Macroeconomics is a subfield of economics that focuses on the behaviour of the economy as a whole, including the markets, firms, consumers, and governments. Macroeconomics studies trends in the economy as a whole, including inflation, price levels, economic growth rates, national income, GDP, and changes in unemployment.
What causes unemployment is one of the important issues that macroeconomics deals with. Macroeconomics makes an effort to gauge an economy's performance, comprehend the factors that influence it, and forecast how it can change.
Macroeconomics, as the name suggests, is an area of study that examines an economy from several angles. This entails taking a close look at elements like inflation, GDP, and unemployment. Macroeconomists also create models that depict the connections between various variables. Governmental organisations utilise these models and the forecasts they provide to help develop and assess economic, monetary, and fiscal policy.
Investors use the models to forecast and prepare for moves in different asset classes, while businesses use them to establish strategies for domestic and international markets.When used correctly, economic theories can shed light on how economies work as well as the long-term effects of various policies and choices. Through a more full grasp of the impacts of general economic trends and policies on their own industries, individual businesses and investors can also benefit from using macroeconomic theory to guide their actions.
Also Read | A Beginner’s Guide to Macroeconomics | Analytics Steps
History of Macroeconomics
Although the word "macroeconomics" is relatively new (dating from the 1940s), many of its fundamental ideas have been the subject of research for much longer. Since the discipline's inception in the 1700s, issues including unemployment, prices, growth, and trade have been of interest to economists. Adam Smith and John Stuart Mill wrote previously about topics that are now known to fall under the macroeconomics umbrella.
Macroeconomics is frequently defined as having its modern origins in John Maynard Keynes' 1936 book The General Theory of Employment, Interest, and Money. Keynes provided an explanation of the effects of the Great Depression, including the unsold commodities and joblessness. Prior to Keynes' views becoming widely accepted, economists rarely distinguished between micro- and macroeconomics. According to Leon Walras, the same microeconomic principles of supply and demand that govern specific good markets also interact across markets to bring the economy to a state of general equilibrium.
Understanding the constraints of economic theory is also crucial. Theories frequently lack precise real-world elements like taxation, regulation, and transaction costs since they are developed in a theoretical vacuum. In addition to being extremely complex, the real world also contains ethical and social issues that resist quantitative study. It is crucial and desirable to monitor significant macroeconomic indices like GDP, inflation, and unemployment despite the limitations of economic theory. This is due to the fact that the economic environment in which businesses operate has a big impact on both their performance and, consequently, the value of their stocks.
Understanding the ideologies that are prevalent and influencing a certain government administration can also be extremely useful. How a government approaches taxation, regulation, spending, and other related measures will depend in large part on its fundamental economic tenets. Investors can at least obtain a peek of the likely future and take confident action by having a deeper understanding of economics and the effects of economic decisions.
Schools of Thought in Macroeconomics
There are numerous schools of thought within the discipline of macroeconomics, each having a unique perspective on how the markets and the people who participate in them function.
Building on Adam Smith's initial views, classical economists believed that prices, wages, and rates are flexible and that markets tend to clear unless impeded by governmental interference. In reality, the phrase "classical economists" refers to past economic theorists who Karl Marx and John Maynard Keynes both disagreed with, not a particular school of macroeconomic theory.
The foundation of Keynesian economics, which established macroeconomics as a distinct field of study from microeconomics, was largely based on the writings of John Maynard Keynes. Keynesians emphasise that the main driver of problems like unemployment and the business cycle is aggregate demand. According to Keynesian economists, the business cycle can be actively controlled by fiscal policy, in which governments increase spending during recessions to increase demand or cut spending during expansions to decrease it. They also support monetary policy, in which a central bank uses lower interest rates to encourage lending or higher rates to restrain it. The supply and demand gap should be properly cleared, according to Keynesian economists, but certain systemic rigidities, particularly sticky prices, prevent this from happening.
The works of Milton Friedman are primarily responsible for the Keynesian school of thought known as the monetarist school. Monetarists contend that monetary policy is typically a more effective and desirable policy tool to manage aggregate demand than fiscal policy, working within and expanding Keynesian models. Monetarists aim to stick to policy guidelines that support stable inflation rates because they recognise that monetary policy has limitations that make adjusting the economy unwise.
The fundamental focus of the New Classical school and the New Keynesians is the reconciliation of the glaring theoretical inconsistencies between macroeconomics and microeconomics. Microeconomics and models built on it are important, according to the New Classical school. In their macroeconomic models, New Classical economists integrate the presumption that all actors seek to maximise their utility and have reasonable expectations. According to New Classical economists, monetary policy may be used to manage inflation, but discretionary fiscal policy destabilises and unemployment is mostly a voluntary phenomenon.
The New Keynesian school makes an additional effort to strengthen conventional Keynesian economic theories with a focus on microeconomics. Although New Keynesians acknowledge that businesses and people follow reasonable expectations, they continue to believe that there are a number of market failures, such as sticky prices and wages. Due to its "stickiness," the government can alter the macroeconomic environment through monetary and fiscal policy.
