The health of the macroeconomy is gauged by three measures: real GDP growth, the unemployment rate, and the inflation rate.
The long-term growth rate of the U.S. economy is approximately 3 percent a year. But output doesn't increase 3 percent every year. In some years real GDP grows faster; in other years growth is slower. Sometimes total output actually declines.
These short-run variations in GDP growth are the focus of macroeconomics. Macro theory tries to explain the alternating periods of growth and contraction that characterize the business cycle; macro policy attempts to control the cycle.
To understand unemployment, we need to distinguish the labor force from the larger population. Only people who are working (employed) or spend some time looking for a job (unemployed) are participants in the labor force. People who are neither working nor looking for work are outside the labor force.
The most visible loss imposed by unemployment is reduced output of goods and services. Those individuals actually out of work suffer lost income, heightened insecurity, and even reduced longevity.
There are four types of unemployment: seasonal, frictional, structural, and cyclical. Because some seasonal and frictional unemployment is inevitable, and even desirable, full employment is not defined as zero unemployment. These considerations, plus fear of inflation, result in full employment being defined as an unemployment rate of 4–6 percent.
Inflation is an increase in the average price level. Typically it is measured by changes in a price index such as the Consumer Price Index (CPI).
Inflation redistributes income by altering relative prices, incomes, and wealth. Because not all prices rise at the same rate and because not all people buy (and sell) the same goods or hold the same assets, inflation does not affect everyone equally. Some individuals actually gain from inflation, whereas others suffer a drop in real income.
Inflation threatens to reduce total output because it increases uncertainties about the future and thereby inhibits consumption and production decisions. Fear of rising prices can also stimulate spending, forcing the government to take restraining action that threatens full employment.
The U.S. goal of price stability is defined as an inflation rate of less than 3 percent per year. This goal recognizes potential conflicts between zero inflation and full employment, as well as the difficulties of measuring quality improvements and new products.
