Sissel testing slideshare Macro

Arne Jon IsachsenDepartment of EconomicsDecember 2012

Chapter 1: The Science of Macroeconomics

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Macroeconomics

• The study of an economy as a whole.• Focussing on aggregates or averages like:– total output of goods and services (GDP),– the rate of unemployment,– the price level and the rate of inflation, – the (average) interest rate,– the trade balance (exports - imports)

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Why use economic models as analytical tools?

• Economic systems are complex, like living organisms, and cannot be fully understood.

• Sometimes models work, sometimes not• Correlation is not causation. – Simultaneous interrelationships among many variables,

not simple causal links.• Cannot do controlled experiments.• Therefore: theoretical models are essential as maps

in trying to understand what is going on.

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Macroeconomic models as tools to understand the economy

• Simplifying reality, permitting us to think about things that have not been observed.

• Impossible to analyze reality directly without theory and models. Those who try use in fact poor theories without knowing it.

• Taxonomy important for perceptions• Which model is the best one, i.e. the most

relevant one, for the situation at hand?

An economic model - Basic structure

Exogenous variables (given)

The Model (theory or story)

Endogenous variables (to be explained)


Chapter 2: The Data of Macroeconomics

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Gross domestic product (GDP)measures economic activity

• GDP is the market value of all final goods and services produced in an economy during a period of time (year, quarter)

• The value of what is produced (GDP) GDP = total income (wages + profits).

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The composition of GDP

• C = consumption, final expenditure in GDP• Gross investment (I), also final expenditure. Investments contain expenditures on new machines, plants,

buildings, ships, etc., and also increases in inventories.

Two more final components of GDP; government consumption (G) and net exports (NX).

• NX = exports of goods and services – imports • Hence, GDP = C + G + I + NX (Very important)

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Value added: The contribution to GDP of a firm

Total sales+ increased inventories= value of production- intermediate goods bought from others= value addedValue added is usually much smaller than total sales,

but much larger than profits: value added includes wages to employees.

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The GDP deflator (P):A price index of GDP

• P is defined as nominal GDP divided by real GDP.• This means that: P*(Real GDP) = Nominal GDP.• The GDP-deflator measures the price level of the

final goods that GDP consists of.• NB! This is not the same as the consumer price

index (CPI) which only represents private consumption of goods and services.

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Consumer price index (CPI)

• Monthly data, based on surveys• Calculated as a weighted average using value

shares in a base year• Published as the annual rate of growth (last 12

months)• Important for monetary policy (inflation

targeting)• Also important for wage formation

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The government sector

• National economy: Private sector and government sector• Government income = taxes + net capital income• Government spending = transfers to the private sector +

government spending on goods and services (both consumption and investment goods)

Simplification: T = net taxes (taxes - transfers), G = government spending• Government budget surplus = net capital income + (T – G) Government surplus huge right now in Norway. Why?

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GDP and welfare

• More GDP could mean less leisure (trade-off)• Pollution and exhaustible natural resources hard to

account for• Household production, like child care, not included• Concern for income distribution– China and USA have huge challenges here. How come?

• The shadow economy: faster growth than GDP?• Conclusion: GDP is an imperfect welfare indicator.


Chapter 3: National Income: Where It Comes From and Where It Goes

Aggregate production function Y = F(K, L)

• Basic idea: Growth of labor (L) and capital (K) explains growth of aggregate output (real GDP). May also include land as a third factor of production, cf. immigration to the US in the 19th century, and into the 20th.

• The law of diminishing returns:– If L increases (K constant), then MPL (marginal product of

labor) decreases– If K increases (L constant), then MPK (marginal product of

capital) decreases

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Total factor productivity (TFP)• If total production increases more rapidly than the weighted

increase in capital and labor, total factor productivity is improving.

Y = AKL1- , A is called total factor productivity: A = Y/KL1-

• TFP-growth is also called intensive growth, i.e. the resources are employed more efficiently. Which means that one can have economic growth even without an increase in the capital stock or in the work force.

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Growth accounting

• During a 10 year period, the average GDP growth rate per year was 4.5 %, the average capital stock growth rate was 4.5 %, and the average labor input growth rate was 1.5 %.

• The labor income share of GDP is 2/3 = 1 - .

Calculation of average TFP growth per year:GDP growth: 4.5 %- growth contribution of K (1/34.5) -1.5 %- growth contribution of L (2/3 1.5)-1.0 %= TFP growth 2.0 %.

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Applying growth accounting• For a specific time period, collect data for the average growth

rates of Y, K and L.• Compute the average share of labor in GDP: 1- = wL/Y• Use the data to calculate the average rate of growth in gA = gY - gK - (1 - )gL (the annual rate of growth of TFP)

• In most OECD countries, the rate of growth of TFP (gA) has been substantial during the post WWII period.

