1 - 3 - macro lecture 1 part 3 (19-15)

7/27/2019 1 - 3 - Macro Lecture 1 Part 3 (19-15)

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process.Of long run economic growth.Don't panic, I will take you through thismodel slowly and carefully and you willsoon understand all of it's intricaciesand subtlety.But I want to give you a test, for whatyou are in for.And the next slide will show one of theways in which we think about the businesscycle.Again this will look completely foreignto you now.However, we all go through theconstruction of this model verycarefully.And you'll find that it is a highlylogical and very powerful way ofanalyzing important aspects of thebusiness cycle.What then, is the rationale foreconomists reliance on abstract modelssuch as these?Given that the subject matter of

economics is so grounded in the realworld.With all of it's complexity, and innatemessiness.The following analogy maybe useful.A paper plane is a highly simplified,abstract representation of a realairplane.One would never trust one's life to apaper plane.Yet the laws of physics that keep a realplane in the air are exactly the same, asthe laws of physics that keep a paper

plane flying.And one can learn a great deal aboutthose laws by observation andexperimentation with a paper plane.Indeed, its simplicity means it is anideal instrument with which to learnabout something which is incrediblycomplex in reality.It is exactly the same with economicmodels.No one, I hope, thinks that the abstract,highly simplified, and stylized modelsthat economists work with correspond

exactly to a real world economy.That is not what the model's designed todo.Instead, models exist as abstract andvery simplified representations ofreality.And in doing so, enable careful analysisand hypothesizing.About the fundamental forces at work in areal world economy.


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Without models, economists would havelittle to say about the economy in anyformal sense.It will take you time to get used toeconomists use of models.For those new to the discipline, it canall seem a bit strange at first.But rest assured, you will soon get thehang of it.And in doing so will come to appreciatethe enormous analytical benefits thateconomists' models provide.Benefits that would not be available anyother way.The third thing we will explore in thiscourse is the role of Public Policy inmanaging the economy.So I mentioned earlier in this lecture acentral tenant of economics is thatmarkets, under ideal conditions, willallocate resources efficiently.Where those conditions don't exist, andmarkets fail to provide optimal outcomes.There may be a role for governments to

become actively involved in the economy.To secure better outcomes.This is the rational for governmentMacroeconomic policy.I know of no modern economy that allowsit's Macroeconomic outcomes to bedetermined purely by market forces.The management of the economy is one ofthe central responsibilities ofgovernment the world over.The picture that you are looking at hereis of the United States Federal Reserve,the Agency responsible for the design and

implementation of US Monetary Policy.And it is Monetary Policy that is one ofthe chief policy instruments available tomanage the Macroeconomy.Particularly in the short to medium term.We will be spending a lot of time in thiscourse discussing Monetary Policy.So, let's look briefly at the main typesof acoreconomic policy.And here I'm going to confine myself topolicies that aim to manage the economyin the short to medium run.An entirely different set of policies

exist to promote long run economicgrowth.First, as just mentioned, is MonetaryPolicy.This is the responsibility of CentralBanks like the United States FederalReserve, or the Bank of England, or theEuropean Central Bank.Monetary policies can take various formsdepending on the economy.


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Most nations operate their Monetarypolicy by targeting a key interest ratein the economy.In the belief that other interest rateswill adjust in line with the rate that isbeing targeted by the Monetary policy.And that this then influences the amountof aggregate spending in the economy.In turn, this exerts a powerful influenceon Macroeconomic outcomes, primarily GDPand inflation.Monetary policy was an important policyresponse for most countries to the globalfinancial crisis.Central banks the world over aggressivelycut interest rates in the hope that thiswould encourage spending by firms andconsumers.The extent to which this was successfulremains a matter of debate.The Monetary policy response to theglobal financial crisis.Resulted in very low interest rates in anumber of countries, such as the United

States.This in itself has created new challengesfor economies because once interest rateshave been driven close to zero.And even more encouragement is needed toentice spending, what can be done?In the US the answer has been a differentform of monetary policy.Quantitative easing, in which liquidity,money, is directly pumped into theeconomy through the federal reservebuying assets from the private sector inreturn for cash.

Whilst the former policy in the US isunorthodox, the intent of this policy isthe same as when Central banks target alow interest rate.Namely, to encourage aggregate spendingin the economy, to try to stimulateeconomic activity.We will spend a lot of time looking atMonetary policy.It's one of the primary ways in which theMacroeconomy is managed.Fiscal policy is the other main arm ofMacroeconomic management.

