Macroeconomics For Dummies

Dan Richards, Manzur Rashid, Peter Antonioni

• Publisher: For Dummies
• Year: 2016
• ISBN:
  9781119184447
• Edition: 1
• Topic: Economics
• Subtopic: Macroeconomics
• Index: Economics

The fast and easy way to make macroeconomics manageable

Macroeconomics is kind of a big deal. Without it, we wouldn't have the ability to study the economy as a whole—which is something that affects almost every aspect of your life, whether you realize it or not. From your employment status to how much you earn and pay in taxes, macroeconomics really matters. Breaking down this complicated and fascinating topic into manageable pieces, Macroeconomics For Dummies gives you fast and easy access to a subject that has a tendency to stump the masses.

With the help of this plain-English guide, you'll quickly find out how to gather data about economies to inform hypotheses on everything from the impact of cutting government spending to the underlying causes of recessions and high inflation.

• Analyze business cycles for overall economic health
• Study economic indicators such as unemployment
• Understand financial trends on the international market
• Score higher in your macroeconomics class

Filled with step-by-step instruction and enlightening real-world examples, this is the only book you need to slay the beast and make macroeconomics your minion!

Part 1

Getting Started with Macroeconomics

IN THIS PART …

Discover why macroeconomics is important and get an overview of the many concepts and policies it covers.

Take a look at the key questions macroeconomists ask about the economy and gain an understanding of why they use models to arrive at answers.

Understand that macroeconomists frequently distinguish between the short run and the long run.

Chapter 1

Discovering Why Macroeconomics Is a Big Deal

IN THIS CHAPTER

Understanding what macroeconomics is all about

Confronting key macroeconomic variables

Seeing why macroeconomists love modeling

Introducing macroeconomic problems and policies

Macroeconomics is what macroeconomists do. Okay, that’s a bit circular. Still, it helps make the point that macroeconomics is different from microeconomics … which is what microeconomists do. Whereas microeconomists study the behavior of individuals — for example, a consumer’s choice of what goods to buy or how much to save — and firms —such as a company’s decision about what price to set — macroeconomists study the economy as a whole. The comedian PJ O’Rourke captured this difference humorously when he noted that “Microeconomics concerns things that economists are specifically wrong about, while macroeconomics concerns things economists are wrong about generally!”

Even macroeconomists (at least most of them) recognize both the humor and the insight in O’Rourke’s comment. From the Great Depression of the 1930s to the Great Recession of recent years, the economy has often taken turns that economists have failed to predict. As we will see, this inability to call every macroeconomic turn is not so surprising … even if it is disappointing. The macroeconomy is a huge and complex system, and macroeconomists don’t and may well never be able to forecast its movements with anything like perfection. Still, macroeconomists do know a lot. Even when they don’t predict events in advance, that knowledge can help us understand events looking back.

This understanding is important for at least three reasons. The first is that macroeconomics affects almost every part of your life. From whether you’re employed or unemployed, to how much you earn, how much tax you pay, what services the government provides and how easy or difficult you find borrowing money — macroeconomics really matters.

The second reason is that knowing some macroeconomics can help policy makers avoid obvious mistakes. And it can help voters who select the politicians to choose ones who won’t make obvious mistakes.

The third reason is that sometimes the right policy is not always clear. Because the macroeconomy is so complex, there will be pros and cons to any policy choice. In fact, it’s largely because different macroeconomists will weigh these pros and cons differently that they’ll sometimes (often?) disagree.

The bottom line then is that understanding some macroeconomics lets you in on a big part of how the world works.

This chapter sets the scene for the rest of the book with a short introduction to macroeconomics. It covers the main topics and concerns of macroeconomists, the tools they use, how macroeconomic theory can guide macroeconomic policy, and how the macroeconomy can run into problems both small and large.

The Big Picture: Checking Out the Economy as a Whole

Macroeconomists try to understand the economy as a whole. This means they look at the behavior of aggregate variables, that is, not just one household’s expenditure on wine or even the consumption of wine in total across all households (intoxicating as that might seem), but the total expenditure of all households for all consumer goods over some interval of time. And along with that total consumer expenditure, macroeconomists consider a host of other aggregate variables such as national unemployment, market interest rates, and some index of what’s happening to prices in general. Of course, all these variables are related. So, working out what a shock to consumer spending means for interest rates, prices, unemployment, and other variables is pretty tricky. Working out how macroeconomic policy should respond to such a shock is trickier still.

As you can see, macroeconomics is a wide-ranging discipline. Therefore, it requires people with exceptional skills (ahem). Here we discuss just two: how macroeconomists are like detectives and doctors (just don’t ask us to take a close look at that unsightly mole — please).

Investigating why macroeconomists are like detectives

Being a good macroeconomist is in many ways like being a detective at a crime scene. Good detectives carefully collect evidence at the scene and form theories about what may have happened. They use that evidence to test which theories are most plausible. Of course, the evidence from a single crime may or may not prove conclusive. Over time, though, evidence from many crimes along with improved technology for gathering and analyzing evidence leads to better theories and an improved ability in any one case to rule some suspects out and others in.

