Review of U.S. Economy

Review of Macro Concepts

Unemployment (Ch. 7)Inflation (Ch. 7)GDP (Ch. 8)Economic growth & determinants (Ch. 9)Money, central bank & monetary policy

(Ch.15+)Macroeconomic policies (Ch. 16)Foreign sector & foreign exchange (Ch.33,

34)

How rich is the U.S.?GDP (nominal terms): $14.6 TrillionLargest “nation” in the world, followed

by China ($1.34 trillion)Note: EU GDP = $20 TrillionUS Population: 310 millionUS GDP per capita: $47,100 (China:

$3,500)Still, does $1 buy you the same amount

of g/s in China as in the US? PPP

US Real GDP, 1920-2010

TREND

Long-Term Economic Growth

Graphically: TREND in Real GDP (per capita)Mathematically, it’s the average % change in

real GDP per capita over a long period of timePost-war (1947-2010) growth: 2.3%Comparison? High or low? Why? See textbookConvergence hypothesis: relatively low for

rich (developed) countries, high for many poor but emerging (developing) countries

What if we take the trend outShort-Run Fluctuations (business cycle)

GDP Growth (%)

-6.00

-1.00

4.00

9.00

14.00

1947 1959 1971 1983 1995 2007

-500

-400

-300

-200

-100

0

100

200

300

400

500

19601963

19661969

19721975

19781981

19841987

19901993

19961999

20022005

2008

So, you see positive & negative gaps

What happens in the business cycle

Inflation generally decreased in a recession

Inflation (%)

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

1947 1959 1971 1983 1995 2007

Unemployment generally increased in a recession

Unemployment Rate (%)

0.00

2.00

4.00

6.00

8.00

10.00

12.00

1947 1959 1971 1983 1995 2007

Policy QuestionWhat should the government

AUTHORITY do in a recession? Federal government: Fiscal policy

(Ch.13)Central bank (Fed): Monetary policy

(Ch.16)

Fiscal PolicyGreat Recession: Dec. 2007 and June 2009Output declined substantially after the

collapse of Lehman Brothers in Oct. 2008January 2009: Obama proposed the

American Reinvestment and Recovery Act, passed by Congress in February 2009 (Stimulus Package of $787 billion in gov’t spending & tax cuts)

Still running NOW!!See recovery.gov

Monetary Policy?See what the Fed did first…

Fed’s policy response in business cycles since 2000

Federal Funds Rate (%)

0.00

2.00

4.00

6.00

8.00

10.00

12.00

2000 2001 2003 2004 2006 2007 2009

Monetary Policy

Started policy easing (lowering interest rates) before the onset of each recession (2001 and 2007)

Too little too late? Not clear because we need to know what would have happened without the policy (the condition that we can never know)

What to do in a recession?

Spending (& GDP) generally falls in a recession

Inflation fallsUnemployment risesThe Fed can raise the money supply, so…

Fed funds rate/discount rate will fallOther interest rates will fallInvestment/consumption spending will

riseProduction (GDP) will rise

Is there any downside?Remember: we are talking about only the

short run so farIn the long run, the economy (long-term

economic growth) is determined by real factors (Ch. 9), not MONEY or government spending

In the long run, too much money leads to only inflation and too much deficit spending leads to a larger debt

Just a myth? Let’s see what happens if you try…

A tale of Zimbabwe

Money is sometimes evil

Foreign SectorForeign exchange & trade (deficit), Ch.

33-34Dollar Exchange Rate, Major Currencies (1973=100)

0

20

40

60

80

100

120

140

160

1973 1985 1997 2009