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RESEARCH & IDEAS

A Macroeconomic View of the


Current Economy
Q&A with: David A. Moss
Published: January 25, 2010
Author: Sean Silverthorne

Concerned or confused by the economic numerous tools for interpreting big-picture effectively as possible.
environment? Take some lessons from history economic developments. I think another thing readers will learn is
and concepts from macroeconomics to get a We asked Moss to talk about the book and that they can look at big developments at the
better understanding of how the economy some of the events now taking place on the macro level and start to think about what they
works. A Q&A with HBS professor David A. macroeconomic horizon. mean—how these developments might come
Moss, author of A Concise Guide to back and affect their bottom line.
Macroeconomics: What Managers, Executives, Sean Silverthorne: What's the definition Let's take exchange rates. Exchange rates
and Students Need to Know. Key concepts of macroeconomics? fluctuate widely, and anybody who tells you
include: David Moss: It involves thinking about the they know what the exchange rate is going to be
• Macroeconomics involves thinking about economy as a whole. Micro is about firms and tomorrow either has godlike powers or is
the economy as a whole, rather than the individual actors and how they behave; macro is putting you on. But there are patterns over time.
actions of individual actors. about aggregate performance of the economy: For example, countries that are running large
• The three pillars of macroeconomics: overall GDP, trade surplus or deficit, inflation. and ongoing current account deficits tend to see
output, money, and expectations. In principle, we should be able to get rid of their currencies depreciate over time. This
• A good grasp of macroeconomics will help the (macro/micro) distinction because all micro doesn't mean that the currency of a country
readers make better sense of the business behavior—all the firms and individuals—add running consistent current account deficits is
news and trends. up to the aggregate economy. But it turns out going to depreciate tomorrow or next week or
• We can use the long history of financial that we're not there yet. There's still a great deal even next month. But over time, you expect it to
markets and institutions in figuring out how we don't fully understand. We see patterns at depreciate. So if you're a business manager, you
to prevent another financial crisis. the macro level that are sometimes hard to probably want to be fairly well hedged against
disaggregate and pinpoint exactly where they this possibility, either by making use of certain
came from at the micro level. So as a result, we financial instruments or by carefully spreading
If they didn't understand it already, separate macro and micro. Someday, if we ever out your real investments across various
executives and corporate managers have learned figured everything out, these things would come countries.
one huge lesson over the past couple of years: together. That's true in many areas of study.
macroeconomics matters. Q: You mentioned that you can't predict
Interest rates. Exchange rates. Trade Q: What will executives and other exchange rates. But are there rules of thumb
deficits. The Gross Domestic Product. Inflation. business readers learn from the book? managers can practice when thinking about
All of these can affect a company's bottom line A: One of the most important things is exchange rates and how to play them?
by influencing the cost and availability of they're going to be able to read the Financial A: I'll mention several.
money, goods, and services. Macroeconomic Times, the Wall Street Journal, and The First, as I just suggested, it makes sense to
forces can conspire to make business more Economist much more effectively than they look at a country's current account deficit or
difficult, but they can also present opportunities could before. Those publications integrate surplus. For countries that are running large
to executives who know how to, for example, macroeconomics with what we know about current account surpluses, like China and Japan,
read a country's national income accounts and business and markets, often in the very same you'd expect their currency to appreciate over
balance of payments. articles. Without some background in sustained periods of time. I can't say for sure
For explanations on how the economic macroeconomics, much of that goes past the that Japan's currency is going to appreciate over
system works and what history teaches us, reader. time, but in all likelihood, it will. I would be
business readers might turn to A Concise Guide What exactly does it mean that the real very surprised if China's doesn't appreciate over
to Macroeconomics: What Managers, interest rate has moved, or the real exchange time.
Executives, and Students Need to Know, by rate has moved this way or that? There are Another thing you want to look at is
Harvard Business School professor David A. different types of productivity—labor inflation. If a country has a higher inflation rate
Moss, who holds graduate degrees from Yale in productivity, capital productivity, and total than its trading partners, you should expect that
economics and history. The book, which grew factor productivity. Which is the right one to its currency is likely to depreciate over time as
out of background notes Moss wrote for his look at in a particular context? well.
MBA students, is a nontechnical, accessible There's a lot of information out Maybe I can put this in some perspective.
explanation of broad concepts such as "output," there—particularly in the business press. If Over the long term, a main driver of a country's
"money," and "expectations"—as well as more these aren't familiar terms, and if one doesn't exchange rate is probably its current account
specific ones ranging from real exchange rates have a way of putting it all together, then you deficit or surplus. In the medium term, you
to total factor productivity. Moss also includes can't process all of this information as probably want to look at inflation rates. But at

