Financial Cycle and Macroeconomics Method

Question: Discussn about the Financial Cycle and Macroeconomics Method. Answer: Introduction: Real GDP represents a macroeconomic measurement tools that help to reflect the value of all products and services manufactured in a particular economy in a specific year. Real GDP also regarded as the inflation adjusted measurement tools that can indicate standard of living of the economy. However, Gordon (2014) have highlighted the fact that several factors can mislead calculation of real GDP regarding the standard of living. For instance, real GDP does not include contribution of the homeowners in the production activity. Thus, the entire production done in the households does not count in the real GDP section, which can mislead the entire production done in the entire economy largely. Furthermore, real GDP ignore the entire underground economy or illegal production activity happens in a particular country. As per the article by Taati et al. (2015), underground economy plays a major role in the overall production activities in different countries. Thus, it reflects a serious measur ement issue regarding the accumulation of the overall production activities. Furthermore, real GDP also does not focus on measurement of life expectancy and people health, which also can create major impact on the standard of living perspective. Moreover, real GDP also does not include the value of leisure time, which also can create positive impact on the economic welfare. It also excluded expenses of environment condition for the production activity. For that reason, Eastern European economies under communism wrongly appear to provide higher economic welfare than a similar economy. In addition, real GDP also does not indicate the amount of social justice and political freedom enjoyed by the citizens of a specific economy. For that reason, real GDP is regarded as unreliable indicator in evaluating standard of living. Unemployment represents a phenomenon that transpire when an individual who is searching job actively and does not able to find a job. Unemployment often utilize as a tool that evaluates health of the economy. As per the article by Hall (2016), unemployment can be categorized into different parts including frictional, structural, cyclical and natural unemployment. Now, frictional unemployment primarily arises from labour market turnover. On the other hand, structural unemployment causes when technological evaluation or increase level of foreign competition induces business firms to focus on people with different level of skills and knowledge. As a result, it enforces many people to face unemployment challenges. Now, in the present competitive business environment, every organization has to focus on the utilization of several innovative technologies to achieve sustainable growth in the market. For that reason, structural unemployment can be considered as unavoidable in the present mark et situation. On the other hand, Georgellis (2015) several people are also looks for achieving better alternative opportunities in the market to enhance their quality of standard of living. Therefore, it is also obvious that those people will face unemployment for specific time period during the transition. Moreover, unemployment also heavily depends on the lag between potential GDP and real GDP. As it helps to indicate the fact that majority of the economy does not perform at their full potential, which will make unemployment unavoidable in certain situation. Almost all the economists have come to a unanimity that increases in average price level of the products and services will create inflation in the market. It established the fact that anything that increases the price level of the economy will eventually influence the inflation rate to grow higher. Thus, an increase in economic activity or decrease in unemployment can act as a major inflationary trigger. In addition, worker wages, commodity prices are also can be considered as a prime trigger that can have major impact on the market inflation. However, Gal (2015) have mentioned that the increase in average price level is not the only factor that can have impact on the inflation perspective. For instance, speculating buying and real income of the individuals can also have major impact on the market inflation perspective. Many studies have consciously focused on mentioning the impact of price level on the inflation but have not used the term money. Because there is no good statistical correlation between changes in various price index and changes in money (Svensson 2015). It has been assessed that decrease in the value level of the money will induce people to spend more on the products and services. Thus, it will also create inflationary effect in the market. On the other hand, increase in the average price level of the products and services will induce people to spend more in the market. Thus, it can be mentioned that average price level can create inflationary impact on the market. In