Macroeconomics

Macroeconomicproblemsoccurwhenthemacro economyfailsto attaintheobjectiveof stability,fullemploymentandeconomicgrowth.Unemploymentariseswhenthegoalof fullemploymentisnot reached.Whenan economyfailsto accomplishtheeconomicgoalof stabilityinflationoccurs(Harberger, Gustavus &amp Ann, 2003). Thesemacroeconomic problemsarecausedby diminished demandforgrossproduction.Unemploymentoccurswhentheaggregate demandis toolittlewhileinflationemergeswhenaggregate demandis toomuch.Stagnantgrowthindicatesthattheeconomyis not in a positionto achievetheeconomicgoalof growth.Thethree macroeconomic problemsmakesthesocietyworsethan itwould be whenthemacroeconomic goalsareachieved(Tragakes,2011). Thispaperwill analyzeandsynthetizetheeffectsof unemployment,inflationandstagnantgrowthon theeconomy,andproviderecommendationsto helpcorrecttheadverseeffectson theeconomy.

Inflation

Oneof themostcommonproblemsin economicsystemsin themodernworldis inflation.At theoutset,inflationis simplya generalrisein prices.Astimegoeson thecostof servicesandcommoditiesincreaseandthevalueof thecurrencygoesdownbecausean economicagentwill can not purchaseas muchwith a dollaras theycould havebefore thepriceincrease(Cashell, 2004).In thislightinflationis definedas a sustainedrisein thegeneralpricelevel. Thetermgeneralpricelevel denotestheprices(value)of all thecommoditiesin theeconomy.In thecircumstancewherethepricesof all thecommoditiesare risingin equalproportions,therelativepriceremainedunchanged.Thisbringsus to theotherimportanttermwhenexemplifyingwhatisinflation-relativeprice.Thistermdenotestheamountof othercommoditiesthat must be givenup, typicallydefinedin monetaryterms,to obtaina serviceora product(Tragakes,2011). Ariseinthe relativepriceof a givencommodityorserviceimpliesthatmoreof theothercommodityshall be givenup to be in a positionto obtainit.Forexamplea riseinthe relativepriceof mangoes meansthatthepriceof mangoes has soaredup morethan thepriceof apples.

Itis worthstatingthata particularlevel of inflationthat is regardedas normalandhealthyfortheeconomy-due to its linkwith employment,someinflationis actuallyadvantageous.In theUnited State,theFED strivesto maintaininflationbetween 2-3% thoughdepending on theunderlying economicenvironmentthislevel can rise(Harberger, Gustavus &amp Ann, 2003).

Principallythere are there are two keyindicesusedto assesstherateof inflation.Thefirstandmostcommonindexis theconsumerpriceindex(CPI). Thisisa computationof thepriceof a groupof commoditiesandservices.Thissetis usuallyreferredto as thebasketof commodities,orthebundleencompassesa setof itemssuchas gasoline,food,computersandevenclothing.Therateof inflationiscalculatedby thechangesin thecostof thebasketof commoditiesover a period(Harberger, Gustavus &amp Ann, 2003). Thesecondcriteriaof rateof inflationis theproducerpriceindex(PPI) unlike theconsumerpriceindexthat assessthechangein thepurchasing powerof an economicagent(consumer),theproducerpriceindexindicatesthechangesin thepurchasing abilityof themanufacturers.PPI is usedto determinehowmuchproducersof thecommoditiesin theeconomyare gettingon thewholesalelevel –pricelevel at which manufacturedcommoditiesaresoldto otherbusinesses(Tragakes,2011). PPI coalescesa chainof diminutiveindicesthat cutacross numerousindustriesandevaluatesthepricesforthree distincttypeof commoditiesfinished,crude andintermediate.

Effectsof Inflation ontheEconomy

Wheninflationsetsin an economy,nobodyis sparedfromits deadlyeffects,from consumersto manufacturers,savers andeveninvestors everyone one losesthepurchasing powerin equalmeasure.Evenifan economicagenthas buriedtheir dollarsin a teacan in thegardenordepositedin thesafestbankin theglobe,moneybecomeslessvaluableas timepasses(Cashell, 2004).

