Measurement Of Macroeconomic Performance Flashcards
What are the possible of conflicts in the macroeconomic policy in the short run when attempting to achieve these objectives?
- Economic Growth vs. Price Stability (Inflation)
- Economic Growth vs Reducing Unemployment
- Economic Growth vs Stable balance of payments
- Reducing Unemployment vs Price Stability
- Price Stability vs Stable Balance of Payments
How does economic growth conflicts with inflation?
Conflict: Higher economic growth often leads to demand-pull inflation, especially if the economy is operating near full capacity. When aggregate demand (AD) increases, firms may struggle to meet demand, leading to rising prices.
Example: If the government implements expansionary fiscal or monetary policies (e.g., lower interest rates, increased public spending) to boost growth, inflationary pressures may emerge.
Trade-off: To control inflation, the central bank may raise interest rates, which could slow down growth.
How does economic growth compatible with unemployment?
Compatible: Policies that stimulate growth (e.g., lower interest rates, tax cuts) typically reduce unemployment, as firms expand and hire more workers.
However, if the economy grows too fast, inflation can rise, leading to tighter monetary policy that may slow growth and increase unemployment.
Example: In the 1970s, many economies experienced stagflation—high unemployment and high inflation—making it difficult to balance these objectives.
How does economic growth conflicts with stable balance of payments?
Conflict: Rapid economic growth often leads to a worsening current account deficit because higher incomes increase imports, and domestic firms may struggle to compete internationally due to rising costs.
Example: The UK has often experienced current account deficits during periods of strong economic growth as consumer spending on imports rises.
Trade-off: To improve the balance of payments, policies may be implemented to reduce spending on imports (e.g., higher taxes, higher interest rates), but this could slow down growth.
How does unemployment conflicts with inflation?
Conflict: Policies that reduce unemployment, such as expansionary fiscal or monetary policy, often increase inflation due to higher aggregate demand.
Example: The Phillips Curve suggests an inverse relationship between inflation and unemployment in the short run, meaning that reducing one can worsen the other.
Trade-off: Governments may tolerate some inflation to achieve lower unemployment, but too much inflation could lead to instability and require tighter monetary policy.
How does inflation compatible with stable balance of payments?
Compatible: Measures to control inflation, such as higher interest rates, may lead to currency appreciation, making exports more expensive and reducing international competitiveness, worsening the current account.
Example: If the Bank of England raises interest rates to reduce inflation, the pound may appreciate, making UK exports more expensive and imports cheaper, worsening the trade balance.
What data is commonly used to measure the performance of an economy?
- Real GDP
Definition: The total value of all goods and services produced in an economy, adjusted for inflation.
Use: It measures economic growth over time.
Limitation: Does not account for income inequality, informal economy, or non-market activities (e.g., household work). - Real GDP per capita
Definition: Real GDP divided by the population.
Use: Provides a measure of average living standards and economic well-being.
Limitation: It does not reflect income distribution or quality of life factors (e.g., health, education). - Consumer prices and retail prices indices (CPI/ RPI)
Consumer Price Index (CPI): Measures changes in the average price of a “basket” of goods and services, excluding mortgage interest payments.
Retail Price Index (RPI): Similar to CPI but includes mortgage interest payments and other housing costs.
Use: Indicators of inflation, which affect purchasing power and economic stability.
Limitation: CPI may not fully reflect the cost of living changes for all household
What are measures of unemployment?
Claimant Count: The number of people claiming unemployment-related benefits (e.g., Jobseeker’s Allowance in the UK).
Labour Force Survey (LFS): A broader measure, including those actively seeking work but not necessarily claiming benefits.
Use: Indicates labor market conditions and economic activity.
Limitation: Does not account for underemployment or discouraged workers who have stopped looking for jobs
How to calculate index numbers?
An index number is a statistical measure used to show changes in a variable over time, relative to a base year.
1. Base Year
The base year is assigned an index value of 100.
Index number = (current year value/ base year value) x 100
- Use of Weights
Different items contribute differently to the overall index, so weights are assigned based on their importance.
Weighed index = sum of (price index x weight) / sum of weights
Example: In CPI, food might have a higher weight than luxury goods because people spend a larger proportion of their income on food.
How index numbers are used to measure changes in economic variables?
- Tracks Economic Growth: A rising real GDP per capita suggests an increase in material living standards.
- Measures Productivity and Incomes: Higher GDP per capita often correlates with improved employment and wages.
- Indicates Government Revenue: Higher national income allows for increased public spending on healthcare, education, and infrastructure.
Limitations:
- Does Not Reflect Income Distribution: GDP per capita is an average and does not show inequality.
- Ignores Non-Market Activities: Unpaid work (e.g., childcare, housework) and informal economies are not included.
- Does Not Account for Negative Externalities: Environmental damage, resource depletion, and congestion reduce well-being but are not deducted from GDP.
- Quality of Life Factors Are Excluded: Economic growth does not necessarily mean better healthcare, education, or happiness.
How to use national income data such as GDP and GDP per capita to assess changes in living standards?
And what are limitations of it?
- Tracks Economic Growth: A rising real GDP per capita suggests an increase in material living standards.
- Measures Productivity and Incomes: Higher GDP per capita often correlates with improved employment and wages.
- Indicates Government Revenue: Higher national income allows for increased public spending on healthcare, education, and infrastructure.
Limitations:
- Does Not Reflect Income Distribution: GDP per capita is an average and does not show inequality.
- Ignores Non-Market Activities: Unpaid work (e.g., childcare, housework) and informal economies are not included.
- Does Not Account for Negative Externalities: Environmental damage, resource depletion, and congestion reduce well-being but are not deducted from GDP.
