Macroeconomics Is Concerned with Behavior and Policies - Essay Example

Introduction Defined in the broadest of sense, macroeconomics is concerned with behavior and policies that affect the whole economy of a country at an aggregate level. It deals with the behavior of economy as whole- consumption and investment, the trade balance, unemployment, inflation, the budget, the interest rates, and national debt (Dornbush et. al. 2007). The Keynesian macrotheory was based on the premise that it is possible and desirable to control the levels of aggregate demand and unemployment. The monetarists believed that it is not necessary for macroeconomic policy to be over-ambitious and proposed a limited role of government. The current global crisis has once again raised the importance of macroeconomic policy to prevent such crisis in future. There has been felt a need to redefine the basic objectives of the macro-economic policy. There is an urgent need for reassessment of macroeconomic policy and theory with a goal to provide a theoretical framework for macroeconomic policy at national and international levels. Objectives of Macro-economic policy In light of current financial crisis, the major objectives of macroeconomic policy can be stated as follows: Price stability: Avoiding excessive inflation or deflation High, but a sustainable rate of economic growth No unemployment Stability in the Balance of Payments Achievement of broad social goals such as income security, education and universal health care We will see the importance of the objectives, and the costs of not achieving these objectives: Price Stability: Consistent high inflation stops the growth of the economy. High inflation leads to increase in interest rates. High interest rates discourage borrowing by consumer (for spending purpose), and companies (for investment purpose). Firms that export will become less competitive. All these factors may lead the economy into a recession. Another aftereffect of high inflation is the redistribution of income from savers to borrowers. This leads to erosion of real value of money. This erosion is good for the borrower, but very bad for the saver. Thus, inflation is a harmful occurrence for the savers. This hurts the economy in the long-run as investment in an economy is majorly dependent on the amount of savings. If the inflation rate is higher than the interest rate in economy, the savers receive a negative real (inflation-adjusted) interest rate. High inflation also results in people wasting time in searching the market for the lowest price. The time (and the shoe leather wasted) in searching is called ‘Shoe leather costs’ of inflation. High inflation is accompanied by variable inflation, leading to unstable prices. This forces the manufacturers to continually change their menus, price, machines, supply systems, etc. This cost is called as the ‘Menu Costs’. Inflation is generally measured as the rate of change in the Retail Price Index (RPI). Many Governments such as that of UK focus on the annual percentage change in RPIX, which is housing costs removed from RPI. Another rate of interest is the Consumer Price Index The RPI, RPIX, CPI Rates in UK (Source: Office for National Statistics, UK, 2009) High, but sustainable rate of economic growth: This is an important objective that any macroeconomic policy should try to achieve. High growth in GDP leads to improvement in the living standards. But, an important point that should be taken care of is that the growth shall be sustainable (without inflation) over a long period of time. Achieving macro-economic stability shall be the center point of every macro-economy policy. In order to understand the sources of economic growth, we shall start with the following equation: Where, Y is level of output, K, is capital, N is labor, and A is the level of technology (TransWeb Educational Services, 2009). The sources of economic growth can be considered as technology, capital investment, and productivity. With high growth there should be an emphasis on equitable distribution, both as a social goal as well to provide a stable macroeconomic system. Unfortunately, there is a serious trade-off between efficiency and equity. High efficiency leads to inequality in distribution of income, in spite of the ‘trickle down effect’, which improves the standard of living of poor households in times of economic growth. Therefore, the objective of macro-economic policy shall be to achieve a stable and sustainable macroeconomic growth with limited consumption growth. Growth is generally measured by GDP is the total value of goods and services produced in an economy or GNP. GDP in UK has been showing a falling trend owing to the current slowdown. Real GDP Quarterly growth (Source: Office for National Statistics, UK, 2009) No Unemployment The goal of full employment became prominent in the 1980s after high unemployment rates. High unemployment rates are a burden on the finances of the government as it has to provide benefits to unemployed people. The government also looses from the potential Income tax that the unemployed person might have otherwise paid. High unemployment also means that a lot of resources