Key Macroeconomic Variables

Macroeconomic Goals

Agenda

• Macroeconomic goals are determined by governments as representatives of society.

• Key Endogenous Variables

• Final Goals:

• Key Exogenous Policy Variables

¾ High Growth, ¾ Smooth Growth, ¾ Low Unemployment, and ¾ Low Inflation.

• Goals may be incompatible with one another. 2

1

Major Macroeconomic Variables

Key Macroeconomic Variables

• Economic output

• Interest rates

¾ Short-run business fluctuations ¾ Long-run economic growth

• Government budget balances and finance

• Unemployment and Employment

• International trade balances and finance

• Inflation

• Productivity 3

4

Economic Output

Real Gross Domestic Product 12,000

• Real Output or GDP: A measure of the economy’s total output of goods and services, Y.

Billions of 2000 Dollars

10,000

8,000

6,000

4,000

2,000 1960

5

1965

1970

1975

1980

1985

1990

1995

2000

2005

6

1

Real Gross Domestic Product 12

Economic Output • Key Questions?

Year-on-Year Percent Change

8

¾ What accounts for its rising long-term trend? ¾ Why has it been so volatile over time? ¾ What can be done to dampen the volatility? ¾ Why has volatility apparently been reduced since 1984?

4

0

-4 1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

7

Potential Economic Output

8

The Output Ratio

• Potential (or Natural) Output or GDP: The maximum sustainable output of goods and services, Y*.

Output Ratio: Ratio of actual-to-potential GDP, Ŷ.

• Standard against which economy is measured. ¾ Policy recommendations are highly dependent on estimates of potential output.

• Output Ratio: Ratio of actual-to-potential GDP, Ŷ. 9

10

Real Gross Domestic Product

The Output Ratio

Actual versus Potential 12,000

• Output Ratio: Ratio of actual-to-potential GDP, Ŷ.

Billions of 2000 Dollars

10,000

¾ Ŷ = [ ( Y – Y*) / Y* ] * 100

8,000

6,000

Series5 Recessions Potential GDP Actual GDP

4,000

2,000 1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

11

12

2

Output Ratio

Unemployment Rate

6

Percent: Actual to Potential GDP

4

• The percentage of people who are not working but who are actively seeking employment, U.

2

0

-2

-4

-6

-8

-10 1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

13

14

Unemployment Rate

Unemployment Rate

12

10

• Key Questions? ¾ Why has it been so high and so variable at times? ¾ Why was it rising between 1970 and 1983? ¾ Why has it been falling since then? ¾ What can be done to dampen its volatility? ¾ What are the economic and social consequences of high and volatile unemployment?

Percent

8

6

4

2 1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

15

16

Unemployment Rates

Natural Rate of Unemployment

Actual Unemployment Rate

Natural Unemployment Rate

12

10

• The unemployment rate that is consistent with the economy being at potential GDP, U*. Percent

¾ Neither desirable nor immutable

8

• The unemployment rate that is consistent with stable inflation. ¾ NAIRU: Non-Accelerating Inflation Rate of Unemployment

6

4

2

0 1960

17

1965

1970

1975

1980

1985

1990

1995

2000

2005

18

3

Payroll Employment 150

Employment • Employment: The total number of people who are working, N. Millions

125

100

75

19

“Full” Employment

50 1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

20

Inflation

• The level of employment that is consistent with the economy being at potential GDP and the natural rate of unemployment, N*.

• The rate of change in the price of a basket of goods and/or services, π. ¾ π = ( Pt – Pt-1 ) / Pt-1 • where P is the general price level.

21

22

Inflation Rate

Inflation

Year-on-Year Percent Change

16

• Key Questions?

12

¾ Why has it been so high and so variable at times? ¾ Why was it rising between 1965 and 1983? ¾ Why has it been falling since then? ¾ What can be done to dampen its volatility? ¾ What are the economic and social consequences of high and volatile inflation?

8

4

0 1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

23

24

4

Interest Rates, 10-Year US Treasury 20

Interest Rates

Real

• The (realized) annualized rate of return on a financial investment. ¾ Nominal: Includes inflation, r. ¾ Real: Excludes inflation, R.

• Influenced by changes in output and changes in monetary policy. 25

Interest Rates

Percent per Annum

15

Nominal

10

5

0

-5 1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

26

Government Budget Balance

• Key Questions? ¾ Why have they been so high and so variable at times? ¾ Why were real interest rates negative in the 1970s? ¾ Why were real interest rates so high in the 1980s? ¾ Why have real interest rates being falling since the early 1980s? ¾ What are the economic consequences of high and volatile interest rates?

• The difference between government receipts and outlays, BB = T – G. ¾ If receipts > outlays, a budget surplus, BB > 0. ¾ If receipts < outlays, a budget deficit, BB < 0.

• Influenced by changes in output and changes in fiscal policy.

27

28

Federal Government Budget Balance

Government Budget Balance

2

1

• Key Questions? Percent of GDP

0

-1

-2

-3

-4 1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

29

¾ Why did the government’s budget fall into persistent deficit between 1980 and 1995? ¾ Why did the government’s budget soared into surplus between 1995 and 2001? ¾ Why did the government’s budget fall into deep deficit between 2002 and 2004? ¾ What are the economic consequences of large persistent budget deficits (or surpluses)? 30

5

Current Account Balance

International Trade Balance

1

• The difference between exports & imports, NX = X – M.

Percent of GDP

-1

¾ If exports > imports, a trade surplus, NX > 0. ¾ If exports < imports, a trade deficit, NX < 0.

• Influenced by changes in output and changes in trade policy.

-3

-5

31

International Trade Balance

-7 1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

32

Labor Productivity

• Key Questions?

• A measure of output per worker.

¾ Why has the trade deficit been so large and so persistent since 1975? ¾ What are the economic consequences of large persistent budget deficits (or surpluses)?

¾ Equals real GDP/Number of Workers, Y/N.

• Can be very volatile in the short-run but longer-term trends are most important.

33

34

Nonfarm Business Productivity

Productivity

3

2.73 2.56

Percent per Annum

• Key Questions? 2

¾ Why was productivity growth so slow between 1973 and 1995? ¾ Why has productivity growth accelerated so sharply since 1995? ¾ What are the economic and social consequences of slow (fast) productivity growth?

1.49

1

0 1951-73

1973-95

1995-06

35

36

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Key Exogenous Variables

Demand Side Policy Variables • Fiscal Policy:

• Key Exogenous Variables

¾ Discretionary government spending, ∆G ¾ Tax rates, ∆t

¾ Fiscal Policy ¾ Monetary Policy ¾ Other Government Policies

• Monetary Policy:

• Demand-side vs. Supply-side Policy Variables ¾ Demand-side policy is generally short-run. ¾ Supply-side policy is generally long-run. 37

¾ Money supply, ∆M ¾ Interest rates (federal funds rate), r or ∆r

• Other Government Policies: ¾ International Trade & Exchange Rates ¾ Regulatory

38

Supply Side Policy Variables • Fiscal Policy: ¾ Tax reform ¾ Tax incentives ¾ Spending reform

• Other Government Policies: ¾ International Trade ¾ Privatization/Nationalization ¾ Regulatory 39

7