Macroeconomics (Centre College ECO 210)

8/14/2019 Macroeconomics (Centre College ECO 210)

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Macroeconomics

8-29-07

Monetary Policy -The graphs of prime, discount, and FFR are highly correlatedThe federal funds rate is the most important of the three ratesThe Fed sets a target for the FFR the rate moves all day longThe rate is based the amount of excess reserves in the system

Legal reserves cash, reserves at the Federal ReserveGovernment Security T bill, T note, T bond

FDIC Federal deposit insurance corporation

Required reserves are a percentage of demand, savings, and time depositsLegal reserves required reserves = excess reservesExcess reserves influence the Federal Funds Rate

What does the Fed do to make us stay close to the FFR target?Buy and sell government securities to manipulate the amount of excess reserves andthus the Federal Funds Rate

Manipulation of the money supply

Open Market Operations the buying and selling of government securities

Changing the Discount Rate Change the reserve requirement

Open Market Operations fine tune the money supplyMoral suasion Fed persuading the banks to borrowA half a percent change in the Discount Rate is a big drop for the FedFiscal Policy The use of government spending and taxation to manipulate the economy

Prime Rate changes when the discount rate changes

National debt takes money away from the investment sector therefore raising interest

rates

Currently there is a high demand for government securities

Poor countries


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Enclave developed countries go into undeveloped countries and target only thepart of the undeveloped country that has a resource valuable to the developedcountry

Capital human and otherwise

GDP Gross domestic product The value of all final goods and services in a country.GNP Gross national product The total value of all final goods and services producedby a country

First oil price shock was in 1973Second oil price shock 1979Recession in 1981-2

Ways to measure inflation

CPI consumer price index

Producer Price index

GDP deflator

Paul Volcker chairman of the fed between 1979-1988

Homework look up the national debt; read first ten pages in Ch. 2

8-31-07The Dow Jones Industrial Average a composite of 30 blue chip companies thatsymbolize the NYSE as a whole

S&P 500 - market of 500 highly competitive large companies Standard and Poors

NASDAQ a market of smaller technological companies

Fed rate cut FFR

Macroeconomy affects politics

Unemployment and Inflation in election years; added together is the misery index(1980) Carter vs. Reagan

Economic Models

irrelevant details are stripped away

Supply and Demand

shows how various events affect price and quantity of cars


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assumes the market is competitive; each buyer and seller is too small to affect themarket price

Variables

Qd quantity of cars that buyers demand

Qs quantity that producers supply P price of new cars

Y aggregate income

Ps price of steel (input)

Demand equation Qd = D(P,Y)Quantity demanded is a function of price and income

D(P,Y) = 60 10p + 2YDemand curve because of the negative Y inverse relationship

Change in Qd change is only effected by change in priceChange in Demand shift of demand curve

Import tariff on Toyotas leftward shift on the supply curve

Endogenous variable output of the modelExogenous given input for the model

Endogenous variables for supply and demand Quantity and Price

For each new model we need to keep track of

Its assumptions Which are exogenous and endogenous

The questions it can answer and those it cant

Classical Adam Smith laissez faireKeynesian 30s The General Theory In the long run were all dead. short runperson prices are sticky and the economy doesnt quickly adjust

Sticky reasons

Most labor contracts set wages for three years

Magazines tend to change their prices every 3-4 years

Supply and demand in the labor market Surplus of products from the setting of a price floor

Keynesian lay people off and we may enter into a recession

Classical do nothing

Consumer confidence last month dropped


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EXAM Why are banks not borrowing from the discount window right now?Markets are calmed

Investment Spending (17%)

business fixed investment (spending on plant and equipment)

Residential fixed investment housing

Inventory investment

Planned inventory is 10 milEnding inventory of 12 MillionUnplanned of 2 million

Classical lower the price and sell the chairs

Keynesian people get laid off until inventory corrects itself

Investment spending is the most volatile type of spending

Stock is measured at a point in time Capital stock

Flow measures something over a period of time

Investment

Wealth = assets liabilities

Government Spending

Payment made by the government to consumers for which consumers do nothingat that time.

