Main ideas of
Macroeconomics
Introduction
• 3 main ideas, output, money and
expectations. They have relationships
between them.
• Macroeconomic theory provides us with a
baseline against which to compare and
assess reality and, more broadly, with a
framework for understanding economic
events.
Introduction
• The basic principles and relationships
help to shed light on a surprisingly broad
range of things, many of which shape the
business environment and affect the
relative risks and rewards of decisions
that all of us make every day.
Output
• The goods and services produced in an
economy.
• Determines a countries level of prosperity
• Gross domestic product.
• GDP = the total value of all final goods
and services produced in a country in a
given year
Money
• Money is critical for facilitating the
exchange of goods and services within an
economy.
• influences interest rates, exchange rates,
and inflation
• An increase in money supply decreases
interest rates, causes the exchange rate
to depreciate, and increases inflation
Money – Nominal and Real
• Nominal values are measured in terms of
current market prices, whereas real
values are measured in terms of constant
prices and thus reflect underlying
quantities, after controlling for inflation.
• A 5 percent increase in real GDP, for
example, means that output—the factor
that macroeconomists most care about—
has increased by 5 percent, regardless of
the inflation rate.
Money Supply
• A central bank's primary tools for
influencing the money supply are the
discount rate, the reserve requirement,
and open market operations e.g. buying
and selling government bonds on the
open market.
• Inflation targeting
Tools of Central Banks
• Open market operations are the principal tool
used by the Federal Reserve to implement
monetary policy. They are a powerful and
flexible means of fostering conditions in the
federal funds market that are consistent with
policy objectives.
• http://www.federalreserve.gov/monetarypolicy/b
st_openmarketops.htm
• https://www.ecb.europa.eu/ecb/educational/eco
nomia/html/index.en.html
Expectations
• Expectations can literally drive reality—
particularly in the short run.
• If individuals and firms expect inflation,
they may actually create it by
preemptively demanding wage and price
increases.
• Negative expectations can prove
particularly brutal when they relate to the
economy as a whole.
Expectations
• If business managers suddenly become
pessimistic about future demand, they
might prepare for "bad times" by canceling
investment projects and laying off
workers.
• Many productive resources are thrown out
of work
• Real GDP falls, unemployment rises, and
prices tend to decline.
Managing expectations
• Great Depression, real GDP had fallen sharply
and unemployment increased rapidly
• Keynes recommended aggressive deficit
spending (expansionary fiscal policy)
• Large deficits would create new demand for
goods and services and, as a result, would lead
people to revise their expectations upward. As
consumers and business managers became
more confident, they would increase their own
expenditures, helping the economy.
Expectations
• Another idea is that by cutting
expenditures the government can create
confidence in their economy and increase
investment.
• By credibly committing to fight whenever it
appears, central banks can help kill off
inflationary expectations.
Conclusion
• Economic relationships that seem perfectly
compelling in theory do not always hold in
practice. To give just two examples: interest
rates do not always fall when money supply
rises, and stagnant economies don't always
improve in response to deficit spending.
• When interpreted well the basic principles of
macroeconomics—which draw connections
between output, money, and expectations—can
prove enormously helpful