Introduction to+Macroeconomics

The Objectives of Government Macroeconomic Policy

What is macroeconomics?

Macroeconomics is concerned with issues, objectives and policies that affect the whole economy. All economic analysis that refers to the overall economy is macro. The unemployment rate, the inflation rate, the rate of economic growth; these are all macro issues.

What are the major objectives of macroeconomic policy? watch the video first which is a nice introduction to the various objectives. Then read the notes below for a more in-depth explanation:



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Traditionally the four major objectives of macroeconomics have been seen to be (i) Low unemployment/full employment, (ii) Low inflation/ price stability, (iii) A high standard of living for all its citizens/ high economic growth, and (iv) keeping the Balance of Payments in equilibrium. (this is a measure of a country’s trade with other countries). Countries will try to avoid a BOP deficit- which is where it exports far less than it imports. A BOP deficit will require a country to finance this deficit often by borrowing. (v) However in recent years economists have concentrated more on achieving the objective of Economic Development rather than Economic Growth. So what is development? Development is measured by outcomes i.e. development occurs when measures of human well-being improve. A reduction of poverty, inequality and unemployment in a growing economy points to successful economic development.


 * First, we will look at the way in which these objectives are measured.
 * Secondly, we shall discuss the relative importance of these objectives.
 * Finally, we will look at the difficulties that governments have in trying to achieve all the objectives at once.

How are these objectives measured?

1. Full employment, or low unemployment The claimant count is the older, more out of date measure of unemployment used in many countries. Those counted must be out of work, physically able to work and looking for it, and actually claiming benefit. However in countries without unemployment benefit, this is a irrelevant and useless measure. <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">For a more realistic count, and for international comparisons, the ILO (International Labour Organisation) measure is used. This includes the young unemployed who are not always eligible to claim, married women who can't claim if their husband is earning enough, and those who claim sickness and invalidity benefits.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">2. Price stability <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Inflation is usually defined as a sustained rise in the general level of prices. Technically, it is often measured as the annual rate of change of the Retail Price Index (RPI. For prices to be stable, therefore, the inflation rate should be zero. Generally, governments are happy if they can keep the inflation rate down to a low percentage. <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;"> Another important statistic is that of average earnings growth. Most economists believe that the growth in wages directly affects the price level.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">3. High (but sustainable) economic growth <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Economic growth tends to be measured in terms of the rate of change of real GDP (Gross Domestic Product). When the word real accompanies any statistic, it means that the effects of inflation have been removed. More on this later! GDP is a measure of the annual output (or income, or expenditure) of an economy. Much more on this later! Sometimes GNP (Gross National Product) is used, which is very similar to GDP. Growth figures are published quarterly, both in terms of the change quarter on quarter and as annual percentage changes. <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Economic growth means more goods are produced and more income is earned, and yet it doesn’t always mean that the quality of life improves in the country. What other measures might we use when we want to measure the quality of life in a particular country?

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">4. Balance of Payments in equilibrium <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Briefly, this records all flows of money into, and out of a country. It is split into two: the Current Account and the Capital and Financial/Capital Accounts <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Probably the most important is the Current Account because this records how well the country is doing in terms of its exports of goods and services relative to its imports. If a country is to 'pay its way' in the world over the long term, then it needs to keep earning enough foreign currency from its exports to pay for its imports. If this is not the case, the account will be in deficit. Japan has historically had the largest surplus in the world, although China has taken that title in recent years. Although a surplus sounds better then a deficit, both can be bad. China's surplus forces other countries in the world to have deficits. In fact, while China’s surplus is the biggest in the world, the USA's deficit is the biggest in the world. This is not a coincidence!

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">5 Economic development/High Quality of Life <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">This is the most complex to measure as it is quite a subjective thing. What leads to a happy contented society?

__<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 18px;">Group Activity __ <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">In groups you will each be given one of the following topics to study. You will have time in class to prepare this topic and then you must teach the topic to the other groups using whatever handouts/teaching resources you feel are relevant. Each topic will be given 15 minutes of "teaching time". <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Here are your topics:
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px; line-height: 1.5;">Why is GDP per capita a too narrow measure of quality of life?
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px; line-height: 1.5;">What is the UN Human Development Index?
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px; line-height: 1.5;">What is the Genuine Progress Indicator?
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px; line-height: 1.5;">[|What are the UN Millenium Development Goals, what have they been replaced by (sustainable development goals), and why are they important?]
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px; line-height: 1.5;">What are other alternative measure of the quality of life we could use (eg Gross National Happiness index) ?

