Macroeconomic Goals

• Many issues with regards to the macroeconomic goals can be traced from System Dynamics especially with how there are delays in the real world .

Economic Growth §

• Rapid and sustained economic growth is a relatively recent experience for the human race.

• Slavery-based societies, favorable demographics, global trading routes, and standardized trading institutions that spread with different empires set the stage for the Industrial Revolution to succeed.

• A healthy economic climate usually involves some sort of market orientation at the microeconomic level.

  • Markets that allow personal and business rewards and incentives for increasing human and physical capital encourage overall macroeconomic growth.
  • Economic growth is dependent on the rule of law. Property and Contractual rights need to be protected for markets to run efficiently.

• Economic growth is also dependent on the following based on the Growth Consensus

  • Physical Capital - incudes equipment and land that firms use as well as infrastructure.
    • More physical capital generally means more output
    • An increase in quality or quantity of physical capital induces economic growth.
  • Human Capital - the accumulated knowledge, skills, and expertise that the average worker in an economy possesses.
    • Generally, more humans = more productivity. Hence why we consider per capita for comparisons.
  • Technological Change - a combination of invention—advances in knowledge, and innovation—applying these advances.

• Labor Productivity is the value that each employed person creates per unit input. It is determined by the following: (1) human capital; (2) technological change; (3) Economies of scale.

• The aggregate production function is the technical relationship by which economic inputs are turned to outputs within the entire economy. It can be tied to GDP or GDP per capita

• Productivity growth is tied to GDP per capita

  • It can also be tied to average wages or productivity per hour (monetary value per hour worked). However, this need not be true always (for example, if labor is automated).

• Capital Deepening - the amount of capital (physical or human) increases per person

  • It could be the result of advancements in science and technology, or of better education, training and level of work experience.
  • Capital deepening is generally tied to economic growth. Generally, what is not accounted for by capital deepening is accounted for by technology.
  • While investment in physical capital is essential to growth in labor productivity and GDP per capita, building human capital is at least as important.

• Investing in the capital deepening and market orientation comes through many forms

  • Using education
  • Private investment and low capital gains tax
  • Infrastructure projects to improve infrastructure
  • Special Economic Zones where the government does not tax trade.
  • Investment in scientific research.

• Economic Convergence - a pattern whereby low and middle income countries grow faster than high-income countries.

  • Arguments for convergence:
    • The law of diminishing returns suggests that as an economy continues to increase its human and physical capital, the marginal gains to economic growth will diminish
    • Low-income countries may find it easier to improve their technologies than high income countries. The former can simply apply what the latter has done to great effect.
    • Many countries have observed the experience of those that have grown more quickly and have learned from it.
  • Arguments against convergence:
    • Developing new technology can provide a way for an economy to sidestep the diminishing marginal returns of capital deepening. Improving technology means more output even at the same level of capital.
    • Improvements in technology have not run (so far) into diminishing marginal return
    • Low-income countries adapting technology need not imply economic growth If they lack the appropriate supportive infrastructure, then it is rendered moot

• Economic convergence proceeds slowly ¹. High income countries have already had a head start.

Unemployment §

• Unemployment exists when quantity of labor supplied exceeds quantity of labor demanded.

• We can divide the population into groups based on employment

  • Employed - currently working for pay
  • Hidden Unemployment - the portion in the labor force involved in redundant work with no productivity.
    • Underemployed - the underuse of a worker because a job does not use the worker’s skills, is part-time, or leaves the worker idle.
    • Discouraged Workers - those who have stopped looking for employment
  • Unemployed - out of work and actively looking for a job
  • Out of the labor force - Out of paid work and not actively looking for a job
  • Labor Force - number of employed plus the number of unemployed

• The unemployment rate is calculated as the percentage of the total labor force who are unemployed.

• Several factors are correlated with high unemployment.

  • Historically, being a woman (although this has lessened)
  • Being young
  • Having less education
  • Being a part of a discriminated group.

• We need to treat cross-country comparisons of unemployment rates with care, because each country has slightly different definitions of unemployment, survey tools for measuring unemployment, and also different labor markets

• Lower unemployment rate is not necessarily a good thing and a High unemployment rate is not necessarily a bad thing

  • A low unemployment rate may be failing to account underemployment and lack of job satisfaction among workers.
  • A high unemployment rate in industries that are outdated can be seen as a good thing.

• Hidden unemployment is likely to be higher during periods of high unemployment compared to low unemployment

  • The economic stress and competition for jobs during high unemployment can lead to more individuals withdrawing from the labor force or becoming discouraged.
  • In contrast, a lower unemployment rate generally encourages people to actively seek employment, potentially reducing hidden unemployment.

• The labor force participation rate is the percentage of the population who are eligible for a job and are either employed or unemployed and looking for a job

Recessions §

• Cyclical unemployment- unemployment due to transitioning from a recession to expansion (i.e., following the business cycle) or due to shifts in the demand curve.