InflationandUnemployment

Inflationis inversely relatedtothelevel of unemploymentin theeconomy.Thislinkbetween inflationis usuallyshownusingthePhillips Curve (Cashell, 2004). Thiscurvedepictstherelationshipbetween a particularlevel of inflationandtheanticipatedlevel of unemploymentthat would resultin theeconomy.Astherateof inflationdecreases,thelevel of unemploymentis expectedto increase.

Source:Cashell(2004).

InflationandInvestments

Inflationaffectsinvestmentin an unprecedentedwaysince allinvestors fearitpowerto wipeout thevalueofinvestment.Succinctly put$1000 todaydoesnot havethesamevalueas a $1000 after five years.Investor alwaysincludestheanticipatedrateof inflationwhencalculatingreturnon investmentandviable destinationto invest.Highrateof inflationcan driveawaybothdomesticandforeigninvestmentbecauseof its erosionpowerof thevalueof moneyinvested(Cashell, 2004).

Throughits effectson investment,inflationhas manyimplicationson theeconomicgrowthanddevelopmentof a country.Inflationis thegroundnumerousdistortionsin theeconomy.Itnot onlyhurtindividualswhohaveretiredbutalsoeveryone livingon a rigidincome(Tragakes,2011). Whenthegeneralpricelevel rises,consumersare not in a positionto purchaseas muchcommoditiesas could beboughtpreviously.Thisdampenssavingsas a consequenceof thefactthatmoneyis worthmoretodaythan in thecomingdays.Thisanticipationdiminisheseconomicgrowthbecausetheeconomyrequiresa particularlevel of savingsto supportinvestment,which enhanceseconomicgrowth(Cashell, 2004). In addition,inflationmakesitextremelydifficultforenterprises to makeprojectionsforthefuture.Itis a gargantuantaskto decidehowmuchto manufacturebecausefirms cannot forecastthedemandfortheir commoditiesat thehigherpricesprevailingunder inflationary conditions.Firms cannot alsobe in a positionto accuratelyforecastwhatshall bechargedinorderto covertheproductioncosts(Tragakes,2011).

Highinflationnotonlydistortstherunning of a country’sfinancialsystemanddiscouragesitintegrationwith theglobal markets.Thisismainlycausedby theinabilityoffinancialinstitutionsto forecastinterestrate,futurepricesandexchangerates,andthusthisaugmentsuncertaintycontingencyandrisksamong potentialtradepartnersanddiscouragingtrade(Tragakes,2011). In thesameway,iterodesthevalueof thedeposits(savings)bankedby clientsin financialsystemsandthebanksloans.Theuncertaintythat gripsan economyas a resultof inflationaugments risklinkedwith investmentandmanufacturingactivitiesof firms andmarkets(Cashell, 2004).

SuggestiontoCorrect Inflation

Controlof inflationis theworkof thegovernmentandcan beachievedthrough a combinationof fiscalandmonetarypolicies.Moreimportantly effectivecontrolinflationnecessitatesa sharpfocuson theprincipalcauseof inflationin theeconomy.

MonetaryPolicy

Monetarypoliciescan be employedto controlinflationthat iscausedby excessivegrowthin demandthat is causedincreasedrateifinterestandcontractionin therealmoneysupply.Theinterestrateissetat a particularlevel with theobjectiveof keepinginflationin check(Kohn, 2012). Higherinterestrateservesa toolto reduceinflationthrough reducingaggregate demandcurvein three keyways:

  • Discouraging borrowing by banks, companies and household

  • Increasing the level of saving

  • Increased mortgage cost will reduce the demand in the housing market.

Dueto theincreasedcostof borrowingfundsfromthe financialinstitutionsinvestmentwill becomelesslucrativeandas a consequencetotaldemandwill fall.Finally,interestratecan be appliedto limitmonetaryinflation.A raise inthe realinterestratehas theeffectof reducingthedemandfromlending andas suchcan condensethegrowthof broadmoney(Kohn, 2012).

