A macroeconomics policy is to improve the welfare of much or all of a nation's population must pursue goals that have achieved some general consent. Macroeconomics goals on which policymakers and the public generally agree include:
- Full and stable employment
- Price stability
- High and rising incomes
Attaining these goals is no simple matter because of the economic cost of unemployment and the groups that bear the unequal burdens of unemployment, the GNP gap, inflation. What is more, due to measurement is important in macroeconomics, for inaccurate or misleading measures can distort the statistics on which government policy decisions are based. Among the many ways of measuring macroeconomics activity, the most important are:
- Gross national product, a measure of overall national production.
- National personal and disposable income, measures of consumer buying power before and after taxes.
- The unemployment rate, a measure of people's inability to find work.
- The consumer price index, a measure of the change in the general price level.
The GNP gap and state Okun's law
Though there are many ways of measuring the nation's general level of economic activity, the one used most often in developing government policy, and cited most often in the news media, is the gross national product (GNP). Gross national product (GNP) is the current market value in dollars (or other currency) of all final goods and services produced in the economy in a given period. Certain keywords in definition must be stressed. First, national production is measured in terms of current value, which means current market prices. Market prices sometimes overstate, and sometimes understate, the intrinsic value of goods. To that extent, GNP may be distorted as a measure of general social welfare. GNP also includes the social "bads" that result from production, such as pollution and congestion, as well as goods designed to remedy them.
Second, only final goods and services are included in GNP. Final goods and services are those goods and services that are purchased for consumption rather than for further processing or resale. That is, GNP excluded the dollar value of intermediate goods used in the production process. Intermediate goods and services are goods and services that are
purchased for further processing or resale. If intermediate goods were included in GNP, the total value of the nation's production would be vastly overstated. All intermediate goods would be counted at least twice – once when they are sold to be used in the production of final goods and again when the final products are sold.
Consider the intermediate good wheat, for instance. Wheat is used to make flour, an intermediate good used to make bread. The table below shows sales prices of given quantities of wheat, flour, and bread. If we add the value of all three transactions, our measure of total economic activity will be €600.
Wheat sold to the miller €100
Flour sold to the baker €200
Bread sold to the consumer €300
Total €600
But this procedure counts the value of the wheat three times: once by itself, once as part of the flour, and once as the bread. Because the value of the bread includes the value of the wheat and flour as well, total production can be measured by the market value of final product alone – the bread.
Furthermore, if intermediate goods were included in GNP, that measure would change with change in the structure of an industry. For example, if wheat production, flour milling, and baking were later consolidated into one firm, our measure of total economic activity would fall from €600 to €300. Yet economic activity would not have changed. the farmer and miller would still be producing their products. But because they were now parts of a single firm, no market value would be attached to their activities.
So the GNP "gap" arises as the gross national product includes only final goods and services that are bought and sold in the market. Because nonmarket activities are excluded, trends in GNP may not accurately reflect changes in social welfare. Moreover, some people are trying to evade taxation and build so-called underground economy. Even the value of today's worker's great leisure time is not reflected in GNP. The negative value of the by-products is not subtracted from the gross national product.
In economics, Okun's Law, named after economist Arthur Okun (1928 – 1980) describes a relationship between the change in the rate of unemployment and the difference between actual and potential real GDP. In the United States during the period since 1965 or so, Okun's Law can be stated as saying that for every one percentage point by which the actual unemployment rate exceeds the "natural" rate of unemployment (non – accelerating inflation rate), there is a 2.5 percent "GDP Gap".
Inflation
Economic problems, like smugglers, have no respect for international boundaries. In the 1980s, unemployment and inflation afflicted most of the industrialized world, as shown in the accompanying table.
Compared with previous experience since World War II, unemployment rates have been high. For example, in 1969, West Germany's unemployment rate was only 0.9 percent, as compered with 7.2 percent in 1987. But after various historical changes and independent those rates have changed significantly Germany unemployment rate from 1987 to 2005 raised also as inflation rate as shown in the table.