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the day-to-day level, changes in short-term called stocks and bonds. going to buy. Firms will start laying off
interest rates seem to be a key driver. For As a result, economists worry a lot about workers. And then, of course, the negative
example, if the European Central Bank how a country can increase its GDP growth expectation becomes self-fulfilling. You can
suddenly (and unexpectedly) raises its key rate, how higher growth of output can be even get stuck there for a long time—in a
short-term interest rate tomorrow, you're achieved over the long term, and how we can recession.
probably going to see the euro appreciate, make sure that in the short term total output That's why in some cases you need either a
almost immediately. If the central bank of the isn't unduly volatile (with unsustainable booms very aggressive monetary policy or large-scale
United States—the Fed—unexpectedly lowers and busts). deficit spending, which is what we've seen this
its interest rate, the dollar may well depreciate a past year. Both aggressive monetary easing
bit that same day. You tend to see these very Q: The second pillar of macroeconomics (lower interest rates) and large-scale deficit
quick fluctuations associated with interest-rate is money. spending send the signal that demand will
changes. But over the longer term, the current A: In some sense money is just another increase, and thus both aim to break the cycle of
account balance is probably far more important. asset, but it turns out to be a rather special asset. negative expectations about the economy.
One of the reasons it is special is that there
Q: What is the current account deficit, seems to be a relationship between people's Q: What's a good way to think about
and why is it important? holdings of that particular asset and their foreign direct investment in the United
A: The current account deficit just means current consumption or spending. And that's States? Are we selling too much of our core
that you (as a country) are consuming, or because money is an asset that you can use to assets to foreign investors?
spending, more than you actually produce. buy things, right now. It's the ultimate form of A: Look, this is a political decision, and it's
Think about a household. If you earn $100,000 liquidity. But another thing that's important above my pay grade. There may be some
a year and spend $106,000, you're going to have about money is that its supply is largely strategic assets that we (as Americans) don't
to borrow $6,000 (or draw down your assets) to controlled by the government. Depending on want to sell to foreigners. Congress is going to
make up the difference. The same is true for a which type of money supply you look at, the have to decide which ones those are. It may be
country. government has either a complete monopoly or that we don't want to sell certain elements of
Between business spending, government a partial one. By their control over the money our media to foreigners, or perhaps certain
spending, and consumer spending—consumer supply, central bankers can essentially set strategic assets that are important for building
spending being the biggest—the United States interest rates, especially short-term interest critical military equipment.
consistently spends more than 100 percent of its rates. One can be too cautious about reliance on
GDP (as high as 106 percent in 2005 and 2006). And that's the basis of monetary policy. It's foreigners. In the early 19th century, the British
But of course we produce only 100 percent of because of that control over the money thought their grain supply was strategic, and
GDP, so we need to borrow the difference. How supply—either increasing or decreasing the they protected it aggressively. Eventually,
do we do that? Well, we ask the Japanese, the money supply—the government can set however, with the repeal of the Corn Laws, the
Chinese, and some others for their goods, and short-term interest rates. And that short-term British decided to move toward free trade in
they give them to us. And then they lend us the interest rate is what central bankers use to try to wheat. It was a controversial move. Skeptics
money to buy them. We are both control inflation and moderate the business feared that other countries that supplied wheat
borrowing—literally borrowing in financial cycle. to Britain could use it as a weapon, by
terms from, particularly, the Asians—and threatening to starve Britain. But it turned out
getting their goods (imports). Someday, they're Q: And what about expectations? Why that nothing of the sort ever happened, and
going to want us to repay, which means they're are expectations the third pillar? Britain was almost certainly better off after it
going to have a claim on our output. And A: Expectations are extremely interesting repealed its Corn Laws.
someday, we're probably going to have to run a because they represent a connection between The broader thing to think about with regard
current account surplus, where we're producing the present and the future. Current decisions are to foreign investors buying assets in the United
more than we spend, and we're shipping off the affected by what people expect the future to States is that if we as a country are going to
rest (the surplus) to our current creditors. bring. For example, business managers set the spend more than we produce—if we're going to
prices of their products—at least in part—based run a current account deficit—year after year,
Q: Your book centers on the three pillars on expectations. More broadly, if people expect then there's in fact no alternative to foreigners
of macroeconomics: output, money, and the price of a good (say, wheat) is going to be buying our assets, either debt or equity. As I
expectations. Can you talk generally why higher in the future, then the price is going to said, if you're earning $100,000 and you're
these are important to understand? start rising today. spending $106,000, you're going to have to
A: When you think about these three things, Although expectations of all sorts are borrow or draw down your assets to make up
output should be in big letters, and the other important, one particular set of the difference. So that's what we're doing as a
ones in smaller letters. Output is really the expectations—about the state of the overall country. The problem is not fundamentally that
center of macroeconomics, and the key measure economy and one's own future income—is foreigners are buying too many American
is the GDP, that is, total aggregate output, the especially important from a macroeconomic assets, but that Americans are spending too
market value of all final goods and services perspective. If people believe the economy is much.
produced. going to falter, even if their reasons are wrong, The right way to fix this, of course, is by
In a sense, all that you (as a country) have is in the short term the economy may well falter. increasing the American savings rate. Up until
the total output that you produce in a If consumers believe that they'll soon be in the economic crisis, household savings were
year—your GDP. Sometimes people think if economic trouble, they will reduce their essentially zero, business was saving in the
everyone owned lots of stocks and bonds, we consumption and start scaling back on vicinity of 15 percent (through retained
could all retire happy, regardless of the GDP. purchases. And what are businesses going to earnings), and the government was dissaving
But if the nation's total output in future years is do? If they see people reducing their (because of its budget deficit) by a few percent
not sufficiently large, then all those stocks and consumption (or even just planning to reduce of GDP each year. Once the crisis struck,
bonds are going to end up being worth a lot less their consumption), business managers may household savings rose, and government
than expected. Total output is the key to how decide to scale back on their own operations, so dissaving (deficits) rose by about the same
much we can consume, not little pieces of paper as not to produce a lot of output that no one's amount.

