Evaluation In Macroeconomics

Evaluation in Macroeconomics

What is evaluation?

Analysis means showing step by step cause and effect.

Evaluation means making a judgement about something, presenting both sides of an argument or explaining what the effect of something depends upon.

For example, consider this question:

To what extent does a reduction in interest rates lead to an increase in AD?

This part of your answer might be termed analysis:

A reduction in the interest rate would cause the cost of borrowing to reduce. This means that more borrowing would take place and there would be more consumption expenditure. There may be well more investment expenditure too as firms will face lower borrowing costs and the reward for their investment would be expected to increase. This means that AD would increase.

This part of your answer might be termed evaluation:

The effect of an interest rate reduction on AD might not be very significant It depends how large the interest rate reduction is a small reduction, especially when the interest rate is very low anyway, would not make much difference as consumers and firms would notice the change in interest costs as much. The effect also depends on what happens to the other components of AD. If the government reduced public spending at the same time, this might cancel out the increase in AD resulting from the interest rate cut.

How to evaluate:

Simple evaluation is all about remembering your watch:

The effect of most things depends on time it takes time for economic agents to respond to changes. The short run effect of a change may well be very different to the long run effect

The effect of most things depends on elasticity in one way or another. It might depend on the price elasticity of demand for imports or for exports, or the price elasticity of demand for a good or service in the domestic market

The effect of most things depends on size the size of the change. For example, a 1% increase in the basic rate of VAT will have less of an effect than a 5% increase

More complex evaluation requires a bit more thought:

Not everything is the same: People have different levels of income, firms have different levels of sales / profit etc. Some countries specialise in primary exports, others specialise in tertiary exports. This means that any change will not affect all people / firms / countries in the same way

Confidence matters: When confidence is low, people tend to delay consumption expenditure and save more instead (but not all people). Firms tend to invest less (but not all firms). The effect of any macroeconomic change will not be the same for all economic agents.

Reactions matter: We live in an inter-connected globalised world. The effect of an interest rate reduction in one country, or most other macroeconomic changes, will depend on how the governments in other countries respond. They may not respond to an interest rate change, but the same is unlikely to be true when a tariff is introduced.

Percentages matter: The significance of any macroeconomic change depends on what percentage of consumers and firms are affected and what percentage of their income / costs are affected.

The multiplier matters: When we consider a change in AD, the effect on growth, inflation and unemployment depends on the size of the multiplier the larger it is, the greater the effect. This in turn depends on MPM, MPS and MPT.

Proximity matters: The significance of any change in AD depends how close the economy is to full employment output. When the economy is at Yfe, any change in AD has a large impact on inflation compared to the impact it has on growth and employment. The opposite is true in a negative output gap.

Exercises:

Use linked chains of reasoning and diagrams where possible to evaluate the following:

1) Evaluate the extent to which a recession in the USA leads to a deterioration in macroeconomic performance in the UK

2) Evaluate the extent to which a fiscal stimulus will lead to an increase in AD.

3) Evaluate the extent to which an increase in inflation is harmful to macroeconomic performance

4) To what extent will a fall in the domestic exchange rate lead to an improvement on the current account balance?

5) To what extent does a current account deficit matter?