An older school of economics, the Austrian School, is experiencing some popularity growth. Microeconomic phenomena are mostly covered by Austrian economic theories. They never strictly distinguished between microeconomics and macroeconomics, just as the so-called classical economists. Important implications of Austrian ideas also apply to topics that are typically thought of as macroeconomic. Due to monetary policy and the function that money and banks play in connecting (microeconomic) markets to one another and across time, the Austrian business cycle theory specifically explains essentially synchronised (macroeconomic) swings in economic activity across markets.
Also Read | 11 Types of Economic Theory | Analytics Steps
Indicators of the Macroeconomy
Despite being a rather vast science, macroeconomics is best represented by two particular research areas. The first area is what influences long-term economic growth or rises in the level of the national income. The second focuses on the factors that contribute to and are affected by short-term changes in employment and national income, generally referred to as the economic cycle.
An economy is said to be experiencing economic growth when its total output rises. To support economic policies that will support growth, progress, and growing living standards, macroeconomists work to understand the elements that either encourage or delay economic growth.
Numerous indicators can be used by economists to gauge economic performance. Ten categories can be constructed from these indicators:
Indicators of the gross domestic product: Calculate the output of the economy.
Spending by consumers indicators: Calculate the amount of capital that consumers contribute to the economy.
Savings and income indicators: measures the earnings and savings of consumers
Indicators of industry performance: assesses the GDP by industry
Indicators of global trade and investment: shows the balance of payments between trading partners, the volume of commerce, and the amount of international investment.
Indicators of prices and inflation: Describe changes in the amount paid for products and services as well as the buying power of different currencies.
Indicate the amount of capital invested in fixed assets by using these metrics.
Occupational indicators: displays employment by sector, state, county, and other factors.
Government indicators: Displays the amount spent and received by the government.
Other economic indicators, like the distribution of personal income, global value chains, healthcare spending, the health of small businesses, and more, are special indicators.
The Economic Cycle
The levels and rates of change of important macroeconomic indicators, such as employment and national production, fluctuate over long-term macroeconomic growth trends. Expansions, peaks, recessions, and troughs are the names given to these oscillations; they also take place in that order.
These oscillations, when plotted on a graph, demonstrate that firms operate in cycles; hence, it is known as the business cycle. GDP and Gross National Income are used by the National Bureau of Economic Research (NBER) to date the business cycle.2 The NBER is the organisation that also announces the start and end of recessions and expansions.
Further Reading | Economic Cycle - Overview, Stages, and Importance
How to Change the Macroeconomy
Given the breadth of macroeconomics, it is difficult and takes a lot longer to have a beneficial impact on the economy than it does to alter certain microeconomic behaviours. Therefore, each economy must have a unit tasked with investigating and identifying methods that can affect significant improvements. The Federal Reserve, the nation's central bank, has the responsibility of fostering maximum employment and price stability. These two elements have been recognised as being crucial for successfully influencing macroeconomic change.
The tools the Fed has created over the years, which seek to affect its dual missions, are used to administer monetary policy in order to affect change. It can use the following tools:
A target range established by the Fed to direct interest rates on overnight lending between depository institutions in order to increase short-term borrowing.
Open Market Activities To alter the supply of reserves, buy and sell securities on the open market.
Loans to depository institutions are made at a discounted rate to assist banks in managing their liquidity.
Reserve Requirements: Keeping a reserve to support banks' liquidity will be eliminated in 2020
Encourages banks to maintain reserves for liquidity and rewards them with interest for doing so.
By selling securities and repurchasing them the next day at a better rate, the Overnight Repurchase Agreement Facility is an additional tool used to assist manage the federal funds rate.
Reserve deposits with a term called "term deposits" are used to draw reserves out of the banking system.
Establishing swap lines for central banks from selected nations to enhance liquidity conditions for central banks in the United States and participating nations
International and foreign monetary authorities A mechanism enabling institutions to make repurchase agreements with the Fed to serve as a liquidity safety net is known as a "repo facility."
Standing A tool to encourage or dissuade borrowing above a certain rate, which aids in regulating the effective federal funds rate, is the overnight repurchase agreement facility.
Models and Graphs
In order to simplify, analyze, and anticipate human behavior, economists employ models in their study of human interactions. Graphs and mathematical models are examples of models. These mathematical models and diagrams are intended to simplify the numerous economic relationships. When analyzing the impact of a specific change on a market or on a country's economy, economists frequently utilise models and assume that everything else remains constant.
We refer to "all else equal" by the Latin phrase ceteris paribus. The idea that economic agents are rational and motivated to make decisions that are always in their own best interests is another one made by economists. Despite the fact that people frequently behave irrationally, economists try to build laws and make predictions about how human interactions will effect society by assuming that people, firms, governments, and other agencies make rational decisions. They also assume ceteris paribus.
We can either utilise positive analysis or normative analysis while considering economic issues. Positive analysis is fact-based, objective problem-solving that considers causes and effects. Economic disagreements are frequently the result of divergent normative analyses. The emphasis when applying normative analysis is on what ought to occur or how preferable one action is in comparison to another action.
Macroeconomics is a branch of study that is used to assess performance and create policies that can strengthen an economy. Economists study the effects of various variables and activities on employment, inflation, spending, and other economic variables such as production and input. Although the discipline of economics has been studied for a very long time, it wasn't until the 1700s that it began to take on its modern form. Decisions made by the government and industry are now heavily influenced by macroeconomics.