• Wages tend to be sticky downward, where they are inflexible and decline very slowly. This can be due to a variety of reasons and hypotheses

  • Due to economic laws and regulations (i.e., minimum wage or wage contracts)
  • Implicit contracts between employer and employee, where the employer will try to keep wages from falling when the business is weak and the employee will not expect huge salary increases when the business is strong
  • Efficiency Wage Theory - worker productivity depends on pay so employers pay employees more than what market conditions dictate. Employers also do not hire additional workers due to increased costs and marginal returns. Instead, they avoid wage cuts.
  • Adverse Selection of Wage Cuts Argument - if an employer reacts to poor business conditions by reducing wages for all workers, then the best workers, those with the best employment alternatives at other firms, are the most likely to leave. Most firms therefore prefer layoffs than wage cuts to retain workers.
  • Insider Outsider Model - those already working for firms are insiders, while employees are for a brief moment outsiders. Cutting wages will alienate the insiders and damage its productivity.
  • Relative Wage Coordination Argument - if most workers were hypothetically willing to see a decline in their own wages in bad economic times as long as everyone else also experiences such a decline, there is no obvious way for a decentralized economy to implement such a plan

• Wages can also be sticky upward but this tends to arise in low-skill markets where employers can avoid raising wages due to insufficient competition.

• Sticky wages result in short-run or long-run unemployment due to supply and demand.

  • Gaps created in shifts of demand and supply from an old equilibrium constitute unemployment.
  • A shift means that for the same price more workers would want to offer labor than what firms are willing to pay for.
  • A decrease in demand for labor means that actual wages do not adjust quickly enough to market wages. So people are not admitted at the current wage because it is more than what firms want to hire.

Normal Economic Times §

• Natural Unemployment Rate - it is the unemployment rate that would result from the combination of economic, social, and political factors that exist at a time, assuming an economy that is neither booming or receding.

• Frictional Unemployment - unemployment due to firms closing (whether due to being outdated, bad decisions, or shifts in consumer preference) and workers not being immediately hired

  • There is a delay between being fired from a failing firm and being hired in a new firm
  • The extent of frictional unemployment depends on the laborer’s knowledge of alternatives and their willingness to pursue these alternatives.

• Structural Unemployment - due to individuals not having jobs because they lack skills valued by the labor market.

  • This is either because they never learnt these skills or because demand shifted from skills they do have.
  • Education is the key to minimizing this.

• An economy is at full employment when the actual unemployment rate is equal to the natural unemployment rate.

  • When the economy is at full employment, real GDP is equal to potential GDP.
  • When the economy is below full employment, real GDP is below the potential GDP
  • When the economy is above full employment, real GDP is above the potential GDP, although this is only possible for a short while since laborers require rest.

• Adjustments of wages to productivity levels will not happen quickly or smoothly It is also difficult to measure productivity. This means that for brief periods of time when demand shifts, there is unemployment.

  • In general unexpectedly low productivity = higher unemployment and vice versa.
  • Over time, this stabilizes and wages will adjust to reflect productivity levels.

• Public policy can influence the natural rate of employment.

  • Policies that assist the unemployed can affect how eager people are to find work.
  • Policies that offer long-term support provide less incentive for the unemployed.
  • The presence of unions can affect a firm’s willingness to hire.
  • Bureaucratic procedure, and regulation for expansion or layoffs may disincentivize businesses to hire.

• Some other factors that can lower the natural rate of unemployment.

  • Information technology that has been disruptive and allowed for greater productivity
  • The temporary worker industry (i.e., contractual workers)
  • Aging demographics.
  • More prevalent laws and regulations.

Inflation §

• Deflation - time when the buying power of money is increased.

  • Deflation marks falling prices and a recession under way.
  • Deflation makes it difficult for monetary policy to address a recession since banks cannot make nominal interest rate negative and so the effective interest rate is stuck at the deflation rate, which means more borrowers default on their loans

• Stagflation - a period with a stagnant economy with high unemployment and inflation

• Hyperinflation - an outburst of high inflation.

• Inflation has less of an economic impact when all prices end up increasing since relative to each other, the purchasing power is the same as it was before

  • Inflation becomes bad when the rate of price increases across sectors (and especially for wages) is out of sync.
  • It also becomes bad because of delays because it can lead to problems.
    • Unintended redistributions which hurt those who have a lot of cash or financial assets whose nominal returns do not keep up with inflation. Conversely, it helps those with few cash or such assets. Inflation makes economic reward and penalties feel more arbitrary and unfair.
    • When interest rates are fixed, rises in the rate of inflation tend to penalize suppliers of financial capital

• Inflation means that we perceive price signals more vaguely — making it harder to gauge demand and supply and react accordingly.

• Interest makes long-term planning difficult because we must consider the uncertain effects of inflation in the distant future.

• The impact of inflation is dependent on how much it is changing. Low inflation rates is rarely a problem.

• Moderate inflation may (arguably) make wages less sticky

Adjusting for Inflation §

• A quantity is indexed if it adjusted for inflation.
• Measures can be taken to use indexed quantities
  • Unions can negotiate cost-of-living adjustments that guarantee their wages keep up with inflation.
  • Contracts may also have quantities which may adjust according to inflation
  • Many government programs are indexed to inflation. Taxes also rise with inflation to make it easier to keep track of what people owe.
• Indexing is always partial since not everyone will implement indexing nor will everyone trust that a quantity will be indexed.

Links §

• Shapiro, MacDonald and Greenlaw - Ch. 20 - 22
• Macroeconomic Policy

Footnotes §

1. This is due to delays but at the same time lack of paradigm shifts to constitute a big enough change to the system. ↩