Fiscal policy involves the government'sbudgetary variables.Government expenditure and taxation andthe difference between them, the budgetdeficit or surplus.And the subsequent implications for thegovernments level of debt.Extent to which Fiscal policy is used asan instrument of short and medium termMacroeconomic management.


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Has ebbed and flowed over a number ofyears.Since around the 1980s the extent towhich governments used Fiscal policy tomanage their economies was greatlyreduced as Monetary policy became seen asa more responsive.And powerful means of securing favorableMacro-, Macroeconomic outcomes.The global financial crisis changed thishowever.As a combination of interest rates beingalready low, this limiting the Monetarypolicy response, and the severity of theproblem.Led many governments to aggressivelypursue Fiscal policy responses to thecrisis.Amongst Macroeconomists, there is a hugedebate now raging about the extent towhich Fiscal policy was an effectiveresponse to the crisis.A lot of the debate, is about the size ofwhat is known as the Fiscal policy

multiplier.The extent to which a change in budgetaryvariables flows through and effects GDPand employment.There's also debate about how best tomanage the massive increase ingovernments debt that the Fiscal policyresponse has created.We will look at these debates, as well asexplaining what governments are hoping toacheive from their Fiscal policyresponses to the crisis.I'm going to conclude this section of the

lecture by outlining six conventionalaims of Macroeconomic policy.Or more broadly, the circumstances thatwould have to occur, before one wouldconclude that a nation was experiencingan overall favorable balance ofMacroeconomic outcomes.The first, is rising living standards.In one sense this is self evident, but atthe same time.defining exactly what we mean by thisstatement is a matter of somecontroversy.

We often use a Nation's Gross DomesticProduct as an admittedly crude measure ofthe standard of living.As we will see in the next lecture, GDPcertainly does give an indication of theavailability of goods and services toenjoy.But as many people have quite correctlypointed out.Access to goods and services is by no


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means equivalent to happiness or a highstandard of living.And when we take into account the manysacrifices that have to be made to securea growing level of GDP.To take but one example, the possibilityof damage to the environment.Then the link between the standard ofliving and GDP may be more tenuous thanwhat at first seems to be the case.We will look at this issue in the nextlecture.What we can say at this stage is thatalong many dimensions, for example humanlife span.There have been clear improvements in thestandard of living over the long run.And this has been associated with growthin GDP.The next slide shows something quitesignifigant about GDP.The extraordinary growth that has beenachieved in Western economies since theconclusion of the second world war.

Whether there are limits to this growth,as some argue, or that the costsassociated with this growth out way thebenefits, as others argue, is a matter offurious debate.We won't shy away from this debate in ournext lecture, but it really is a topicfully deserving of it's own course.The second indicator of goodMacroeconomic performance is to avoidextreme outcomes.Essentially this means managing thebusiness cycle.

Ensuring that GDP grows smoothly withouteither excessive growth which may putupward pressure on prices or significantslowdowns which are associated withincreased unemployment.For a period over the 1990s and 2000smany economies appeared to have achievedexactly this.Federal Reserve Chairman Ben[UNKNOWN]christened this period the GreatModeration.By which he meant Macroeconomic outcomesin many countries were relatively benign.

Featuring solid growth.And the avoidance of recessions.The global financial crisis put paid tothis, with Macroeconomic outcomes thatwere nothing short of disastrous.By this criterion, recent Macroeconomicperformance in many parts of the worldhas been, to put it mildly, poor.The maintenance of the real value of thecurrency refers to avoiding high rates of


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Saving represents a particular economicdecision, namely, to postpone currentspending, and transfer that purchasingpower into the future.This decision, in aggregate, has farreaching consequences, for Macroeconomicoutcomes, including, in the short run,the business cycle.And in the long run, economic growth.For this reason, Macro economists pay alot of attention to what is happening tosaving in an economy.The graph shown in this slide, whichpresents data for Australia, shows onetype of saving, that undertaken byhouseholds.Specifically, the graph show theproportion after after tax, or disposableincome that is saved.As you can see, household decisions aboutsaving can change through time.And in this course, you will learn howthis has important implications for awhole variety of Macroeconomic outcomes.

Finally, the performance of the economyis often judged by the extent to whichthose seeking work are able to findemployment.The unemployment rate.This is probably the most visible effectof the business cycle.In a variable that shows considerablevariation across countries.The chart in this slide shows Spain'sunemployment record since 1980.Spain is a country that has had apersistently high rate of unemployment.

The rates reached in the wake of theglobal financial crisis are worryingindeed.

1 - 3 - macro lecture 1 part 3 (19-15)

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