FICA 6.2% goes to Social SecurityWe are currently taking more money in than we are taking outIn about 2012 we will start taking out more than we put inIn about 2040 SSI will be bankruptThe SSI trust fund is all government securities

Fixing SSI

Increase the taxes

Delay collection age

Lower the benefits COLA (cost of living adjustment)

If we lower the COLA by 1% that would make everything by several decadesWhen it began the SSI tax was .5% up to $2000There is a limit on SSI tax $93,000

Bonds

Corporate


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Municipal Bonds (tax exempt)

Treasury Bill, notes, bond

How do you make money off of stocks?Increase in value of stock capital gains

Dividends

Homework check the FFR against the Discount rate; lookup for 2006 our trade deficit;finish chapter 2

Deficit - $565 BrillionFFR 4.9%; Discount 5.75%

9-5-07

12% of subprimes are defaultingThe other group that invested in housing to flip it is defaulting

Excess inventory unplanned inventoryUnplanned inventory is a form of investment

Nominal Verses RealNominal the face value of somethingReal adjusted for inflation

Nominal GDP can change due to:

Changes in prices

Changes in quantity produced

The GDP went down in the 1930s during the Great Depression because there were fewergoods produced and then sold at lower prices.

The Great Depression was our last period of substantial deflation.Changes in real GDP can only be changes by changes in quantities

GDP Deflator = 100 x Nominal DGP/Real GDP

CPI consumer price indexCPI measures a certain basket of goods while the GDP measures the inflation of all goodsAdjusts for COLAs

Government likes to use is the GDP deflator

CPI

Survey consumers on the typical basket of consumer goods


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Every month collect data on the prices of all items in the basket

CPI in any month equals 100 x Cost of basket in that month/Cost of basket in basemonth

Substitution bias CPI overstates inflation because it does not account for substitution

Introduction of new goods the CPI does not take into account the affect of new goodsimpact on the quality of lifeUnmeasured changes in quality better products for same price are not taking intoaccount

Generally speaking, most economists say that the CPI is about 1% too high

Prices of Capital Goods

Included in GDP deflator

Excluded from CPI

Price of imported consumer goods Included in CPI

Excluded from GDP deflator

Basket of goods

CPI fixed

GDP deflator changes every year

Homework pp. 40 questions 5 and question 6; read chapter 3

Laspeyres fixed basket

Paasche changing basket

5.) See Excel for Numbers; Yes, Personal Consumption is the highest component ofGDP in all three years, GPDI staid relatively equivalent in all three years, Governmentpurchases rose only slightly, and National Defense purchases staid almost equal.However, state and local purchases increased from 1950 as well as imports. Also, netexports when further and further negative as time progressed with the exception of 1950.

6.) a) See Excel for numbers.b) They have increased by $10,000 for cars and $10 for bread. With a Laspeyres

measurement prices have gone up 20% and with a Paasche measurement they have gone

up 52%. The difference is that with the CPI (Laspeyres) we use a fixed basket of goodsthat take into account a fairly even distribution of price change. However the GDPdeflator allows the basket to change and include all goods thereby reflecting the changedifferently.

c) CPI, because it is more likely to reflect the actual change in COLA than the GDPdeflator.


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9-7-07Libor Londons FFRCategories of the Population

Employed

Unemployed

o Must be capable of work

o Must be willing to work

o Must be looking for work

o Must be without work

Labor Force

Not in the Labor Force

Discouraged workers

Unemployment Rate percentage of the labor force that is unemployedLabor force participation rate the fraction of the adult population that participates in the

labor force (below 16 is not a part of the labor force)

U.S. adult population by group, June 2006Employed 144.4 MillionUnemployed 7 MillionTotal Adult 228.8MillionTotal population 300Million

Labor Force 151.4

Not in the labor force 77.4Labor force participationrate 66%Unemployment rate 4.6%