A comparison of the U.S. unemployment rate with that shows 1987 unemployment rate become lower in 2005. To some extent, these international differences in unemployment rates are due to the fact that unemployment is defined differently in one country than in another. In some countries, to be counted as unemployed, you must register with government unemployment exchanges. Another reason for the international differences in unemployment rates is that institutional and cultural arrangements differ from country to country. In Japan many large firms commit themselves to a policy of lifetime employment for workers. this is one reason for Japan's relatively low unemployment rates.
As for the rate of inflation, the accompanying table shows that the price level increased at a slower rate during 2005 than during 1978 in all of these countries. United Kingdom performance seemed better than in some of the other countries, although it was not as good in this regard as in Germany or Japan. But a 4 percent annual rate of inflation is high, relative to 25 years more. Many economists, and citizens as well, would be glad to return to the days when the price level seldom rose at more than a couple of percentage points per year – and unemployment rarely exceeded 4 or 5 percent.
Unemployment and Inflation rates in seven countries
| |
Unemployment rate |
Inflation rate |
| 1978 |
1987 |
2005 |
1978 |
1987 |
2005 |
| United States |
6.0 |
6.2 |
5.1 |
7.6 |
4.4 |
3.2 |
| Canada |
8.4 |
8.9 |
6.8 |
9.0 |
4.4 |
2.3 |
| France |
5.5 |
11.1 |
10.0 |
9.2 |
2.7 |
1.9 |
| Germany |
3.4 |
7.2 |
11.6 |
2.7 |
0.3 |
2.0 |
| Italy |
3.5 |
6.3 |
7.9 |
12.2 |
6.1 |
1.9 |
| Japan |
2.3 |
2.8 |
4.3 |
3.9 |
0.6 |
-0.2 |
| United Kingdom |
6.1 |
10.0 |
4.7 |
8.3 |
4.1 |
2.2
|
Two types of cost-push or supply – side inflation
To begin distinguish two types of supply – side inflation it is very important to look at supply-side economics. In the late 1970s and 1980s, some economists advocated tax reductions in order to stimulate national output. Their views came to be known as supply-side economics, and received considerable attention when some of them received high-level post in the Reagan administration. They played an important role in formulating and helping to push through the very large tax cut passed in August 1981.
Tax reduction on labor income. The supply-siders advocated cuts in taxes on labor income on the grounds that people will work longer and harder. Many economists are skeptical of this proposition. The available evidence seems to indicate that the hours worked by prime-age males would not be married women seems more responsive to changes in tax rates. (If the marginal tax rate is high, some women feel that it is not worthwhile to take a job outside their home.
Tax reduction on capital income. The supply-siders also advocated reductions in taxes on capital income. For example, they called for cuts in taxes on dividends, interest income, and capital gains. In their view, such cuts would encourage additional saving. Although economists agree that saving and investment tend to promote the growth of an economy, there is considerable controversy over the extent to which saving is influenced by tax cuts. Early studies of consumption and saving found saving behaviour to be relatively insensitive to changes in the rate of return that savers receive. (That is, if people can obtain a 15 percent annual return from their savings in banks and elsewhere, they may not save much more than if they can obtain only 10 percent.)
Demand-pull inflation occurs when aggregate demand for goods and services in an economy rises more rapidly than an economy's productive capacity. One potential shock to aggregate demand might come from a central bank that rapidly increases the supply of money. The increase in money in the economy will increase demand for goods and services from D0 to D1. In the short run, businesses cannot significantly increase production and supply (S) remains constant. The economy's equilibrium moves from point A to point B and prices will tend to rise, resulting in inflation.
Costs and benefits for various groups from unanticipated inflation
One of the basic ideas in economics is as follows:Because all money incomes do not go up at the same rate as prices, inflation results in an arbitrary redistribution of income. People with relatively fixed income, lenders and savers tend to be hurt by it, and major inflation tend to cripple total output as well.
Fixed money incomes. Inflation may seem no more than a petty annoyance; after all, most people care about relative, not absolute prices. For example, if the Howe family's nominal income increases at the same rate as the price level, the Howe family may be no better or worse off under inflation than if its nominal income remained constant and no inflation occurred. But not all people are as fortunate as the Howes. Some people can not increase their wages to compensate for price increases because they work under long-term contracts, among other reasons. These people take a considerable beating from inflation.
