ECO 202- INTRODUCTION TO MACROECONOMICS

NATURE, SCOPE AND RELEVANCE

The word “macro’ is a Greek word meaning “large” therefore macroeconomics is seen as the
aggregative study of a nation’s economy. Macroeconomics is a branch of economic theory that is
complemented by the other branch, which is Microeconomics. Microeconomics is also derived
from a Greek word micro meaning “small”. Hence microeconomics is the study of economics in
the “small”. It is the study of economic activities of individuals and small groups of individuals.
It includes the study of particular households, particular firms, particular commodities and
particular prices.

On the other hand Macroeconomics is the study of a nation as a unit and in particular studies
national incomes, general prices and national output etc. it is concerned with current output,
long-run economic growth, economic fluctuations, unemployment, inflation and the effect of
increasing globalization upon domestic output. Microeconomics, by contrast, analyses household
and firm behaviour to understand the determinants of price and output in individual markets.
Macroeconomics seeks not only to understand Macroeconomics phenomena, but to find polices
which promote maximum output, employment and price stability over time. Economists hold
differing views on the need for and effectiveness of economic policy. Positions can be
categorizes as interventionist (Keynesian or non-monetarist) and non-interventionist (classical or
monetarist). Although each school of thought supports different policies, common theoretical
models are used to analyse macroeconomics activity. Thus, Macroeconomics focuses upon
economic growth, business cycles, unemployment, inflation and the output effects of
globalization.

In explaining Microeconomics and Macroeconomics Ragner Friseh adopted the concepts of twin
in 1993. But Professor Ackley brought the distinction of the twins concept to the fore. His option
centred on the fact that Microeconomics is see as akin to the study of the individual trees that
make up the forest while Macroeconomics is seen as the study of the entire forest as a unit.
Ackley posits that Macroeconomics deals with the economic affairs in the large, which concerns
the overall dimensions of economic life.

Perhaps Lipsey and Chrystal sees macroeconomics as the study of how the economy behaves in
broad outline without dwelling much on its interesting but sometimes confusing details. In the
words of Jhingan (1997), Macroeconomics is the study of aggregates or averages covering the
entire economy, such as total employment, unemployment, national income/output, total
investment, total consumption, total saving, aggregate demand, aggregate supply, general price
level, wages, interest rates etc. it is aggregative economics examining the interrelations among
the various aggregates, their determination and cause as well as fluctuations in them.
To professor Milton Iyoha Macroeconomics can be view from a narrow and broad perspective
and from analytical and policy perspectives. To him macroeconomics is the aggregate study of a
nation’s economy. In a broader study macroeconomics includes the study of the international
economy on an aggregative basis. At the analytical level macroeconomics deals primarily with
the study of the determination of the short run levels of aggregate income, employment and
price. Furthermore, it includes the study of the determinants of other broad economic aggregates
like consumption, saving, investment, Government expenditures, and the balance of payments.

Macroeconomics analysis also includes an examination of the inter temporal determinants and
hence the movement overtime of these key economic aggregates. Therefore its scope is to
analyse economic fluctuations and growth in national economies. This power of
macroeconomics analysis is sometimes tagged “positive” macroeconomics theorizing. The
“normative” aspect of macroeconomics relates to macroeconomics policy making.

Macroeconomics policy shows the deliberate and various measures undertaken by government to
regulate and control key Macroeconomics aggregates to guarantee short run stability and long
run sustained growth in the economy. Macroeconomics policy deals with the control overtime of
the key economic aggregate especially national income, employment, the price level and balance
of payments. Positive economics is about what is while normative economics is what ought to
be. Macroeconomics policy is the area through which macroeconomics impinges on the lives of
the generality of citizens, example, government policy on job creation in Nigeria and the
implementation on ground on such a policy determine the level of unemployment in Nigeria. In
fact the joys, sorrows, and wellbeing of the citizenry in any modern society depend critically on
the state of the macro economy and on the policies of the government of the day. This is as true
in the area of inflation as in the sphere of unemployment, in the area of economic growth as in
that of taxation, the balance of payments, tariff, import quotas, and the exchange rate. The more
complex an economy is, the more complex the nature of macroeconomics issues it is faced with.

