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Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of
economics Economics () is a social science Social science is the branch A branch ( or , ) or tree branch (sometimes referred to in botany Botany, also called , plant biology or phytology, is the science of plant life and a bran ...

economics
dealing with performance, structure, behavior, and decision-making of an
economy An economy (; ) is an area of the production Production may be: Economics and business * Production (economics) * Production, the act of manufacturing goods * Production, in the outline of industrial organization, the act of making products ( ...

economy
as a whole. For example, using interest rates, taxes, and government spending to regulate an economy’s growth and stability. This includes regional, national, and
global economies The world economy or the global economy is the economy An economy (from Greek language, Greek οίκος – "household" and νέμoμαι – "manage") is an area of the Production (economics), production, Distribution (economics), distributi ...
. According to a 2018 assessment by economists Emi Nakamura and Jón Steinsson, economic "evidence regarding the consequences of different macroeconomic policies is still highly imperfect and open to serious criticism." Macroeconomists study topics such as
GDP Gross domestic product (GDP) is a monetary In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in the left corner">174x174px Money is any ...
,
unemployment Unemployment, according to the (Organisation for Economic Co-operation and Development), is people above a specified age (usually 15) not being in paid or but currently available for work during the . Unemployment is measured by the unemplo ...
(including
unemployment rates
unemployment rates
),
national income A variety of measures of national income and output are used in economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distr ...

national income
,
price indicesA price index (''plural'': "price indices" or "price indexes") is a normalized average (typically a weighted average) of price A price is the (usually not negative) quantity of payment or compensation given by one party to another in re ...
,
output Output may refer to: * The information produced by a computer, see * An output state of a system, see * , the amount of goods and services produced ** in economics, the value of net output or GDP plus intermediate consumption ** in economics, ...
,
consumption Consumption may refer to: *Resource consumption *Tuberculosis, an infectious disease, historically in biology: * Consumption (ecology), receipt of energy by consuming other organisms in social sciences: * Consumption (economics), the purchasing of ...
,
inflation In economics, inflation refers to a general progressive increase in prices of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a r ...

inflation
,
saving Saving is income In microeconomics, income is the Consumption (economics), consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms.Smith's financial dictionary. Smit ...
,
investment Investment is the dedication of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance Finance is the study of financial institution ...
,
energy In physics Physics is the that studies , its , its and behavior through , and the related entities of and . "Physical science is that department of knowledge which relates to the order of nature, or, in other words, to the regula ...
,
international trade International trade is the exchange of capital Capital most commonly refers to: * Capital letter Letter case (or just case) is the distinction between the letters that are in larger uppercase or capitals (or more formally ''majuscul ...
, and
international finance International finance (also referred to as international monetary economics or international macroeconomics) is the branch of financial economics Financial economics is the branch of economics Economics () is a social science So ...
. Macroeconomics and
microeconomics Microeconomics is a branch of mainstream economics Mainstream economics is the body of knowledge, theories, and models of economics, as taught by universities worldwide, that are generally accepted by economists as a basis for discussion. Als ...
are the two most general fields in economics. The United Nations
Sustainable Development Goal 17 Sustainable Development Goal 17 (SDG 17 or Global Goal 17) is about "partnerships for the goals." One of the 17 Sustainable Development Goals The Sustainable Development Goals (SDGs) or Global Goals are a collection of 17 interlinked global g ...

Sustainable Development Goal 17
has a target to enhance global macroeconomic stability through policy coordination and coherence as part of the 2030 Agenda.


Development


Origins

Macroeconomics descended from the once divided fields of
business cycle theory
business cycle theory
and
monetary theory Monetary economics is the branch of economics that studies the different competing theories of money: it provides a framework for analyzing money and considers its functions (such as medium of exchange, store of value and unit of account), and it c ...
.Dimand (2008). The
quantity theory of money#REDIRECT Quantity theory of money In monetary economics, the quantity theory of money (QTM) states that the general price level of goods and services is directly proportional to the amount of money in circulation, or money supply In macroeco ...
was particularly influential prior to World War II. It took many forms, including the version based on the work of
Irving Fisher Irving Fisher (February 27, 1867 – April 29, 1947) was an American economist An economist is a practitioner in the social sciences, social science discipline of economics. The individual may also study, develop, and apply theories and concep ...

