Economics 122aYale University

Fall 2012

William Nordhaus

Today’s plan1. Describe the course2. Introduction and major questions of macro

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Course SyllabusDESCRIPTION AND PREREQUISITES

• The course covers business cycles, economic growth, major macro topics, and their application to fiscal and monetary policy and history.

• This course is to be taken after completing both terms of Introductory Economics. Exceptions will be rare. Calculus will be used.

• Course web page is

http://www.econ.yale.edu/~nordhaus/homepage/Econ122_2012.htm

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 Readings TEXTBOOK.

Charles Jones, Macroeconomics, second edition, Norton, 2011.

For textbook options, see web page.

There are many supplemental readings, available online or on the course web site.

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 Schedule

We will generally meet M W 11:35-12:50We will occasionally meet on Friday for optional special

sessions.Lectures will be posted after the class.

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Tests  and Grading

There will be one mid-term examination, which will take place in class on Wednesday, October 14. The final examination will be three hours and is Dec 14.

There will be four graded problem sets, four ungraded but required problem sets, and a short paper due at the end of the semester.

The grade is based 45 percent on the final exam, 25 percent on the hour tests, and 30 percent on the problems and paper.

Grade distribution (verbal description in class).

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Sections There will be sections led by teaching fellows from

Department of Economics. Each student will be assigned to a section.

Sections will go over the analytical material from the course, cover questions raised by students, and review problems and exams.

Tentative section times are:Wednesday 7:00-7:50 and 8:00-8:50 pmThursday 4:00-4:50 and 5:00-5:50 pm

Thurs 7:00-7:50 and 8:00-8:50 pm

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Limited enrollment

Limit to 120 + ε students. The following is the priority list: All those who got bumped last year; all seniors

and juniors economics majors; other seniors and juniors; sophomores who are declared economic majors.

The balance of shoppers will be selected by lottery. Freshmen are not eligible.

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 Alternative macroeconomics courses:

Econ 122b (?). Roughly the same with emphasis on labor economics.

Econ 126b (Moscarini). Intensive version. More analytical and mathematical.

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What is macroeconomics?• Macroeconomics is the study of the overall

behavior of economies (output, inflation, unemployment, trade balance, financial markets, …)

• The interesting point is that the total behaves differently from simple adding up of the parts– think of parties or bank runs

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Major themes

There are two major recurrent themes running through macro:

i) Business cyclesii) Economic growth

Virtually every macroeconomic issue revolves around these issues, or a confusion concerning them.

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The muddle of macroeconomics

“The resources of nature and man’s devices are just as fertile and productive as they were. The rate of our progress towards solving the material problems of life is not less rapid. We are as capable as before of affording for everyone a high standard of life and will soon learn to afford a standard higher still.But today we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand.”

[ J.M. Keynes, The Great Slump of 1930 ]

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Business cyclesOne major set of issues involves the business cycle.

These are the short-run changes in output, employment, and inflation.

Important business cycle questions:

1.What caused the global financial crisis of 2008? Why did it lead to the Great Recession that is still going on?

2.Why has unemployment rises so sharply and remained so high?

3.Do government deficits increase or decrease growth?

4.How should we balance the needs of recovery today and versus reducing government debt in the future?

5.How does the Fed affect output and inflation? 12

Origins of the Great Recession (2007 - ???)• Housing prices peaked in mid 2006 and have fallen

about 40 percent.• In 2007, investors suddenly discovered that subprime

mortgages were much riskier than had been supposed. • This led to financial problems, especially for highly

leveraged financial intermediaries (banks, hedge funds, etc.).

• Risk premiums increased, credit was tightened, and there was a financial panic in the fall of 2008. This led to bank runs and multiple bankruptcies or near-ones in 2008.

• The Fed responded forcefully. The Congress passed a bailout bill in 2008 and a major “stimulus package.”

• The federal deficit and debt shot up with recession and stimulus.

• But the economy is stuck at high unemployment and relative stagnation. The end is not in sight….

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Real GDP over the cycle

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12,000

12,500

13,000

13,500

14,000

14,500

15,000

2004 2005 2006 2007 2008 2009 2010 2011 2012

Real GDP (Actual)Real Potential GDP

Rea

l GD

P (b

illion

s of

200

5 $)

Large GDP “gap”

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-500

0

500

1,000

1,500

2,000

2,500

2004 2005 2006 2007 2008 2009 2010 2011 2012

Losses per household by quarter in current recession

Total = $27,000 through June 2012.

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Unemployment rate over the cycle: 1960 - 2011

Shaded areas are NBER recessions.

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4

5

6

7

8

9

10

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1960 1970 1980 1990 2000 2010

The exploding government debt

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Today’s macro dilemma

• Monetary policy has “run out of bullets” and cannot by itself restore full employment.

• This leaves fiscal policy (tax cuts and expenditure increases).

• But fiscal expansion will increase the large and growing government debt; and faces strong opposition from conservatives and deficit hawks.

How should we balance the needs of recovery today and versus reducing government debt in the future?

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Economic growth

Economic growth concerns the trend in output over the long run.

Important growth questions:

6. Why is average American 10x richer than Americans 100 years ago?

7. How will the growing government debt affect growth over the medium term?

In macroeconomics, we use the neoclassical growth model to understand economic growth.

Asia’s economic renaissance

20Source: McKinsey (but not to be taken as good data).

Per capita output 3 big regions

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400

4,000

40,000

1980 1985 1990 1995 2000 2005 2010

Per capita output (2005 US$)

United States China

Sub-Saharan Africa

Per capita growth trends in 3 big regions

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International macro

In a world of rapid globalization, international macro becomes increasingly important.

Role of exchange rates, international trade, currencies.

The biggest issues today are:

8. What are “global imbalances?” Why does the US have such a huge current trade deficit while China has such a large surplus? How will these resolve? 9. What is the reason for the Euro crisis? Will the Eurozone fall apart, or evolve closer to a standard fiscal union? Is disaster waiting around the corner?

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