MACROECONOMICSMACROECONOMICS

The Big PictureThe Big Picture

Goals of Macroeconomic PolicyGoals of Macroeconomic Policy

Price StabilityPrice Stability

Economic GrowthEconomic Growth

Full EmploymentFull Employment

INFLATIONINFLATION

A sustained increase in the A sustained increase in the general price level as measured general price level as measured

by the by the consumer price index (CPI) consumer price index (CPI) or the implicit price deflator (IPD)or the implicit price deflator (IPD)

Unanticipated inflation hurts Unanticipated inflation hurts lenders and helps borrowerslenders and helps borrowers

Why interest? Lenders have to be Why interest? Lenders have to be compensated for foregoing current compensated for foregoing current consumptionconsumptionThe real rate of interest The real rate of interest – The nominal or market rate minusThe nominal or market rate minus– The rate of inflationThe rate of inflation

If the nominal rate is If the nominal rate is 5%5% and the rate and the rate of inflation is of inflation is 6%6%, the real rate of , the real rate of interest is interest is %%

Unanticipated inflation hurts Unanticipated inflation hurts lenders and helps borrowerslenders and helps borrowers

Why interest? Lenders have to be Why interest? Lenders have to be compensated for foregoing current compensated for foregoing current consumptionconsumptionThe real rate of interest The real rate of interest – The nominal or market rate minusThe nominal or market rate minus– The rate of inflationThe rate of inflation

If the nominal rate is If the nominal rate is 5%5% and the rate and the rate of inflation is of inflation is 6%6%, the real rate of , the real rate of interest is interest is -1%-1%

InflationInflationPerverse Robin HoodPerverse Robin Hood

HelpsHelps– BorrowersBorrowers– Some businessesSome businesses– Home ownersHome owners

Inflation Inflation Perverse Robin HoodPerverse Robin Hood

HurtsHurts– LendersLenders– Home ownersHome owners– Fixed income Fixed income

earnersearners

Lenders are hurtLenders are hurt

$20.00

$20.00

Lenders are hurtLenders are hurt

$21.00

$21.80

Interest rate = 5%

Inflation rate = 9%

Real Interest rate = -4%

Inflation affects othersInflation affects others

Distorts price signalsDistorts price signals

Those living on fixed incomesThose living on fixed incomes

Businesses with fixed contractsBusinesses with fixed contracts

Property Property owners with fixed leasesowners with fixed leases

Businesses who can raise pricesBusinesses who can raise prices

COLA’s COLA’s

How does Inflation/Deflation How does Inflation/Deflation affect you?affect you?

If your purchasing power increases If your purchasing power increases

as a result of inflation/deflation, you as a result of inflation/deflation, you

win.win.

If your purchasing power falls as a If your purchasing power falls as a

result of inflation/deflation, you lose.result of inflation/deflation, you lose.

Full EmploymentFull EmploymentThe labor forceThe labor force 16 to 65, able and willing to work, working or 16 to 65, able and willing to work, working or

actively seeking workactively seeking work

The unemployment rate – the household The unemployment rate – the household surveysurvey

Number of people unemployedNumber of people unemployed

labor forcelabor force

Change in nonfarm Change in nonfarm payroll employmentpayroll employment

The establishment surveyThe establishment survey

A better but not good indicatorA better but not good indicator

What is the difference between the What is the difference between the number of employees you had last number of employees you had last month and the number you have this month and the number you have this month?month?

Economic GrowthEconomic Growth

Nominal GDP doesn’t tell you Nominal GDP doesn’t tell you anything; it must be “deflated.”anything; it must be “deflated.”

Use the IPD to change nominal to Use the IPD to change nominal to real GDPreal GDP

REAL GDP = REAL GDP = Nominal GDPNominal GDP * 100 * 100

IPDIPD

Economic GrowthEconomic Growth

The rate of economic growthThe rate of economic growth

Real GDPReal GDP22 - Real GDP - Real GDP11

Real GDPReal GDP11

THE CIRCULAR FLOWTHE CIRCULAR FLOW

THE EXPANDED CIRCULAR THE EXPANDED CIRCULAR FLOWFLOW

Total ExpendituresTotal Expenditures

E = C + I + G + (X-M)E = C + I + G + (X-M)

C = Personal consumption C = Personal consumption

I = Business investmentI = Business investment

G = Total government spendingG = Total government spending

(X-M) = Net exports (exports minus (X-M) = Net exports (exports minus imports)imports)

Main PointsMain PointsMacroeconomics investigates the Macroeconomics investigates the relationships between different sectors of relationships between different sectors of the economy and the affect of changes in the economy and the affect of changes in different variables on those sectors. different variables on those sectors. Macroeconomics is the study of market Macroeconomics is the study of market aggregates such as gross domestic aggregates such as gross domestic product, the unemployment rate, and the product, the unemployment rate, and the consumer price index.consumer price index.Three goals for an economy are full Three goals for an economy are full employment, price stability, and economic employment, price stability, and economic growthgrowth

Main PointsMain Points

Inflation is an increase in the overall Inflation is an increase in the overall price level price level

Inflation arbitrarily redistributes Inflation arbitrarily redistributes purchasing power and distorts price purchasing power and distorts price signals.signals.

The real rate of interest is the market The real rate of interest is the market rate minus the rate of inflation. rate minus the rate of inflation.

Main PointsMain PointsTwo measures of the strength of the labor Two measures of the strength of the labor market are the unemployment rate and market are the unemployment rate and the change in nonfarm payroll the change in nonfarm payroll employment.employment.Economic growth is the rate of change of Economic growth is the rate of change of Real GDP for a specific time period, usually Real GDP for a specific time period, usually a year. a year. Economic growth should be strong enough Economic growth should be strong enough to generate employment but not so strong to generate employment but not so strong as to cause inflation as to cause inflation

Main PointsMain Points

The circular flow illustrates the The circular flow illustrates the interdependence of different sectors interdependence of different sectors of the economy.of the economy.

Total expenditures are composed of Total expenditures are composed of consumption, investment, consumption, investment, government, and net exportsgovernment, and net exports

E = C + I + G + (X-M)E = C + I + G + (X-M)

Main PointsMain PointsConsumption is the largest spending Consumption is the largest spending category (2/3 of total spending) in GDP category (2/3 of total spending) in GDP and is affected mainly by income.and is affected mainly by income.Investment is the least stable spending Investment is the least stable spending category and is determined mainly by the category and is determined mainly by the relationship between the cost of borrowing relationship between the cost of borrowing and the expected return on investment.and the expected return on investment.Government spending is fairly predictable Government spending is fairly predictable due to its contractual nature and built in due to its contractual nature and built in stabilizers.stabilizers.