Irving Fisher
: :M\cdot V = P\cdot Q In the typical view of the quantity theory,
money velocity, calculated by dividing nominal Gross Domestic Product, GDP by the M2 stock (M1 plus time deposits), 1959–2010. The employment-to-population ratio is displayed in blue, and periods of recession are represented with gray bars.Image:M1VelocityEMrati ...
(V) and the quantity of goods produced (Q) would be constant, so any increase in
money supply In macroeconomics, the money supply (or money stock) refers to the total volume of money held by the public at a particular point in time in an economy. There are several ways to define "money", but standard measures usually include Circulati ...
(M) would lead to a direct increase in
price level The general price level is a hypothetical measure of overall prices for some set of Good (economics), goods and Service (economics), services (the consumer basket), in an economy or monetary union during a given interval (generally one day), num ...
(P). The quantity theory of money was a central part of the classical theory of the economy that prevailed in the early twentieth century.


Austrian School

Ludwig Von Mises Ludwig Heinrich Edler von Mises (; 29 September 1881 – 10 October 1973) was an Austrian School economist, historian, logician, and Sociology, sociologist. Mises wrote and lectured extensively on the societal contributions of classical liberal ...

Ludwig Von Mises
's work ''
Theory of Money and Credit ''The Theory of Money and Credit'' is a 1912 economics book written by Ludwig von Mises Ludwig Heinrich Edler von Mises (; 29 September 1881 – 10 October 1973) was an Austrian School The Austrian School is a Heterodox economics, heterodo ...
'', published in 1912, was one of the first books from the
Austrian School The Austrian School is a heterodox In religion, heterodoxy (from Ancient Greek Ancient Greek includes the forms of the Greek language used in ancient Greece and the classical antiquity, ancient world from around 1500 BC to 300 BC. It ...
to deal with macroeconomic topics.


Keynes and his followers

Macroeconomics, at least in its modern form,Blanchard (2011), 580. began with the publication of ''
General Theory of Employment, Interest and Money ''The General Theory of Employment, Interest and Money'' of 1936 is a book by English economist John Maynard Keynes John Maynard Keynes, 1st Baron Keynes, ( ; 5 June 1883 – 21 April 1946) was an English economist, whose ideas fundamenta ...
'' written by
John Maynard Keynes John Maynard Keynes, 1st Baron Keynes, ( ; 5 June 1883 – 21 April 1946) was an English economist, whose ideas fundamentally changed the theory and practice of macroeconomics and the economic policies of governments. Originally trained in ma ...

John Maynard Keynes
. When the Great Depression struck, classical economists had difficulty in explaining how goods could go unsold and workers could be left unemployed. In classical theory, prices and wages would drop until the market cleared, and all goods and labor were sold. Keynes offered a new theory of economics that explained why markets might not clear, which would evolve (later in the 20th century) into a group of macroeconomic schools of thought known as
Keynesian economics Keynesian economics ( ; sometimes Keynesianism, named after British economist John Maynard Keynes John Maynard Keynes, 1st Baron Keynes, ( ; 5 June 1883 – 21 April 1946) was an English economist, whose ideas fundamentally changed the t ...
– also called Keynesianism or Keynesian theory. In Keynes' theory, the quantity theory broke down because people and businesses tend to hold on to their cash in tough economic times – a phenomenon he described in terms of
liquidity preference__NOTOC__ In macroeconomic theory, liquidity preference is the demand for money In monetary economics Monetary economics is the branch of economics that studies the different competing theories of money: it provides a framework for analyzing ...
s. Keynes also explained how the
multiplier effect In macroeconomics, a multiplier is a factor of proportionality that measures how much an endogenous variable changes in response to a change in some exogenous variable. For example, suppose variable ''x'' changes by 1 unit, which causes another v ...
would magnify a small decrease in consumption or investment and cause declines throughout the economy. Keynes also noted the role uncertainty and animal spirits can play in the economy. The generation following Keynes combined the macroeconomics of the ''General Theory'' with neoclassical microeconomics to create the
neoclassical synthesis The neoclassical synthesis (NCS), neoclassical–Keynesian synthesis, or just neo-Keynesianism was a post-World War II World War II or the Second World War, often abbreviated as WWII or WW2, was a World war, global war that lasted from ...
. By the 1950s, most economists had accepted the synthesis view of the macroeconomy. Economists like
Paul Samuelson Paul may refer to: *Paul (given name), a given name (includes a list of people with that name) *Paul (surname), a list of people People Christianity *Paul the Apostle (AD 5–67), also known as Saul of Tarsus or Saint Paul, early Christian mis ...

Paul Samuelson
,
Franco Modigliani Franco Modigliani (18 June 1918 – 25 September 2003) was an Italian-American economist An economist is a practitioner in the social sciences, social science discipline of economics. The individual may also study, develop, and apply theo ...

Franco Modigliani
,
James Tobin James Tobin (March 5, 1918 – March 11, 2002) was an United States, American economist who served on the Council of Economic Advisers and consulted with the Board of Governors of the Federal Reserve System, and taught at Harvard and Yale Universi ...