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 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Now in different groups (teacher assigned) do some research on a country of your choice and try and find as much information on that country in terms of GDP per capita, economic growth, unemployment, inflation, BOP, HDI, and any other relevant measure. Try and reach a conclusion as to the quality of life in that country **

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 18px;">Here is Mr Oldfield's example
 * <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">[|Here is the marking rubric we'll use for this activity] **

<span style="font-family: "Trebuchet MS",Helvetica,sans-serif; font-size: 16px;">As an example of what you may find, here is a short video on China's economic performance. What are the strengths and weaknesses outlined in the video and what is expected for 2011?

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<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Which Macroeconomic objective is the most important?

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">In the 1960s, the Balance of Payments was considered very important. A deficit was considered highly embarrassing. The long term sustainability of a deficit was a big problem in the days before global free movements of capital. Nowadays, with huge global capital flows, many economists believe that balance of payments deficits or surpluses simply do not matter. This was reflected in the fact that nobody seemed to bat an eyelid at the continual deficits of the 90s. <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Full employment was considered very important after the Second World War. It was probably the number one objective of the socialist government of the late 40s and continued to be at the front of politicians' minds for the next three decades. <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Growth and low inflation have always been important. Without growth peoples' standard of living will not increase, and if inflation is too high then the value of money falls negating any increase in living standards. Nowadays these are definitely the two most important objectives of macroeconomic policy. Inflation it is argued must be controlled as high inflation makes countries uncompetitive and stifles enterprise, and so unemployment increases and economic growth declines. However inflation is quite low in most countries at the moment, and therefore there is less emphasis on it. Why worry about inflation? Infact many countries are more worried about negative inflation (i.e. prices falling. Why?) <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">So in conclusion there is no definitive answer to which is the most important objective. Most countries are at the moment just coming out of the recession of 2008-10, so economic growth has been a key worry for them. China however managed to avoid recession and continued to experience high levels of economic growth. It has however started to worry about inflationary pressure and this is probably its’ key concern in 2011.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Are there any conflicts between these objectives?

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Unfortunately, it is virtually impossible for a government to score in all these goals at once. We shall begin with the three major conflicts and then look at two more that are linked to microeconomics.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">1. Healthy growth and low inflation <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">If an economy grows too quickly, especially if it is due to excessive consumer spending as it tends to be in many countries, then demand will outstrip supply and prices will rise. Equally, the steps taken to keep inflation low, like relatively high interest rates, can often restrict growth via reduced consumer spending and investment. It is difficult to achieve both aims. <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">The 'trend' rate of growth is seen as the rate of growth an economy can grow without igniting inflation.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">2. Healthy growth and a Balance of Payments equilibrium <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">When an economy is growing quickly, consumer spending tends to be high, particularly in developed economies where Consumption is the “Engine of economic growth”. Hence, import growth picks up relative to exports, leading to a worsening trade deficit. However for many developing countries, economic growth is not only compatible with trade surpluses but is actually dependent on them. China’s economic growth is primarily export led growth.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">3. Low unemployment (or full employment) and low inflation <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">This is the classic conflict in economic theory. In fact, an economist called Phillips constructed a curve using empirical data to show that this conflict existed (although this did not mean that the relationship would hold forever). <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">These two variables have, in theory, an inverse relationship. If a government tries to reduce unemployment through reflationary measures, such as lower interest rates or increased public spending, then the resulting reduction in unemployment will push wages, and then prices, higher. On the other hand, when the government tries to control high inflation with higher interest rates and reduced spending, the resulting reduced consumer spending and lower investment will result in job losses.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">4. Healthy growth and the environment <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Of course, not everyone would consider the environment a 'minor' objective, but unfortunately governments have not quite woken up to the problem yet. Although there have been summits at which controls on various types of pollution were agreed, the US amongst others seem to find it difficult to keep their promises! <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Quite simply, the faster the rate of growth, the higher the level of production, and so the level of pollution from factories, cars, etc. rises. Also, vital rain forests tend to disappear, not just because we consume the wood; new factories, towns and housing are built on the resulting land.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">5. Healthy growth and equality <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Equality was an objective of socialist governments and so is now obsolete in the world of 'new' Labour. Although it is true to say that forcing equality throughout a country can lead to inefficiencies (where are the incentives?), those on the left wing feel that it is an admirable and important aim. Ronald Reagan used to talk about the 'trickle down' effect. As an economy grows the poor may well get a smaller slice of the cake, but the cake gets so large that the poor man still gets more cake. Of course this does overlook the fact that the rich man is getting a larger slice of a bigger cake! <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">The developed world has grown hugely since the Second World War, but even with the creation of welfare states it is the wealth creators that have benefited hugely whilst those at the bottom of the pile have seen their standard of living just plod along. <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">There is a major concern that whilst economic growth in China has led to a reduction in poverty there has also been at the same time a growth in inequality.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">EXTENSION VIDEO FOR THOSE WHO REALLY WANT TO UNDERSTAND IN DEPTH:

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