are being wasted in the economy. These unutilized resources mean that the economy can never reach its optimal production capacity. Besides, unemployment also generally leads to an increase in crime rates, which add external costs to the economy. High unemployment also leads to future loss of a person’s income. An unemployed person will find it harder to find relevant job in the future, because he either lacks the experience, or the necessary skills. This objective has taken special emphasis in this financial crisis as companies are laying down employees to remain profitable, cutting pay scales, and unemployment rates are high. The financial crisis has resulted in a drop in the employment rates over the last 2-3 years in UK. One important issue in unemployment rates is the percentage of active and inactive members of the working age. For example, students and early retirees are considered inactive. Employment Rates in UK (Source: Office for National Statistics, 2009) Stability in Balance of Payments The current economy is truly globalized in the sense that many of the countries have opened their doors for foreign trade and have removed trade barriers that earlier existed. The importance of equilibrium in BoP differs from developing countries to developed countries. Developed countries have the ability to finance their current account deficit by attracting foreign investment on the capital account. Contiguous current account deficit is not an encouraging position, and represents the uncompetitiveness of the firms in the country. Developing countries on the other hand may just find it difficult to pay for their imports owing to lack of foreign investment, and they may have to borrow from institutions like IMF, or the WB. Current account surplus on the other hand is not good as it represents sacrificing of the consumption within the country to exports. This also means that the home economy is majorly dependent on the foreign economy, and any economic activity will lead to significant impact on the home currency. In the first quarter of 2009, UK witnessed a fall in surplus on trade in services, and increase in deficit on current account transfers. This was however negotiated by high surplus on income with lower deficit of trade in goods. BoP for UK (Source: Office for National Statistics, 2009) Achievement of broad social goals such as income security, education and universal health care Macroeconomic policies have a deep impact on the social and poverty outcomes of a country. The macroeconomic policy shall attempt to increase the improve consumption, human capital, and social equality, as well as to embrace environmental sustainability and social development (World Bank 2004). The benefits of the growth shall be shared to develop a social consensus around a country’s development. A macroeconomic policy that does not take care of this objective will not be able to sustain its growth over large periods of time. It will have adverse effect on the environment, education levels, economic disparity, health care, and many other facets of the social life of the people. Conflicts amongst objectives Although macroeconomic policy shall try to score on all these objectives, but it is impossible as all these objectives have trade-offs against some of the others. Some of these trades-offs are: High growth and stable BoP A high growing economy has the tendency to get more goods from imports, as compared to home produced products. This leads the country to get a high trade deficit. Full employment and low inflation This classical conflict depicted by Philips Curve is a major issue that shall be taken care off while devising a macro-economic policy. Reduction in unemployment will increase the wage levels in the economy, leading to higher prices and inflation. High growth and low inflation Often, high growth leads to an increased demand for products, leading to inflation. If the growth in a country is the result of increased consumer spending, it yields to increase in prices due to more demand, and less supply. This results in inflation. The rate at which, an economy can grow without resulting inflation is called the ‘trend rate of growth’. High Growth and Social objectives Often high growth leads to the failure to achieve social objectives like protection of environment, social equity, etc. High growth is achieved by higher levels of production. Higher levels of production are generally responsible for higher pollution, more cutting of trees, and more inequitable distribution of income. References Dornbush, R., Fisher, S., Startz, R., 2007. Macroeconomics, 9th ed. New York: The McGraw-Hill Companies Inc. Office for National Statistics, UK. 2009. Inflation [Online] Available at: http://www.statistics.gov.uk/default.asp [Accessed 22nd July, 2009] TransWeb Educational Services. 2009. Macroeconomic policy—monetary and fiscal policy [Online] Available at: http://www.transwebtutors.com/economics/Macroeconomic_policy.aspx#Macroeconomic_policy_monetary_and_fiscal_policy [Accessed 17th July, 2009] World Bank 2004. Responsible Growth for the New Millennium: Integrating Society Ecology and the Economy. (Washington: World Bank). Read More