James Tobin
, and
Robert Solow Robert Merton Solow, Order of Prince Henry, GCIH (; born August 23, 1924) is an American economist whose work on the theory of economic growth culminated in the exogenous growth model named after him. He is currently Emeritus List of Institute Prof ...
developed formal Keynesian models and contributed formal theories of consumption, investment, and money demand that fleshed out the Keynesian framework.


Monetarism

Milton Friedman Milton Friedman (; July 31, 1912 – November 16, 2006) was an American economist An economist is a practitioner in the social sciences, social science discipline of economics. The individual may also study, develop, and apply theories and c ...

Milton Friedman
updated the quantity theory of money to include a role for money demand. He argued that the role of money in the economy was sufficient to explain the
Great Depression The Great Depression was a severe worldwide economic depression An economic depression is a sustained, long-term downturn in economic activity in one or more economies. It is a more severe economic downturn than a economic recession, recess ...
, and that aggregate demand oriented explanations were not necessary. Friedman also argued that monetary policy was more effective than fiscal policy; however, Friedman doubted the government's ability to "fine-tune" the economy with monetary policy. He generally favored a policy of steady growth in money supply instead of frequent intervention. Friedman also challenged the
Phillips curve The Phillips curve is a single-equation economic model In economics, a model is a theory, theoretical construct representing economic wikt:process, processes by a set of Variable (mathematics), variables and a set of logical and/or quantitative ...

Phillips curve
relationship between inflation and unemployment. Friedman and
Edmund Phelps Edmund Strother Phelps (born July 26, 1933) is an American economist An economist is a practitioner in the social sciences, social science discipline of economics. The individual may also study, develop, and apply theories and concepts from e ...
(who was not a monetarist) proposed an "augmented" version of the Phillips curve that excluded the possibility of a stable, long-run tradeoff between inflation and unemployment. When the oil shocks of the 1970s created a high unemployment and high inflation, Friedman and Phelps were vindicated. Monetarism was particularly influential in the early 1980s. Monetarism fell out of favor when central banks found it difficult to target money supply instead of interest rates as monetarists recommended. Monetarism also became politically unpopular when the central banks created recessions in order to slow inflation.


New classical

New classical macroeconomics New classical macroeconomics, sometimes simply called new classical economics, is a school of thought in macroeconomics that builds its analysis entirely on a neoclassical economics, neoclassical framework. Specifically, it emphasizes the importan ...
further challenged the Keynesian school. A central development in new classical thought came when Robert Lucas introduced
rational expectations In economics, "rational expectations" are model-consistent expectations, in that agent (economics), agents inside the model (economics), model are assumed to "know the model" and on average take the model's predictions as valid. Rational expectat ...
to macroeconomics. Prior to Lucas, economists had generally used
adaptive expectations In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods an ...
where agents were assumed to look at the recent past to make expectations about the future. Under rational expectations, agents are assumed to be more sophisticated. A consumer will not simply assume a 2% inflation rate just because that has been the average the past few years; they will look at current monetary policy and economic conditions to make an informed forecast. When new classical economists introduced rational expectations into their models, they showed that monetary policy could only have a limited impact. Lucas also made an influential critique of Keynesian empirical models. He argued that forecasting models based on empirical relationships would keep producing the same predictions even as the underlying model generating the data changed. He advocated models based on fundamental economic theory that would, in principle, be structurally accurate as economies changed. Following Lucas's critique, new classical economists, led by and Finn E. Kydland, created
real business cycle Real business-cycle theory (RBC theory) is a class of new classical macroeconomics New classical macroeconomics, sometimes simply called new classical economics, is a school of thought in macroeconomics that builds its analysis entirely on a neocl ...
(RB C) models of the macro economy.Blanchard (2011), 587. RB C models were created by combining fundamental equations from neo-classical microeconomics. In order to generate macroeconomic fluctuations, RB C models explained recessions and unemployment with changes in technology instead of changes in the markets for goods or money. Critics of RB C models argue that money clearly plays an important role in the economy, and the idea that technological regress can explain recent recessions is implausible. However, technological shocks are only the more prominent of a myriad of possible shocks to the system that can be modeled. Despite questions about the theory behind RB C models, they have clearly been influential in economic methodology.


New Keynesian response

New Keynesian New Keynesian economics is a school of macroeconomics Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics Economics () is the social science that studies how people interact with va ...
economists responded to the new classical school by adopting rational expectations and focusing on developing micro-founded models that are immune to the Lucas critique.
Stanley Fischer Stanley Fischer ( he, סטנלי פישר; born October 15, 1943) is an Israeli American Israeli Americans ( he, אָמֵרִיקָאִים יִשׂרָאֵליִם lit. ''Ameriqaim Yisra'elim'') are Americans Americans are the Citizensh ...

