Applied Macroeconomics

Abstract

Macroeconomics is a branch of economics created by John Maynard Keynes, a British economist. Macroeconomics looks at the economy on a large scale either nationally, regionally or between countries. Keynes's view differed from the classical approach to macroeconomics. The classical view held that there should be no government interference in the economy because it is always in equilibrium or adjusts to put itself in equilibrium. Keynes's view was that certain circumstances, such as a depression, would not improve through self-regulation of the economy and required government intervention. For example, during a depression, unemployment may not automatically improve and often requires government intervention to create jobs. Large scale macroeconomic indicators can measure the health of the economy and compare the current state of the economy to other periods in time. These measures can also predict what policies and actions will benefit the economy. Applied macroeconomics is applying assumptions about large scale economic measures to real world economic problems. Macroeconomic indicators include the unemployment rate, gross domestic product, interest rates, money collected in taxes compared to spending, and the inflation rate.

Overview

Applied macroeconomics is taking aggregate theories and applying them to real world scenarios. Aggregate theories are assumptions about aggregate (total or sums) measures in the economy. For example, aggregate supply is the sum of goods and services produced in an economy; it also serves as a measure of how strong the economy is. Applied macroeconomics can be used as a tool to create an accurate picture of current economic events and to suggest approaches for improvement or correcting mistakes. Economists, governments, companies and individuals have an interest in looking at the economy as a whole because all are affected by changes in the economy. Economists may look at a problem in macroeconomics as an opportunity to predict or design a better future economic state or further the development of the field of economics. Governments may look at macroeconomics to define new policies that address economic issues and support the economy. Companies and individuals may be interested because information about the broad tendencies of the economy can guide decision making such as looking for a new job or hiring workers and buying equipment.

Some of the big problems and concerns of macroeconomics are based on indicators of the economy. These can include unemployment, inflation, interest rates, and supply and demand. In the United States and other countries including Japan, the economy is based on the free market or capitalist system where people may engage in the business of producing and selling goods and services competitively. The government influences business activity by controlling monetary policy and possibly with regulations governing certain aspects of business. Countries take different approaches to creating a healthy and growing economy. These approaches can include how productive resources are used by the producers of goods and the level of government involvement to support and encourage growth. If the economy is healthy, there is the potential to improve the standard of living of the people in that country. A decline in business activity can create a recession and negatively impact spending and incomes. In countries like China, the government exerts additional control over businesses by owning the businesses and deciding how they will be run. Also, in countries where governments control business, they also guarantee full employment by employing all who can work.

A History of Macroeconomics. John Maynard Keynes "was a British economist . . . who created macroeconomics, the study of economics on a large scale" (Gilman, 2006, p. 41). Macroeconomics asks a number of questions such as:

• What is the unemployment rate? How easy or difficult is it to find work?
• What is the strength of the dollar relative to other forms of currency around the world?
• What is the level of prices? Are they rising, falling, staying the same? How does this period of pricing compare to prices in another period?
• What revenue is the government collecting in taxes and how does that compare to government spending?
• What is the level of indebtedness to other countries?
• What is the production rate of the country and is the overall income level growing or falling?
• How easy or difficult is it to borrow money based on interest rates?

Schools of Macroeconomic Thought. There are many different versions or flavors of macroeconomics beyond what Keynes studied. Some simply disagree with his views while others build on his ideas. Gottheil (2007, p. 546) lists the following schools of macroeconomic theory and thought:

• Classical
• Keynesian
• Neo-Keynesian
• Rational expectations
• Supply side economics

Gottheil cautions that within each school of thought there can be differences of opinion. Gottheil discusses the schools of thought with respect to unemployment and inflation about which economists desire to uncover the causes and cures. As one example, Gottheil states that classical economists think unemployment is temporary and a condition that will be corrected by the market. Similarly, classical economists believe that prices will eventually move to where they should be. Keynesian economists think that unemployment can go on indefinitely with prices remaining at high levels and that inflation can have many causes. De Rooy (1995, p. 143) describes a phenomenon called demand-pull inflation in which a country's income is growing so fast that it cannot produce goods and services fast enough. The growth comes from an increase in the "supply of money and credit in the economy." Demand-pull inflation can be compared to cost-push inflation which occurs when there are shortages of certain goods and services. Another scenario is stagflation when prices are high, inflation is high and the economy gets progressively worse. Stagflation (stagnation and inflation) was termed in the 1970s and 80s when unemployment and inflation were simultaneously high. At this time, the economy did not react the way Keynesian economist expected and led to a new movement of neo-Keynesians.

