1. PowerPoint Slides prepared by:
Andreea CHIRITESCU
Eastern Illinois University
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The Goals of
Macroeconomic Policy
When men are employed, they are best contented.
BENJAMIN FRANKLIN
Inflation is repudiation.
CALVIN COOLIDGE

2. Goals of Macroeconomic Policy
• Economic growth – ingredients
–Aggregate supply
–Aggregate demand
• Inputs
–Labor, machinery, other resources
–Used to produce outputs
• Output
–Goods and services
–Produced in economy
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3. Goals of Macroeconomic Policy
• Macroeconomics policy
–Growth policy
• Make the economy grow faster in the long-
run
–Stabilization policy
• Manage aggregate demand
• Avoid high unemployment
• Avoid high inflation
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4. Productivity and Growth
• Small differences in growth rates
–Enormous difference in the long run
• 109 years; 1870 – 1979
–GDP per capita annual growth
• U.S. – 2.3%
• U.K. – 1.8%
• Japan – 3%
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5. Productivity and Growth
• Labor productivity
–Amount of output
–One worker produces
• In an hour (or a week, or a year) of labor
–If output is measured by GDP
• Labor productivity = GDP per hour of work
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6. Productivity Growth
• Productivity growth
–Almost everything in long run
• Rising productivity
–Raising standard of living – long run
• Long periods of time
–Small differences in rates of productivity
growth - compound over time
–Enormous difference to society’s
prosperity
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7. Productivity Growth
• Productivity growth
–Reduction of poverty
–Increases in leisure time
–Increases in country’s ability to finance
• Education
• Public health
• Environmental improvement
• Arts
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8. Potential GDP
• The capacity to produce: potential GDP
and the production function
• Potential GDP
–Real GDP the economy would produce
–If labor and other resources were fully
employed
• Labor force
–Number of people holding or seeking jobs
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9. Potential GDP
• Estimate potential GDP
–Count up the available supplies of labor,
capital, and other productive resources
• Estimate how much output these inputs could
produce if they were all fully utilized
– Transformation of inputs into outputs
• Assessment of the economy’s technology
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10. Potential GDP
• Production function
–Shows the volume of output that can be
produced
–From given inputs (such as labor and
capital)
–Given the available technology
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11. Potential GDP
• Along the production function
–Constant capital and technology
• Better technology or more capital
–Shift upward the production function
–Raise the potential GDP
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12. Figure 1
The Economy’s Production Function
12
0 Labor input
(hours)
RealGDP
(a) Effect of better technology (b) Effect of more capital
L0
Y0
K
M
Y1
A
0 Labor input
(hours)RealGDP
L0
Y0
K0
K1
Y1
A
B
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13. Growth Rate of Potential GDP
• Growth rate of potential GDP
–Depends on
• Growth rate of labor force
• Growth rate of capital stock
• Rate of technical progress
• GDP = Hours of work Output per hourˣ
= Hours of work Labor productivityˣ
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14. Growth Rate of Potential GDP
• Growth rate of potential GDP =
= Growth rate of labor input +
+ Growth rate of labor productivity
• Growth rates: actual and potential GDP
–Over long periods of time: similar
–Over short periods of time
• Diverge sharply due to cyclical fluctuations
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15. Table 1
Recent Growth Rates of Real GDP in the United States
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16. The Goal of Low Unemployment
• Unemployment rate
–Number of unemployed people
–As percentage of labor force
• If GDP grows slower than the economy’s
potential
–Unemployment rate rises
• If GDP grows faster than the economy’s
potential
–Unemployment rate falls
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17. Table 2
The Economic Costs of High Unemployment
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18. Figure 2
Actual and Potential GDP in the United States since 1954
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19. The Goal of Low Unemployment
• Cumulative gap between actual and
potential GDP
–Over the three years 2008 to 2010
• Evaluated in 2005 prices
–Is roughly $2.3 trillion
–At 2010 levels, this loss in output as a
result of unemployment
• Over two months worth of production
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20. High Unemployment
• Human costs of high unemployment
–Income loss
–Hunger, cold, ill health
–Psychological cost
• Some help for the unemloyed
–System of unemployment insurance
–Social welfare programs
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21. High Unemployment
• Unemployment rates
–Lower for
• Married men
• Whites
• Well-educated people
–Higher for
• Teenagers
• Nonwhites
• Blue-collar workers
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22. Figure 3
Unemployment Rates for Selected Groups, 2009
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23. Counting the Unemployed
• Employed
–Everyone currently at work, including part
time workers
• Unemployed
–People not currently working
• Temporarily laid-off, expected to return
• Actively looking for a job (4 weeks)
• Out of the labor force
–Nor looking for work
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24. Counting the Unemployed
• Discouraged worker
–Unemployed person
–Gives up looking for work
–No longer counted as part of labor force
• Hidden / disguised unemployment
–Involuntary part-time
–Loss of overtime
–Shortened work hours
–Discouraged workers
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25. Types of Unemployment
• Frictional unemployment
–Due to normal turnover in the labor
market
–People who are temporarily between jobs
• Moving or changing occupations
• Unemployed for similar reasons
• Structural unemployment
–Workers displaced by automation
–Their skills are no longer in demand
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26. Types of Unemployment
• Cyclical unemployment
–Portion of unemployment that is
attributable to a decline in the economy’s
total production
–Rises during recessions
–Falls as prosperity is restored