Stanley Fischer
and John B. Taylor produced early work in this area by showing that monetary policy could be effective even in models with rational expectations when contracts locked in wages for workers. Other new Keynesian economists, including
Olivier Blanchard Olivier Jean Blanchard (; born December 27, 1948) is a French economist and professor who is a senior fellow at the Peterson Institute for International Economics The Peterson Institute for International Economics (PIIE), previously known as t ...
,
Julio Rotemberg Julio Jacobo Rotemberg was an Argentine/American economist An economist is a practitioner in the social sciences, social science discipline of economics. The individual may also study, develop, and apply theories and concepts from economics a ...
,
Greg Mankiw Nicholas Gregory Mankiw (; born February 3, 1958) is an American macroeconomist who is currently the Robert M. Beren Professor of Economics at Harvard University. Mankiw is best known in academia for his work on New Keynesian economics. Mankiw h ...
,
David Romer David Hibbard Romer (born March 13, 1958) is an American economist, the Herman Royer Professor of Political Economy at the University of California, Berkeley The University of California, Berkeley (UC Berkeley, Berkeley, Cal, or California) ...
, and Michael Woodford, expanded on this work and demonstrated other cases where inflexible prices and wages led to monetary and fiscal policy having real effects. Like classical models, new classical models had assumed that prices would be able to adjust perfectly and monetary policy would only lead to price changes. New Keynesian models investigated sources of sticky prices and wages due to
imperfect competitionIn economics, imperfect competition refers to a situation where the characteristics of an economic market do not fulfil all the necessary conditions of a perfectly competitive market, resulting in market failure. The structure of a market can sign ...
, which would not adjust, allowing monetary policy to impact quantities instead of prices. By the late 1990s, economists had reached a rough consensus. The nominal rigidity of new Keynesian theory was combined with rational expectations and the RBC methodology to produce
dynamic stochastic general equilibrium Dynamic stochastic general equilibrium modeling (abbreviated as DSGE, or DGE, or sometimes SDGE) is a method in macroeconomics Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics Econ ...
(DSGE) models. The fusion of elements from different schools of thought has been dubbed the
new neoclassical synthesis The new neoclassical synthesis (NNS) or new synthesis is the fusion of the major, modern macroeconomic schools of thought, new classical and New-Keynesianism, into a consensus on the best way to explain short-run fluctuations in the economy. Thi ...
. These models are now used by many central banks and are a core part of contemporary macroeconomics. New
Keynesian economics Keynesian economics ( ; sometimes Keynesianism, named after British economist John Maynard Keynes John Maynard Keynes, 1st Baron Keynes, ( ; 5 June 1883 – 21 April 1946) was an English economist, whose ideas fundamentally changed the t ...
, which developed partly in response to new classical economics, strives to provide microeconomic foundations to
Keynesian economics Keynesian economics ( ; sometimes Keynesianism, named after British economist John Maynard Keynes John Maynard Keynes, 1st Baron Keynes, ( ; 5 June 1883 – 21 April 1946) was an English economist, whose ideas fundamentally changed the t ...
by showing how imperfect markets can justify demand management.


Macroeconomic models


Aggregate demand–aggregate supply

The has become the standard textbook model for explaining the macroeconomy. This model shows the price level and level of real output given the equilibrium in
aggregate demand In macroeconomics Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics Economics () is a social science Social science is the branch A branch ( or , ) or tree branc ...
and
aggregate supply In economics, aggregate supply (AS) or domestic final supply (DFS) is the total supply of goods and services that firms in a national economy plan on selling during a specific time period. It is the total amount of goods and services that firms ...

