4: Economic Activity and Performance

Macroeconomic performance and policy continue to dominate the media, political debates, and public discussion in Canada, the U.S. and Europe. The 2008 economic crisis in the American financial and housing markets had profound and lasting effects on U.S. banks and households. Major financial institutions collapsed on an international scale. Output and employment fell sharply and continuously in the midst of the most dramatic recession since the 1980s. Recession spread quickly and widely to other countries through international capital markets and financial flows, trade flows, commodity prices, and exchange rates. The crisis triggered unprecedented government intervention in U.S and European financial markets and calls for large and innovative changes in both monetary and fiscal policy stimulus.

The after-effects of the crisis and policy responses continue to dominate the financial news. Financial institution bailouts in many countries combined with initial fiscal stimulus to fight recession create large government budget deficits in North America and Europe. These deficits drew attention to an underlying concern about government debt to GDP ratios. Markets reacted negatively to increased risks of default on the sovereign debt of weaker countries in the euro zone like Portugal, Ireland, Greece and Spain, (the PIGS). New European policy initiatives to provide financial support for these and other troubled EU countries included requirements for strong fiscal austerity to reduce government budget deficits. To the extent that austerity programs cut economic growth and caused deeper recessions, the deficit and debt problems intensified. Larger support programs were needed. This process continues in 2013 as France Germany, Italy and Spain discuss the design of an effective stabilization program to sustain the euro.

Macroeconomic theory and models emerged from an earlier major financial collapse and crisis followed by the depression years of the 1930s. Although today’s economies are larger and more complex they still behave by the same basic principles. Macroeconomics studies the national economy as a system. It starts with carefully developed measures of the economy’s total output of goods and services, and expenditures on current output by households, businesses, national governments, and residents of other countries. Expenditures generate incomes for households and businesses and, through taxation, revenues for governments. Money, banking, financial markets, and foreign exchange markets play key roles in financing these expenditure flows. Macroeconomics explains the ways in which different parts of the economy interact to determine outputs, incomes, prices, and employment in the whole economy.

Macroeconomic theory, models and institutions also provide for the design and evaluation of national monetary and fiscal policies. Most countries have a central bank charged with designing and pursuing monetary policies to control inflation while supporting high levels of national income and employment. Similarly, national governments, and in many cases junior governments as well, have fiscal policy responsibilities. Fiscal policies fund a set of public services by designing government budgets that control deficits and government debt while at the same time contributing to stability and growth in national income and employment. The media report regularly on the monetary and fiscal policy announcements of the Governor of the Bank of Canada, Stephen Poloz and the Federal Minister of Finance, the Honorable Joe Oliver.

To understand the different dimensions of economic activity, economic conditions and macroeconomic policies we need a framework that captures how they are related and how they interact. Macroeconomics provides that framework, based on a consistent and comprehensive system of definitions for the measurement of economic activity in the national economy.