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27. Full Employment
• Full employment
–Everyone who is willing and able to work
can find a job
–Unemployment rate is still positive
• Difficult to estimate
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28. Unemployment Insurance
• Unemployment insurance
–Government program
–Replaces some wages lost by eligible
workers who lose their jobs
–Helps prop up aggregate demand during
recessions
–Benefits the unemployed
• And the economy - greater spending
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29. Unemployment Insurance
• Payroll taxes and unemployment benefits
–Spreads the cost of unemployment over
the entire population
–Doesn’t eliminate the basic economic
cost
• Higher unemployment benefits
–Disincentive to look for job
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30. The Goal of Low Inflation
• Purchasing power of a given sum of
money
–Volume of goods and services that it will
buy
• Real wage rate - purchasing power of
wages
–Wage rate – adjusted for inflation
–Nominal wage divided by price index
• Volume of goods and services that the
nominal wages will buy
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31. Figure 4
Rates of Change of Wages and Prices in the United States
since 1948
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32. Inflation: Myth and Reality
• Myth: inflation erodes real wages
–No inflation, and wages increase 2% per
year due to increased labor productivity
–Inflation 3%, and wages increase 5%
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33. Inflation: Myth and Reality
• Inflation
–Increase in “average price”
• Relative price of an item
–Its price in terms of some other item
• Inflation
–Not to blame when some goods become
more expensive relative to other goods
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34. Table 3
Pure Inflation
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35. Table 4
Real-World Inflation
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36. Inflation as Redistributor
• Inflation as a redistributor of income and
wealth
• Redistribution caused by inflation
–Harm: lenders
–Gain: borrowers
–Arbitrarily
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37. Real vs. Nominal Interest Rates
• Expected rate of inflation
–Anticipated inflation
• Unexpected inflation
• Real rate of interest
–Percentage increase in purchasing power
• That the borrower pays to the lender for the
privilege of borrowing
–Increased ability to purchase goods and
services that the lender earns
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38. Real vs. Nominal Interest Rates
• Nominal rate of interest
–Percentage by which the money the
borrower pays back
–Exceeds the money that was borrowed
–Making no adjustment for any decline in
the purchasing power of this money that
results from inflation
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39. Real vs. Nominal Interest Rates
• Nominal interest rate =
= Real interest rate + Expected inflation
rate
• If inflation is accurately predicted
–No income redistribution
–Expected rate of inflation = Actual rate of
inflation
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40. Inflation Distorts Measurements
• Capital gain
–Difference between the price at which an
asset is sold
–And the price at which it was bought
• Malfunctioning tax system
–Taxes on nominal interest
–Taxes on nominal capital gain
–High tax rates when inflation is high
• Discourage saving, lending, and investing
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41. Other Costs of Inflation
• Rapidly changing prices
–Riskier to enter long-term contracts
–Economic stagnation
–Shop around more
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42. Costs of Low vs. High Inflation
• Steady inflation
–More predictable than variable inflation
–Smaller social and economic costs
• Average level of inflation
–Steady inflation at 6% per year
• More damaging than steady inflation at 3%
per year
• Hyperinflation
–Very high inflation
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43. Costs of Low vs. High Inflation
• Low inflation
–Doesn’t necessarily lead to high inflation
• Inflation
–Sometimes speeds up
–Sometimes slows down
• Runaway inflations
–When government prints incredible
amounts of money
• Finance wartime expenditure
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44. Appendix
How statisticians measure inflation
• Index numbers for inflation
• Index number
–Cost of a market basket of goods relative
to its cost in some “base” period
• Base year
–Year used as a basis of comparison
44
100×=
yearbasein
basketmarketofCost
yeargivenin
basketmarketofCost
yeargiveninCPI
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45. Appendix
Index numbers for inflation
• Index number problem
–Changing relative prices
–No “perfect price index” correct for every
consumer
–Statistical index
• Understate increase in cost of living for some
families
• Overstate increase in cost of living for other
families
–Index - “average” family
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46. Appendix
Consumer price index
• Consumer price index (CPI)
–Bureau of Labor Statistics (BLS)
–Monthly
–Representative typical urban household
budget
–Same bundle of goods and services
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47. Table 5
Results of Student Expenditure Survey, 1983
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48. Table 6
Prices in 2009
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49. Table 7
Cost of 1983 Student Budget in 2009 Prices
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50. Appendix
Consumer price index
• Student price index (SPI)
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100
100 142
Cost of budget in 2009
SPI=
Cost of budget in 1983
$142
SPI=
$100
×
× =

51. Appendix
Using price index to ”deflate” monetary
figures
• Deflating
–Process of finding the real value of some
monetary magnitude
–By dividing by some appropriate price
index
51
100
Real spending Nominal spending in 2009
Price index of 2009in 2009
= ×
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52. Appendix
Using a price index to measure inflation
• Inflation
–Rate of increase in price level
–CPI2009 = 214.5
–CPI2010 = 218.1
–CPI2010 / CPI2009 = 218.1/214.5 = 1.017
–Inflation rate = 1.7%
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53. Appendix
GDP deflator
• GDP deflator
–Price index used to deflate nominal GDP
–Broad measure of economy-wide inflation
• Includes the prices of all goods and services
in the economy
53
100×=
deflatorGDP
GDPNominal
GDPReal
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