aggregate supply
. The aggregate demand curve's downward slope means that more output is demanded at lower price levels. The downward slope is the result of three effects: the Pigou or real balance effect, which states that as real prices fall, real wealth increases, resulting in higher consumer demand of goods; the Keynes or interest rate effect, which states that as prices fall, the demand for money decreases, causing interest rates to decline and borrowing for investment and consumption to increase; and the net export effect, which states that as prices rise, domestic goods become comparatively more expensive to foreign consumers, leading to a decline in exports. In the conventional Keynesian use of the AS-AD model, the aggregate supply curve is horizontal at low levels of output and becomes inelastic near the point of
potential output In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods an ...
, which corresponds with
full employment Full employment is a situation in which there is no cyclical or deficient-demand unemployment. Full employment does not entail the disappearance of all unemployment, as other kinds of unemployment, namely structural A structure is an arrangement ...
. Since the economy cannot produce beyond the potential output, any AD expansion will lead to higher price levels instead of higher output. The AD–AS diagram can model a variety of macroeconomic phenomena, including inflation. Changes in the non-price level factors or determinants cause changes in aggregate demand and shifts of the entire aggregate demand (AD) curve. When demand for goods exceeds supply,there is an inflationary gap where
demand-pull inflation Image:Push-pull-inflation.jpg, 300px, Aggregate Demand increasing faster than production Demand-pull inflation is asserted to arise when aggregate demand in an economy outpaces aggregate supply. It involves inflation rising as real gross domestic ...
occurs and the AD curve shifts upward to a higher price level. When the economy faces higher costs,
cost-push inflation Image:As AD cost push.svg, 283px, AD-AS model, Aggregate supply – aggregate demand model illustration of aggregate supply (AS) shifting to AS' and causing price level to increase while output shrinks Cost-push inflation is a type of inflation cau ...
occurs and the AS curve shifts upward to higher price levels. The AS–AD diagram is also widely used as an instructive tool to model the effects of various macroeconomic policies.


IS-LM

The IS–LM model gives the underpinnings of aggregate demand (itself discussed above). It answers the question "At any given price level, what is the quantity of goods demanded?". This model shows what combination of interest rates and output will ensure equilibrium in both the goods and money markets. The goods market is modeled as giving equality between investment and public and private saving (IS), and the money market is modeled as giving equilibrium between the money supply and
liquidity preference__NOTOC__ In macroeconomic theory, liquidity preference is the demand for money In monetary economics Monetary economics is the branch of economics that studies the different competing theories of money: it provides a framework for analyzing ...
. The IS curve consists of the points (combinations of income and interest rate) where investment, given the interest rate, is equal to public and private saving, given output The IS curve is downward sloping because output and the interest rate have an inverse relationship in the goods market: as output increases, more income is saved, which means interest rates must be lower to spur enough investment to match saving. The LM curve is upward sloping because the interest rate and output have a positive relationship in the money market: as income (identically equal to output) increases, the demand for money increases, resulting in a rise in the interest rate in order to just offset the incipient rise in money demand. The IS-LM model is often used to demonstrate the effects of monetary and fiscal policy. Textbooks frequently use the IS-LM model, but it does not feature the complexities of most modern macroeconomic models. Nevertheless, these models still feature similar relationships to those in IS-LM.


Growth models

The
neoclassical growth model Neoclassical or neo-classical may refer to: * Neoclassicism Neoclassicism (also spelled Neo-classicism; from Greek Greek may refer to: Greece Anything of, from, or related to Greece Greece ( el, Ελλάδα, , ), officially the Helle ...
of
Robert Solow Robert Merton Solow, Order of Prince Henry, GCIH (; born August 23, 1924) is an American economist whose work on the theory of economic growth culminated in the exogenous growth model named after him. He is currently Emeritus List of Institute Prof ...
has become a common textbook model for explaining economic growth in the long-run. The model begins with a
production function In economics Economics () is a social science Social science is the Branches of science, branch of science devoted to the study of society, societies and the Social relation, relationships among individuals within those societies. ...
where national output is the product of two inputs: capital and labor. The Solow model assumes that labor and capital are used at constant rates without the fluctuations in unemployment and capital utilization commonly seen in business cycles. An increase in output, or economic growth, can only occur because of an increase in the capital stock, a larger population, or technological advancements that lead to higher productivity (
total factor productivity In economics, total-factor productivity (TFP), also called ''multi-factor productivity'', is usually measured as the ratio of aggregate output (e.g., GDP) to aggregate inputs. Under some simplifying assumptions about the production technology, g ...
). An increase in the savings rate leads to a temporary increase as the economy creates more capital, which adds to output. However, eventually the depreciation rate will limit the expansion of capital: savings will be used up replacing depreciated capital, and no savings will remain to pay for an additional expansion in capital. Solow's model suggests that economic growth in terms of output per capita depends solely on technological advances that enhance productivity. In the 1980s and 1990s
endogenous growth theory Endogenous growth theory holds that economic growth Economic growth can be defined as the increase or improvement in the inflation-adjusted market value of the goods and services produced by an economics, economy over time. Statisticians conv ...
arose to challenge neoclassical growth theory. This group of models explains economic growth through other factors, such as increasing returns to scale for capital and learning-by-doing, that are endogenously determined instead of the exogenous technological improvement used to explain growth in Solow's model.


