What is magic square?

As an economic concept, the magic square is intended to ensure overall economic equilibrium.

It consists of the economic policy objectives:

  • steady and reasonable growth of the economy
  • Stability of the price level
  • high level of employment
  • external balance

In this chapter you will learn what the magic square is and when it plays a role. We will also show you which extensions to the magic square are possible. With the help of the exercises on the magic square, you can test your knowledge in this area and prepare for your next exam.

Why is the magic square important?

With the concept of the magic square and the economic policy goals contained therein, the overall economic equilibrium of an economy is to be preserved. The resulting steadily increasing prosperity in the country is intended to promote social cohesion and thus prevent political and social unrest.

In the course of time, more and more additions to the magic square have developed.

In addition to the four central points, the following points are also often seen today as central elements and economic policy goals:

  • Fair distribution of income.
  • Balanced balances in public budgets.
  • Preservation of the environment.
  • Decent working conditions.
  • Securing and preserving natural resources.

What is the magic square?

According to phonecations, the magic square is supposed to enable the overall economic equilibrium in an economy. As part of the Stability Act, the achievement of macroeconomic equilibrium was defined as one of the national goals of the Federal Republic of Germany in the Basic Law.

As a means of doing this, the magic square also found its way into German legislation. This economic policy goal was set so that the attention of the state, social partners and the central bank is constantly focused on these economic and social areas in order to be able to prevent undesirable developments at an early stage.

magic square

Magic square

The choice of the term “magical” suggests that all goals can only be achieved with difficulty together. In fact, individual goals support each other, ie they are congruent to each other.

For example, steady economic growth often goes hand in hand with a high level of employment. However, within the magic square there are also goals that are not congruent to one another. The stability of the price level, for example, can make it difficult to achieve a high level of employment.

How are the individual indicators measured?

To ensure compliance with the Stability Act to review objectives issued in 1967, requires it to the measurement of different indicators. These are incorporated into the Federal Government’s annual report, which also makes a future-oriented forecast of developments on the basis of the national accounts.

Measurement of economic growth

The designation of steady and reasonable economic growth is understood to mean the growth of general prosperity in the country. This is particularly important for less well -off population groups, as the steady growth is intended to avoid extreme fluctuations in employment.

For this purpose, the development of the price-adjusted gross domestic product is used as an indicator. Although this is characterized by recurring positive and negative fluctuations, an average annual growth of 2.4% was recorded in 1967.

An example that illustrates steady growth despite economic fluctuations is the fact that the amount of goods and services produced in 2000 was 28 times the amount in 1870.

Measurement of the stable price level

The inflation rate is primarily decisive for measuring the price level. This denotes the percentage increase in prices for goods and services in an ideal basket of goods compared to the previous year.

If prices rise, one speaks of inflation. When prices fall, this is known as deflation. The European Central Bank has also set itself the central goal of creating a stable price level. This is at an inflation rate of just under 2%.

In Germany, too, compliance with a stable inflation rate is being promoted as a means of achieving the goal of a stable price level. This is achieved on average, although there have been some strong fluctuations in the past decades.

Maintaining price stability is therefore important so that money retains its function as a medium of exchange for goods and services and thus the economy can continue to grow through consumption.

Measurement of the employment level

To assess the level of employment, the unemployment rate on the one hand, but also the number of people in employment in the country on the other. Both parameters are affected by economic fluctuations.

The unemployment rate is calculated as follows:

If the unemployment rate is below 3%, it is referred to as full employment. The proportion of unemployed below 3% is referred to as “voluntary unemployment”, “ seasonal unemployment ” or “ frictional unemployment ”. At the end of 2019, the unemployment rate in the Federal Republic of Germany was 4.8%.

Measurement of the external balance

In order to be able to assess compliance with the external balance, the external contribution of an economy is used. It indicates the difference between imported and exported goods. As the “world export champion”, the export contribution of the Federal Republic of Germany has always been in a clearly positive range in recent years.

The external trade ratio, which relates external trade to nominal gross domestic product, is also viewed as an indicator of external balance.

The external contribution ratio is calculated as follows:

Advantages and disadvantages of the magic square

Advantages:

The achievement of all goals of the magic square is the basis for the overall economic equilibrium of an economy.

Disadvantages:

Some of the goals formulated in the magic square can compete with each other, which is why it is almost impossible to achieve all goals at the same time.

 

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