  strict  
 
• In  the  U.S.,  the  task  of  determining  when  a  recession  
begins  and  ends  is  assigned  to  an  independent  panel  of  
experts  at  the  NaTonal  Bureau  of  Economic  Research  
(NBER).  They  look  at  a  number  of  economic  indicators,  with  
the  main  focus  on  employment  and  producTon,  but  
ulTmately  the  panel  makes  a  judgment  call.    
   à  someTmes  controversial  
Global  Comparison:  Interna=onal  Business  Cycles  
Taming  the  Business  Cycle  

• Policy  efforts  undertaken  to  reduce  the  severity  of  


recessions  are  called  stabiliza=on  policies.    
 
• One  type  of  stabilizaTon  policy  is  monetary  policy:  changes  
in  the  quanTty  of  money  or  the  interest  rate.    
 
• The  second  type  of  stabilizaTon  policy  is  fiscal  policy:  
changes  in  tax  policy  or  government  spending,  or  both.  
 
ECONOMICS  IN  ACTION  
Comparing  Recessions  
 
• In  parTcular,  some  recessions  have  been  much  worse  than  
others.    
 
• Comparing  historical  recessions:    
§ Terrible  slump  of  1929–1933  
§ 1981–1982  recession:  generally  considered  the  worst  
economic  slump  since  the  Great  Depression  
§ RelaTvely  mild  2001  recession  
ECONOMICS  IN  ACTION  
Comparing  Recessions  
 
• These  recessions  differed  in  duraTon:  the  first  lasted  43  
months;  the  second,  16  months;  the  third,  only  8  months.  
Even  more  important,  however,  they  differed  greatly  in  
depth.  
 
• Let’s  compare  the  two  most  recent  recessions:  the  2001  
recession  and  the  Great  Recession  of  2007-­‐2009.  
§ These  recessions  differed  in  duraTon:  the  first  lasted  only  8  
months,  the  second  more  than  twice  as  long;  they  also  they  
differed  greatly  in  depth.  
Comparing  Recessions  
ECONOMICS  IN  ACTION  
Comparing  Recessions  
 
• We  compare  the  depth  of  the  recessions  by  looking  at  what  
happened  to  industrial  producTon  in  the  months  aVer  the  
recession  began.  
• In  each  case,  producTon  is  measured  as  a  percentage  of  its  
level  at  the  recession’s  start.    
• Thus,  the  line  for  the  2007-­‐2009  recession  shows  that  
industrial  producTon  eventually  fell  to  about  85%  of  its  
iniTal  level.  
• Clearly,  the  2007-­‐2009  recession  hit  the  economy  vastly  
harder  than  the  2001  recession.  
ECONOMICS  IN  ACTION  

Comparing  Recessions  
 
• The  1929–1933  recession  hit  the  economy  vastly  harder  
than  any  of  the  post–World  War  II  recessions.    
• The  1981–1982  recession  did  eventually  reduce  industrial  
producTon  by  about  10%,  although  producTon  then  staged  
a  rapid  recovery.    
• In  2001,  the  decline  in  industrial  producTon  was  very  
modest.    
• By  Great  Depression  standards,  or  even  those  of  the  1980s,  
the  2001  recession  was  very  mild.  
 
Other.1  

LONG  RUN  ECONOMIC  GROWTH  


Long-­‐Run  Economic  Growth  

• Long-­‐run  economic  growth  is  the  sustained  upward  trend  


in  the  economy’s  output  over  Tme.  
 
• A  country  can  achieve  a  permanent  increase  in  the  
standard  of  living  of  its  ciTzens  only  through  long-­‐run  
growth.      
 
• A  central  concern  of  macroeconomics  is  what  determines  
long-­‐run  economic  growth.  
Long-­‐Run  Economic  Growth  

• In  1905,  we  find  that  life  for  many  Americans  was  startlingly  
primiTve  by  today’s  standards.  
 
• Americans  have  become  able  to  afford  many  more  material  
goods  over  Tme  thanks  to  long-­‐run  economic  growth.  
Long  Run  Growth  in  U.S.  
Long  Run  Growth  in  U.S.  
FOR  INQUIRING  MINDS  

When  Did  Long-­‐Run  Growth  Start?    


 
• Long-­‐run  growth  is  a  relaTvely  modern  phenomenon.    
 
• From  1000  to  1800,  real  aggregate  output  around  the  world  
grew  less  than  0.2%  per  year,  with  populaTon  rising  at  
about  the  same  rate.    
 
