Tyler Cowen on the four most important things to know about macroeconomics

ECONS101 teaching starts next week. While we won't get to macroeconomics until the last four weeks (and even then I'm not teaching that part of the paper), I thought this Bloomberg article by Tyler Cowen (of the Marginal Revolution blog) was interesting, because in it he highlights the four most important things to know about macroeconomics:

The first and most important thing to know about macroeconomics is that a strong negative shock to demand — a sudden decline, in other words — usually leads to a loss of output and employment. Nominal wages are sticky, for a complex mix of sociological reasons, and so employers do not always respond to lower demand with lower wages for workers. Instead they lay some people off, and that can lead to a recession.

That may sound pretty simple. But it is one of the most important discoveries in history. It was true in the Great Depression, in the disinflation of the 1970s and ‘80s, and in the financial crisis following 2008.

The second thing to know is that well-functioning central banks can offset such demand shocks to a considerable degree — or even prevent them from arising in the first place. The bank can engage in complex financial transactions or simply print more currency to stabilize nominal demand and restore some measure of order.

The third thing to know is that if central banks go crazy increasing the money supply, the result will be high price inflation. There is one exception to this, which was evident in 2008 and 2009, when the Fed paid interest on bank reserves: If central banks simultaneously act to decrease the velocity of money — that is, if they take measures to reduce borrowing and lending — then price inflation will be limited accordingly.

A fourth thing to know is that non-monetary shocks, if they are large enough, can also create recessions or depressions. Consider the oil price shock of 1973, the current pandemic, or bad harvests in earlier agrarian societies. Central banks can partially stabilize such shocks, but they cannot erase them.

I believe an overwhelming majority of macroeconomists would largely agree with these propositions, even if they might place the emphasis differently.

We only have four weeks of macroeconomics in the ECONS101 paper at Waikato. Les Oxley teaches the macroeconomics section, so how does he do relative to Cowen's four important things? All four are in there, plus more. The first and fourth points are covered in Topic 9 (Economic fluctuations and unemployment), the second point is covered in Topic 12 (Monetary policy), the third point is covered in Topic 10 (Money and inflation). That we cover all of Cowen's four important things is a useful affirmation for our ECONS101 paper, even though we can only fit four weeks of macroeconomics into it.

For completeness, Topic 11 of ECONS101 covers government fiscal policy (taxing and government spending). It may be somewhat surprising that Cowen has no 'important thing' associated with fiscal policy, which is a staple of every introductory macroeconomics textbook. Although maybe it isn't that surprising, since having read the MR blog for many years, I get the distinct feeling that Cowen is a sceptic about the fiscal multiplier (the idea that an additional dollar of government spending leads to more than a dollar of total output for the economy). I haven't formed a particular view myself. The idea of the fiscal multiplier is sound in theory, while the empirical evidence as far as I am aware is that multipliers are generally quite small. However, it still seems like a big idea in macroeconomics, and I'm glad that we include it in ECONS101.

[HT: Marginal Revolution]