FiscalPolicy

Fiscalpoliciesreducetheeffectsof injectionsin theeconomyby increasingtherateof leakages from thecircularflowof income.,andby reducingintensityof demandpullinflationat theexpenseof unemploymentandslowereconomicgrowth(Tragakes,2011).Someof thefiscalmeasuresto curbinflationinclude:

Labour-MarketReforms

Creatinga flexiblelabourthat allowsthe growthof temporaryandpart-timeworkinghoursempowerfirms in theeconomyto controltheir labourcostswhich in turnreducescost-pushinflation.Tiltingthebalanceof powertowards firms in theeconomyandawayfrom employeeraisesjobinsecurity.Workerscan not pushforexorbitantwageincreasethat can causecost-pushinflation.

Unemployment

Unemploymentis one of thefatalmacroeconomic conundrumsthat affectsmodernsocietiesandeconomies.In thesphereof macroeconomics,nothingis moreimportantto theaveragepersonthan theemployment(Tragakes, 2011). Employmentis akeysourceof incomethat determinesthelivingstandardof a person.Unemploymentistermthat denotestheproportionof thelaborforcewillingandreadyto workbutwhodonot havea job.Unemploymentis configured by dividingtheproportionof peoplewhoare unemployedwith thatof theentireworkforcein theeconomy.Theworkforce isconstitutedindividualin theeconomywhoare readyto work,with theexceptionof thosewhoare disabled,retiredandthosewhoare not seekingemployment.

Manyfactors cause unemployment, andthenatureof unemploymentisidentifiedby theleadingfactorof unemployment.Itis difficultto achievefullemploymentbecausesometypesof unemploymentsuchas frictional unemploymentandstructural,causedby factorssuchas changein technology, geographicalandoccupationalimmobilityare difficultto solvewith monetaryandfiscalpolicies(Tragakes, 2011).Nonetheless,cyclicalunemploymentcan besolvedwith thesemeasures.

Cyclicalunemployment

Thistakesplace whenpeoplelosetheir jobsas a result of thereductionin aggregate demandoreconomicdownturn. Itisalsoreferredto as demanddeficientunemploymentandis causedbyan insufficientdemandthat can not createfullemployment(Tragakes, 2011).

(Pettinger,2011)

Thediagram shows that when aggregate demand reduce from AD to AD1 thetotal output will reduce by Y-Y1, and this means that jobs will belost are firms must lower their production level due to low demand(Pettinger, 2011).

Realwage unemployment (classical unemployment)

Thistype of unemployment occurs when the wage rate in a competitivemarket are pushed to a higher level, above the equilibrium. Thediagram below shows how classical unemployment occur (Pettinger,2011). At W2 the labour supply depicted by Q3 is greater than thedemand of labour depicted by Q2.

(Pettinger,2011)

Tradeunionsandgovernmentmoveof establishingminimumwageare thetow majorfactorsthat can forcewagesabove theequilibriumlevel.

Effectsof Unemployment

Unemploymentlowersthespending abilityofthe unemployedindividualandtheir families.Thismeansthatindividualwithouta jobcan be ableto save,andtheyhaveverylittleto spend.Whenthere is a largenumberof an individualin theeconomywithout a jobtheeffectscan be disastrous(Tragakes, 2011). Whenpeopledonot haveenoughmoneyto spend,firms sufferfrom reducedconsumerdemand.Whenfirmsaresubjectedto a longdurationof reduceddemandsdue to lowspending in theeconomydue to unemployment,theymay be coercedto layoff someworkforce orclosedown, exacerbatingan alreadyworryingrateof unemployment.

Recession

Whenunemploymentcontinuesto increaseotherfacetsof theeconomyare alsoaffected,suchasthe qualityof healthcare, poverty,healthcostsandstandardof living.Suchfactorsdoravagenot only the economybutalsoaffecttheentiresociety(Tragakes, 2011).