Full Employment 4%

Will always have frictional unemployment when you are unable to synchronize jobendings and job beginnings

Structural unemployment unemployment due to mismatching of jobs available andworkers skills

Work leisure trade off

K = capital (plant and equipment)L = Labor (the physical and mental efforts of workers; human capital)


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Production Function Y = F(K,L)o Shows how much output an economy with K units of capital and L units of labor

o Reflects the economys level of technology

o Exhibits constant returns to scale if both inputs go up by the same factor the

output goes up by the same factor

Law of diminishing returns for every input eventually your output levels offDecreasing returns to scale if you increase both inputs by the same percentage theoutput changes by a lesser percentageDiseconomies of scale related to size and output

Marginal additional, change, delta, slope, 1st derivative

EXAM:Returns to scale - Y1 = F(K1, L1)If both inputs increase by z

If constant Y2 = zY1If increasing Y2 > zY1If decreasing Y2 < zY1

Example:F(K,L) = square root of KLF(zK, zL) = Square root of (zK, zL)

Numbers are K = 10 and L = 20Homework F(K,L) = K2 + L2, Square root K + square root L

1.) 500 2000 (Increasing returns to scale)2.) 7.6 10.8 (Decreasing returns to scale)

9-10-07Constant returns to scale

Technology is fixed

Economys supply of capital and labor are fixed

Output is determined by the fixed factor supplies and the fixed state of technology:

Y=F(K,L) (with lines over everything but F)

Factor prices what you pay for factors of production

Wage price of L

Rental Rate price of K

W = nominal wageR = nominal rental rate


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P = price of outputW/P = real wageR/P = real rental rate

Factor prices are determined by supply and demand

Demand for Labor

Assume markets are competitive

A firm hires each unit of labor if the cost does not exceed the benefitCost = real wageBenefit = marginal product of labor

Produce where MC = MR

MPL marginal product of labor = the extra output the firm can produce using an

additional unit of labor (holding other inputs fixed)

MPL = F(K,L+1) F(K,L)

A firm hires labor until MPL = W/P

Classical very supply side work on Investment, cut taxes to investors (trickle down)

John-Baptist Say classical economist supply creates its own demandNeoclassical 1870s with marginalists supply and demandDemand side economics Keynesian says to concentrate on Consumer, increase publicspending

Wages are set by addition to outputTrophy wage a super-high wage for performance incentive

Law of diminishing marginal utility each additional unit of a good gives you lesspleasure

Homework redo to percentage with 2000 basket; read 4 pages; write about theSubprime mortgage industry, regular mortgages, what effect has it had on stocks, bonds,internationally (four sources, source at end of the paper) due Monday

9-12-07Paper Volatility, credit crunch, foreign markets

REIT sector packaged debt in real estate


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Hedge funds historically not been used for common investors; historically a type ofinsurance; today hedge funds deal in the futures markets (currencies, interest rates)Institutions large investors (Pension funds, insurance groups); they buy blocs of stock

Labors input in the GDP had been constant over time

Alpha = capitals total share of total incomeCapital income = alpha YLabor Income = (1 alpha)YY = AKalphaL (1-alpha) cobb-douglas function Production possibilitiesConsumption is a function of disposable incomeC = C(Y T)

The slope of the consumption function is the marginal propensity to consume

We want to find when the economy is in equilibrium

Investment function is I = I(r)r = real interest ratei = nominal interest rateThe real interest rate is the cost of borrowing as well as the opportunity cost of usingones own funds to finance investment spending.

