Macroeconomics

What is Macroeconomics? Macroeconomics (from prefix "macr(o)-" meaning "large" + "economics") is a branch of economics that deals with the performance, structure, and behavior of an economy as a whole.

Aggregate Demand Aggregate demand shows the total (or aggregate) demand for final goods and services at a range of prices during a stated period of time. Aggregate demand for an economy is divided into the following components: consumer(consumption), investment, government and net exports (exports minus imports). Changes in any of these components will cause the aggregate demand curve to change.

Aggregate Supply Aggregate supply shows the total (or aggregate) production of final goods and services available at various price levels during a stated period of time. The aggregate supply curve can increase or decrease for several reasons: As population or productivity increases, aggregate supply increases; that is, at every given price level for outputs, firms will produce a greater total quantity of goods and services. Higher prices for inputs such as labor or oil cause aggregate supply to decrease; because, firms will produce a lesser quantity of total output for every given price.

BUDGET DEFICITS AND PUBLIC DEBT Each year, the government collects tax revenues and makes expenditures. If taxes collected exceed government expenditures in a given year, the government has a budget surplus. If taxes collected are exactly equal to expenditures in a given year, the government has a balanced budget. If taxes collected are less than the money spent in a given year, the government has a budget deficit. When a budget deficit occurs, the government borrows the money that it needs to finance its expenditures. For example, the U.S. government borrows by issuing Treasury bonds.   Public debt refers to the total accumulation of all the annual government deficits and/or surpluses from years past. For example, imagine that at some point in time, the government has no outstanding debt. Then, in the next three years, it has a budget deficit of $100 in the first year, a budget surplus of $50 in the second year and a budget deficit of $80 in the third year. Total public debt would be $130, which is the sum of the yearly deficits and surpluses. Public debt is sometimes called government debt held by the public or just government debt.

Economic Growth Economic growth refers to the ability of the economy to increase its total real output or real GDP, or its real output per person. Sources: improvements in the education, experience and skill level of the workforce (human capital); greater amounts of physical capital/capital goods (plant and equipment per worker); and improved technology. Economic growth is critical to job-creation and economic well-being. Economic growth slows down as the economy approaches its peak and becomes negative as it goes into recession. Economic growth becomes positive as it begins its recovery.

Fiscal Policy Fiscal policy refers to how government taxing and spending policy can be used to influence the economy. Fiscal policy can be used to reduce the extremes of recession and inflation by increasing aggregate demand through some combination of tax cuts and/or spending increases. If an economy is suffering inflation, then a contractionary fiscal policy can reduce aggregate demand through some combination of tax increases and/or spending cuts.

Federal Reserve System The Federal Reserve System (also known as the Federal Reserve, and informally as the Fed) is the central banking system of the United States. A regional structure with 12 districts Subject to general Congressional authority and oversight – although it functions somewhat independently. Operates on its own earnings

Current Functions of the Fed: To address the problem of banking panics To serve as the central bank for the United States To strike a balance between private interests of banks and the centralized responsibility of government : To supervise and regulate banking institutions To protect the credit rights of consumers To manage the nation's money supply through monetary policy to achieve the sometimes-conflicting goals of : maximum employment stable prices, including prevention of either inflation or deflation moderate long-term interest rates To maintain the stability of the financial system and contain problems that arise in financial markets To provide financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation’s payments system To facilitate the exchange of payments among regions To respond to local liquidity needs To strengthen U.S. standing in the world economy

Three part structure of the Fed: Board of Governors Federal Open Market Committee Federal Advisory Council 7 members serving staggered 14-year terms Appointed by the U.S. President and confirmed by the Senate Oversees System operations, makes regulatory decisions, and sets reserve requirements The System's key monetary policymaking body Decisions seek to foster economic growth with price stability by influencing the flow of money and credit Composed of the 7 members of the Board of Governors and the Reserve Bank presidents, 5 of whom serve as voting members on a rotating basis Research arm of the Federal Reserve System. 12 district presidents Provides updates regarding economic issues in 12 districts.

The Fed: Ben Bernanke is the current chairman of the Board of Governors, the main governing body of the Federal Reserve Bank.

Fed district locations:

Federal Reserve Banks of Atlanta: Atlanta is district 6 Identifying letter on currency- F Subsidiary banks locations: Birmingham, Alabama Jacksonville, Florida Miami, Florida Nashville, Tennessee New Orleans, Louisiana

Monetary Policy Monetary policy is the set of policies enacted by the Federal Reserve Bank that control the rate at which the money supply in an economy expands, and thus causes interest rates to rise or fall. Recession: expansionary monetary policy is used, when the Fed seeks to reduce interest rates by expanding the supply of money in the economy. In turn, the lower interest rates will encourage additional aggregate demand for consumption and investment, and thus help shorten or end the recession. Inflation: during this period , monetary policy is implemented that seeks to raise interest rates by contracting (or reducing the rate of growth in) the money supply.