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Over the long term, we'll need to find a way If inflation is rising above the 2 percent level, careful student of the Great Depression; he
to save more across the board. We'll need to he's likely to push the short-term interest rate understood it quite well, particularly from a
increase our national savings rate quite upward, in order to contain inflation. If inflation monetary standpoint. The level of monetary
substantially. That's ultimately the only way is falling below the 2 percent level, he's likely understanding is much better than it was in the
we're going to turn around our current account to push the short-term interest rate downward. past. And that reduces our odds of falling into
deficit and ultimately stimulate the kind of That would be the best way to predict what he's another Great Depression. Again, it doesn't
growth longer term that we'd all like to see. going to do in normal times. eliminate those odds, but it reduces them.
So what does that mean? We need to figure Of course, these haven't been exactly Macroeconomists deserve a lot of credit for
out how to encourage households to increase normal times. With the financial system in that.
their savings, especially once the recession is serious jeopardy and unemployment surging, That said, excessively low interest rates
clearly behind us. I think that will have to be Mr. Bernanke put aside inflation-targeting and during the boom years may well have helped to
front and center. Also, once the recession is used just about every weapon in his arsenal to cause the crisis. So monetary policy, while
over, we'll definitely need to get our budget save the economy from collapse. He lowered much better than in the past, is still nowhere
deficits under control—most likely by the federal funds rate to just about zero—the near perfect. For example, we still know very
controlling spending and raising taxes. We'll lowest ever—and he developed and employed little about how to prevent a bubble from
certainly need to prepare for the retirement of all sorts of unconventional tools to help becoming a problem in the first place.
the baby boomers. stabilize things, including asset purchase
programs, large-scale financial guarantees, and Q: In your own field of research, what
Q: The Federal Reserve Board and its direct lending to nonbank financial institutions. are you working on these days?
chairman, Ben Bernanke, have tremendous My own view is that while he inevitably made A: Well, I'm working on a number of
influence on the business environment, all sorts of mistakes (especially in the lead-up to things. I've spent a great deal of time over the
particularly on interest rates. If you're a the crisis), his extraordinary actions in the heat past year thinking about financial regulation
manager and interest rates affect your of the crisis may well have saved us from a and what it should look like, and I've been
business, how do you think about this? complete financial collapse and a far worse talking with lawmakers in Washington about
A: It's worth putting yourself in the shoes of macroeconomic crisis. this quite a bit.
Ben Bernanke and trying to imagine how he Once the biggest dangers are behind us, Mr. I've also launched a new second-year course
thinks about it. That's going to be helpful in Bernanke will have to figure out how to get at Harvard Business School on financial history.
assessing what he might do. things back to normal. His aggressive I started creating the course long before the
As a central banker, Mr. Bernanke has to stimulation of the economy could easily prove financial crisis hit, but it's definitely been
worry about a number of different things: inflationary if he doesn't bring rates back up in fascinating to teach about past financial booms
inflation, unemployment, GDP growth, time. But it will be a delicate balancing act if and busts—about the history of financial
exchange rates, the stability of the financial unemployment remains unusually high. innovation, financial growth and excess, and
system, and so on. Eventually, if all goes well, we'll get back to financial regulation—at this particular moment.
In more normal economic times, he would standard inflation-targeting, and monetary Financial history has truly come alive over
likely focus mainly on maintaining a low and policy will become far more predictable again. the past couple of years. My hope is that we can
stable rate of inflation—perhaps around 2 But for the time being at least, the Federal use that history—the long history of financial
percent. He has written and spoken in the past Reserve remains in uncharted waters. markets and institutions—in figuring out how to
about his belief in inflation-targeting. The basic prevent another financial crisis going forward.
idea is that if the central bank manages to keep Q: As a field of academic study, where do That's where much of my work has been
inflation within the target range (again, around you think macroeconomists have made the focused these days.
2 percent), then everything else will tend to fall most progress?
into place: low unemployment, relatively stable A: There's a lot that macroeconomists don't
GDP growth, and so on. know. But I think in monetary policy they've
About the author
So, once the financial crisis and the made a good deal of progress. Had we had the Sean Silverthorne is editor-in-chief of HBS
recession are well behind us, probably the best same level of knowledge today that we had in Working Knowledge.
way to predict how Bernanke will set interest the early 1930s, we might have faced a second
rates is by looking at where inflation is headed. Great Depression. Bernanke, of course, was a

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