Output, Inflation and Growth

Frontmatter

1. The Scope of this Book

Abstract

The social result of economic activity is the satisfaction of human wants. In any period of time, say a year, an immense variety of goods (cars, clothes, books and beer) and services (such as those of doctors, dentists, politicians and pop singers) becomes available in varying quantities. These goods and services satisfy the wants of those who purchase them. Obviously not all wants are satisfied by this economic activity for wants are virtually insatiable and resources are scarce. But if we think of the ‘economic system’ of a country in this way we can, subject to some obvious safeguards, regard it as a ‘machine’ for organising the production of goods and services which ultimately satisfy human wants.

D. C. Rowan

2. The Process of Economic Analysis

Abstract

In Chapter 1 we defined the four main problems with which this book deals as being to explain

(i)

what determines the level of output in any period;

 

(ii)

what determines the rate at which ‘output’ grows between any two periods;

 

(iii)

what determines the general level of prices in any period;

 

(iv)

what determines its rate and direction of change between any two periods.

 

We have thus selected particular aspects of the economic system for intensive study. How are we to set about analysing these problems?

D. C. Rowan

3. Definition of Concepts and Measurement of Output

Abstract

In this chapter we define some of the concepts which we shall need to employ in describing how the economy operates and developing a theory to explain why the economy operates as it does.

D. C. Rowan

4. National Income and National Product

Abstract

In the last chapter we erected a consistent set of definitions which provided us with a conceptual scheme in terms of which we can (and shall) describe economic behaviour. How do we measure the concepts we have defined ? The easiest way of answering this question is to construct, and work through, a simple example.

D. C. Rowan

5. Output and Capacity

Abstract

We have now defined a set of accounting concepts in terms of which we can describe, in a systematic and unambiguous way, the behaviour of the United Kingdom economy. To do this we had to spend some time and effort in looking at purely accounting problems. There is therefore a risk that in concentrating on the development of a conceptual framework we have lost sight of our main objective. Accordingly this is a good point at which, before looking at the behaviour of the United Kingdom economy in Chapter 6, to take stock of what we have learned.

D. C. Rowan

6. A Sketch of British Economic Experience

Abstract

In Chapter 5, in making use of the concept of the production possibility curve, we distinguished between two macro-economic problems.

D. C. Rowan

7. Analytical and Expository Devices

Abstract

Many students of economics find the analytical and expository devices used by economists forbidding or even frightening. This is particularly the case where the devices employ — or look as if they employ — mathematical modes of expression and mathematical methods of reasoning.

D. C. Rowan

8. The Determination of Equilibrium Output

Abstract

In this chapter we begin our main job of constructing an economic theory which can be used to explain why the economic system behaves as we saw that it did in Chapter 6. We approach this task by developing a model of the economic system. Since the economic system is complicated, the model, to be useful, must necessarily also be complicated. We shall begin, however, by constructing a model of extreme simplicity and introduce complexities later only when the properties of the simple model have been thoroughly understood. Accordingly we start with a system in which (i) there is no government (i.e. no public sector) economic activity; and (ii) there is no international trade. We also make one additional assumption, namely that the price of a unit of output is constant. This enables us to identify changes in the money values of variables with changes in their ‘real’ values and postpone discussion of the determination of prices. Each of these assumptions is removed later.

D. C. Rowan

9. The Consumption Function and the Multiplier

Abstract

In the last chapter we argued that enterprises would adjust their output per period until planned sales and actual sales were equal. At this level of output enterprises would be in equilibrium: that is, have no reason to adjust their output plans in any way.

D. C. Rowan

10. The Investment Function

Abstract

In Chapter 9 we showed that if we knew

(i)

the propensity-to-consume schedule; and

 

(ii)

the rate of real planned investment

 

we could determine the equilibrium level of output and hence, via the production function, the equilibrium level of employment. We also demonstrated that the equilibrium level of output (= income) was stable.†

D. C. Rowan

11. Liquidity Preference and the Theory of Interest

Abstract

In Chapter 10 we developed a theory of investment and found that, given (i) the marginal efficiency of capital schedule adjusted for borrowers’ risk; and (ii) the cost of borrowing, we could determine the equilibrium rate of real planned investment. Given the rate of real planned investment (determined in this way) we could then, from the schedule of the propensity to consume (itself derived from the consumption function) determine the equilibrium level of output and employment from the condition that, in equilibrium, planned saving must be equal to planned investment.

D. C. Rowan

12. The Theory of Income Determination

Abstract

As a result of our work in Chapter 11 we now have a theory of the determination of the equilibrium rate of interest. Our elementary model is thus complete. It is, therefore, convenient at this point to summarise our argument: that is to display in full the characteristics of the model at this stage. Once this is done we can proceed (i) to see where the model needs further extensions; and (ii) to see what predictions it yields.

D. C. Rowan

13. The Public Sector and the International Sector

Abstract

Now that we have developed our static theory of the determination of income and interest in an economy without either government economic activity or international trade we need to extend our model to take account of these elements of the problem.