Thereare two fundamentalstrategiesof reducingunemployment:

  • Supply side policies to lower natural rate of unemployment

  • Demand side policies to lower the cyclical unemployment

  • Demand Side Policies

FiscalPolicy

Fiscalpolicycan lowertherateof unemploymentby stimulatingaggregate demandandtherateof economicgrowth.An expansionary policycan be usedto stimulateaggregate demandincreasinggovernmentspending andreducingbothcorporate andtaxableincome(Pettinger, 2011). Lowertaxeswill meanthatindividualswill losea comparativelylowerincomeinformof taxesandas suchthiswill augmenttheir disposable income.Thiswillassistto increaseconsumption,leadingto a higheraggregatedemand.Ahigherdemandwill pushtheGDP upwards with theassumptionthatthere is sparecapacityin theeconomy(Pettinger, 2011). Whenfirms are in a positionto producemore,theywill be a higherdemandforworkersandhencea lowercyclical unemployment.An elevatedaggregatedemandandstrongeconomicgrowthwill meanthatthenumberof firms in theeconomythat will gobankruptwill reduce,andmorejobswill becreated.Thediagrambelowshowshowgovernmentinterventionthrough expansionary policycan reducethe rateof unemployment.

(Pettinger,2011)

Anexpansionarypolicywill increaseaggregate demandfrom ADto AD2,whichwill increasenationaloutputby Y2-Y. Thisincreasein outputmeansthatfirms must engagemoreindividualsto meettheincreaseddemand(Pettinger, 2011). Theeffectiveness of expansionary policycan onlyworkifthe governmentdoesnot borrowfrom theprivatesectorbecausethismight causecrowdingout effect.In such a scenario,theprivatesectorspending abilitywill be diminishedandas suchADmay not increase(Pettinger, 2011).

MonetaryPolicy

Monetarypolicyto addressunemploymentwould encompassthe reductionof interestrates.ALowerlevel of interestsignificantly reducesthecostof borrowingmoneyfrom thefinancialinstitutionsandencouragesindividualsin theeconomyto spendandinvest(Kohn, 2012). Thisincreasesaggregate demandandshould boostGDP growth.In addition,interestratemakesexports morecompetitivein theglobal marketby reducingtherateof exchange.

SupplySide

Thesupplysidepoliciesaimat correctinglabourmarketimperfectionsthat reduceclassical,frictional andstructuralunemployment.Governmentcan improvethegeographicalmobilityof individualsby givinga taxbreakto firms in theaffectedregions(Pettinger, 2011). In mostcases,unemploymentis moreconcentratedin certainareas,andthismeanssuchfirms will reducetheir costsandcreatemoreopportunitiesforunemployed.Governmentcan alsoprovideemploymentsubsidiesto firms in areaswherethere is massiveunemployment.Thisfinancialaidassistsinfirmsto createmoreopportunitiesforemploymentandgivesthem confidence(Tragakes, 2011).

StagnantGrowth

Thelastproblemthat can havea significantimpactonthe economyis stagnantgrowth.Stagnantgrowthemanatesfrom theinabilityof thesupplysideof theeconomyto moveat thedesiredrate.Thismeansthatsupplyof aggregate productiondoesnot increaseat a desiredpaceoris decreasing.Under normalcircumstance,theaggregateproductionof commoditiesandservicesought to increaseto keeppacewiththerisingstandardof livingin theeconomyandtherisingpopulation(Forsythe,2012). Stagnantgrowthoccurswhenlagsbehind thegrowthof thefactorsmentionedabove.Consequently,themacroeconomic objectiveof economicgrowthis not attained.Thequantityandqualityof factorsof productionsare thefactorsthat influencegrowth.Thequantityavailableforland,labour,capitalandentrepreneurship can restrictthe growthof production.Thetotalpopulationandproportionof populationwillingandreadyto workare thetwo maindeterminant f thequantitiesof labouravailablein forproduction.Whenthebothdecline,economicgrowthcan not growat theanticipatedrate(Forsythe,2012).

