Think of the macroeconomy as if it were a concert with an array of musicians on stage playing different roles. Instead of a singer, guitarist, drummer, keyboard player, and bassist, the players are consumers, investors, importers, exporters, and government policy makers. The interactions of all these players create harmony and melody, generating the broader movements that form the music of macroeconomics.
But we can watch the concert from different vantage points. A seat that’s up high and to the west of the stage gives a different perspective on how the music is made than one that’s over on the east side of the stage. Both seats provide a good view of the show—it’s largely a matter of opinion about which perspective reveals more about the music you’re hearing. So it is with macroeconomics: The facts of the economy don’t change, but you can examine them from different angles.
This brings us to a decision: Where will you sit for this concert? The next set of chapters offers the opportunity to examine business cycles from one of two different vantage points; your instructor will choose the perspective they judge best suited to your needs. Each perspective gives you a good view of the stage—and if you choose to continue your study of economics beyond this course, you will explore them both in time.
The first option is what we call The Fed View. Think of this as the view from backstage. Just as government policy makers do, we use an IS curve to track the real economy, an MP curve to illustrate the Federal Reserve Board’s interest rate decisions, and a Phillips curve to analyze inflation.
The second option is The AD-AS View, short for aggregate demand and aggregate supply. It’s a perspective that instructors often find useful when teaching first-time economics students. Think of this as a center seat in the mezzanine, from which you can clearly see the interplay between output and the price level.
The roadmaps ahead present an overview of each path through this material. Either path will get you to the same place, which is a clear understanding of business cycles. And they both prepare you for the final part of our journey in Part IX, on economic policy, where we’ll use what we’ve learned about business cycles to see how policy makers can help counter the ups and downs of the business cycle. We’ll explore how the Fed adjusts interest rates as part of its monetary policy. And then we’ll turn to how the government adjusts its spending and taxation as part of its fiscal policy.
In this pathway, we’ll start with a broad overview of business cycles. You’ll learn to distinguish between short-term fluctuations and longer-term trends, to recognize some common characteristics of business cycles, and to use some key macroeconomic indicators to assess where the economy is and where it might be going.
From there, we’ll take our seats at the concert and learn to find the macroeconomic equilibrium using the IS-MP framework. If the economy were a concert, you might think of this as the view from the Federal Reserve because it’s the perspective from which government policy makers view the economy. We’ll start with a brief introduction to aggregate expenditure and how it responds to changes in the interest rate, before learning how to use the use IS curve and the MP curve to build a framework for forecasting macroeconomic outcomes.
Continuing down this path, you’ll learn to use the Phillips curve to forecast inflation, taking account of the role of inflation expectations, the output gap, and supply shocks.
If you want to bring all the pieces together—to truly see the show the same way the Fed does—then we bring together real interest rates, the output gap, and inflation in a brief capstone chapter on the Fed model.
This alternative option for examing business cycles provides you with a different but equally useful view of the economy. We begin once again with a broad overview of business cycles. You’ll learn to distinguish between short-term fluctuations and longer-term trends, to recognize some common characteristics of business cycles, and to use some key macroeconomic indicators to assess where the economy is and where it might be going.
From there, you’ll skip ahead to Chapter 33, to explore the aggregate demand and aggregate supply framework. This perspective provides a familiar view of the economy. Think of it as the view from the center mezzanine. You’ll see how the tools of supply and demand can be effectively scaled up to demonstrate how aggregate demand and aggregate supply determine macroeconomic equilibrium. You’ll learn to use this framework to forecast how the economy will respond to a variety of economic shocks.
Depending on the path you take, Chapter 30 or Chapter 33 provided a brief introduction to two key concepts in economics: aggregate expenditure and the multiplier. For a deeper dive into these topics, dig into the more thorough treatment in this fully developed appendix (located at the back of this book).