In fact, to fully understand the majority of the decisions of government in a modern economy,
knowledge of macroeconomics is increasingly becoming imperative.

Microeconomics is the study of the behaviour of the individual economic unit and small groups
of individual economic units, these include the behaviour of the household to spend or not to
spend its limited resources; the behaviour of the firm or industry in allocating productive
resources to the production of a given commodity and also how prices of goods and services are
determined by economics agent. On the other hand, macroeconomics is the study of broad
aggregate i.e. changes in unemployment / employment, investment, balance of payments,
national output, general output and general price level and how they affect the overall economy.
Microeconomics objective analyses how consumers maximize utility (satisfaction) from the
limited resources, while the producers; the aim is to maximize profit at minimum cost.
Macroeconomics polices of every government are to ensure minima unemployment level, price
stability, economic growth, favourable balance of payment among others.

The basis of Microeconomics is the price mechanism which operate with the help of the forces of
demand and supply and hence the determination of the equilibrium price in the market,
Macroeconomics is based on national income, output, employment and the general price level
which are determined by aggregate demand and supply.

However, Microeconomics is centred on assumption of rational behaviour of individuals,

Microeconomics assumptions on the other hand, are based on such variables as aggregate
volume of output of the economy with the extent to which resources are employed, together with
the size of national income and the general price level.

Finally, Microeconomics is based on the partial equilibrium approach. Partial in the sense that, it
helps to explain the equilibrium conditions of the economic agents, Macroeconomics is based on
the general equilibrium analysis i.e the working of economic system as whole.

Macroeconomic Policy: Objectives and Instruments

The two main subfields of economics—macroeconomics and microeconomics—have different

goals to pursue. The effective utilization of employed resources and the effective distribution of
output are the main microeconomic objectives. Efficiency and equity are the microeconomics
field's two main objectives. However, macroeconomic objectives are very different from
individual unit goals because the economy's overall response cannot be the same.
Macroeconomics' goals are aggregative in nature because it considers the totality. In other words,
these two areas of economics concentrate on different economic goals due to the differing levels
of aggregation.

1. Macroeconomic Policy Objectives:

The macroeconomic policy objectives are the following:
(i) Full employment,
(ii) (ii) Price stability,
(iii) (iii) Economic growth,
(iv) (iv) Balance of payments equilibrium and exchange rate stability, and
(v) (v) Social objectives.

(i) Full employment:

Any government's performance is evaluated in relation to its aims of achieving full employment
and price stability. These two could be regarded as the most important economic health
indicators. In other words, both unemployment and inflation rates are targets for modern
administrations. Unemployment is the term used to describe the involuntary idleness of
productive resources, primarily the labor force. The level of unemployment (of labor) is directly
correlated with total economic production. The gap between actual aggregate output (or
GNP/CDP) and potential output widens as the unemployment rate rises. Therefore, ensuring full
employment is one of macroeconomic policy's goals.

The Great Depression era saw a rise in the unemployment rate across the board, with the
exception of the USSR, a socialist nation at the time, and full employment became a top priority
for policymakers. It should be underlined that full employment is a constant feature of a free
enterprise capitalist economy. Full employment may be a desirable objective, but it is impossible
to achieve, according to Keynes. Therefore, full employment does not imply that there are no
unemployed people. The country is considered to be fully employed even if 4 or 5 percent of the
entire population remain unemployed. Although theoretically possible, full employment is
challenging to achieve in a market-based economy. Given this, the goal of full employment is
frequently interpreted as the goal of "high employment." Although this objective is desirable,
"how high" should it be? The goal for high employment should therefore not be to achieve a
level of unemployment of zero, but rather a level of above zero consistent with full employment
at which the demand for labor matches the supply of labor, according to one scholar. The natural
rate of unemployment is this amount.