Applied macroeconomics seeks to understand or explain fluctuations in the economy and to determine what actions make sense to respond to the fluctuations (Australian Graduate School of Management, 1997).

Economic Indicators. Moffatt (2009) describes an economic indicator as a statistic about the economy. Examples of economic indicators are unemployment levels and the Gross Domestic Product (GDP). Every economic indicator has three characteristics:

• Relationship to the business cycle economy
• Frequency
• Timing

There are three possible relationships to the economy:

• Procyclic
• Countercyclic
• Acyclic

Procyclic indicators move with the economy while countercyclic indicators move against the economy. Acyclic indicators do not have an observable relationship with the movement of the economy.

Frequency. The frequency of an economic indicator refers to how often the indicator is tracked or measured. Some are measured monthly, others quarterly and still others annually. Economic indicator timing shows the relationship between the appearance of the indicator and the same trend being present in the economy. Economic indicators can be leading, lagging or coincident. A leading indicator is one that shows up before the economy follows suit. A lagging indicator is "a measurable economic factor that changes after the economy has already begun to follow a particular pattern or trend. Lagging indicators confirm long-term trends, but they do not predict them" ("Lagging indicator," 2009). While leading indicators give an indication of future events, coincident indicators have a direct relationship with the economy and move at the same time as the economy.

Business Cycles. De Rooy discusses business cycles as events that happen in the economy without a single way to measure them all. Indicators could move slowly or quickly in any direction possible. Even in a recession, which is commonly thought of as a downturn, there are parts of the economy that may flourish. People may pay to repair items instead of purchasing new ones. People may take care of some tasks themselves instead of availing themselves of service providers such as beauty or barber professionals. De Rooy (1995, p. 41) lists GDP, business profits, "big-ticket consumer items called durable goods" and short term interest rates as measures that move with the business cycle. Nondurable goods like food are not as affected by the economy because they are always needed in good times and bad.

The Issues Considered in Macroeconomics. Macroeconomics looks at the economy as whole instead of individual consumer behavior (microeconomics). Macroeconomics studies the decisions that businesses and households make to lead to specific results such as the unemployment rate or inflation. There are two major problems considered in macroeconomics Long term growth and economic fluctuations. Macroeconomic analysis looks at aggregates or totals of activity in the economy and uses mathematical models to examine the behavior of aggregate information (Drozd, 2008). Economists, governments, individuals and businesses are directly and indirectly affected by the economy and changes in it. De Rooy (1995, p xi) noted the importance of economic literacy by stating that skill is only part of one's success and that "Your success is significantly influenced by the economic environment."

Economic Growth. Economic growth can mean an improved situation for the citizens of a country. Long term growth can be determined by examining production in an economy. The economy can grow because of improved means of production and population growth. Both can allow work to be done faster and more efficiently and can help countries benefit from innovation and new knowledge (Burda & Wyplosz, 2004). Since growth may not appear consistently, economists attempt to understand fluctuations in the economy, the causes and the remedies. Economic growth might be stagnated in third world countries because of high levels of poverty and a limited tax base. In developed countries, fluctuations may be caused by changes in aggregate supply and demand or unemployment. The unemployment rate is the number of workers who are unemployed when compared to all the eligible, employable people. Unemployment affects the entire economy because workers without incomes change their spending habits out of necessity which in turn affects businesses that depended on sales from these now unemployed workers. Unemployment can be devastating to the individual but also to entire communities experiencing high levels of unemployment.

Gross Domestic Product. Countries may look at the gross domestic product because it is the output of the economy and a result of the labor and capital put into the overall economic system. Amadeo (2009) noted that the economy is measured by the gross domestic product and described it as "everything produced by all the people and all the companies in the U.S." Drozd (2008, p.2) notes that macroeconomics can explain why certain economic conditions exist and allows us to answer questions such as:

• What makes a country grow richer or poorer in a given period of time?
• Why do we have recessions?
• Why did prices tend to rise more rapidly in Russia than in Switzerland?
• Why [did the] inflation rate [vary] so much in the U.S. in the 70s and 80s?
• What determines the value of the U.S. dollar?

Gottheil (2007, p. 378) suggests similar questions macroeconomists can answer such as:

• Why are there periods of recession and inflation?
• What causes prosperity?
• What causes economic growth?

