This chapter explains what macroeconomics is and what are the main issues it tries to solve.
The major points in the chapter are:
The Greatest Challenge Today
In 2018, the greatest challenge to the American economy is the sluggishness of the recovery from the Great Recession of 2007–2009. That recession of 2007 to 2009 caused unemployment for over 14 million people. (A recession means a significant decline in economic activity across the entire economy. It can last from a few months to many years.) The financial crisis of 2008 witnessed all of the largest banks on the verge of bankruptcy and the whole system on the verge of collapse.
In addition to over 20 million people fully or partly unemployed, the wealth and income of Americans took a terrible blow. In just three years, from 2007 to 2010, the average American family lost 39% of its wealth. Lost wealth means houses worth less, the value of stocks and therefore most people’s retirement accounts shrinking. In just three years of decline, the wealth of the typical American fell back to the level of almost 20 years earlier (the 1992 level). The losses hit all groups in the economy, but the rich managed to regain the same level of wealth by the end of those years.
Moreover, the median employee suffered an 8% decrease in wages and salaries he or she took home, falling to $45,600 a year (Mui, 2012, citing data from a Federal Reserve report).
What Is an Economy?
The economy is the activity in which people produce food, clothing, shelter, education, health care, and recreation. In other words, the economy is all the actions that produce goods and services to satisfy human needs and desires.
These usual economic activities were depressed in the Great Recession, from 2007 through 2009. Furthermore, the recovery of 2009 to 2015 was very weak. During the period of recovery which began in June of 2009, it took close to five years for the jobs lost in the Great Recession to be regained. Unfortunately, during that period, the population grew so that the percentage of the working age population with a job remained below its previous high. (This was even true in 2018.) Some economists consider the recession and weak recovery just the beginning of a long period of stagnation. Some even have used the term depression.
This severe recession affected the entire world. Some nations, such as Iceland in 2009 and Greece in 2012, were left teetering on the edge of total collapse.
What has caused such a crisis both for America and the world? And why has the recovery been so uneven and frustrating for large percentages of the population? The study of macroeconomics exists to answer those challenging questions among others.
What Is Macroeconomics?
Some economists study small pieces of the economy. For example, an economist may study what is happening to the price of gasoline or may investigate the range of wages in a particular industry. Looking at the behavior of individual consumers, individual employees, and individual businesses are all part of what economists call micro economics (usually written as one word, microeconomics).
Other economists study the big picture of the whole economy. This focus on the economic growth of whole nations, the economy of the whole world, or on expansions and recessions that engulf a nation, is called macro economics (usually written as one word, macroeconomics).
Macroeconomics, also called aggregate economics, focuses on total or aggregate movements. For example, it looks at all consumer spending. The first economist to look at theproblems of whole countries was Adam Smith in his book, The Wealth of Nations.
BOX 1.1 Adam Smith (1723–1790)
Adam Smith is considered the father of the science of economics. He was born in Kirkcaldy, Scotland, and lived much of his life in Glasgow. Smith was an important part of the Scottish school of history, political economy, and philosophy. He served as a professor of moral philosophy at the University of Glasgow from 1752 to 1763, and during that time wrote The Theory of Moral Sentiments, in which he argues that human beings interact not only out of self-interest but also out of “sympathy” for each other.
Smith’s economic studies included work on small, individual subjects, such as how several workers might be more efficient at making a watch than just one worker. He also wrote on vast national and international subjects. His most famous book, An Inquiry into the Nature and Causes of the Wealth of Nations, falls into the latter category. The book was published in 1776, an easy date for Americans to remember. Smith’s goal in The Wealth of Nations was to explain how whole nations prospered or failed to prosper.
For nearly 250 years, Smith’s name has been linked to a frequently misunderstood quote from The Wealth of Nations. This quote describes the functioning of markets in which individuals pursuing their own self-interest are led, as if by an “invisible hand,” to produce good results for society as a whole. Conservatives have taken this to mean that an economy must be built exclusively around private enterprise, with no government spending except on law and order. Yet Smith himself made no such dogmatic statement. In the only passage of The Wealth of Nations that refers to the “invisible hand,” Smith said something quite different.
Here is what he actually wrote:
Every individual endeavors to employ his capital as near home as he can and consequently as much as he can in the support of domestic industry. … By preferring the support of domestic to that of foreign industry, he intends only his own security… and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.
