CE

In-depth Notes on Economic Fluctuations and Their Management

  • Economic Factors Linked to Quality of Life

    • Elements like welfare, standard of living, longevity, access to education, and healthcare impact overall quality of life.

  • Long Run vs Short Run

    • In the long run:
    • Money doesn't matter;
    • Key components are population, capital, and technology.
    • Keynes' Perspective:
    • Keynes (John Maynard Keynes) highlighted that people are ‘dead’ in the long run, implying that attention should be given to short-term economic management and interventions.
    • Important for government to play an active role in managing economic fluctuations.

  • Recession and Its Effects

    • A recession is defined as a period of declining economic activity.
    • Real incomes can fall when inflation exceeds wage growth.
    • The National Bureau of Economic Research (NBER) designates recessions.
    • Not all individuals experience recessions equally; personal circumstances vary.

  • GDP and Economic Performance

    • Real GDP growth is expected to be around 1.75% per year, reflecting long-term potential GDP driven by labor, capital, natural resources, and technology.
    • Fluctuations typically exist around this potential GDP, indicating periods of over or under production.
    • Overproduction can lead to lower unemployment than the natural rate, while underproduction leads to economic instability.

  • Business Cycle Characteristics

    • Economic fluctuations are irregular and unpredictable, corresponding to changes in business conditions.
    • Business cycles vary in length and intensity.
    • Economic variables such as real GDP, unemployment, and real investment often correlate with business cycle phases.

  • Investment during Recessions and Expansions

    • Observations from Arthur Mernsback (former Fed Chair): During recessions, investment falls, unemployment rises, and real GDP declines.
    • In expansions, the reverse is true: investments increase, unemployment falls, and GDP rise.

  • Short Run and Long Run Economic Variability

    • In the short run, changes in nominal variables (like wages and prices) can lead to real economic fluctuations.
    • Classical dichotomy emphasizes the separation of real (like GDP) and nominal variables (like inflation).
    • In the short run, real and nominal variables are intertwined, and the money supply can impact economic performance.

  • Aggregate Demand and Supply Model

    • The AE model is used to analyze economic fluctuations, impacting inflation, output, and unemployment.
    • The Aggregate Demand (AD) curve has a downward slope because of phenomena such as the wealth effect and interest rate effect.

  • Wealth Effect

    • A decrease in price level raises the real value of money, encouraging higher consumption as purchasing power increases.
    • Consumers feel wealthier which drives demand.

  • Interest Rate Effect

    • Lower price levels reduce the demand for money, leading to increased savings and lower interest rates.
    • Lower interest rates encourage borrowing and investment, stimulating economic growth.

  • Implications of Economic Fluctuations

    • Expansionary periods tend to drive inflation, as increased demand puts upward pressure on prices.
    • Economic expansions can be sustainable to a point; beyond that, inflation can become problematic, leading to cycles of job loss and output decrease.

  • Government Role in Managing Economic Fluctuations

    • The Federal Reserve aims for maximum employment at natural rates and stable prices.
    • Tools include monetary policy interventions to smooth out these fluctuations and minimize adverse social impacts.