Economists can help present approaches that will lead to better economic results using macroeconomics. The goals of macroeconomics are "long-term growth, high employment, price, employment and output stability" (Drozd, 2008, p.2). Long-term growth has been sustained in developed countries but the population growth in these same countries does not match the population growth in under-developed countries. As a result, there have been increases in outsourcing capabilities by which developed countries can benefit from the cheap and easily available labor in other countries. Inflation is "the rate of change of the average level of prices" (Burda & Wyplosz, 2004, p. 7). Massive levels of inflation are called "hyperinflation" when the monthly level of inflation is greater than 50 percent. Intuitively, it is possible to surmise the outcome of incredible increases in the inflation rate. Significant economic instability is likely to result.

Economic Policy. De Rooy (1995, p. 72) defines economic policy as "any government activity designed to improve the condition of the economy." Heijman feels that it is important to understand what the goals of economic policy are in order to easily understand macroeconomics. Heijman (2001, p.7) lists the commonly agreed upon goals as:

• An acceptable level of economic growth
• Full and fulfilling employment
• A fair distribution of income
• A stable price level
• A stable exchange rate
• Equilibrium on the balance of payments or equality in imports and exports
• A good environmental quality

All of these goals are necessary to ensure a sound economy and an environment in which people want to stay and work where they feel they can thrive. Heijman acknowledges the difficulty of getting all of these working at the same time and even acknowledges that these factors may compete with each other. Each government has in place monetary policy experts who will observe the outcomes of the economy and suggest governmental policy or intervention to shape the desired economic outcomes. De Rooy (1995, p. 391) agrees stating that "A government, through its central bank, will often influence its money's exchange rate to help it improve exports, attract foreign investment, or to reduce inflation." As an example, government policy intervention in the case of high employment might be to:

• Increase government spending, thus increasing economic activity and hopefully jobs
• Lower wages
• Shorten the work week
• Put more money into circulation to encourage spending and investment (Heijman, 2001, p. 10)

De Rooy notes that there are times when intervention by the government can result in harm to the economy. Harm to the economy does not just come from making the wrong decision about a variable being acted upon. Harm can also come from not understanding what other variables in the economy will be affected. For example, De Rooy (1995, p. 391) says "When a central bank increases its nation's money supply to devalue it, domestic interest rates are likely to fall." Without considering outcomes from each point of view, a government could increase economic problems instead of improving them.

Supply & Demand Policy. Macroeconomic policy is made up of supply and demand policy. Managing supply and demand can impact the underpinnings of the economy. However, it is often unclear what the long term benefit of government intervention is. Ulman (2009) notes that the current economic stimulus plan will slow down the increasing unemployment in a particular region but may not have a long term impact on annual job growth. Demand policy is determining how to bring production to a place where there is full employment and all production capacity is consumed. Demand policy works in the short term and medium long term (Heijman, 2001). Supply policy which emphasizes production capacity, is concerned with the skill and education of workers and is tied to long term results. McAfee (2006, p. 14) states "Supply and demand are the most fundamental tools of economic analysis. Most applications of economic reasoning involve supply and demand in one form or another." McAfee (2006, p. 38) also says that supply and demand help economists to better understand trade.

Macroeconomic Policy Tools. Heijman (2001, p. 13) lists the tools of macroeconomic policy as:

• Fiscal policy
• Monetary policy
• Income and price policy
• Other instruments

Heijman notes that it is important to know what tools are available but also to know when to use them. Heijman (p. 13) says fiscal policy relates to government taxes and spending while monetary policy is concerned with money circulating in the economy, interest rates, inflation, deflation, and exchange rates. Income and price policies are important because labor is the highest cost in product production and if the cost is too high productivity suffers. Similarly, a lack of control of prices can create instability in the economy. The government has tools of legislation "to influence the economic process" (Heijman, 2001, p. 13).

Heijman credits Jan Tinbergen, a Dutch economist, with being the first to devise a process for setting economic policy. Tinbergen suggested four steps policymakers should take which Heijman (2001, p. 15) refers to as the "normative theory of economic policy":

• The policy maker should specific goals in conjunction with the government's concern for social welfare
• Targets within the goals should be set
• The policy maker should determine what instruments or tools are available to effect the policy
• The policy maker should have an economic model which links the tools to the targets so that the policy maker can play with the variables and maximize the outcomes

A systematic process implies discipline on behalf of the policy makers. However, it is possible that bureaucracy and politics could affect the policymakers' ability to act systematically.

