Macroeconomics

The question mark in the subtitle of Macroeconomics For Life: Smart Choices For All?  is crucial to my approach. Here are the opening paragraphs for students.

According to Adam Smith’s invisible hand, price signals in markets create incentives so that while each person acts only in her self-interest, the unintended consequence is the production of all of the products and services we want. Macroeconomics questions how well Smiths’ invisible hand works in a wider context. When all the smart choices of individuals are combined, is the result the best outcome for the economy as a whole?

Consider this example. During tough economic times, many people are unemployed — they can’t find jobs, aren’t earning incomes, and cut back on their spending. Businesses aren’t selling enough because consumers aren’t buying — products sit on shelves and profits are down. But if only businesses would hire the people looking for work, those new employees would earn incomes and buy the unsold products. It seems everyone — workers and businesses — could be better off, yet those mutually beneficial exchanges don’t happen. Why?

This is a core question for Macroeconomics. Do smart choices by consumers and businesses imply that smart choices are being made for the economy as a whole? What are the implications of this question for government economic policy; for you as a consumer, a businessperson, and an investor; and for your choices as a voter?

Economists disagree far more about Macroeconomics than Microeconomics. I simplify those disagreements into two major camps, giving you a framework for understanding Macroeconomics and for thinking about the appropriate role for government economic policy.

Macroeconomics for Life: Smart Choices for All? incorporates those disagreements into what I call the fundamental macroeconomic question:

If left alone by government, how quickly do the price mechanisms of market economies adjust
to maintain steady growth in living standards, full employment, and stable prices?

The core concepts focused on are those students must learn to answer that question for themselves, including measurements of living standards, GDP, growth, unemployment and inflation. For differing macroeconomic models, adjustment mechanisms to shocks and policy responses are key to the differing answers.

The two main answers are:

  • Markets Quickly Self-Adjust, So Government Hands-Off
  • Market Fail Often, So Government Hands-On

I tie the Hands-Off position to Say’s Law, Hayek, and those who assume markets clear quickly and are generally efficient. I tie the Hands-On position to Keynes and those who assume that markets often fail and benefit from the visible hand of government. In many countries, there are correlations between Hands-Off and the political right, and between Hands-On and the political left. Besides presenting the agreed-upon core of macroeconomic theory using the expanded circular flow and AD/AS models, I present sympathetically the best arguments behind economists’ Hands-Off and Hands-On positions.

No other textbook takes this approach. Students will hear these policy arguments from politicians for the rest of their lives, and as citizens, must make up their own minds about which position they support. Informed and engaged citizens must be able to think critically about these positions.

Macroeconomics For Life nuances the differences between the Hands-Off and Hands-On positions by also stressing the substantial agreements among macroeconomists:

  • There is some role for government in setting the rules of the game;
    They differ on how small or large a role government policy to change the economy should play.
  • There can be market failure and government failure;
    They differ on which failure is more likely.
  • Prices and markets adjust;
    They differ on how long the adjustment takes, and whether prices are flexible or sticky in adjusting.
  • Savings and business investment are important in determining macroeconomic outcomes;
    They differ on whether changes in interest rates or expectations are most important for investment decisions, and on how savings and investment interact in the loanable funds market.
  • Business cycles happen in the short run;
    They differ on whether the causes are external or internal to the economy, and on how markets respond after a boom or bust.
  • There is long-run economic growth;
    They differ in focusing on the long-run successes of growth or the short-run problems of business cycles.

By reframing principles of economics as a guide to smart choices, I want to empower students as successful participants in the economy and as engaged citizens in a democracy who can use economic models to critically evaluate policy claims.