D. C. Rowan

14. Money, Debt and Liquidity

Abstract

In our outline of the liquidity preference theory of interest we have already put forward a definition of the money supply. This definition, however, was stated dogmatically and the principles underlying it were never discussed. At the same time we made reference to the concept of liquidity. Our task in this chapter is to examine the concepts of money and liquidity in more detail and thus explain and justify the brief references made in the course of our earlier analysis.

D. C. Rowan

15. Commercial Banks and the Money Supply

Abstract

In the previous chapter we saw that modern money consists of two components: (i) demand deposits with the commercial banks; (ii) notes. Of these the first, and most important component, consists of liabilities of the commercial banks, the second of liabilities of the central bank. Since we have defined the money supply as:

the nominal value of demand deposits and notes held by the non-bank public

it follows that, to explain its determination, we must examine the behaviour of the commercial banks and the central bank for, just as an individual controls the nominal value of the I.O.U.s he issues, so do banks and, in doing so, the latter control the money supply.

D. C. Rowan

16. Central Banking and the Money Supply

Abstract

In the previous chapter we found that there were three determinants of the money supply:

(i)

the asset preferences (cash/deposit ratio) of the commercial banks;

 

(ii)

the preferences of the non-bank public regarding the form in which they wish to hold their money (i.e. as deposits or notes);

 

(iii)

the cash reserves of the commercial banks.

 

D. C. Rowan

17. The Theory of the Price Level

Abstract

So far the whole of our analysis has proceeded on the simplifying assumption that the price level is given and invariant. This does not mean that the level of prices exerts no influence in our model. Indeed if we look back at Chapter 11 we see that the price level is a determinant of the demand for active (M₁) balances and thus of the rate of interest. Since the rate of interest, given the M.E.I. schedule, determines (as explained in Chapter 10) the rate of real planned investment which, in its turn, determines, via the multiplier, the equilibrium level of real income and, via the production function, the level of employment, it is clear that the level of prices exerts a considerable influence in our system. It is plain, therefore, that to complete our theory we need to consider how the price level itself gets determined. To explain this is the job of this chapter.

D. C. Rowan

17*. The Quantity Theory of Money

Abstract

In the previous chapter we analysed the consequences for the endogenous variables of our model, and in particular for the price level, of an assumed exogenous change in the nominal money supply. We now seek to compare the predictions of our theory with an older theory known as the Quantity Theory of Money. What is the nature of this theory?

D. C. Rowan

18. Keynes and His Predecessors

Abstract

In Chapters 7–17 we have gradually developed a macro-economic model which is, in all essentials, derived from the work of Keynes. In developing this model there is a risk that, in our detailed examination of its component parts, we have lost sight of its overall characteristics. To guard against this, in this chapter we take, as it were, a step back and attempt to set out the principal characteristics of the model as a whole. We begin by looking at its structure.

D. C. Rowan

19. Economic Growth

Abstract

In developing the analysis of earlier parts of this book we made use of the assumption that the capacity of the economic system to produce output was given.

D. C. Rowan

20. Fluctuations in Economic Activity

Abstract

In Chapter 19 we developed an account of the process whereby, over the long run, the capacity of the economy to produce output grows. In this chapter we consider why, as a matter of observation, the growth path followed by the economy involves fluctuations in the extent to which, in any given year, the available capacity is utilised. The problem of economic fluctuations is often discussed under the heading of the theory of economic cycles. What then is a cycle?

D. C. Rowan

21. Rising Prices and Inflation

Abstract

In this chapter we examine the problem of rising prices — commonly called the problem of inflation. In Chapter 17 we developed, as part of our short-run static model, a theory which explained the determination of equilibrium level of prices. In that chapter we did not discuss inflation although we did characterise one situation described in that chapter as an inflationary one.

D. C. Rowan

22. Economic Analysis and Economic Policy

Abstract

In Chapters 1–21 of this book we have tried to do two things. The first is to show how economists seek to develop — and test — theories which explain the way the economic system operates. The second is to set out those parts of macro-economic theory which, as the result of the work of many economists, now command a broad measure of general support. In short we have tried to display the methods and some of the results of positive economics.

D. C. Rowan

23. The Model in Action: Economic Stabilisation

Abstract

In the first twenty-two chapters of this book we have aimed at the gradual development of a macro-economic model sufficiently simple to be manageable without recourse to either higher mathematics or electronic computers but, at the same time, sufficiently realistic to enable us to use it to throw light upon some of the problems presently facing the British economy. In Chapter 22, we set out, in broad outline, the relationship between macro-economic models of economic behaviour and policy recommendations. In this chapter and the final two chapters of the book, we now employ the model, and the techniques of analysis which we used in building it, to analyse a particular policy problem.

D. C. Rowan

24. Economic Stabilisation: The Use of Monetary Policy

Abstract

Our purpose in this chapter is to consider the way in which monetary policy influences aggregate demand and how far monetary measures can be used to generate the additional £90 m. of demand we require in the fourth quarter of 1963.

D. C. Rowan

25. Economic Stabilisation: The Use of Fiscal Policy

Abstract

Our examination of monetary policy led us to discard it as a short-run stabilisation device. We thus assume monetary policy to be unchanged and have to select a fiscal policy appropriate to raising gross domestic product to the target level by the fourth quarter of 1963. What are the issues involved ?

D. C. Rowan

Backmatter