(ii) Price stability:

The achievement of full employment is no longer seen as a macroeconomic objective. The focus
now is on price stability. Price stability must not be interpreted as a constant price level
throughout time. Price increases are not always undesirable, especially if they are contained
within a fair range. In other words, higher price fluctuations are never desirable. Determining the
acceptable or tolerable pace of inflation is challenging, though. However, both a persistent rise in
prices and a decline in prices have a destabilizing effect on the economy. Therefore, ensuring
(relative) price level stability is one of macroeconomic policy's goals. This objective aids in
achieving consistent growth while also preventing economic swings.
(iii) Economic growth:
In a capitalist system, economic growth is never constant. These economies' performance goes
through ups and downs. In the years following World War II, this goal took precedence (1939-
45). Such fluctuations in economic performance are referred to by economists as the trade cycle
or business cycle. Such oscillations may show depressions or prosperity in the short run (boom).
The rate of increase in output over time is one of the key metrics used to assess an economy's
performance. The three main drivers of economic growth. viz. (i) the growth of the labour force,
(ii) capital formation, and (iii) technological progress. A nation aims to attain more economic
growth over an extended period of time so that, on the whole, people's living conditions or
quality of life rise. It should be mentioned that when discussing increased economic growth, we
consider broader, social, and environmental concerns to ensure that the demands of both the
present and future generations of people are addressed.

However, promotion of higher economic growth is often hampered by short run fluctuations in
aggregate output. In other words, there is a tension between the goals of economic stability and
expansion (in prices). It is believed that macroeconomic policy should encourage economic
growth while maintaining a sufficient level of price stability in light of this contradiction.

(iv) Balance of payments equilibrium and exchange rate stability:

From a macroeconomic perspective, it is possible to demonstrate that an international transaction
varies from a domestic transaction in terms of the exchange of (foreign) currency. All nations
strive for a balanced inflow and outflow of products, services, and assets over time. When this
occurs, the overall level of reserves is thought to be steady. A nation experiences a balance of
payments surplus or a buildup of reserves, such as gold and foreign currency, if its exports are
more than its imports. A deficit in the balance of payments occurs when a country loses reserves
(or imports exceed exports).

However, the depletion of reserves indicates a poor economy and thus causes a number of issues.
Every nation strives to accumulate sizable amounts of foreign exchange reserves for this reason.
Regardless, the exchange rate—the price at which one currency is exchanged for another to
conduct international transactions—is a major determinant of the growth of foreign exchange
reserves. As much as feasible, there should be stability in the foreign exchange rate. This is what
is meant by price external stability.

The free flow of commodities and services between states is hampered by external price
instability. Additionally, it damages the trust in money. However, maintaining external stability
is no longer regarded as a macroeconomic policy goal or an instrument of macroeconomic
policy. However, the work of achieving this macroeconomic policy objective has grown
increasingly challenging due to the increased interconnectedness and interdependence between
many states in the globalized globe.
(v) Social objectives:
The list of goals we've provided here is by no means complete; further goals can be added. Even
then, the significant ones have been included. A few social goals or social welfare are also
attained through the application of macroeconomic policy. As a result, there is a need for a more
fair and equal income distribution system. Some people benefit more than others in a capitalist,
market-based society. Policymakers employ macroeconomic policy tools to ensure social justice.
We can expand our list of societal objectives. This is what economic freedom aims to achieve.
This is distinguished by everyone having the freedom to make their own economic judgments
(rich or poor, high caste or low caste).

2. Macroeconomic Policy Instruments:

Monetary Policy

Monetary policy attempts to stabilise aggregate demand in the economy by influencing the
availability or price of money, i.e., the rate of interest, in an economy. Monetary policy may be
defined as a policy employing the central bank’s control of the supply of money as an instrument
for achieving the macroeconomic goals.