Retained earnings = after tax income dividends

Government Spending government spending on goods and servicesG excludes transfer paymentsAssume T and G are both exogenous

Aggregate Demand = C(Y-T) + I(r) + GAggregate Supply Y = F(K,L)Equilibrium Y = C(Y-T) + I(r) + G

Loanable funds market supply and demand model for our financial systemOne assets

Demand for funds investment

Supply of funds savings

Commercial banks financial intermediary that brings these two groups togetherPrice of funds is the real interest rate

Investment function is also the demand curve for loanable funds

Supply of loanable funds comes from the savings of

When were hula hoops in use 1958


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Homework Send notes to Tyler Current; assume that the number is still too low,increases G to 20; pp. 73-4 3-1, 3-7; read chapter 4

9-17-09Functions of money

Medium of exchange

Store of value

Unit of account

C CC M C

M C M` (Karl Marx) Money to commodity to more money middle C is laborpower

C = CommodityM = Money

Monetary policy the use of Federal Reserve tools to manipulate the economy

Money supply is the quantity of money in the economyM1 the most liquid form of money

Currency

Depositable Accounts Travelers checks

M2 second most liquid

M1

small time deposits

savings deposits

money market mutual funds (short term investments like t-bills)

money market deposit accounts

Classical theoryConcept of velocity the turnover of money during a given year

The equation of exchangeMV = PYIts an identity

Money x Velocity = Price Level x Transactions (goods and services)


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M/P = real money balances (the purchasing power of money)Money supply divided by prices

(M/P)d = kYK = how much money people wish to hold for each dollar of income (exogenous)

K = 1/V

Quantity Theory of MoneyStart with the equation of exchangeAssumes V is constant and exogenous

Inflation = change in M over M minus the change in Y over Y

Hence, the Quantity Theory predicts a one-for-one relation between changes in themoney growth rate and changes in the inflation rate.

Milton Friedman Inflation is always and everywhere a monetary phenomenon.Chicago School of Economics, very conservative, classical

Empirical Research number research to prove a theory

Seigniorage when you spend money without raising taxes or issuing bond

Inflation Tax printing money to raise revenue, inflation is like a tax on people who holdmoney

Real interest rate adjusted for inflationsr = i piThe Fisher effect i = r + pi

Homework finish correct terms on reserve in notebook; look at footnotes in the bookand put down three papers that you would be interested in doing (author, title of thearticle, and where it is in the book); finish chapter 4

9-19-07Lowering of the rate is being called a moral hazard encouraging risky behavior byremoving the consequences from a bad choice

Could the real interest rate be negative yes

The quantity theory of money depends only on real incomeThe reasons we have money is transaction purposes


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Another determinant in money demand is the nominal interest rate

Transaction demand for money classicalPrecautionary demand for money Keynesian

Speculative demand for money KeynesianPeople use money to invest and attempt to earn a return on their money

You either hold money or bonds:If the interest rate is very high the demand for money is extremely low because you couldmake so much by investing it

When the rate is high you hold on to bonds because their value will go upYou dont want to hold bonds at a low rate because the rate will go up and its value willgo down

Homework - pp. 73 3-1, 3-7; read 10 pages into ch. 5

9-21-07

Options backdating - changing the date on an option so that the books look different

Gold soars on inflation fears - gold is a store of value that will not fluctuate withinflation

Hyperinflation more than 50% inflation a monthMoney ceases to function as a store of valueInflation is always and everywhere a monetary phenomenon.Classical dichotomy nominal variables dont affect realNeutrality of money changes in the money supply do not affect real variables

C = C(Y-T)Y = C(T-T) + I + GPrivate Savings = (Y-T) - CPublic Savings = T G

In an open economy

spending does not need to equal output

saving need not equal investment

NX = EX IM = Y (C + I + G)


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Twin deficits government deficit and trade deficit

Net capital outflow = S IIf S>I a country is a net lender

The exogenous world interest rate determines investment

Three experiments on the exam

fiscal policy at home

fiscal policy abroad

an increases in investment demand

Homework look up the inflation level in early Germany, Hungary, Yugoslavia; finishchapter 5

Germany July 1922 = 1January 1924 (18 months later) = 750,000,000,000

Yugoslavia

January 1993 = 1

January 1994 = 600,000,000,000,000

Hungary June 1945 = 1June 1946 = 828,000,000,000,000,000,000,000,000

Macroeconomics (Centre College ECO 210)

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