- Quality of Life Factors Are Excluded: Economic growth does not necessarily mean better healthcare, education, or happiness.
How to use GDP and GDP per capita to compare living standards between countries?
And what are the limitations?
- Provides a Simple Comparison: GDP per capita allows a broad comparison of economic performance and average income levels.
- Indicates Economic Development Levels: Higher GDP per capita suggests higher industrialization and economic sophistication.
- Helps Identify Poorer vs. Wealthier Nations: Useful for policy decisions and aid distribution.
Limitations:
- Differences in Cost of Living: A country with a lower GDP per capita may still have higher living standards if costs are lower.
- Quality of Goods and Services Varies: The same level of spending may not provide the same standard of healthcare, education, or public services.
- Exchange Rate Distortions: Comparing GDP using market exchange rates may not reflect real purchasing power.
What is PPP?
- Purchasing Power Parity (PPP) adjusts exchange rates to reflect differences in the cost of living between countries.
- It measures how much a standard basket of goods costs in different countries, ensuring fairer comparisons.
Example:
In 2023, China’s nominal GDP per capita was about $12,000, while the PPP-adjusted GDP per capita was over $20,000, reflecting a higher actual standard of living.
Why PPP is important to make international comparisons of living standards?
- Removes Exchange Rate Bias: Market exchange rates fluctuate due to speculation, trade imbalances, and government intervention, which can distort comparisons.
- Reflects True Living Standards: A country with low GDP per capita may have higher real purchasing power due to lower prices.
- Improves Accuracy in Development Comparisons: Developing countries often have lower costs for essentials like food, housing, and services.
How the importance of macroeconomic objectives changes over time?
Macroeconomic priorities shift based on economic conditions. Inflation control dominated the 1980s and 1990s, but crises like COVID-19 and climate change have refocused attention on employment, sustainability, and financial stability in the 2020s. Governments must balance these objectives as conditions evolve.
What are macroeconomic objectives in post-WWII to 1970s?
- After WWII, governments prioritized economic growth and full employment to rebuild economies.
- Keynesian policies (high government spending, demand management) were widely used.
- Example: The UK and US saw low unemployment and rising living standards during the 1950s and 1960s.
Shift: 1970s Stagflation (High Inflation + High Unemployment)
- The oil crises (1973, 1979) led to rising inflation and economic stagnation.
- Governments began prioritizing price stability over growth.
- Example: The UK and US shifted toward monetarist policies (e.g., higher interest rates) to control inflation.
What are macroeconomic objectives between 1980s - 1990s?
- Inflation control became the primary objective, with many central banks adopting monetary policy as the key tool.
- Privatization and deregulation became popular (e.g., Thatcher’s reforms in the UK, Reaganomics in the US).
Example: The UK’s inflation targeting policy (1992) helped reduce inflation but led to short-term economic slowdowns.
What are macroeconomic objectives in 2000s?
- Governments aimed to maintain steady economic growth with low inflation.
- Increased focus on financial stability, especially after the 2008 Global Financial Crisis.
- Example: The US Federal Reserve and the Bank of England used quantitative easing (QE) to support growth.
What are main macroeconomic objectives in 2020s?
- COVID-19 pandemic (2020-2021): Governments prioritized unemployment reduction and economic recovery, using high public spending and ultra-low interest rates.
- Inflation Surge (2022-2023): Central banks refocused on price stability, raising interest rates to curb inflation.
- Environmental Sustainability: Increasing emphasis on green growth and climate-related policies.
- Example: The EU Green Deal and the UK’s net-zero targets.
What are other macroeconomic objectives of government policy (1) ?
Balancing the Budget (Fiscal Stability)
Why It Matters:
- A balanced budget ensures that government spending does not exceed tax revenue, reducing reliance on borrowing.
- Reduces the national debt, lowering interest payments and making public finances more sustainable.
- Helps maintain investor confidence, reducing the risk of a debt crisis.
Trade-Offs:
- During economic downturns, cutting spending to balance the budget can worsen unemployment and slow growth.
- Austerity policies (e.g., UK post-2010) can reduce public services, impacting long-term economic potential.
- Example: The Eurozone debt crisis (2010s) forced countries like Greece and Spain to implement austerity to reduce deficits, but this led to recessions and high unemployment.
What are other macroeconomic objectives of government policy (2) ?
Achieving an Equitable Distribution of Income
Why It Matters:
- Reduces income inequality, improving social stability and economic efficiency.
- Prevents the emergence of poverty traps, where low-income individuals struggle to escape hardship.
- Supports long-term growth by ensuring broad-based consumption and investment in human capital (e.g., education, health).
Policies to Reduce Inequality:
- Progressive taxation: Higher earners pay a greater proportion of their income in tax (e.g., UK income tax system).
- Welfare programs: Unemployment benefits, pensions, and child support to protect vulnerable groups.
- Minimum wage laws: Ensure a living wage for low-income workers.
- Education and healthcare investment: Reduces barriers to upward mobility.
Trade-Offs:
- Higher taxes on the wealthy may reduce incentives to work and invest.
- Excessive redistribution can lead to lower productivity and efficiency.
Example:
- Nordic countries (e.g., Sweden, Norway) have high taxes but strong public services, resulting in low inequality and high living standards.
- The US has lower taxes but higher inequality and weaker social safety nets.
What are four main objectives of government macroeconomic policy?
Economic growth - a rise in real GDP
Price stability (inflation) - price level maintain at 2% +/- 1%
Minimising unemployment - low percentage of unemployed people over the total population
A stable balance of payments on current account - the total value of imports close to the total value of exports