Implemented by central banks, monetary policy is an action that influences money supply and
interest rates. The central bank can set interest rate targets for direct results. Money supply also
affects the interest rate, with increased supply usually lowering interest rates (negative
correlation). As previously mentioned, interest rates influence consumer consumption and
investment. There are two types of monetary policy:

1. Expansionary Monetary Policy

In times of economic slump, the government can encourage economic growth by implementing
an expansionary monetary policy. They purchase securities from the open market and ease
reserve requirements to increase the money supply, and on the other hand, lowering the interest
rate target.

2. Contractionary Monetary Policy

In economic booms, high inflation rates in the long term can spell trouble by reducing
purchasing power. To cool down inflation, the government can decrease the money supply and
increase interest rates by selling securities on the open market, tightening reserve requirements,
and increasing the interest rate target.

Fiscal Policy
Fiscal policy, on the other hand, aims at influencing aggregate demand by altering tax-
expenditure-debt programme of the government. The credit for using this kind of fiscal policy in
the 1930s goes to J.M. Keynes who discredited the monetary policy as a means of attaining some
of the macro- economic goals—such as the goal of full employment. As fiscal policy has come
into scrutiny in terms of its effectiveness in achieving the desired macroeconomic objectives, the
same is true about the monetary policy. One can see several rounds of ups and downs in the
effectiveness of both these policy instruments consequent upon criticisms and counter- criticisms
in their theoretical foundations.

It may be pointed out here that as there are conflicts among different macroeconomic goals,
policymakers are in a dilemma in the sense that neither of the policies can achieve desired goals.
Hence the need for additional policy measures like income policy, price control, etc. Further,
while the objectives represent economic, social and political value judgements they do not
normally enter the mainstream economic analysis. Ultimately, policymakers and bureaucrats are
blamed as troubleshooters.

The government implements fiscal policy through spending and taxes to guide the macro
economy. Government spending influences job creation and infrastructure improvements, which,
in turn, affects money in circulation. Taxes affect consumer disposable income. Fiscal policy is
also segmented into two types:

1. Expansionary Fiscal Policy

To increase inflation, governments increase spending to increase money in circulation or cut

taxes, so consumers have more money to spend.

2. Contractionary Fiscal Policy

To ease inflation, governments decrease spending to reduce money in circulation or increase

taxes. As a result, money available for consumers to spend becomes less.

Goals of Macroeconomics

The overarching goals of macroeconomics are to maximize the standard of living and achieve
stable economic growth. The goals are supported by objectives such as minimizing
unemployment, increasing productivity, controlling inflation, and more. The macro economy of
a country is affected by many forces, and as such, economic indicators are invaluable to
assessing different aspects of performance.

Economic Indicators

1. Gross Domestic Product (GDP)

Often used as the primary indicator of macroeconomics, absolute GDP represents the economy’s
size at a point in time. GDP is usually calculated and released by the government on a quarterly
or annual basis.

As a rule of thumb, spending stimulates growth. Individual consumer consumption drives

businesses, business investments promote growth, and government spending maintains social
welfare. Net exports, as calculated by (exports – imports), measures trade. Positive net exports
represent a trade surplus, while negative net exports represent a trade deficit.

Economic growth can be calculated by comparing GDP over time, such as year-over-year
increases.

2. Inflation

Inflation is the increase of overall price levels and consequently the decrease in purchasing
power. It occurs primarily due to increased demand for products and services, which, in turn,
raises prices. Inflation, therefore, represents growth.

However, too much inflation is also harmful if purchasing power decreases much more than
inflated prices, decreasing overall spending and devaluing the currency. The target inflation rate
is usually around 1% to 3%.

3. Unemployment

Unemployment accounts for individuals who are jobless and are actively seeking one.
Individuals who are retired or disabled are not included as unemployed. Unemployment is a
natural occurrence and cannot be completely eliminated. We can distinguish unemployment into
different categories:
  Frictional unemployment occurs when individuals spend time searching for a job.
 Structural unemployment occurs when jobs are eliminated due to economic structural
changes.
 Cyclical unemployment occurs due to fluctuations in the business cycle.

The sum of frictional and structural is called natural unemployment. It arises from everyday
events, such as individuals changing jobs or industries shrinking from a decline in demand.

