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Chapter 2 focused on output, income, and expenditure in real terms, that is, in the prices and costs of a particular base year. But nominal values (i.e., current money values), which reflect both aggregate inflation and changes in relative prices, are equally important.1 Price and cost changes add several additional dimensions to macroeconomic analysis. Not only can we account for output, income, and expenditure in easy-to-measure nominal terms, but we also get the tools to assess inflationary or deflationary conditions and the influences of relative prices on the allocation of resources, the international competitiveness of a country, and the distribution of income.
This chapter covers the measurement and analysis of a country’s aggregate economic activity, a term typically used synonymously with total output. The chapter is concerned with “real” measures and concepts – i.e., measures that do not include changes in prices.
Macroeconomics is ubiquitous and nobody questions its importance. Media commentary on breaking economic data – perhaps the gross domestic product (GDP) and its growth, employment, inflation, or the balance of payments – is almost inescapable. Political campaigns often revolve around starkly conflicting views on exchange rates, movements of jobs across borders, or concerns about government deficits and debt. For a discipline that is called a science, macroeconomics displays a confusing divergence of views on real-world developments.
Fiscal policy is where political theory and ideology intersect with the everyday practice of governance, and, ultimately, the economics of budget constraints. Legislators have to make practical decisions on how much to spend, how to allocate this spending, which activities and citizens to tax and at what rates. The public debate usually appeals to broad principles – the appropriate role of government in the economy, the dangers of distorting market signals, and the balance between efficiency and equity – with positions reflecting ideological predilections.
In this chapter we establish a framework for analyzing how a country’s economy interacts with the rest of the world. In focusing on how the domestic economy and monetary, fiscal, and financial sector policies influence and are influenced by the rest of the world, it draws on and provides some synthesis of the first six chapters of the book. The chapter covers four broad topics
Money is the source of much confusion in economic thinking. Many people do not differentiate clearly between monetary holdings and command over real resources, between money and real wealth. Casual discussion about money and wealth brings to mind the story of a central bank governor of a high-inflation country who tells his dictatorial president-for-life that the country is running out of money. The governor has in mind hard currency holdings (foreign exchange reserves) that can be used to buy goods, as opposed to local currency that can be produced at will but has become almost worthless over years of high inflation.
A strong financial sector is a force for good. It intermediates funds from savers to borrowers, facilitating both investment and intertemporal consumption smoothing. Without this intermediation, economic activity would be severely constrained. Leverage, that portion of an undertaking financed by borrowing rather than owners’ equity, makes it possible for a resource-constrained entrepreneur to undertake a profitable venture. Insofar as the returns on the investment exceed the cost of borrowing, leverage amplifies the rate of return on equity.
Understanding macroeconomic developments and policies in the twenty-first century is daunting: policy-makers face the combined challenges of supporting economic activity and employment, keeping inflation low and risks of financial crises at bay, and navigating the ever-tighter linkages of globalization. Many professionals face demands to evaluate the implications of developments and policies for their business, financial, or public policy decisions. Macroeconomics for Professionals provides a concise, rigorous, yet intuitive framework for assessing a country's macroeconomic outlook and policies. Drawing on years of experience at the International Monetary Fund, Leslie Lipschitz and Susan Schadler have created an operating manual for professional applied economists and all those required to evaluate economic analysis.
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