Macroeconomics Policies

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Transcript of Macroeconomics Policies

  • 1. Basics of Macroeconomic Policies Sy Sarkarat, Ph. D. United States Fulbright Scholar for Azerbaijan State Economics University , Baku, Azerbaijan. Fall 2008 Copy Rights: This lecture was prepared to CRRC and it is designed for educational purpose not for profit.
  • 2. Warming up
    • Q:Why did God create economists ?
    • A:In order to make weather forecasters look good.
    • Q. What does an economist do?
    • A. A lot in the short run, which amounts to nothing in the long run.
  • 3. The Business Cycle Trough Peak Peak Peak Trough REAL GDP (units per time period) TIME Growth trend
  • 4. Macro Equilibrium PRICE LEVEL (average price) REAL OUTPUT (quantity per year) D 1 S 1 Q E P E Aggregate demand Aggregate supply P 1 E
  • 5. Macro Failures
    • There are two potential problems with macro equilibrium:
      • Undesirability - the price-output relationship at equilibrium may not satisfy our macroeconomic goals.
      • Instability even if the designated macro equilibrium is optimal, it may be displaced by macro disturbances.
  • 6. An Undesired Equilibrium PRICE LEVEL (average price) Q E P E Aggregate demand Aggregate supply E Equilibrium output Full-employment output Q F P* F
  • 7. Stable or Unstable?
    • Prior to 1930s, macroeconomists thought there could never be a Great Depression
    • They believed that a market-driven economy was inherently stable and that government intervention was unnecessary.
    Adam Smith 17231790
  • 8. The Business Cycle in U.S. History Korean War World War II Vietnam War Great Depression Source: U.S. Bureau of the census, The Statistics of the U.S.A. Growth recession Long-term average growth (3%) Recession
  • 9. Inflation and Unemployment: 1900-1940 Source: U.S. Bureau of the Census. 24 20 16 12 8 4 0 4 8 1900 1910 1920 1930 1940 Inflation Unemployment
  • 10. Macro Disturbances AS 0 PRICE LEVEL (average price) REAL OUTPUT (quantity per year) ( b ) Demand shifts AD 0 AD 0 AS 0 PRICE LEVEL (average price) REAL OUTPUT (quantity per year) ( a ) Supply shifts F P* Q F AD 1 F P* Q F AS 1 G P 1 Q 1 P 2 Q 2 H
  • 11. The Keynesian Revolution
    • British economist, John Maynard Keynes developed an alternate view of the macro economy.
    • Keynes asserted that a market-driven economy is inherently unstable.
    1885 -1942
  • 12. Government Intervention
    • In Keynes view, the inherent instability of the marketplace required government intervention.
  • 13. Fiscal Stimulus Package
    • 1960s, a tax cut in 1964 to stimulate economic growth and reduce unemployment
    • $168 billion fiscal stimulus package - the largest legislative initiative ever designed to ease an economic slowdown.
    • According to the Congressional Budget Office (CBO), the goal of a fiscal stimulus is to boost economic activity by increasing short-term aggregate demand.
  • 14. The Multiplier
    • The cumulative decease in total spending is equal to the gap multiplied by the multiplier.
    • A recessionary gap of $100 billion per year would decrease total spending by $400 billion per year (If MPC = 0.75) .
  • 15. The Multiplier Process 1. $100 billion in unsold goods appear 3. Income reduced by $100 billion 4. Consumption reduced by $75 billion 5. Sales fall $75 billion 6. Further cutbacks in employment or wages 7. Income reduced by $75 billion more 8. Consumption reduced by $56.25 billion more Factor markets Product markets Business firms Households 9. And so on 2. Cutbacks in employment or wages
  • 16. Fiscal Policy
    • Fiscal policy is an integral part of modern economic policy.
    • Fiscal policy is the use of government taxes and spending to alter macroeconomic outcomes.
  • 17. The Multiplier Cycles
  • 18. The Multiplier
  • 19. Monetary Theories
    • Money and credit affect the ability and willingness of people to buy goods and services.
    • If credit isnt available or is too expensive, consumers curtail the credit purchases and businesses might curtail investment.
    Milton Friedman 19122006)
  • 20. Monetary Stimulus
    • The goal of monetary stimulus is to increase aggregate demand.
      • Aggregate Demand The total quantity of output demanded at alternative price levels in a given time period, ceteris paribus.
  • 21. Investment
    • Lowering interest rates lowers the cost of borrowing which encourages investment.
    • Increased investment injects new spending into the circular flow.
    • The multiplier effect result in an even larger increase in aggregate demand.
  • 22. Monetary Tools
    • The Federal Reserve controls the money supply using the following three policy instruments:
      • Reserve requirements
      • Discount rates
      • Open-market operations
  • 23. Monetary Policy - Last Two Recessions
    • 1991 and 2001, the Fed lowered rates, and the impact was evident about nine months after the rate cuts started.
    • In 1990, the Fed started cutting rates on July 13. The rate cuts were slow and small, but ten months later real GDP rose at a 2.6% annual rate starting in the second quarter of 1991.
    • In 2001, the Fed started cutting rates Jan. 3. Nine months later, real GDP rose at a 1.6% annual rate in the fourth quarter, and was followed by a 2.7% growth rate in the first quarter of 2002.
  • 24. List of the rate cuts and a rebound in GDP growth: from the start of the rate cut cycle to a rebound
    • 1991: Six rate cuts totaling 200 basis points - to 6.0% in GDP in nine months
    • 2001: Eight rate cuts totaling 350 basis points -to 3.0% in GDP in nine months
    • 2007-08: Five rate cuts totaling 225 basis points - to 3.0% in GDP in five months
  • 25. Limits on Monetary Restraint
    • Two factors make it harder for the Fed to restrain aggregate demand:
      • Expectations.
      • Global money.
  • 26. Constraints on Monetary Stimulus Inelastic demand Investment demand Rate Of Investment 7 6 0 Interest Rate Inelastic investment demand can also impede monetary policy A liquidity trap can stop interest rates from falling The liquidity trap Interest Rate E 1 E 2 g 1 g 2 Quantity Of Money Demand for money
  • 27. Shifts of Aggregate Supply AS 2 E 2 Rightward AS shifts reduce unemployment and inflation AS 1 E 1 Output (real GDP per period) 0 Price Level (average price per unit of output) AD
  • 28. Instability
    • The aggregate supply curve shifts to the left when there is an increase in production costs.
    • The aggregate demand curve shifts when volatility in currencies cause significant changes in import and export prices.
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  • 32. Aggregate Supply
    • The macro economy experienced stagflation in the 1970s.
    • Stagflation is the simultaneous occurrence of substantial unemployment and inflation.
  • 33. Supply-Side Theories
    • Decreases in aggregate supply cause inflation and higher unemployment.
    • Increases