The sum of natural unemployment and cyclical unemployment represents the actual
unemployment. Naturally, in recessions, employees are laid off, and in times of prosperity,
employment rates skyrocket.

Since employment is directly related to economic output, it is a good indicator of economic

conditions. Actual unemployment is useful to gauge the economy’s short-term conditions, while
natural unemployment can identify trends in the long term.

4. Interest Rates

Interest rates are the return the borrower pays from lending. They are set by the central bank –
the Federal Reserve in a country. Because interest rates influence consumer decisions, it is a very
useful tool for influencing economic activity.

When interest rates are high, borrowing becomes more expensive, so consumers are incentivized
to reduce spending. Conversely, when interest rates are low, it is cheaper to borrow, so
consumers will be incentivized to spend more.

What is Monetary Policy?

Monetary policy is an economic policy that manages the size and growth rate
of the money supply in an economy. It is a powerful tool to regulate
macroeconomic variables such as inflation and unemployment.
These policies are implemented through different tools, including the
adjustment of the interest rates, purchase or sale of government securities,
and changing the amount of cash circulating in the economy. The central
bank or a similar regulatory organization is responsible for formulating these
policies.

Objectives of Monetary Policy

The primary objectives of monetary policies are the management of inflation

or unemployment and maintenance of currency exchange rates.

1. Inflation

Monetary policies can target inflation levels. A low level of inflation is

considered to be healthy for the economy. If inflation is high, a contractionary
policy can address this issue.

2. Unemployment

Monetary policies can influence the level of unemployment in the economy.

For example, an expansionary monetary policy generally decreases
unemployment because the higher money supply stimulates business
activities that lead to the expansion of the job market.

3. Currency exchange rates

Using its fiscal authority, a central bank can regulate the exchange rates
between domestic and foreign currencies. For example, the central bank may
increase the money supply by issuing more currency. In such a case, the
domestic currency becomes cheaper relative to its foreign counterparts.

Tools of Monetary Policy

Central banks use various tools to implement monetary policies. The widely
utilized policy tools include:
1. Interest rate adjustment

A central bank can influence interest rates by changing the discount rate. The
discount rate (base rate) is an interest rate charged by a central bank to banks
for short-term loans. For example, if a central bank increases the discount rate,
the cost of borrowing for the banks increases. Subsequently, the banks will
increase the interest rate they charge their customers. Thus, the cost of
borrowing in the economy will increase, and the money supply will decrease.

2. Change reserve requirements

Central banks usually set up the minimum amount of reserves that must be
held by a commercial bank. By changing the required amount, the central
bank can influence the money supply in the economy. If monetary authorities
increase the required reserve amount, commercial banks find less money
available to lend to their clients, and thus, money supply decreases.

Commercial banks can’t use the reserves to make loans or fund investments
into new businesses. Since it constitutes a lost opportunity for the commercial
banks, central banks pay them interest on the reserves. The interest is known
as IOR or IORR (interest on reserves or interest on required reserves).

3. Open market operations

The central bank can either purchase or sell securities issued by the
government to affect the money supply. For example, central banks can
purchase government bonds. As a result, banks will obtain more money to
increase the lending and money supply in the economy.

Expansionary vs. Contractionary Monetary Policy

Depending on its objectives, monetary policies can be expansionary or

contractionary.

Expansionary Monetary Policy

This is a monetary policy that aims to increase the money supply in the
economy by decreasing interest rates, purchasing government securities by
central banks, and lowering the reserve requirements for banks. An
expansionary policy lowers unemployment and stimulates business activities
and consumer spending. The overall goal of the expansionary monetary policy
is to fuel economic growth. However, it can also possibly lead to higher
inflation.

Contractionary Monetary Policy

The goal of a contractionary monetary policy is to decrease the money supply

in the economy. It can be achieved by raising interest rates, selling
government bonds, and increasing the reserve requirements for banks. The
contractionary policy is utilized when the government wants to control
inflation levels.