- What kinds of problems do we study in macroeconomics?
The economic decisions you witness inside Kentucky Fried Chicken (KFC) are only a few examples of the vast number of economic transactions that take place daily across the globe. People buy and sell goods and services. Firms hire and lay off workers. Governments collect taxes and spend the revenues that they receive. Banks accept deposits and make loans. When we think about the overall impact of all these choices, we move into the realm of macroeconomics. Macroeconomics is the study of the economy as a whole.
While sitting in KFC, you can also see macroeconomic forces at work. Inside the restaurant, some young men are sitting around talking and looking at the newspaper. It is early afternoon on a weekday, yet these individuals are not working. Like many other workers in France and around the world, they recently lost their jobs. Across the street, there are other signs that the economy is not healthy: some storefronts are boarded up because many businesses have recently been forced to close down.
You know from your economics class that the unemployed workers and closed-down businesses are the visible signs of the global downturn, or recession, that began around the middle of 2008. In a recession, several things typically happen. One is that the total production of goods and services in a country decreases. In many countries, the total value of all the goods and services produced was lower in 2008 than it was in 2007. A second typical feature of a recession is that some people lose their jobs, and those who don’t have jobs find it more difficult to find new employment. And a third feature of most recessions is that those who do still have jobs are unlikely to see big increases in their wages or salaries. These recessionary features are interconnected. Because people have lower income and perhaps because they are nervous about the future, they tend to spend less. And because firms are finding it harder to sell their products, they are less likely to invest in building new factories. And when fewer factories are being built, there are fewer jobs available both for those who build factories and for those who work in them.
Down the street from KFC, a large construction project is visible. An old road and a nearby bridge are in the process of being replaced. The French government finances projects such as these as a way to provide more jobs and help the economy recover from the recession. The government has to finance this spending somehow. One way that governments obtain income is by taxing people. KFC customers who have jobs pay taxes on their income. KFC pays taxes on its profits. And customers pay taxes when they buy their food.
Unfortunately for the government, higher taxes mean that people and firms have less income to spend. But to help the economy out of a recession, the government would prefer people to spend more. Indeed, another response to a recession is to reduce taxes. In the face of the recession, the Obama administration in the United States passed a stimulus bill that both increased government spending and reduced taxes. Before you studied macroeconomics, this would have seemed quite mysterious. If the government is taking in less tax income, how is it able to increase spending at the same time? The answer, you now know, is that the government borrows the money. For example, to pay for the $787 billion stimulus bill, the US government issued new debt. People and institutions (such as banks), both inside and outside the United States, buy this debt—that is, they lend to the government.
There is another institution—called the monetary authority—that purchases government debt. It has specific names in different countries: in the United States, it is called the Federal Reserve Bank; in Europe, it is called the European Central Bank; in Australia, it is called the Reserve Bank of Australia; and so on. When the US government issues more debt, the Federal Reserve Bank purchases some of it. The Federal Reserve Bank has the legal authority to create new money (in effect, to print new currency) and then to use that to buy government debt. When it does so, the currency starts circulating in the economy. Similarly, decisions by the European Central Bank lead to the circulation of the euro notes and coins you saw being used to purchase fried chicken.
The decisions of the monetary authority have a big impact on the economy as well. When the European Central Bank decides to put more euros into circulation, this has the effect of reducing interest rates, which means it becomes cheaper for individuals to get a student loan or a mortgage, and it is cheaper for firms to buy new machinery and build new factories. Typically, another consequence is that the euro will become less valuable relative to other currencies, such as the US dollar. If you are planning a trip to the United States now that your class is finished, you had better hope that the European Central Bank doesn’t increase the number of euros in circulation. If it does, it will be more expensive for you to buy US dollars.
Today, the world’s economies are highly interconnected. People travel from country to country. Goods are shipped around the world. If you were to look at the labels on the clothing worn by the customers in KFC, you would probably find that some of the clothes were manufactured in China, perhaps some in Malaysia, some in France, some in the United States, some in Guatemala, and so on. Information also moves around the world. The customer sitting in the corner using a laptop might be in the process of transferring money from a Canadian bank account to a Hong Kong account; the person at a neighboring table using a mobile phone might be downloading an app from a web server in Illinois. This globalization brings many benefits, but it means that recessions can be global as well.
Your study of economics has taught you one more thing: the idea that you can take a trip to the United States would have seemed remarkable half a century ago. Despite the recent recession, the world is a much richer place than it was 25, or 50, or 100 years ago. Almost everyone in KFC has a mobile phone, and some people are using laptops. Had you visited a similar fast-food restaurant 25 years ago, you would not have seen people carrying computers and phones. A century ago, there was, of course, no such thing as KFC; automobiles were still a novelty; and if you cut your finger on the sharp metal edge of a table, you ran a real risk of dying from blood poisoning. Understanding why world economies have grown so spectacularly—and why not all countries have shared equally in this growth—is one of the big challenges of macroeconomics.
- In macroeconomics, we study the economy as a whole to understand why economies grow and why they sometimes experience recessions. We also study the effects of different kinds of government policy on the overall economy.
CHECKING YOUR UNDERSTANDING
- If the government and the monetary authority think that the economy is growing too fast, what could they do to slow down the economy?