Economics 101: Now Is a Good Time to Bone Up

May 18, 2009

For release May 20 and thereafter (791 words)

In the past few months, as the U.S. stock market declined and unemployment increased, several former students indicated to me that they would have preferred to be studying macroeconomics this semester. Evidently, they did not learn as much as they would have liked in previous classes.

As an instructor of introductory economics, I have misgivings and obviously some regrets about the long-term economic insights absorbed by students. Perhaps, it is time for a five-minute review.

A typical introductory macroeconomics class consists of four parts. In the first section, after quickly reviewing supply and demand, the uses and limitations of the unemployment rate, price indexes and gross national product are introduced as measurements of economic well-being in a particular economy such as the United States.

The second section offers a theoretical model of the flows of consumer, government, business and export-spending within the domestic economy. If the spending stream is insufficient to maintain normal unemployment, inventories rise and businesses cut back on production.

“How or should officials respond to increasing unemployment and economic distress resulting from reduced private spending?”

One solution, associated with 1930’s economist John Maynard Keynes, is for government to run budget deficits to ensure that employment and production not slip beyond some targeted range. Each additional dollar of government spending, given excess productive capacity, can create a multiplier effect on total spending. This is normally referred to as discretionary “fiscal policy.”

Another option in dealing with business cycle is to admit that the market is subject to ups and downs along its long-term growth path. However, within 18 months to two years, the economy will self-correct unless aggravated by misguided official policy.

The third section of macroeconomics studies how the central bank-Federal Reserve (FED) controls liquidity to encourage financial institutions to expand or contract lending, increasing the money supply. Whenever unemployment rises and production decreases, the Fed generally increases liquidity in order to lower interest rates. Lower interest rates, it is hoped, will stimulate consumption and investment. This is referred to as “monetary policy.”

Too much liquidity, as productive capacity is approached, leads to a sustained increase in average prices, called inflation. Inflation reduces the real incomes of all workers, lowers real returns to lenders and decreases exports. As well, the FED is expected to operate non-politically to maintain the purchasing power of the dollar by keeping prices relatively stable.

As time permits, the fourth section of a macroeconomics’s class deals with conflicts between trying to achieve full employment and price stability, between government deficits and required interest payments on the national debt and between domestic prices and the value of the dollar in international markets. We also discuss shocks to the economic system and self-fulfilling expectations.

About half-way through the class, students begin to question the instructor: “Do economists really know or agree on anything?” The somewhat unsatisfactory answer is that economists generally agree on how to approach specific economic problems. However, economic goals conflict, there are always some unintended consequences and the timing of policy effectiveness is imprecise.

“Can politicians or government officials control the economy?”

Yes, they certainly can use the coercive power of government to destroy the market economy, or, on the other hand, they can abdicate their responsibilities in providing clear and consistent laws and regulations necessary for prosperity and economic growth.

To what degree should the government be involved in the economy? This depends in a democracy on the constitution and the wishes of the people expressed through voting. Economists assist in outlining some of the consequences of any policy decision; each decision has to be carefully explained and diligently debated.

“But what do you, our instructor, personally believe about macroeconomic policy?”

Markets should be allowed to operate within the law, but officials have the responsibility to monitor and act if indicators of economic distress greatly exceed normal levels. If necessary, fiscal policy should target unemployment independently of monetary policy which is best suited to maintain price stability and the value of the dollar.

Open and free trade is in every nation’s best interest. The United States is the most efficient world producer of certain goods and services which we export abroad. Producers and consumers benefit by opening its markets to lower priced products from abroad. All together, a healthy and well-prepared workforce, individuals willing to assume risks and a government committed to enforcing contracts will ensure both the economic growth of the United States and its global competitiveness.

It is the instructor’s prerogative to ask the final question, one that not only my students but every citizen should be addressing today:

“In detail, what would you do personally as an elected official to nudge the economy back onto a path of positive growth and prosperity?”

Maryann O. Keating, Ph.D., an adjunct scholar of the Indiana Policy Review Foundation, is a member of the associate faculty at Indiana University South Bend. Contact her at mkeating@inpolicy.org.



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