L01: Core Macroeconomic Concepts and Terminologies

In late 19th century in Europe there was a battle of methodologies. On the side there were people who argued that economics is a historical subject, it is qualitative, and it does not have a mathematical formula. On the other side there were the scientists who said we can’t learn anything from history as it is very particular and unique how can one learn anything from it. Unless we can find a law any historical event is useless. This argument has a great deal of logic to it but it is wrong. Since the 1890’s, when the scientific methodology became dominant there has been a steady decline in understanding the economics. Currently the economic theories are just false the latest evidence for this is the Global Financial Crisis of 2007 and out of seven none of school of thought could predict this crisis. Even after the event it was very difficult to understand what has happened because according to standard classical economic theory this could not happen. In fact it was told to economists that something very unusual is happening in the stock market and there is fear of collapse of financial market due to bubble economy. But Fama said no there is no such thing as bubble because people are rational. Other famous economists said that financial market cannot collapse but actually it doing very well.

Macroeconomics is about achieving full employment, achieving stable prices (no inflation) and about achieving rapid growth. There are controversies about how to achieve these goals. Different schools of thought have different ideas about what is the policy required to achieve these goals. Every school has a point to achieve full employment but what it means and how it can be achieved is very much controversial. As far as stable prices are concerned everybody agrees that inflation is not a good thing so we should try to achieve zero or small amount of inflation but how it can be achieved is controversial. Rapid growth as a goal is now subject to controversy because although it has been widely believed and still confused to be widely believed that we need to have rapid growth in GNP per capita to eradicate poverty but there is lot of evidence that this is not true. Basically the idea of the rapid growth is that if we increase income then it will help the poor. But the fact is over the past thirty years enormous amount of growth has taken place but all of the gains have gone to the top one percent. If we have even more growth and gains from it keep going to the top one percent the bottom 99 percent don’t benefit from it. So there is no point to achieve such growth.

Macroeconomic theory was created by the Great Depression. This event was not forecasted by economists at that time and nobody could understand it. Leading economists of the time said this is not a serious thing and this recession will recover very quickly but it didn’t happen because the theories were wrong. According to the theories the labor market will automatically will find equilibrium so there can be no unemployment because if there is access unemployment then wages will go down and supply will go down $ demand will rise and unemployment will eliminate. But it didn’t happen for more than fifteen years there was large unemployment, starvation, hunger and social destruction of all kinds. But economists kept waiting for the market mechanism to work but it didn’t.

Macroeconomics of today is the direct result of the things that happen in USA and in Europe so history is very crucial. It means that learning only formulas, calculus and differential equation and apply it in economics does not make any sense. Today’s theories are devised in very special, concrete and specific scenario to solve any particular problem which came in US in 20th century and now studying these theories is out of context. Now idea that these theories are science is the problem itself because if it’s a science then it is universally invariant but it is not. Macroeconomics fiscal and monetary policy does not work in Pakistan in the same way as it works in USA. Same policy would have different effect in USA and Pakistan. So we have to study everything within its own historical context.

In the global economy early 90s Russia Collapsed so the one alternative which existed to Capitalism collapsed and as a result the Washington consensus was born in IMF and World Bank, in this consensus it was said that this is the policy which will work everywhere. According to these policies what one need to do is to private, liberalize, deregulate and automatically the economies will progress. It means that if you come to Pakistan, and you want to improve the economy of Pakistan you don't need to know anything about Pakistan but sell all of the government factories, you will back down the customs duties and taxes and that's it. So there is no need to know what is grown in Pakistan, what kind of industries are there, what kind of people are there, what is the rural sector life, who are the landlord, who are the serfs, who are the bounded labor, so nothing of them. So it's one size fits all this is what Stiglitz called. As a normal human being one would think that if I want to make an economic positive in Pakistan, I should study Pakistan but according to IMF and World Bank it's not needed at all as they have already got the magic bullet.

There are the reasons why the existing theory of economics as developed by the West is wrong. There is an impression that west has done lot of progress and we are hundred years behind them so if we want to learn economics then we have to follow the west without questioning them. It is not true because everything they are currently teaching is wrong and it is very easy to make a contribution. For example if it is asked that how does your mother, who is not brainwashed from economic theories, spend money to any lay man. Then his answer will be that she divide her budget according to needs like some portion is allocated for vegetables, meat, dressing etc. But as we have been brainwashed by economic theories that’s why we will start calculating utility maximizing bundle for the consumer although it has nothing to do with real life experience.

Macroeconomics is a very important subject as all countries are being run according to false macroeconomic theories and if we learn the right theories and learn how to apply these in real world then we can change the world. It is very big game and also has very serious consequences. First step is to have a confidence which we have lost from past three centuries. Macroeconomics is about the things that we can understand provided that we have a confidence in ourselves. Truth about macroeconomics is easy to understand in a sense that it is all about that we can observe and understand from daily life experiences as compare to understanding abstract differential equations, comparative statics and total differential etc.

Link of the Lecture: https://www.youtube.com/watch?v=zvS9DoJdZ_0