Similarly, macroeconomists gather evidence about economies in the form of data. They then form a hypothesis about how the data came to be and test it to see whether the data supports it or not.

Unfortunately, neither detectives nor macroeconomists have labs in which they can run carefully controlled experiments to test their various hypotheses precisely. This is an advantage reserved to natural sciences such as chemistry, physics, and medicine. If a macroeconomist wants to work out the impact on the economy of cutting government spending by half, she can’t just do it and see what happens! She can, however, look at the data (across countries and across time) and try to infer the likely relationship between government spending and other macroeconomic variables (like inflation, unemployment, and real GDP).

That kind of statistical inference though is fraught with problems. For example, imagine that you notice two facts: that countries with higher levels of education tend to be richer and that as the people of a country become more educated, it becomes richer. On the basis of these facts you reach the conclusion that more education causes people to become richer.

But wait a minute! How do you know that it isn’t the other way around: when a country is richer it spends more on education? In which case, people becoming richer is causing them to have more education. Or a third variable may be causing high levels of education and wealth (such as a well-functioning political and legal system). In which case, a country being well off and well educated is correlated but not causally linked.

Macroeconomists and their models

Partly because economists (micro and macro) can’t easily conduct lab experiments, and partly because statistical inference is complicated, they turn to building models — simplified versions of reality — in order to think through complex problems (see the later section “Modeling the Macroeconomy” for more on models).

There are several advantages to using formal models:

• Macroeconomic problems are complex: They’re so complex that trying to tackle them head-on is almost bound to fail. In this case, a model is like a roadmap. It doesn’t tell you every twist and turn or bump in the road. But it does give a good tool for thinking about how to go from point A to point B. For example, if the question is why average wages in the U.S. are much higher than average wages in Bangladesh, a macroeconomist can safely build a model that ignores the fact that within each country there is a lot of wage and skill variability across workers. That data would be relevant to explaining why different people have different wages, but not why the U.S. average is many times that of the Bangladesh average.
• Modeling forces you to develop logically consistent hypotheses. For example, it’s likely that interest rates include an inflation premium. All else equal, lenders charge a higher interest rate in an environment of 10 percent inflation than in one of 0 inflation. If this is true, however, then a model that says the Federal Reserve can set the interest rate wherever it likes regardless of the inflation rate has a consistency problem even before one starts to test it with data.
• Modeling forces you to make your assumptions explicit: Results in economics papers often read along the following lines: “If we assume X and Y, then Z must be true.” For example, “If we assume that households decide how much to spend on consumer goods today based on the income they expect to earn on average in the future, then their spending will be less sensitive to changes in income this period.”
  Making assumptions explicit is good practice because it means economists can’t easily pull the wool over people’s eyes.’ In other words, it keeps economists honest.
• 

  Intuition can lead you astray: You can spend a lot of time thinking about an economic problem and come to a conclusion that modeling subsequently proves is wrong.
  For example, your intuition may tell you that firms rather than workers should pay payroll taxes (the mandatory taxes due when someone works) so that ordinary people get to keep more of their income. But by modeling this problem, economists worked out that it doesn’t matter who officially pays the tax (the worker or the firm), the outcome is the same regardless. If the firm officially pays the tax, then it passes some of the tax onto the worker by lowering wages, and if the worker officially pays the tax, then she passes on some of the tax to the firm by only being willing to work for a higher wage.
• Comparative statics: Don’t let the jargon scare you; comparative statics simply means comparing the outcome before and after some change. Modeling allows you to see what would happen if certain things within the model change. For example, after you’ve written down your model, you may want to see what would happen to the economy if government spending increased. The model allows you to see the impact without having to change government spending in the real world.

Macroeconomists and their questions

Macroeconomists are quite an ambitious bunch. They want to understand why the world is the way it is, and they ask some of the biggest questions around:

• Why do economies grow over time — and why do they sometimes slip backwards into recession?
• What causes the prices of things to rise or fall?
• What determines key outcomes like the level of interest rates and the rate of unemployment?
• How can economic policies foster economic growth and mitigate recessions and unemployment?

Thanks to macroeconomists, a lot is now known about the answers to these and many other questions. But being an economist is much more than just ‘knowing stuff’ — good economists are able to look at a problem they’ve never seen before and use their analytical tools to see something that others may have overlooked. That’s another one of the benefits of modeling.

Chapter 2 contains plenty more on the questions that macroeconomists like to ask.

Diagnosing why macroeconomists are like doctors

If you get sick, you’re likely to visit a medical doctor. The physician checks out your symptoms and makes a diagnosis about the likely cause of your illness. Based on this diagnosis, she recommends a course of treatment to cure you in no time – you hope.

Just like people, economies can also get sick with things such as recessions, high inflat...