One group that tends to be particularly hard by inflation is the elderly. Old people often must live on pensions and other relatively fixed forms of income.
Lenders. Inflation hurts lenders and benefits borrowers, since it results in the depreciation of money. A euro (or other currency) is worth what it will buy, and what it will buy is determined by the price level. If the price level increases, a euro is worth less than it was before. Consequently, if you lend Bill Dvorak € 100 in 2006 – when a euro will buy much less in 2013 – you are losing on the deal. In term of what the money will buy, he is paying you less than what he borrowed. Of cause, if you anticipate considerable inflation, you may be able to recoup by charging him a high enough interest rate to offset the depreciation of the euro, but it is not easy to forecast the rate of inflation and protect yourself.
Savers. Inflation can have a devastating and inequitable effect on savers. the family that works hard and saves for retirement (and a rainy day) finds that its savings are worth far less, when it finally spends them, than the amount it saved. Consider the well-meaning souls who invested $1,000 of their savings in United States savings bonds in 1939. By 1949, these bonds were worth only 800 1939 dollars, including the interest received in the 10-year period. Thus these people had $200 taken away from them, in just as real a sense as if someone had picked their pockets.
Those who stand to lose from inflation include: holders of demand and savings deposits; creditors; bond buyers; businesses and workers tied to long-term price and wage agreements, and taxpayers.
Possible effects of inflation on output and employment
Creeping inflation, unlike unemployment, does not seem to reduce national output; in the short run, output may increase, but, although a mild upward creep of prices at the rate of a few percent per year is not likely to reduce output, a major inflation can have adverse effect on production. For one thing, it encourages speculation rather than productive use of savings. People find it more profitable to invest in gold, diamonds, real estate, and art (all of which tend to rise in monetary value during inflation) than in many kinds of productive activity. Also, businessmen tend to be discouraged from carrying out long-range projects because of difficulty of forecasting what future prices will be. If the rate of inflation reaches the catastrophic heights that prevailed in Germany after World War I, the monetary system may break down. People may be unwilling to accept money. They may insist on trading goods or services directly for other goods and services. The result is likely to be considerable inefficiency and substantially reduced output.
If expenditure is very low, this means that economy will operate in Range A, where national output is far below its maximum. Because the low level of expenditure means a low level of demand for the nation's goods and services, firms can not sell enough goods and services to make it profitable to hire many of the workers who want to work.
Thus employment is low, and the unemployment rate is high. As for the inflation rate, it is low, since there are plenty of excess capacity and unemployed resources. It is no time to raise prices. Under these circumstances, suppose that an increase occurs in the total level of spending. National output and employment will rise, and the employment rate will fall, but there will be little or no increase in the price level since output can be increased without bidding up the prices of labor and other inputs. When the level of expenditure increases to the point where output and employment are in Range B, the unemployment rate will be substantially lower than in Range A, but the price level will begin to rise. Why? Because bottlenecks occur in some parts of the economy, and labor pushes harder for wage increases (and firms are more willing to agree to such increase).
Finally, if the level of spending increases to the point where output and employment are in Range C, there will be no further decreases in the unemployment rate, since national output, which has reached its maximum, can grow no longer. In this range, the rate of inflation is very high, since total spending far exceeds the value of national output at initial prices. There are "too many dollars chasing too few goods."
Under the circumstances shown in (10), the inflation rate is likely to increase as output and employment increase – which means that it is likely to increase as unemployment decreases. Thus some economists maintain that there is likely to be an inverse relationship between the unemployment rate and inflation rate, at least in the short run.
The cost of inflation are widely recognized, and often exaggerated. When people think about inflation, they tend to consider only the reduction in the purchasing power of their used currency. They often fail to recognize that their wages rise along with prices during inflationary times. But people both gain and lose from inflation. Indeed, if it benefited no one and hurt everyone, including government, the political opposition to inflation would probably be overwhelming.
Because government and some segments of population benefit from rising prices, inflation is difficult to stop once started also as it is impossible to employ all population.
