Macroeconomics, Third Edition

David G. Tuerck

• Verlag: Business Expert Press
• Jahr: 2021
• ISBN:
  9781953349255
• Auflage: 3
• Thema: Economics
• Thema: Macroeconomics

This book brings these theories together under one methodological roof, where the choices made by economic agents depend on their varying perceptions of the economic constraints they face, combining new classical principles, under which the economy operates at full employment, with theories that allow for extended periods of underemployment brought about by mixed signals from workers and employers.

The task of macroeconomics is to provide the tools for understanding the performance of the aggregate economy, as measured by production, employment, inflation, and other economic indicators. Most books on this topic compare different theories of macroeconomic performance, under alternative assumptions about how individual consumers, workers and investors adjust to the economic environment in which they find themselves.

This book brings these theories together under one methodological roof, where the choices made by economic agents depend on their varying perceptions of the economic constraints they face, combining new classical principles, under which the economy operates at full employment, with theories that allow for extended periods of underemployment brought about by mixed signals from workers and employers. The book takes up modern monetary theory and its bearing on the massive deficits run up the federal government over the ongoing 'corona contraction' and the earlier 'great contraction'. The author also reviews the policy interventions undertaken by the federal government during these contractions, with a view toward assessing their effectiveness.

CHAPTER 1

Introduction

Macroeconomics is the study of the economy as a whole, as distinguished from microeconomics, which is the study of individual consumers, workers, firms, industries, and markets. Microeconomics focuses on the individual economic decision maker (or “agent”) without attempting to take into account the full range of interactions that take place between one decision maker and another. Thus, for example, a microeconomic study of an excise tax on the purchase of cigarettes would consider the effect of that tax on the sales of cigarettes but not attempt to account for the effects of that tax on the sales of watermelons and then its feedback effects on the demand for cigarettes.

Macroeconomics, on the other hand, is a study of feedback effects—of interactions between major economic sectors in response to extraneous events and changes in government policy. It’s just that when we do macroeconomics, we don’t focus on individual products such as cigarettes or watermelons. We focus on major economic indicators such as gross domestic product (GDP), the capital stock, and the supply of goods and workers.

Yet macroeconomics does take into account how individual decision makers affect these indicators. At the heart of the question of how these indicators behave is the question of how individual economic agents adjust their actions to changes in government policies and other events that influence their behavior. Even though macroeconomics considers the economy broken down into major sectors, it can take—and here we do take—what is called a “microfoundations” approach to its study. Thus, in studying the labor sector, we first ask how the individual worker adjusts the amount of time he spends working to the reward he gets for working and how the individual saver adjusts his saving to the reward he gets for saving. Only after we have understood how the individual adjusts his decision to work and save can we understand how the aggregate supply of labor and the aggregate supply of capital adjust to changes in the rewards for work and saving.

The purpose of any economic system is to provide a mechanism through which buyers and sellers can coordinate their activities to their advantage and in such a way as to exploit as many opportunities as possible for mutual gain. For the most part, and throughout the developed world, it is the marketplace through which this goal is achieved. There is, to be sure, a great deal of direction that comes from government as well. Every country has a government that engages in its own transactions and imposes taxes to finance those transactions. And in some countries with mostly free economies, government transactions account for a large fraction of economic activity. But most of the transactions that take place around the world come about as a result of voluntary exchanges between buyers and sellers. The microfoundations of macroeconomics lie in the decisions taken by individual economic actors to work and save and, at the firm level, to hire labor and acquire capital.

In this book, we focus first on the services of labor and capital as supplied by, and as demanded by, individual economic agents. This provides a framework for understanding the effects of taxes and government spending on individual choices and, through those choices, the aggregate economy. Macroeconomics, however, is also the study of major swings in the economy that originate from forces beyond the control of any individual. Those we take up in the later chapters.

This book appears as the United States attempts to recover from a major economic contraction. The outbreak of the coronavirus and the resulting government restrictions on business caused U.S. GDP to fall by 5% in the first quarter of 2020 and employment to fall from 3.5% in February 2020 to 13.3% in May.

The current contraction—labelled the “Corona Contraction” here—follows the Great Contraction of 2007 through 2009. Between that earlier contraction and the one under way now, the country experienced a period of economic growth and low unemployment. Thus, the recent past is rich in contrasting macroeconomic episodes, and with those episodes, challenges for the macroeconomist to explain.