Ontheotherhand,thequantityof capitalis determinedby theamountof investmentexpenditurein relationto thedepreciationof thecurrentstockof capital.Whendepreciationincreasesandtheinvestmentexpendituregoesdown,nomeaningfulgrowthcan takeplace(Forsythe,2012). Forexample,ifgovernmenttaxesandregulationsare sotightthattheycan discouragecompaniesfrom expandingandas suchoverall quantityof capitaldiminishes.Thequalityof factorsof productioncan alsoresultinsluggisheconomicgrowth.Allocatinglimitedresourcesto educationandtechnology can hampertheir progressandas suchlimitthequalityof resourcesusedduringthe productionprocess(Cashell,2004).

FiscalandMonetary Policies to solvestagnantgrowth

Grossdomesticproductis a sumof investment,consumption,netexports andgovernmentexpenditure.GDP= C(Y – T) + I(r) + G + NX (Forsythe,2012)Stagnantgrowthcan besolvedby expansionary fiscalpoliciesgovernmentspending andreducingtaxesto boostconsumption.(Y- T) Representdisposable incomeandas suchthelevelof consumptionin theeconomyispeggedon thelevelof incomeandtaxes.C(Y – T).R denotesthe rateof interest,andthisaffectsthelevel of investment(I).Whenrateof interestdecreases,investmentincreasesandviceversa (Forsythe,2012).

IntheUnited States,Congresscan authorizethepresidentto reducetaxesin timesof stagnantgrowthandincreasegovernmentexpenditurein theeconomyto stimulategrowth.Reductionin taxesincreasesdisposable income,which increasesconsumptionandthereforethe growthrateofgrossdomesticproduct(Cashell,2004).

Conclusion

Macroeconomicproblems occur whenthemacroeconomic goalsof stability, full employment and economic growth arenot achieved.Thesemacroeconomic problemsarecausedby diminished demandforgrossproduction.Unemploymentoccurswhentheaggregate demandis toolittlewhileinflationemergeswhenaggregate demandis toomuch.Stagnantgrowthindicatesthattheeconomyis not in a positionto achievetheeconomicgoalof growth.Unemploymentlowersthespending abilityofthe unemployedindividualandtheir families,lowers thequalityof healthcare, increases poverty,healthcostsandlowers standardof living. Prolonged high level unemployment is a precursor to recession.Inflationeffectsconsumers, manufacturers,savers andeveninvestors, by reducing their purchasing power, causing unemploymentand lowering the attractiveness of economy for investment. Economicstagnation has similar effects but when it is prolonged it cantotally crimple the economy.

Fiscalpolicycan lowertherateof unemploymentby stimulatingaggregate demandandtherateof economicgrowth.An expansionary policycan be usedto stimulateaggregate demandincreasinggovernmentspending andreducingbothcorporate andtaxableincome.Fiscalpoliciesreducetheeffectsof injectionsin theeconomyby increasingtherateof leakages from thecircularflowof income,andby reducingintensityof demandpullinflationat theexpenseof unemploymentandslowereconomicgrowth.Monetarypoliciescan be employedto controlinflationthat iscausedby excessivegrowthin demand,increasedrateifinterestandcontractionin therealmoneysupply.When macroeconomic problems of unemployment and inflation are solvedthey create a background for economic growth which eliminatesstagnation.

References

Cashell,B.W. (2004). Inflationand Unemployment: What is the Connection?Washington, DC: Congressional Research Service.

Forsythe,A.(2012). TheBusiness Cycle, Aggregate Demand and Aggregate Supply.Retrieved from:http://www.colorado.edu/economics/courses/econ2020/section7/section7-main.html

Harberger,A.C., Gustavus, F. and Ann, M. Swift. (2003). BasicProblems In .Retrieved from: http://www.econ.ucla.edu/harberger/ah-basic.pdf

Kohn,D. (2012). Monetary Policy and the State of the Economy. Retrievedfrom:http://www.brookings.edu/research/testimony/2014/02/11-monetary-policy-state-of-the-economy-kohn

Pettinger,T. (2011). Policiesfor Reducing Unemployment.Retrieved from:http://www.economics.org/3881/economics/policies-for-reducing-unemployment/

Tragakes,E. (2011). Economicsfor the IB Diploma.Cambridge: Cambridge University Press.