Macroeconomics: GDP, inflation and unemployment

Looking at the big picture

Macroeconomics studies the economy as a whole. It asks:

• Is the economy growing?
• Are prices rising too quickly?
• Do people have jobs?
• What can governments and central banks do?

Three key indicators answer these questions: GDP, inflation and unemployment.

GDP: measuring output

Gross domestic product (GDP) is the total market value of all final goods and services produced in a country in a year.

The expenditure approach

GDP = C + I + G + (X − M)

Real versus nominal GDP

• Nominal GDP uses current prices.
• Real GDP adjusts for inflation, showing true growth in output.

GDP per capita

GDP divided by population gives a rough measure of average living standards.

Limits of GDP

GDP doesn’t measure inequality, unpaid work (like caregiving), environmental damage, leisure or well-being. Alternatives include the Human Development Index and measures of well-being.

Inflation

Inflation is a general rise in prices over time. It reduces purchasing power: the same money buys less.

• Measured by the Consumer Price Index (CPI), which tracks prices of a typical basket of goods and services.
• Both the Bank of Canada and the U.S. Federal Reserve target inflation of about 2% per year.

Causes

• Demand-pull: too much spending chasing too few goods
• Cost-push: rising production costs, such as energy or wages
• Expectations: if people expect prices to rise, they may demand higher wages and businesses may raise prices

After the COVID-19 pandemic, supply chain problems, energy price shocks and strong demand pushed inflation in Canada and the U.S. to the highest levels in about 40 years in 2022.

Deflation

Falling prices, or deflation, can also be harmful, because people delay purchases and debts become harder to repay.

Unemployment

The unemployment rate is the percentage of the labour force (people working or actively looking for work) who are jobless and looking.

Some unemployment is normal. "Full employment" still includes frictional and structural unemployment.

The business cycle

Economies move through cycles:

1. Expansion: growing GDP, rising employment
2. Peak: highest point
3. Contraction: slowing growth, rising unemployment; a recession if significant
4. Trough: lowest point, before recovery

Major downturns include the Great Depression (1930s), the 2008–09 Global Financial Crisis and the brief but deep COVID-19 recession in 2020.

Managing the economy

Monetary policy

Monetary policy is run by independent central banks: the Bank of Canada and the U.S. Federal Reserve.

• To fight inflation: raise interest rates, making borrowing more expensive and slowing spending.
• To fight recession: lower interest rates, encouraging borrowing and spending.

Fiscal policy

Fiscal policy is set by governments.

• In a recession: increase spending or cut taxes to boost demand (often creating deficits).
• During high inflation: reduce spending or raise taxes to cool demand.

Economists debate the right mix and timing. Policies can have lags and trade-offs: fighting inflation with higher rates can increase unemployment in the short term.

Try it yourself

1. Classify these as C, I, G or X − M: a family buys a car; a company builds a factory; the government builds a bridge; Canada sells lumber to Japan.
2. Find Canada’s or the U.S.’s latest inflation and unemployment rates. What do they suggest about the economy?
3. Explain how raising interest rates can reduce inflation.
4. Debate: "GDP is not a good measure of a country’s well-being."

Quick recap

• Macroeconomics studies the economy as a whole.
• GDP measures total output; real GDP adjusts for inflation.
• Inflation is rising prices; central banks target about 2%.
• Unemployment can be frictional, structural, cyclical or seasonal.
• Central banks use monetary policy and governments use fiscal policy to manage the economy.