• Economic  stagnaTon  meant  unchanging  living  standards.  
For  example,  informaTon  on  prices  and  wages  from  such  
sources  as  monastery  records  shows  that  workers  in  
England  weren’t  significantly  beYer  off  in  the  early  
eighteenth  century  than  they  had  been  five  centuries  
earlier.    
FOR  INQUIRING  MINDS  

When  Did  Long-­‐Run  Growth  Start?    


 
• However,  long-­‐run  economic  growth  has  increased  
significantly  since  1800.    
 
• In  the  last  50  years  or  so,  real  GDP  per  capita  has  grown  
about  3.5%  per  year.  
ECONOMICS  IN  ACTION  
A  Tale  of  Two  Colonies  
 
• One  of  the  most  informaTve  contrasts  in  long-­‐run  growth  is  
between  Canada  and  ArgenTna.    
 
• Economic  historians  believe  that  the  average  level  of  per  
capita  income  was  about  the  same  in  the  two  countries  as  
late  as  the  1930s.    
ECONOMICS  IN  ACTION  
A  Tale  of  Two  Colonies  
 
• AVer  World  War  II,  however,  ArgenTna’s  economy  
performed  poorly,  largely  due  to  poliTcal  instability  and  bad  
macroeconomic  policies.    
 
• Meanwhile,  Canada  made  steady  progress.    
§ Thanks  to  the  fact  that  Canada  has  achieved  sustained  long-­‐
run  growth  since  1930,  but  ArgenTna  has  not,  Canada  today  
has  almost  as  high  a  standard  of  living  as  the  United  States—
and  is  about  three  Tmes  as  rich  as  ArgenTna.  
Goal  =  Price  Stability  

INFLATION  AND  DEFLATION  


Infla=on  and  Defla=on  

• A  rising  aggregate  price  level  is  infla=on.    


 
• A  falling  aggregate  price  level  is  defla=on.  
 
• The  infla=on  rate  is  the  annual  percent  change  in  the  
aggregate  price  level.  
 
• The  economy  has  price  stability  when  the  aggregate  price  
level  is  changing  only  slowly.    
Infla=on  and  Defla=on  
ECONOMICS  IN  ACTION  
A  Fast  (Food)  Measure  of  Infla=on  
 
• McDonald’s  opened  in  1954:  Hamburgers  cost  only  15  
cents;  25  cents  with  fries.  
 
• Today  a  hamburger  at  a  typical  McDonald’s  costs  five  Tmes  
as  much─  between  $0.70  and  $0.80.  
 
• Is  this  too  expensive?  
 
• No.  In  fact,  a  burger  is,  compared  with  other  consumer  
goods,  a  beYer  bargain  than  it  was  in  1954.    
ECONOMICS  IN  ACTION  
A  Fast  (Food)  Measure  of  Infla=on  
 
• Burger  prices  have  risen  about  400%,  from  $0.15    to  about  
$0.75,  over  the  last  half  century.    
§ But  the  overall  consumer  price  index  has  increased  more  than  
600%.      
 
• If  McDonald’s  had  matched  the  overall  price  level  increase,  
a  hamburger  would  now  cost  between  90  cents  and  $1.00.    
Foreign  Trade  

OPEN  ECONOMY  
MACROECONOMICS  
Interna=onal  Imbalances  

• An  open  economy  is  an  economy  that  trades  goods  and  


services  with  other  countries.  
 
• A  country  runs  a  trade  deficit  when  the  value  of  goods  and  
services  bought  from  foreigners  is  more  than  the  value  of  
goods  and  services  it  sells  to  them.    
 
• It  runs  a  trade  surplus  when  the  value  of  goods  and  
services  bought  from  foreigners  is  less  than  the  value  of  the  
goods  and  services  it  sells  to  them.  
Interna=onal  Imbalances  

Exports, Exports Imports


imports
(billions)

$2,500

2,000

1,500

1,000

500

United States Germany China Saudi Arabia


ECONOMICS  IN  ACTION  
BALTIC  BALANCING  ACT  
 
• The  Soviet  Union  broke  up  into  15  independent  countries  in  
1991.  Many  of  these  countries  experienced  hard  economic  
Tmes  in  the  years  that  followed.    

• The  three  small  naTons  of  Estonia,  Latvia,  and  Lithuania  –  


oVen  referred  to  as  the  BalTcs,  because  they  all  have  
coastlines  on  the  BalTc  Sea  –  were  quick  both  to  establish  
democraTc  insTtuTons  and  to  move  to  market  economies,  
building  strong  Tes  to  the  democraTc  market  economies  of  
Western  Europe.  