macroeconomics, aggregate demand (AD) represents the total amount of final demand for goods and services in a particular economy. In fact, AD highlights the amount of products or services will be purchased at all possible price level (Rao 2016). Now, the above figure highlights the fact that AD curve is slopped downward, which highlights the fact that price level and quality level of the products are inversely correlated. As price level decreases, it creates positive impact on national income. As per the article by Abe, Inakura and Tonogi (2016), any decrease in the price level enhances the value of the money in the market, which eventually increases the quantity demanded in a major way. Furthermore, many studies have highlighted three reasons including Keynes's interest-rate effect, Pigou's wealth effect and Mundell-Fleming's exchange-rate effect that enforces the AD curve remains downward. Pigou's wealth effect has mentioned that real value of the money entirely depends on price level. Thus, if price level increases, real value of the money falls that reduce the quantity demanded. Conversely, Keynes's interest-rate effect has mentioned that higher prices consumes majority of the available currency. As a result, people possess lesser amount of currency to purchase products, which eventually reduces quantity demanded. Lastly, Mundell-Fleming's exchange rate indicates the fact that interest rate also fall with the fall in the price level. Now, as interest becomes lower in the domestic economy, foreign investors focuses on the economy to produce more at cheaper prices (Goyal and Tripathi 2015). As a result, it also increases the quantity demanded in the market. Thus, all three factors have highlighted negative relationship between the quantities demanded and price level, which enforces the AD curve to remain downward. Long-run aggregate supply curve reflects the fact that any changes in the aggregate demand curve only causes temporary changes in the total output of an economy. As per the article by Mankiw (2014) labour, capital and technology are the only factors that can have impact on the aggregate supply curve. Thus, supply volume in long-run can only be increased if size of workforce, capital stock or education level of the community increases. Now, increase of any of these factors with the given price level will increase the productivity of a particular economy. Thus, changes in price level will not have any impact on the LRAS curve. It will make LRAS curve to become vertical in long-run. However, Short-run Aggregate Supply Curve (SRAS) have to deal with fixed amount of capital, as new factory or capital cannot be developed in short span of time. In short-run, organizations have to focus on more utilization of the workforce to increase the present level of supply volume (Benassy 2014). Furthermore, in short-run any increase the in price level of goods encourages the organizations to focus on producing more. Thus, it reflects a positive correlation between the price level and quantity supplied, which enforces the SRAS curve to slope upward. References: Abe, N., Inakura, N. and Tonogi, A., 2016. Estimation of Aggregate Demand and Supply Shocks Using Commodity Transaction Data. Research Institute of Economy, Trade and Industry (RIETI). Benassy, J.P., 2014. Macroeconomics: an introduction to the non-Walrasian approach. Academic Press. Bernanke, B., Antonovics, K. and Frank, R., 2015. Principles of macroeconomics. McGraw-Hill Higher Education. Borio, C., 2014. The financial cycle and macroeconomics: What have we learnt?. Journal of Banking Finance, 45, pp.182-198. Gal, J., 2015. Monetary policy, inflation, and the business cycle: an introduction to the new Keynesian framework and its applications. Princeton University Press. Georgellis, Y., 2015, January. Regional unemployment and employee organizational commitment. In Academy of Management Proceedings (Vol. 2015, No. 1, p. 12430). Academy of Management. Gordon, R.J., 2014.A New Method of Estimating Potential Real GDP Growth: Implications for the Labor Market and the Debt/GDP Ratio(No. w20423). National Bureau of Economic Research. Goyal, A. and Tripathi, S., 2015. Separating shocks from cyclicality in Indian aggregate supply. Journal of Asian Economics, 38, pp.93-103. Hall, R.E., 2016. Why Has the Unemployment Rate Fared Better than GDP Growth?. Mankiw, N.G., 2014. Principles of macroeconomics. Cengage Learning. Michaillat, P. and Saez, E., 2013. A model of aggregate demand and unemployment. Rao, B.B. ed., 2016. Aggregate demand and supply: a critique of orthodox macroeconomic modelling. Springer. Svensson, L.E., 2015. The possible unemployment cost of average inflation below a credible target. American Economic Journal: Macroeconomics, 7(1), pp.258-296. Taati, S., Hakimipour, N., Alipour, M.S., Saberi, R. and Faramarzi, A., 2015. Analysis of Conditional Asymmetric Volatility of Real GDP and Main Economic Sectors Growth Rates in Iran.International Journal of Research and Reviews in Applied Sciences,23(1), p.1.a