Macroeconomics is the study of the behaviour and performance of the economy as a whole. The word ‘macro’ comes from the Greek word ‘makro’ meaning large. It is talking about economics at the government level. Macroeconomics focuses on the aggregate or total changes in the economy such as unemployment, the growth rate, output and inflation. It considers the relationship between two economic sectors, the government and the non-government, and examines how the domestic economy interacts with the rest of the world.
Macroeconomics is not concerned with analysing the behaviour of each individual, person or firm. This is known as microeconomics.
Modern Monetary Theory
Modern Monetary Theory is a branch of macroeconomics which describes how money works in a modern economy. It starts with the simple recognition that in most countries the currency itself is a public monopoly – that means the currency is issued by the State. That’s what is meant by a ‘sovereign currency’.
Because the State issues the currency it doesn’t face the same constraints as households and businesses. This gives it a unique power to manage its budget because it can never run out of money and can never be forced into default.
Countries that operate their own sovereign currencies like the UK, US, Japan and Canada spend, tax and provide savings in a currency that it, and only it, can create. It uses a ‘money thing’, in our case the £, known as a fiat currency which is not converted into a physical thing. This means that within real resource constraints, a sovereign currency issuing government is free to determine its own key economic factors. These are employment, output and inflation.
Not all countries are sovereign currency issuers
Sovereign currency issuing powers do not apply to countries like those in the Eurozone or those pegged to another currency or using fixed exchange rates.
When countries like France, Spain, Italy and Greece joined the Eurozone they gave up control over their economy by abandoning their currency for what is essentially a foreign one, the Euro. In spending terms this makes them more like our own local authorities and regional councils which, except for a small amount of government sourced funding, have to tax or borrow in order to spend. For example, Greece has to borrow Euros or obtain them via trade. This is very different from the UK government which can create pounds and authorise payments.
Some countries, like Argentina, which have accumulated large debts in $US, can also get into financial difficulty. This is because they have to earn $US through trade or by attracting foreign investment to make their debt and interest payments.
Other countries, often but not always developing economies, operate fixed exchange rate mechanisms . To manage them effectively and ensure that the fixed rate can be maintained a country needs access to a large pool of foreign currency reserves to enable it to keep its conversion promise (how much of its currency equals a fixed amount of another currency). To do this they run current account surpluses (exporting more goods and services than they import) or they borrow them. For such countries it may be possible to manage for a time with such limitations but many have defaulted when faced with an economic crisis. Having higher export than import levels is often portrayed to be a good thing, but in the case of developing economies it is highly damaging to sell the real resources and products of the country to foreign countries when they are badly needed by the people themselves.
Thanks for this introduction to macroeconomics. It does however have some very particular features that you have not mentioned, and which apply outside that which money plays its part. I would like to suggest and share with you the idea that macroeconomics has been considerably jumbled and confused by its many diverse schools of thought and political biasing. In my opinion we need to better understand of what it comprises and how it works. To further this end I have researched and written a derivation that looks at it from an engineering viewpoint, using cold logic to replace its unfortunate past confusing and complex intuitive guesses.
Making Macroeconomics a Much More Exact Science
Today macroeconomics is treated inexactly within the humanities, because at a first look it appears to be a very complex and easily confused matter. But this does not give it fair justice, because we should be trying to find an approach to the topic and examine it in a better way that avoids these problems of complexity and confusion. Suppose we ask ourselves the question: “how many different KINDS of financial (business) transaction occur within our society?” Then the simple and direct answer shows that that only a limited number of them are possible or necessary.
Although our sociological system comprises of many millions of participants, to properly answer this question we should be ready to consider the averages of the various kinds of activities (no matter who performs them), and simultaneously to idealize these activities so that they fall into a number of commonly shared ones. This employs some general terms for expressing the various types of these transactions, into what becomes a relatively small number of operations. Here, each activity is found to apply between a particular pair of agents—each one having individual properties. Then to cover the whole sociological system of a country, the author finds that it requires only 19 kinds of exchanges of the goods, services, access rights, taxes, credit, investment, valuable legal documents, etc., versus the mutual opposing flows of money. Also these flows need to pass between only 6 different types of representative agents.