• What  has  this  meant  for  their  internaTonal  trade?    


ECONOMICS  IN  ACTION  
BALTIC  BALANCING  ACT  
• The  figure  at  right  shows  the  
three  countries'  current  
account  balances  –  a  broad  
definiTon  of  their  trade  
balances  -­‐-­‐  from  2000  to  
2010.    
• As  you  can  see,  in  the  middle  
years  of  that  decade  all  three  
countries  began  running  
sizable  deficits  (amounTng  in  
each  case  to  more  than  10%  
of  the  total  value  of  goods  
and  services  they  produced.)    
• Then,  aVer  2008,  all  three  
suddenly  moved  into  surplus.  
ECONOMICS  IN  ACTION  
BALTIC  BALANCING  ACT  
 
• Does  this  mean  that  these  economies  were  doing  badly  
around  2005  or  2006,  and  that  they  rapidly  improved  late  
in  the  decade?    
§ Actually,  it  was  the  opposite!!    
 
• During  the  period  from  2000  to  2007,  financial  markets  
were  extremely  opTmisTc  about  the  economic  prospects  of  
the  BalTc  naTons,  and  poured  money  into  the  countries  –  
allowing  them  to  engage  in  high  rates  of  investment  
spending  and,  correspondingly,  to  run  large  trade  deficits.  
ECONOMICS  IN  ACTION  
BALTIC  BALANCING  ACT  
 
• When  the  world  plunged  into  financial  crisis,  this  inflow  of  
funds  dried  up,  forcing  the  BalTcs  to  move  into  trade  
surplus.  The  adjustment  was  hard  on  the  three  countries,  
all  of  which  saw  unemployment  rates  rise  to  Depression-­‐
era  levels.    
VIDEO  
§ PBS  NEWSHOUR:  Laughing  at  Macroeconomics:  The  Cartoon  
Introduc7on:  
hYp://www.pbs.org/newshour/mulTmedia/cartoonecon/
index.html  
Summary  

1. Keynesian  economics,  which  emerged  during  the  Great  


Depression,  advocates  the  use  of  monetary  policy  and  
fiscal  policy  to  fight  economic  slumps.    
 
Prior  to  the  Great  Depression,  the  economy  was  thought  to  
be  self-­‐regula=ng.  
Summary  

2. One  key  concern  of  macroeconomics  is  the  business  cycle,  


the  short-­‐run  alternaTon  between  recessions,  periods  of  
falling  employment  and  output,  and  expansions,  periods  of  
rising  employment  and  output.    
 
The  point  at  which  expansion  turns  to  recession  is  a  
business-­‐cycle  peak.  The  point  at  which  recession  turns  to  
expansion  is  a  business-­‐cycle  trough.  
Summary  

3. Another  key  area  of  macroeconomic  study  is  long-­‐run  


economic  growth,  the  sustained  upward  trend  in  the  
economy’s  output  over  Tme.    
 
Long-­‐run  economic  growth  is  the  force  behind  long-­‐term  
increases  in  living  standards  and  is  important  for  financing  
some  economic  programs.  
Summary  

4. When  the  prices  of  most  goods  and  services  are  rising,  so  
that  the  overall  level  of  prices  is  going  up,  the  economy  
experiences  infla=on.  When  the  overall  level  of  prices  is  
going  down,  the  economy  is  experiencing  defla=on.    
 
In  the  short  run,  inflaTon  and  deflaTon  are  closely  related  
to  the  business  cycle.  In  the  long  run,  prices  tend  to  reflect  
changes  in  the  overall  quanTty  of  money.    
 
Because  inflaTon  and  deflaTon  can  cause  problems,  
economists  and  policy  makers  generally  aim  for  price  
stability.  
Summary  
5. Although  comparaTve  advantage  explains  why  open  
economies  export  some  things  and  import  others,  
macroeconomic  analysis  is  needed  to  explain  why  
countries  run  trade  surpluses  or  trade  deficits.    
 
The  determinants  of  the  overall  balance  between  exports  
and  imports  lie  in  decisions  about  savings  and  investment  
spending.  
Key  Terms  

• Self-­‐regulaTng  economy   • Price  stability  


• Keynesian  economics   • Open  economy  
• Monetary  policy   • Trade  deficit  
• Fiscal  policy   • Trade  surplus  
• Recession    
• Expansion    
• Business  cycle  
• Business-­‐cycle  peak  
• Business-­‐cycle  trough  
• Long-­‐run  economic  growth  
• InflaTon  
• DeflaTon  

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