The three tools of the Fed: Open Market Operations Reserve Requirement Discount Rate Buying and selling government bonds. When the Fed buys bonds, it increases the amount of money in the economy; when the central bank sells bonds, it reduces the amount of money in the economy. The percentage of deposits that banks are required to hold and not lend out. A higher reserve requirement reduces the money supply by limiting bank lending; a lower reserve requirement increases the money supply by increasing bank lending. The rate charged by the central bank if individual banks wish to borrow funds. A higher discount rate reduces the money supply while a lower discount rate increases the money supply.

Business Cycle Contraction - When the economy starts slowing down. Trough - When the economy hits bottom, and generally stagnates at a low level. Expansion - When the economy starts growing again. Peak - When the economy is in a state of extreme growth. Recession can be measured with statistics like a reduced GDP, higher unemployment, a decline in industrial production and lower sales.

Gross Domestic Product GDP is the total market value of all final goods and services produced within a country, usually measured over a year. GDP is the most inclusive measure of an economy's output. Nominal GDP measures the output of goods and services in current prices while real GDP measures the output of goods and services in constant (adjusted for inflation) prices. Intermediate products are not counted. Second hand sales are not counted. Only goods/services that have are brand new. Per capita GDP is calculated by dividing GDP by the population and it is useful for making comparisons between countries with different population levels or at different points in time. For example, the GDP of China is much higher than that of Switzerland, because China has so many more people, but the per capita GDP of Switzerland is much higher than that of China.   Potential GDP is the level of output when non-labor resources are fully employed. Even if the economy has reached its potential GDP, there will still be people unemployed, and this is called the natural level of unemployment.

INFLATION Inflation is an increase in the average price level in the economy. A positive rate of inflation represents an average price increase for the goods and services in the economy. The Consumer Price Index (CPI) is a measure of inflation that tells how much the price of a representative bundle of goods and services purchased by consumers has increased. The GDP deflator is a measure of inflation that tells how much the price of all goods included in GDP has increased. GDP formulas: GDP = C+I+G+NX GDP = C+I+G+F GDP = C+I+G+Xn

Nominal vs. Real An economic variable expressed in nominal terms uses the prices that applied at that particular time. For example, the nominal GDP of the U.S. economy in 2000 was $9.8 trillion; the price of a gallon of gasoline in the United States in 2000 was $1.50 per gallon; and the interest rate charged by banks to their most trustworthy borrowers in 2000 was 9.2 percent.   In contrast, an economic variable expressed in real terms is adjusted for the effects of inflation. Adjusting economic variables from nominal to real terms is commonly done to facilitate comparisons between different points in time. For example, the U.S. GDP in 1990 was $5.8 trillion. The nominal U.S. GDP in 1990 is expressed in the dollars prevailing in 1990, while the nominal U.S. GDP in 2000 is expressed in the dollars prevailing in 2000. But because of inflation between 1990 and 2000, a dollar was worth less in 2000 than in 1990. If the nominal U.S. GDP in 1990 was expressed in terms of the dollars in 2000, it would need to be increased by 32 percent to account for inflation--from $5.8 trillion to $7.6 trillion. Thus, the real increase in GDP from 1990 to 2000 is a rise from $7.6 trillion (the 1990 GDP expressed in year 2000 dollars) to $9.8 trillion (the 2000 GDP expressed in year 2000 dollars).

Nominal v. Real (continued) Similarly, the price of gasoline in 1990 was about $1.20 per gallon. With 32 percent inflation between 1990 and 2000, the nominal price of gasoline in 1990, expressed in year 2000 dollars, would be $1.58 ($1.20 x 1.32). By this measure, even though the nominal price of gasoline at $1.50 a gallon in 2000 was higher than in 1990, the real price of gasoline was lower in 2000 than it was in 1990. To calculate a real interest rate, after adjusting for inflation, use the formula: real interest rate = nominal interest rate - rate of inflation. In 2000, for example, the rate of inflation in the U.S. economy was 3.4 percent. Thus, the real interest rate was 9.2 percent - 3.4 percent = 5.8 percent. A loan is repaid in the future, so if inflation exists, the dollars used to repay the loan are worth less than the dollars that were originally loaned out.