Viewpoint

Macroeconomics & Today's Economic Confusion. The global economic crisis can be frightening and fascinating for economists and individuals. Hanke (2009, para. 1) says "Shock and confusion describe the state of investors today." Hanke further notes that wealthy people and retirees have lost a large amount of money. "In 2008, the average household net worth dropped by 22.7%" (2009). Hanke feels that the economic experts have led investors astray. "Many investors are walking around like zombies. When they hear economic prognostications, they become even more confused." Shock and confusion means that the conventional wisdom of what works economically is no longer taken at face value. As the economy transitions, it becomes apparent that what worked before may not work again and that even economic experts are not in full agreement on how to solve tough problems (Hanke, 2009, para. 6). Rosen (2009) quotes Hanke as being partially critical of the economic stimulus efforts by the government. Hanke believes that the United States is in a recession but not a depression. He also believes that the federal stimulus plan will not have an effect of the economic crisis. He is in favor of the "monetary and tax policies" because he feels they stimulate economic recovery more effectively than government spending (Rosen, 2009, para. 4).

Macroeconomics will likely be updated in light of the new problems the current economic crisis provides. The development of new types of economic problems is not unusual. Drago, Wooden, and Black discuss changing workplace demographics and the need for flexibility in work hours. With the introduction of women into the workforce, the pressure on employers to adapt to the need for flexibility has increased. At different points in everyone's life, the ability to maintain a certain work level changes; not responding to that change affects productivity in the workplace. Given that women are such a large part of the workforce, the effect on the economy could be substantial. There are also men who do not want to be recognized only as "financial" support to their families. Other life changing events are listed by Drago, Wooden, and Black. Events include marriage, separation, and divorce as well as retirement. The economies of the developed nations will change dramatically as baby boomers begin to age and leave the workforce.

Most importantly, there may not be agreement among economists before, during, or after an economic period on what happened and what would be the best policy for the economy. Gottheil (p. 546) says there is not very much "consensus among economists on macroeconomic policy" because of imperfect information, different approaches and perspectives and different political stances. While some advocate more government intervention and others less, macroeconomics is filled with economists that spread the ideological spectrum.

Terms & Concepts

Consumer Price Index (CPI): An economic indicator tracked by the U.S. Department of Labor which measures monthly changes in the prices of goods and services purchased by people. The CPI can be a measure of inflation (Gilman, 2006).

Debt: The state of owing something; often refers to the ability to make a purchase today and pay tomorrow.

Economic Policy: Actions the government takes regarding the economy, such as setting interest and tax rates.

Economics: The study of how people choose to limited use resources which can include land, labor, money, equipment, taxes and investments ("What is economics," n.d.).

Fiscal Policy: The government's fiscal policy is its plan for spending and taxation designed to steer aggregate demand in a certain direction (Baumol & Blinder, 2001).

Gross Domestic Product: (GDP) The sum of the money value of goods and services produced and sold on the open market for a period of time, e.g., one year. (Baumol & Blinder, 2001).

Inflation: Increase in the average level of prices. High levels of inflation make it more difficult to purchase goods and services.

Macroeconomics: The study of aggregate or total behavior in an economy such as within a nation or between countries (Heijman, 2001). It is a subset of the field of economics and looks at behaviors in the national or regional economy. Macroeconomics looks at large scale indicators like the unemployment rate and tries to find relationships between these indicators ("What is macroeconomics," 2009).

Microeconomics: Usually refers to the impact an individual's behavior and decision making have on supply and demand for goods and services ("What is macroeconomics," 2009).

Monetary Policy: The Federal Reserve's actions to change or alter interest rates or the money supply.

Supply and Demand: Supply is the amount of a product a company is willing and able to produce while demand is the amount of product consumers wish to purchase (Gilman, 2006).

Bibliography

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Suggested Reading

Caetano, J. & Caleiro, A. (2009). Is there a relationship between transparency in economic and political systems and foreign direct investment flows? ICFAI Journal of Applied Economics, 8, 45–58. Retrieved April 1, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36670183&site=ehost-live

The economy. (2009). Country Profile. China, 22 - 30. Retrieved April 1, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=36085623&site=ehost-live

Kumar, S. (2009). Estimating export equations for developing countries. ICFAI Journal of Applied Economics, 8, 17–28. Retrieved April 1, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36670180&site=ehost-live

Popescu, G. H. (2016). Does economic growth bring about increased happiness? Journal of Self-Governance & Management Economics, 4(4), 27–33. Retrieved January 11, 2018, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=120464443&site=ehost-live&scope=site

Vadlamannati, K.C. & Veni, L. K. (2009). Fiscal synchronization hypothesis in Andhra Pradesh: An empirical testing. ICFAI Journal of Applied Economics, 8, 29–44. Retrieved April 1, 2009, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36670182&site=ehost-live