Macroeconomics as a field of study came into being from the publication of The General Theory of Employment, Interest, and Money, in 1936, by economist John Maynard Keynes (Keynes 1936). Keynes tried to show why existing theories—“classical” theories he called them—could not explain the persistence of the Great Depression, then underway, or how government could use its policy tools to escape it. Keynes did not use the term “macroeconomics”; it was coined by someone else, apparently before Keynes wrote his fateful book.1 But Keynes did set the stage for a theory of the economy in which wage and price adjustments that normally keep the economy at full employment (a term on which we elaborate later) fail and, having failed, leave the economy in a state that calls for government intervention in the form of expansive monetary and fiscal policy. Government policies aimed at correcting for the failure of an economic system to achieve full employment are frequently referred to as stabilization policies, connoting the idea that it is the job of government to stabilize the economy at a level that brings about full employment without inflation.

Macroeconomics, as presented in most textbooks, is still articulated in the spirit of Keynes’s book, focusing primarily on whether and how government can use monetary and fiscal policy to keep the unemployment rate below some threshold level, say, 5% (or perhaps, now, 3%) and the inflation rate below its threshold level, lately 2%. Current wisdom has it that if the unemployment rate rises above its threshold level, the government needs to intervene by raising demand. If the inflation rate rises above its threshold level, then it needs to lower demand. Macroeconomic policy becomes a matter of juggling these two priorities.

We explain further on why this approach is overly simplified. Indeed, a central purpose of this book is to show why this view of the macroeconomic problem is dangerously (for the economy) oversimplified. The macroeconomic problem, if there is one, can lie on the supply side of the economy, as well as on the demand side. One supply-side problem can arise from distortions in the markets for labor and capital that pull down the level of potential, full-employment output. Supply-side economics, as traditionally defined, is about removing these distortions with the aim of increasing output. But a different supply-side problem can arise as well. This problem arises from maladjustments in prices and wages that keep aggregate supply below aggregate demand. Economists refer to this much neglected phenomenon as suppressed inflation—the failure of prices and wages to rise in tandem with a rise in aggregate demand and for firms and workers, as a result, to withhold their products and services from the marketplace.

There are therefore two supply-side problems that can lead to suboptimal performance by the economy—one that arises from distortions in the individual markets for labor and capital and another that arises because of a misalignment between aggregate supply and demand. The existence of two supply-side problems requires the economist to delineate between the two. This book attempts to do just that by focusing first on distortions (for example, taxes) that negatively affect the flow of labor and capital services into production and then by focusing on distortions between aggregate supply and demand.

One way to simplify matters is to identify a single macroeconomic indicator whose behavior is taken to represent the performance of the overall economy. Here that indicator is real (that is, inflation-adjusted) GDP. GDP is a measure of the goods and services produced within a geographic unit (here, the United States) in a year’s time. This book focuses on the conditions that determine the level of real GDP and on how the appropriate government measures—or the absence of those measures—can affect real GDP.

One important concept based on this measure is potential or full-employment real GDP, which refers to real GDP when aggregate supply is aligned with aggregate demand. We think of this also as GDP when the unemployment rate is low enough so that, for all practical purposes, everyone who wants a job has a job.

There are, to be sure, other measures of economic performance. Another, probably superior but less utilized, measure is real GDP per person. Another is real consumption per person. We will consider these alternative measures when we take up the question of economic growth. But we can make our lives easier by thinking of the macroeconomic problem as one of maintaining a high rate of growth of real GDP, given that the quality of economic life is not just about production (and consumption) but also about smelling the roses or, as we will view it, the ability of economic agents to enjoy leisure.

Another simplifying technique is to separate macroeconomics into a short-run and long-run problem. The underlying idea is that, in the long run the economy gravitates toward full employment, whereas in the short run it may not. Keynes criticized what he called classical economics for not allowing for this difference. As Keynes saw it, an imbalance between aggregate supply and demand might be self-correcting, as classical economics argued, but sometimes it will not (as witnessed in the severity and length of the Great Depression).

When defenders of the classical tradition claimed that imbalances between aggregate supply and demand would be self-correcting, at least in the long run, Keynes famously answered that “in the long run we are all dead.” Keynes saw himself as the originator of a new school of economic thought that would force the profession (and politicians) to understand that the short run could become very long indeed.

This book recognizes the distinction between self-correcting and protracted imbalances between aggregate supply and demand. Self-correcting imbalances do not require government intervention through monetary and fiscal policy to bring aggregate supply and demand back into line with each other. Arguably, protracted imbalances do.

For some three decades after its publication, Keynes’s General Theory remained the bedrock of macroeconomics. The working assumption was that policy makers should be aware of the behavior of economic indicators such as real GDP and the unemployment rate and stand ready to deploy the weapons available to them at any moment to prevent production and employment from falling, while, at the same time, keeping an eye on the inflation rate.