Humanity's economic system as a subsystem of the global environment

In the macroeconomic models in
ecological economics Ecological economics, bioeconomics, ecolonomy, eco-economics, or ecol-econ is both a transdisciplinary Transdisciplinarity connotes a research strategy that crosses many disciplinary boundaries to create a holistic Holism (from Greek Greek m ...
, the economic system is a subsystem of the environment. In this model, the
circular flow of income 360px, Basic diagram of the circular flow of income. The functioning of the free-market economic system is represented with household.html"_;"title="firms_and_household">firms_and_households_and_interaction_back_and_forth. The_circular_flow_of_in ...

circular flow of income
diagram is replaced in ecological economics by a more complex flow diagram reflecting the input of solar energy, which sustains natural inputs and
environmental services File:Mothugudem road near Chintoor.jpg, Social forestry in India, Social forestry in Andhra Pradesh, India, providing fuel, soil protection, shade and even well-being to travellers. Ecosystem services are the many and varied benefits to humans p ...
which are then used as units of
production Production may refer to: Economics and business * Production (economics) Production is the process of combining various material inputs and immaterial inputs (plans, know-how) in order to make something for consumption (output). It is the act of ...
. Once consumed, natural inputs pass out of the economy as pollution and waste. The potential of an environment to provide services and materials is referred to as an "environment's source function", and this function is depleted as resources are consumed or pollution contaminates the resources. The "sink function" describes an environment's ability to absorb and render harmless waste and pollution: when waste output exceeds the limit of the sink function, long-term damage occurs.Harris J. (2006). ''Environmental and Natural Resource Economics: A Contemporary Approach''. Houghton Mifflin Company. Some persistent pollutants, such as some organic pollutants and nuclear waste are absorbed very slowly or not at all; ecological economists emphasize minimizing "cumulative pollutants". Pollutants affect human health and the health of the ecosystem.


Basic macroeconomic concepts

Macroeconomics encompasses a variety of concepts and variables, but there are three central topics for macroeconomic research. Macroeconomic theories usually relate the phenomena of output, unemployment, and inflation. Outside of macroeconomic theory, these topics are also important to all economic agents including workers, consumers, and producers.


Output and income

National
output Output may refer to: * The information produced by a computer, see Input/output In computing Computing is any goal-oriented activity requiring, benefiting from, or creating computing machinery. It includes the study and experimentation of alg ...
is the total amount of everything a country produces in a given period of time. Everything that is produced and sold generates an equal amount of income. The total output of the economy is measured GDP per person. The output and income are usually considered equivalent and the two terms are often used interchangeably, output changes into income. Output can be measured or it can be viewed from the production side and measured as the total value of
final goods A final good or consumer good is a final product In Production (economics), production, a final product, or finished product is a product (business), product that is ready for sale.Wouters, Mark; Selto, Frank H.; Hilton, Ronald W.; Maher, Mich ...
and services or the sum of all
value added In business, total value added is calculated by tabulating the unit value added (measured by summing unit profit Profit may refer to: Business and law * Profit (accounting) Profit, in accounting Accounting or Accountancy is the meas ...
in the economy. Macroeconomic output is usually measured by
gross domestic product Gross domestic product (GDP) is a monetary Image:National-Debt-Gillray.jpeg, In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in the ...
(GDP) or one of the other
national accounts National accounts or national account systems (NAS) are the implementation of complete and consistent accounting technique Technique or techniques may refer to: Music * The Techniques, a Jamaican rocksteady vocal group of the 1960s *Technique ...
. Economists interested in long-run increases in output, study economic growth. Advances in technology, accumulation of machinery and other
capital Capital most commonly refers to: * Capital letter Letter case (or just case) is the distinction between the letters that are in larger uppercase or capitals (or more formally ''majuscule'') and smaller lowercase (or more formally ''minusc ...
, and better education and
human capital Human capital is a concept used by human resource professionals to designate personal attributes considered useful in the production process. It encompasses employee knowledge Knowledge is a familiarity or awareness, of someone or someth ...

human capital
, are all factors that lead to increase economic output over time. However, output does not always increase consistently over time.
Business cycle The business cycle, also known as the economic cycle or trade cycle, are the fluctuations of gross domestic product Gross domestic product (GDP) is a monetary Image:National-Debt-Gillray.jpeg, In a 1786 James Gillray caricature, the pl ...

Business cycle
s can cause short-term drops in output called
recession In economics Economics () is a social science Social science is the Branches of science, branch of science devoted to the study of society, societies and the Social relation, relationships among individuals within those societies. ...
s. Economists look for
macroeconomic policies Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), producti ...
that prevent economies from slipping into recessions, and that lead to faster long-term growth.


