This is a tour of historic economic events decoding them to understand core concepts in Macro-Economics.
Let's parse that
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The late 1970's were a tough time for US and UK. High inflation, unemployment and interest rates prevailed. Soon followed the parliamentary elections toppling the existing parties of power.
Unemployment is closely affected by various macro-economic triggers. Economist pool unemployment into 4 broad categories. Inflation leaves a deep mark on the unemployment levels because of shift in aggregate demand in the Economy.
Inflation is a period of rising prices and the value of money reduces. A change in price is a change in the factors affecting demand and supply which are assumed to be constant. This brings about a change in aggregate demand and aggregate supply in the economy.
There are two types of inflation, i.e. demand pull and cost push, one being better for the economy than other. Both have very varied effects on the economy.
President Reagan formulated the action plan to bring USA out of the turmoil. Arguably the best of his action was the tax cuts which shifted the money flow to more productive activities. He accompanied tax cuts with deficit financing.
Money supply, i.e. quantum of money available to people is regulated by the Central Bank through the Monetary Policy. Monetary Policy dictate the interest rates. Too much money available with the people can go into unwanted activities like speculation and can lead to inflation.
The Gross Domestic Product or GDP is the function of consumption, investments, Government spending and imports and exports of the entire economy taken as a whole. All four have different bearings on the Economic activities and influence the decisions taken at the parliament and the Central Bank.
Only prices of FINAL goods and services are taken into GDP. Prices impact GDP but what matters most is fixed prices without impact of inflationary trends. The only GDP that matters is the Real GDP and not Nominal GDP.
The Per Capita income gives the indication of well being of the citizens. The Disposable income at the aggregate level tells us how much money is available with the people in the Economy either to spend on consumption or put into savings to be used by industries for productive purposes. This is Investments.
Japan is the third largest economy in the world in terms of nominal GDP and world's largest creditor. Japan achieved all of these due to the regulatory reforms in 1960s to 1980s. This period is called the Japanese Post War Economic Miracle coming right after the World War II. The GDP growth story of Japan is worth studying.
China emerged as a manufacturing powerhouse starting from late 1970s. China's economic growth rates are astonishing coming from a fact that prior to 1970s China was a heavily inefficient communist economy. Yet another growth story worth analysing.
Singapore's economic success is equally surprising given the fact that the country had high levels of unemployment and poverty in the 1960s and lacks natural resources. Today Singapore is the one of the richest economies in the world known for social harmony. A must-know growth story for sure.
Central Bank controls the supply of money in order to put the Economy in the first gear in GDP growth. The money supply controls inflation, influences investment and savings, reduces unemployment and most importantly puts money into productive purposes.
Most powerful tool with Central Bank to control money supply was the Federal Discount Rate. The starting point of the Global Economic recession of 2008 was the astonishingly low Fed discount rate coupled with relaxed regulations. Many new financial instruments surfaced in the US economy like the Sub-Prime Mortgages and the Collateralised Debt Obligation.
The Global Recession of 2008 was the fallout of loans given to borrowers without basic background check. Once the interest rates were hiked, all of these borrowers defaulted and that was the sharp pin which pierced all the housing bubbles.
The Balance of Payments is the statement of account for the transactions between residents of the country. It has two legs, i.e. Current account and capital account. The Current account transactions include broadly 4 categories all of which have no future rights or obligations.
Capital Account transactions in the balance of payments are those which have future rights or obligations again having 4 broad categories. It is these transactions that try to balance out the current account transactions and the net of these two determine a companies deficit or credit position.
Price of one currency in terms of another gives the Foreign exchange rate, the catalyst for international trades. They are determined through forces of demand and supply but a major determinant is the Purchasing Power Parity. US dollars should be able to purchase equal quantity of similar goods from anywhere in the world.
The Purchasing Power Parity implied rates are different from the real exchange rates due to transportation costs, trade barriers, etc. Prices impact foreign exchange rates and inflation impacts prices. Inflation can appreciate or depreciate foreign exchange rate.
Oil, a scarce but extremely useful resource, divides the world into two: Oil importing and Oil exporting. The trade of oil influences the exchange rates of almost all countries in the world. The impact on oil importing countries differs depending on whether a country is heavily export oriented or not.
Every macro-economic variable has an impact on every other variable. The connections between all the factors are a must-know to understand the big picture of what is going on in the economic front.
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