(Smith 1776/1976, 475–477)
Clearly, the point Smith is making is that the laudable goal of promoting domestic rather than foreign investment can be achieved without the heavy hand of government intervention. Elsewhere in his writings, he asserts that investing in one’s home country is preferable to investing abroad because it will create more jobs at home.
Smith emphasized how markets work best without government interference, but his message must be understood in its proper historical context. The author lived in an era when most governments were controlled by kings and nobility. They often spent money to build extravagant palaces, live a luxurious life, and fight wars mostly for egotistical and dynastic purposes. Smith vehemently attacked all such government spending, calling it unproductive. He also strongly opposed the practice of certain monarchs who gave monopolies over some part of foreign trade (and sometimes to all economic policies in a colony) to a favored group of businessmen. (Recall Smith’s view that private decisions to invest at home would be very helpful to economic growth.)
What Smith did not condemn is the idea of modern government spending on such productive things as health care or education—huge expenses that did not even exist in his day. Rather, he was arguing that the “invisible hand” of competition got better results than the unproductive spending and economic interference perpetrated by kings.
Three Macroeconomic Issues
There are three main macroeconomic issues treated in this book. One issue is nationwide unemployment and the business cycle of boom and bust. The second is the uses of money and credit as well as the panics, inflationary surges, and crises that have come with their use. The third is the wonders of economic growth as well as the calamities of economic waste and stagnation.
Unemployment and Misery
Unemployment has brought enormous human misery to millions of real people. Unemployment refers to people of working age who are willing and able to work but who cannot find a job. In the U.S. during the worst of the Great Recession of 2007 to 2009, there were 15 million women and men fully unemployed and another 10 million working with involuntarily reduced hours.
Each of these 25 million people could tell a story of loss and deprivation when they were deprived of full-time jobs. The kinds of misery recorded as rising among the unemployed include mental and physical sickness, divorce, crime, and even suicide. According to a grim, startling study published by the Joint Economic Committee of Congress (Brenner 1976), in the U.S., a sustained 1% increase in unemployment is associated with the following percentage increases: suicide, 4.1%; state mental hospital admissions, 3.4%; state prison admissions, 4.0%; homicide, 5.7%; deaths from cirrhosis of the liver, 1.9%; and deaths from cardiovascular diseases, 1.9%.
The unemployed begin to feel isolated from society and alienated from others. They feel weak, unable to change their lives, and certainly unable to change society. Unemployment often leads to unhappy marriages, especially if a spouse is convinced that a partner’s unemployment is due to that partner’s own laziness or stupidity. The data thus show a close relationship between the percentage of unemployed people and the percentage of couples that get divorces.
Another social problem worsened by unemployment is crime. In those communities in which many young adults have no jobs, they first sit around and talk about how bad things are. Then they are easy targets for gangs to recruit them to become criminals. People who ordinarily would not stoop to crime may see it as the only option to feed their family. Crime rises in each city in very close relationship to the amount of unemployment.
We must not think, however, that the damage done by unemployment is confined to the unemployed—though they and their families experience the worst of it. When people are unemployed, that means that output that could have been produced is not. This means that incomes that could have been earned are not. A company’s sales may not rise as much as in previous years and people working for that company may not get raises. A town’s revenues may not rise and the town may not be able to hire more police officers or a school may not get a new roof.
That loss of output is forever gone—it cannot be made up. While they were unemployed, the potential workers were aging. Since human beings have finite lives, their ability to work at that age is gone forever as is the output that society failed to produce. The loss to the U.S. economy as a result of the Great Depression in the 1930s was reduced output over ten years of insufficient economic growth. Even though there was a period of growth in the 1930s, the total product did not return to its 1929 peak until 1939.
During the period of the Great Recession in 2007 to 2009, and since then during the painfully slow recovery, thousands of factories have stood idle and millions of people have been unemployed. In this terrible time, society has not just lost a great deal of potential output. Society has also lost future potential production because fewer new plants and new equipment have been produced. This means there has been less growth of productive potential for future expansions. Every recession lowers the long-run rate of growth somewhat, but deep recessions have more powerful and lasting impacts.
Recessions are marked not only by increased unemployment but also by increases in bankruptcy, farmers losing their land, banks closing, and credit evaporating (so obtaining loans for new businesses is either more difficult or impossible). At first glance, why recessions happen appears to be an impenetrable mystery, which could only be understood by a wizard like Harry Potter. The fact that millions of people are out of a job because there is insufficient demand for food, clothing, and/or shelter while others urgently need more food, clothing, and shelter appears just weird. Meanwhile, some politicians get plenty of media attention claiming peop...