Beginning in the late 1960s, however, a counterrevolution was launched that challenged Keynes’s ideas. This counterrevolution spawned a new classical economics, which argues that Keynes’s remedies for a failing economy were likely to be ineffectual and unnecessary. Imbalances would correct themselves, and Keynes’s policy tools were likely to be ineffective anyway. This school of thought succeeded in stripping Keynes of much of his intellectual authority, at least until the downturn that began in December 2007. It is safe to say that, until that downturn, the exponents of the new classical economists and their allies from various subbranches of that line of thinking were carrying the day.

I will state up front that I subscribe to this new classical school, insofar as I think that it has much to say about improving economic performance, especially through tax and welfare reform. Thus, the book is focused on explicating the new classical world, in which the economy is performing normally (which is to say, it hasn’t broken down owing to imbalances between aggregate supply and aggregate demand) and will respond positively to policy reforms that incentivize people to work and save. The book also, however, considers policies that may be appropriate for correcting protracted periods of low employment and reviews the policies that were adopted over the span of the recent Great Contraction and that are being implemented now for dealing with what I will call the Corona Contraction.

Getting back to Keynes, his core idea was that a sudden, unanticipated fall in the demand for goods and labor could create a state of affairs in which the economy would sink into a long-lasting slump. This fall in demand could come from various sources. The fact that the U.S. money supply shrank by nearly one-third during the Great Depression no doubt helps explain its depth and length. If a downturn occurs because of a fall in aggregate demand, a housing crisis or a related financial crisis, a pandemic, or any other such cause or combination of causes, then the obvious remedy, thought Keynes, is for government to increase demand through expansive monetary and fiscal policy.

This line of thinking, though presumably invalidated by the new classical economics, sprang phoenix-like from the ashes when the Great Contraction got under way in late 2007. In reality, Keynesian thinking had remained—and remains today—alive and well in the deliberations of the Federal Reserve system, through which Federal Reserve officials preside over monetary policy. It is rising again through the trillions of federal dollars being spent to rescue the economy from the Corona Contraction. The architects of the new classical economics—economists such as Robert Barro, Robert Lucas, and Thomas Sargent—had won all the battles but never quite won the war against what they saw as Keynesian dogma.

The new classical economists argued that expansive monetary and fiscal policies would fail in their purpose, because, once those policies are known to have been implemented, individual economic agents will adjust their behavior in such a way as to defeat the purpose for which the policies were implemented. A collateral proposition is that the government should focus its attention not on the demand side but on the supply side of the economy, where, by reducing distortions in economic activity, particularly in the form of taxes, it can improve the performance of the economy. From this point of view sprang the practice of supply-side economics.

The recognized way of putting the distinction between Keynesian and new classical thinking is to allow for two states in which the economy can find itself. In one state—the classical state—markets clear through appropriate price and wage adjustments, and government can improve economic performance only through the elimination of distortions in individual markets for goods and for labor and capital. The other state—the Keynesian state—represents a state in which price and wage rigidities prevent markets from clearing and cause the economy to contract in response to a fall in the demand for goods and labor. The trick is to recognize which state the economy is in and to apply the appropriate remedies. For some economists, it is a matter of distinguishing the short run from the long run.

In an article entitled “The Economy Needs More Spending Now,” economist Alan S. Blinder offered his own characterization of the short-run/long-run distinction (Blinder 2013). “Poor economic policy,” he argued, stems, among other things, from “the failure to distinguish between the short-run and the long-run effects of particular policies.”

“In the short run,” said Blinder,

output is demand-determined. The big question is how much of the country’s productive capacity is used. And that depends on the strength of demand—the willingness of businesses, consumers, foreign customers and governments to buy what American businesses are able to produce.

The long run, however, is different. “In the long run,…a larger accumulated public debt probably spells higher interest rates, which deter some private investment spending. Economies that invest less grow less” (Blinder 2013).

Blinder characterizes short-run unemployment as a demand-side problem: If...

Inhaltsverzeichnis

• Cover
• Half Title
• Title Page
• Copyright Page
• Dedication
• Description
• Contents
• Acknowledgments
• Chapter 1 Introduction
• Chapter 2 Macro Measures
• Chapter 3 Individual Equilibrium
• Chapter 4 Saving
• Chapter 5 Capital and Labor
• Chapter 6 Economic Growth
• Chapter 7 Taxes and the Macroeconomy
• Chapter 8 Government Spending
• Chapter 9 Monetary Policy
• Chapter 10 Budget Policy
• Chapter 11 Managing Aggregate Supply and Aggregate Demand
• Chapter 12 Diagnosing the Economy
• Chapter 13 The Twin U.S. Contractions
• Chapter 14 Lessons from Recent Macroeconomic Policy Making
• References
• About the Author
• Index
• Other Titles From The Economics And Public Policy Collection
• Back Cover