Macroeconomics for Everyone (I)
by Sher Mehta
What is macroeconomics?
Simply put, macroeconomics is that branch of economics that focuses on the economy (how it works) as a whole and its behavior or understanding the functioning of an economy by analyzing how national income/output, inflation and employment are determined, what causes fluctuations in these aggregate variables in the short run and what creates or determines economic growth in the long run.
Macroeconomics for the short run and long run
Traditionally, macroeconomics has been divided into the short run and the long run. In macroeconomics for the short run (my area of core competence), the focus is on determination of national income/total output, aggregate or overall price level and employment, measuring the economic performance of an economy (the three key economic indicators for this purpose are changes in the rate of growth of output, inflation and unemployment), understanding and analyzing fluctuations in economic activity or output (along with fluctuations in other important macroeconomic variables such as unemployment, exchange rates, interest rates and so on) – termed as ‘business cycles’ – causes of such fluctuations and macroeconomic policies (monetary and fiscal policies) that are devised in an economy to smoothen these fluctuations (as they affect macroeconomic stability). The concepts of demand and supply are used to analyze output and price level in an economy and changes or fluctuations in the same (I will explain these two concepts later in subsequent posts).
In macroeconomics for the long run, the focus is on long run economic growth and the factors and policies that determine it. The macroeconomic policies that seek to enhance long run economic growth in an economy focus on maximizing supply of output with price stability and full employment in the long run or over time spanning decades.
My focus is on macroeconomics for the short run.
Having stated the above, I wish to make you aware of some key questions (stated below) that you need to keep in mind, while attempting to understand the macroeconomic environment or trying to make sense of the economic events/developments happening around you. Once you grasp the basic concepts of macroeconomics required for such purposes through my posts, you should be able to comprehend the importance of these questions and obtain relevant information in order to come up with satisfactory answers to these questions. Don’t worry if you don’t understand or can’t fully comprehend these questions at this stage.
How is my economy performing and how sound has its economic performance been in the recent past (1-3-5 years) in terms of growth rates of aggregate output, inflation and unemployment and what explains changes in the same during this period?
What is and has been causing fluctuations in consumption, investment and net exports in the recent past (1-3-5 years) in my economy and what have been their growth rates over the same period? Has the growth during this period been consumer, investment or export led or driven?
Are interest rates in my economy high or low and how do they compare with the interest rates in the recent past (1-3-5 years) and in what way are they influencing current domestic economic activity and demand for loans? Further, what has been the recent impact of interest rates on household debt, corporate debt, public or government finances and household disposable incomes in my economy?
What is and has been the relationship between inflation and unemployment in my economy in the recent past (1-3-5 years)?
What is and has been the state of public or government finances in my economy in the recent past (1-3-5 years) and size of fiscal deficit if any?
What monetary and fiscal policy measures are being taken to stabilize fluctuations in economic activity in my economy and enhance its growth rate and how effective have these policies been in the recent past (1-3-5 years)?
Have any demand side (for example, the recent global financial crisis) and/or supply side (for example, surge in oil prices) shocks buffeted my economy very recently or in the recent past (1-3-5 years) and how has it affected output, inflation, unemployment, consumer and business confidence, financial sector and lending/credit via the banking sector and financial markets?
Does my economy have a growing current account deficit, a depreciating currency and is it prone to massive capital outflows, due to external actions such as the stance of monetary policy in other major economies, which can undermine domestic macroeconomic stability and fuel inflationary pressures?
What reforms are being undertaken to boost business fixed investment in my economy or have been taken in the recent past (1-3-5 years) which bolster both current growth and the productive capacity of an economy?
What is and has been the ratio of gross fixed investments and gross domestic savings to GDP in my economy in the recent past (1-3-5 years)?
What is the current state of the global economy, commodity and financial markets and what are the major current global macroeconomic developments and how are they influencing output, inflation, unemployment and exchange rates in my economy? Further, what has been the state of the global economy in the recent past (1-3-5 years) and how has it impacted or affected my economy?
What are the levels of household, corporate and external debt in my economy and do they pose a threat to the rate of growth in the short run or macroeconomic stability?
Is my economy an attractive destination for foreign direct investment and how much foreign direct investment has taken place in the recent past (1-3-5 years)?
Having stated the aforesaid questions, I have given below a brief explanation of the types of economies that exist (in reality) in the world today. Knowing the type of economic system that exists in your economy is important, as this has an important influence on the macroeconomic environment, performance and development of an economy, and the economic fluctuations it faces in the short run.
Type of economies:
Basically, in reality, there are two types of economies:
Mixed economies: which are economic systems that include both private enterprise and a degree of government control or intervention or involvement, which varies from country to country. In reality, there is no economy in the world that can be called a ‘free market’ economy, where all economic decisions are made by the private sector and there is no government intervention or involvement in the economy. Some mixed economies are ‘market oriented,’ while a few others are becoming more ‘market oriented’ and are termed as ‘emerging’ economies. The rest of the mixed economies are economies which can’t be categorized as ‘emerging’ and such developing economies have demonstrated economic performance that leaves much to be desired or is highly dismal or appalling.
Centrally planned economies: in such economies, the state controls all the factors of production (land, labour and capital) and allocation of resources. What to produce, how to produce and in what quantities to produce is all decided by the state through the mechanism of central planning.
Market oriented economies are actually mixed economies where the forces of demand and supply or market forces predominantly determine the price level and drive most economic activities with reference to production, distribution, consumption, investment and trade (basically most decisions are make by the market), and government intervention, ownership or involvement is modest. The best example of such an economy is the US. Another excellent example is Singapore. Few other examples are UK and other Western European countries, Japan, Canada and Australia, however the government plays a larger role in these economies than in the US. In such economies, market forces play the leading role in allocation of resources and ownership of productive assets is mostly with the private sector, rather than the public sector.
Next, there are mixed economies across the globe which are becoming more market oriented and are gradually liberalizing, to enhance their economic growth and integration into the world economy. Such economies (known as ‘emerging’ economies’) have been undertaking reforms and restructuring themselves to reduce the role of undue government intervention in economic activity or state led development and seek to considerably enhance the role of market forces in decisions pertaining to setting of prices, production, distribution, consumption, investment, trade and allocation of resources, increase private ownership of productive assets and expand their financial sector, in order to engender more dynamism in their economies and achieve higher rates of growth and full economic potential. Examples of such economies are Brazil, India, Russia, Mexico, South Africa, Nigeria, Indonesia, South Korea, Mexico etc.
China too is an example of such an economy today. At one time it was a centrally planned economy. By virtue of gradual, yet sustained, economic reforms, the market mechanism in this country plays a much greater role. The public and private sector co-exist in this economy, however, the public sector is still dominant in China.
There are other economies, which though mixed, do not come in the category of emerging economies and have demonstrated continued macroeconomic mismanagement and the state of such economies is worrying or appalling. Examples of such countries are Zimbabwe, Ghana, Liberia etc.
One of the only centrally planned economies that exist today is North Korea.
Having briefly stated the types of economies that exist in the world today, I am now closing this post. Please be on the look out for my next post after two weeks.
Disclaimer: The information, material or knowledge contained here and prepared by me is intended to provide general information on macroeconomics and other related topics and not an exhaustive treatment of the same. Users of such information, material or knowledge contained here so at their own risk. I will not be responsible for any personal, professional or business loss sustained by any person who relies on what is stated here on this site.