The analysis that led to this initially unexpected result was prepared by the author and it may be found in his working paper (on the internet) as SSRN 2865571 “Einstein’s Criterion Applied to Logical Macroeconomics Modeling”. In this model these 19 double flows of money verses goods, etc., are shown to pass between the 6 kinds of role-playing entities. Of course, there are a number of different configurations that are possible for this type of simplification, but if one tries to eliminate all the unnecessary complications and sticks to the more basic activities, then these particular quantities and flows provide the most concise result, which is presentable in a comprehensive and seamless manner, and one that is suitable for further analysis of the whole system.
Surprisingly, past representation of our sociological system by this kind of an interpretation model has neither been properly derived nor formally presented before. Previously, other partial versions have been modeled (using up to 4 agents, as by Professor Hudson), but they are inexact due to their being over-simplified. Alternatively, in the case of econometrics, the representations are far too complicated and almost impossible for students to follow. These two reasons of over-simplification and of over-complexity are why this pseudo or non-scientific confusion is created by many economists, and explains their failure to obtain a good understanding about how the whole system works.
The model being described here in this paper is unique, in being the first to include, along with some additional aspects, all the 3 factors of production, in Adam Smith’s “Wealth of Nations” book of 1776. These factors are Land, Labor and Capital, along with their returns of Ground-Rent, Wages and Interest/Dividends, respectively. All of them are all included in the model, as a diagram in the paper.
(Economics’ historians will recall, as originally explained by Adam Smith and David Ricardo, that there are prescribed independent functions of the land-owners and the capitalists. The land-owners speculate in the land-values and rent it to tenants, whilst the capitalists are actually the owners/managers of the durable capital goods used in industry. These items may be hired out for use. Regrettably, for political reasons, these 2 different functions were deliberately combined by John Bates Clark and company about 1900, resulting in the later neglect of their different influences on our sociological system– the terms landlord and capitalist becoming virtually synonymous along with the expression for property as real-estate.)
The diagram of this model is in my paper (noted above). A mention of the related teaching process is also provided in my short working paper SSRN 2600103 “A Mechanical Model for Teaching Macroeconomics”. With this model in its different forms, the various parts and activities of the Big Picture of our sociological system can be properly identified and defined. Subsequently by analysis, the way our sociological system works can then be properly seen, calculated and illustrated.
This analysis is introduced by the mathematics and logic, which was devised by Nobel Laureate Wellesley W. Leontief, when he invented the important “Input-Output” matrix methodology (that he originally applied only to the production sector). This short-hand method of modeling the whole system replaces the above-mentioned block-and-flow diagram. It enables one to really get to grips with what is going-on within our sociological system. Subsequently it will be found that it is the topology of the matrix which actually provides the key to this. The logic and math are not hard and is suitable for high-school students, who have been shown the basic properties of square matrices and the notation of the calculus.
By this technique it is comparatively easy to introduce a change to a preset sociological system that is theoretically in equilibrium (even though we know that this ideal is never actually attained–it simply being a convenient way to begin the study). This change creates an imbalance and we need to regain equilibrium again. Thus, sudden changes or policy decisions may be simulated and the effects of them determined, which will point the way to what policy is best. In my book about it, (see below) 3 changes associated with taxation are investigated in hand-worked numerical examples. In fact, when I first worked it out, the irrefutable logical results were a surprise, even to me!
Developments of these ideas about making our subject more truly scientific (thereby avoiding the past pseudo-science being taught at universities), may be found in my recent book: “Consequential Macroeconomics—Rationalizing About How Our Social System Works”. Please write to me at email hidden; JavaScript is required for a free e-copy of this 310 page book and for any additional information.
My above comment is not how I arranged it and I hope it will not cause you any bother. The ideas are sound but there are no spaces between the paragraphs etc.
Best wishes…