Macroeconomics

1. Macroeconomics What you need to know

2. SSEMA1: How is economic activity measured? • Income, employment & prices are determined by the decisions of households, businesses, the government & net exports • Gross Domestic Product: final $ value of all products, goods, services & structures produced inside a country in one year • Economic growth: An increase in the capacity of an economy to produce goods and services, compared from one period of time to another.

3. Consumer Price index (CPI): measures price changes for a “basket” of frequently used consumer items • Inflation: general rise in prices • Stagflation: stagnant growth + inflation • Aggregate supply: total value of all goods & services that would be produced by all firms at all prices • Aggregate demand: total quantity of goods & services demanded at different price levels

4. Calculations • Growth: usually measured by GDP = Consumer Spending + Investment Spending + Government Spending + (Exports – Imports) • Unemployment: % (number of unemployed people divided by # of people), based on people who work less than 1 hour/week in a for-profit business & who want to work • Inflation: compares prices year by year

5. Types of unemployment • Structural: caused by fundamental change in the economy that reduces demand for workers (like mechanization of car plants) • Cyclical: related to swings in the business cycle (when people save instead of spending, some industries lay people off) • Frictional: when workers change jobs or want new jobs (like when teens switch jobs)

8. What is a Depression? • Depression: severe economic downturn lasting several years—last one was the Great Depression • Many experts say that the Great Depression was aggravated by contractionary monetary policy. The Federal Reserve rightly sought to slow down the stock market bubble in the late 1920s. However, once the stock market crashed, the Fed kept raising interest rates to defend the gold standard. Instead of pumping money into the economy, and increasing the money supply, the Fed allowed the money supply to fall 30%. This created massive deflation, where prices dropped 10% each year. As people expected lower prices, they delayed purchases. Real estate prices plummeted 25%, and people lost their homes.

9. Debt vs. Deficit • The deficit is the difference between how much the federal government spends and how much it collects in one year. If the government “earns” $2 trillion in taxes in one year, but spends $3 trillion, that’s a deficit of $1 trillion. In order to pay for the difference, the government has to borrow money from itself, American citizens, foreign countries, and other sources. • The federal budget deficit for 2009 was a record-breaking $1.4 trillion and $1.3 trillion in 2010. • The national debt is the total amount we owe. Every year that we borrow more money, the debt grows larger. • The difference between the deficit and the debt is especially important because when politicians talk about reducing the deficit, all that really means is that our debt isn’t growing as fast. It does not mean we’re getting out of debt. • CURRENT DEBT: $16 trillion and growing(http://www.usdebtclock.org/)

10. What does that mean?? In more personal terms: If you have an income of $50,000 per year, and you spend $60,000, that’s a deficit of $10,000. You would need to borrow that $10,000 from someone, maybe with a credit card or a home equity loan. If you reduce your spending the following year, to $55,000, you have “halved the deficit”, but you’re still spending $5,000 more than you’re earning, and going further and further into debt. After two years, despite halving your “deficit spending,” you’re $15,000 in debt .

12. The “Fed” (Federal Reserve System)SSEMA2 • US Central Bank • Led by Chairman & Board of Governors: set monetary policy • Chairman appointed by the President: current chairman is Ben Bernanke • Open Market Committee: guides interest rates • 12 regional banks

13. The Fed & Monetary policy • Primary purpose: to control inflation without triggering a recession (monetary policy: expanding & contracting the money supply thru interest rates & reserve requirements) • Also supervises the banking system, • Works to keep markets stable… • Is the central bank for other banks, the government, & foreign banks. • By restricting credit, can reduce the money supply (higher interest rates): “contractionary”

14. Lower interest rates: more credit, more jobs, expands money supply (“expansionary”) • Reserve requirement: 10% banks must keep on hand. Fed loans them $ if they need it—at discount rate through the discount window. • (Banks would rather buy from other banks, tho—Fed is bank of last resort) • NOT run by government! • Can take over banks that are “too big to fail” to make sure they are safe for consumers

15. Fed functions • Price stability: high inflation curbs growth & costs jobs, money, etc. Fed manipulates interest rates to keep prices as stable as possible. • Full employment: difficult to measure & control; “maximum” is the goal • Economic growth: can’t really do this without letting inflation rise—added by Congress

16. Fiscal Policy [SSEMA3] • Defined: use of government spending and revenue collection measures to influence the economy • Price stability: trying to shift the curve to the right demand-side economics (tax & spend) [Keynesian model] • Investing affects business: less jobs, less spending, businesses go under, less taxes paid: downward spiral • Government can spend or lower taxes to stimulate spending—deficit spending!

17. Supply-side economics • Designed to stimulate production instead of demand (Reagan) • Reduce government role in economy • Deregulation a major goal • Lowering taxes • Less taxes collected less revenue • Some instability

18. Fiscal vs. Monetary policy • Monetary policy goal: monetary growth at low inflation rates. Lower interest rates, lower inflation, slow growth in money supply (linked to GDP). Not a cure for unemployment. FED! • Fiscal policy: attempt by the government to stabilize the economy by taxing & spending. Plan a budget using surpluses or deficit s to maintain steady level of spending. Examples: unemployment, Social Security, tax cuts. Moving away from this to monetary policy.