Unemployment

The amount of
unemployment Unemployment, according to the (Organisation for Economic Co-operation and Development), is people above a specified age (usually 15) not being in paid or but currently available for work during the . Unemployment is measured by the unemplo ...
in an economy is measured by the unemployment rate, i.e. the percentage of workers without jobs in the
labor force The workforce or labour force is the labour Labour or labor may refer to: * Childbirth Childbirth, also known as labour or delivery, is the ending of pregnancy where one or more babies leaves the uterus by passing through the vagina or ...

labor force
. The unemployment rate in the labor force only includes workers actively looking for jobs. People who are retired, pursuing education, or discouraged from seeking work by a lack of job prospects are excluded. Unemployment can be generally broken down into several types that are related to different causes. * Classical unemployment theory suggests that unemployment occurs when wages are too high for employers to be willing to hire more workers. Other more modern economic theories suggest that increased wages actually decrease unemployment by creating more consumer demand. According to these more recent theories, unemployment results from reduced demand for the goods and services produced through labor and suggest that only in markets where profit margins are very low, and in which the market will not bear a price increase of product or service, will higher wages result in unemployment. * Consistent with classical unemployment theory,
frictional unemployment Frictional unemployment is a form of unemployment Unemployment, according to the OECD The Organisation for Economic Co-operation and Development (OECD; french: Organisation de Coopération et de Développement Économiques, OCDE) is an ...
occurs when appropriate job vacancies exist for a worker, but the length of time needed to search for and find the job leads to a period of unemployment. *
Structural unemployment Structural unemployment is a form of involuntary unemployment Involuntary unemployment occurs when a person is unemployed Unemployment, according to the OECD The Organisation for Economic Co-operation and Development (OECD; french: Organ ...
covers a variety of possible causes of unemployment including a mismatch between workers' skills and the skills required for open jobs. Large amounts of structural unemployment commonly occur when an economy shifts to focus on new industries and workers find their previous set of skills are no longer in demand. Structural unemployment is similar to frictional unemployment as both reflect the problem of matching workers with job vacancies, but structural unemployment also covers the time needed to acquire new skills in addition to the short-term search process. * While some types of unemployment may occur regardless of the condition of the economy,
cyclical unemployment Unemployment, according to the OECD The Organisation for Economic Co-operation and Development (OECD; french: Organisation de Coopération et de Développement Économiques, OCDE) is an intergovernmental organization, intergovernmental eco ...
occurs when growth stagnates.
Okun's law In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods a ...
represents the empirical relationship between unemployment and economic growth. The original version of Okun's law states that a 3% increase in output would lead to a 1% decrease in unemployment.


Inflation and deflation

A general price increase across the entire economy is called
inflation In economics, inflation refers to a general progressive increase in prices of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a r ...

inflation
. When prices decrease, there is
deflation In economics Economics () is a social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics focuses on the behav ...

deflation
. Economists measure these changes in prices with
price index A price index (''plural'': "price indices" or "price indexes") is a normalized average In colloquial Colloquialism or colloquial language is the style (sociolinguistics), linguistic style used for casual (informal) communication. It is the most ...
es. Inflation can occur when an economy becomes overheated and grows too quickly. Similarly, a declining economy can lead to deflation.
Central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" in the most specific sense is money ...

Central bank
ers, who manage a country's money supply, try to avoid changes in price level by using
monetary policy Monetary policy is the policy adopted by the monetary authority In finance and economics, a monetary authority is the entity that manages a country’s currency and money supply, often with the objective of controlling inflation targeting, infla ...

monetary policy
. Raising interest rates or reducing the supply of money in an economy will reduce inflation. Inflation can lead to increased uncertainty and other negative consequences. Deflation can lower economic output. Central bankers try to stabilize prices to protect economies from the negative consequences of price changes. Changes in price level may be the result of several factors. The
quantity theory of money#REDIRECT Quantity theory of money In monetary economics, the quantity theory of money (QTM) states that the general price level of goods and services is directly proportional to the amount of money in circulation, or money supply In macroeco ...
holds that changes in price level are directly related to changes in the
money supply In macroeconomics, the money supply (or money stock) refers to the total volume of money held by the public at a particular point in time in an economy. There are several ways to define "money", but standard measures usually include Circulati ...
. Most economists believe that this relationship explains long-run changes in the price level. Short-run fluctuations may also be related to monetary factors, but changes in aggregate demand and aggregate supply can also influence price level. For example, a decrease in demand due to a recession can lead to lower price levels and deflation. A negative supply shock, such as an oil crisis, lowers aggregate supply and can cause inflation.


Macroeconomic policy

Macroeconomic policy is usually implemented through two sets of tools: fiscal and monetary policy. Both forms of policy are used to stabilize the economy, which can mean boosting the economy to the level of GDP consistent with full employment.Mayer, 495. Macroeconomic policy focuses on limiting the effects of the business cycle to achieve the economic goals of price stability, full employment, and growth. According to a 2018 assessment by economists Emi Nakamura and Jón Steinsson, economic "evidence regarding the consequences of different macroeconomic policies is still highly imperfect and open to serious criticism." Nakamura and Steinsson write that macroeconomics struggles with long-term predictions, which is a result of the high complexity of the systems it studies.


Monetary policy

Central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" in the most specific sense is money ...

Central bank
s implement monetary policy by controlling the money supply through several mechanisms. Typically, central banks take action by issuing money to buy bonds (or other assets), which boosts the supply of money and lowers interest rates, or, in the case of contractionary monetary policy, banks sell bonds and take money out of circulation. Usually policy is not implemented by directly targeting the supply of money. Central banks continuously shift the money supply to maintain a targeted fixed interest rate. Some of them allow the interest rate to fluctuate and focus on targeting inflation rates instead. Central banks generally try to achieve high output without letting loose monetary policy that create large amounts of inflation. Conventional monetary policy can be ineffective in situations such as a
liquidity trap A liquidity trap is a situation, described in Keynesian economics, in which, "after the rate of interest has fallen to a certain level, liquidity preference may become virtually absolute in the sense that almost everyone prefers holding cash ...
. When interest rates and inflation are near zero, the central bank cannot loosen monetary policy through conventional means. Central banks can use unconventional monetary policy such as
quantitative easing Quantitative easing (QE) is a monetary policy whereby a central bank purchases predetermined amounts of government bonds or other financial assets (e.g., municipal bonds, corporate bonds, stocks, etc.) in order to inject money into the economy to ...
to help increase output. Instead of buying government bonds, central banks can implement quantitative easing by buying not only government bonds, but also other assets such as corporate bonds, stocks, and other securities. This allows lower interest rates for a broader class of assets beyond government bonds. In another example of unconventional monetary policy, the United States Federal Reserve recently made an attempt at such a policy with Operation Twist. Unable to lower current interest rates, the Federal Reserve lowered long-term interest rates by buying long-term bonds and selling short-term bonds to create a flat yield curve.


Fiscal policy

Fiscal policy is the use of government's revenue and expenditure as instruments to influence the economy. Examples of such tools are Government spending, expenditure, taxes, debt. For example, if the economy is producing less than potential output, government spending can be used to employ idle resources and boost output. Government spending does not have to make up for the entire output gap. There is a Fiscal multiplier, multiplier effect that boosts the impact of government spending. For instance, when the government pays for a bridge, the project not only adds the value of the bridge to output, but also allows the bridge workers to increase their consumption and investment, which helps to close the output gap. The effects of fiscal policy can be limited by Crowding out (economics), crowding out. When the government takes on spending projects, it limits the amount of resources available for the private sector to use. Crowding out occurs when government spending simply replaces private sector output instead of adding additional output to the economy. Crowding out also occurs when government spending raises interest rates, which limits investment. Defenders of fiscal stimulus argue that crowding out is not a concern when the economy is depressed, plenty of resources are left idle, and interest rates are low. Fiscal policy can be implemented through automatic stabilizers. Automatic stabilizers do not suffer from the policy lags of discretionary fiscal policy. Automatic stabilizers use conventional fiscal mechanisms but take effect as soon as the economy takes a downturn: spending on unemployment benefits automatically increases when unemployment rises and, in a progressive income tax system, the effective tax rate automatically falls when incomes decline.


Comparison

Economists usually favor monetary over fiscal policy because it has two major advantages. First, monetary policy is generally implemented by independent central banks instead of the political institutions that control fiscal policy. Independent central banks are less likely to make decisions based on political motives. Second, monetary policy suffers shorter inside lags and outside lags than fiscal policy. Central banks can quickly make and implement decisions while the discretionary fiscal policy may take time to pass and even longer to carry out.


See also

* Dynamic stochastic general equilibrium * Economic development


Notes


References

* * Blanchard, Olivier. (2009).
The State of Macro
" ''Annual Review of Economics'' 1(1): 209-228. * * Blaug, Mark (1986), ''Great Economists before Keynes'', Brighton: Wheatsheaf. * * * Bouman, John
Principles of Macroeconomics – free fully comprehensive Principles of Microeconomics and Macroeconomics texts
Columbia, Maryland, 2011 * * * * * * Leijonhufvud, Axe
''The Wicksell Connection: Variation on a Theme''
UCLA. November, 1979. * * * * * * * Nakamura, Emi and Jón Steinsson. (2018).
Identification in Macroeconomics.
''Journal of Economic Perspectives'' 32(3): 59-86. * * Reed, Jacob (2016)
AP Economics Review
Macroeconomics. * * Snowdon, Brian, and Howard R. Vane, ed. (2002). ''An Encyclopedia of Macroeconomics''
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