In Norway: about half the growth rate of Y.

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(1)

(2) What is produced

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Final Demand

At the equilibrium interest rate, the demand for goods and services equals the supply.

Savings = Income that is not consumed

Y – T – C = Private savings T – G = Public savings

Y – C – G = National savings = S

(3) Y – C – G = I

In the closed economy, savings = real investment

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S(r)

I(r)

I and S

r

P&A, no 5, p76


Chapter 4: Money and Inflation

Some observations

Some months in 1923 the monthly rate of inflation exceeded five hundred percent in Germany. What were the consequences?

In macroeconomics we consider money as a STOCK, rendering liquidity services, as money is the accepted means of payments.

Money can also be used as a store of valueMoney is a measuring rod, ie. prices are quoted in monetary terms

Monetary policy is the central bank’s control over the supply of money. Much is happening here these days. QE3 by the Fed, what is that?

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The Demand for Money

The demand for money is derived from the demand for the SERVICES rendered by the STOCK of money.

Portfolio theory to decide on the stock of money you like to have. Depends upon what ALTERNATIVE assets are available.

Money facilitates the exchange of goods and services (as well as of assets). An increase in GDP, and the demand for money, ceteris paribus, also increases.

Money is non-interest bearing financial assets (or low interest rates), i.e. liquid bank deposits mostly.

OPPORTUNITY COST of money is the rate of interest foregone.

An increase in the rate of interest, and the demand for money declines.

Money is demanded in terms of its PURCHASING POWER,i.e. (M/P) is what is demanded

The stock of money in Norway

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The broad monetary aggregate M2 amounted to NOK 1 697 billion at end-September 2011, of which the major part, 91.3 per cent, consisted of bank deposits. Notes and coins only accounted for 2.6 per cent. The rest of the broad monetary aggregate mainly consisted of shares in money market funds and certificates of deposits, which accounted for 5.7 and 0.4 per cent respectively.

Putting it together

Question 10 page 114 P&A no 9 p115

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i = Nominal rate of interest

Fisher effect (p. 97)

Nominal rate of interest = real rate + expected rate of inflation


Chapter 5: The Open Economy

(1) Y = C + I + G + IM(2) Y = C + I + G + NX(3) NX = X – IM NX is Net exports(4) NX = Y – (C + I + G)NX = Output – Domestic spending

From (2)(5) Y – C – G = I + NX(6) Y – C – G = S

• Surplus (deficit) on the trade balance = Net capital outflow (inflow)

• International capital markets, and need not have real investments = domestic savings

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S – I = NX (7)

Ex. • Norway 1980’s: NX < 0 Borrowed in ROW• Norway since early 1990’s: NX > 0

accumulated claims on ROW

Expansionary fiscal policy that reduces savings in a country,may lead to trade deficit, i.e. borrowing abroad.

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P*: Price level abroad P : Price level at home

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e : Nominal exchange rate

ε: Real exchange rate

Define:

Assume P* increases from 100 to 102 P increases from 100 to 106

, and calculate

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The real exchange rate stays put at 8, if the nominal rate goes from 8 to 8.31, as the price level increases by 6% in Norway and by 2% in Euroland.

4% depreciation to stay competitive. What implications for Greece in particular and EMU in general?


Chapter 7: Economic Growth 1


Chapter 8: Economic Growth 2

(1)

(2)

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Growth in output

Contribution of capital

Contribution of labor

Growth in TFP


Chapter 10: Aggregate Demand

Long-run analysis and prices do change to clear markets. Economic growth is a supply side phenomenon. Growth in production factors (capital stock and labor force) and improvedefficiency (TFP-growth) account for economic growth.

Short-run analysis and prices are sticky. Need to apply stabilization policy (fiscal policy and monetary policy) to smooth economic fluctuations.

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• Goods market, to develop IS-curve.• Money market, i.e. demand and supply of the STOCK of

money, to develop LM-curve.

• Equilibrium where the two intersect.

The rate of interest is the crucial variable, connecting the monetary part of the economy (LM-curve) with the real part (IS-curve).

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Multipliers(1)Y = C(Y-T) + I + G

Let(2) C = a + b(Y-T) Y = a + b(Y-T) + I + G

Y – bY = a – bT + I + G

(3)

Let b = 0,6 G has a multiplier of 2.5

Multiplier for T:

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Disposable income

Where b is the marginal propensity to consume

(1) Y = C(Y-T) + G + I I = I(r)(4) I = I(r)

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Supply of loanable funds

Demand for loanable funds

The rate of interest does the job ofequilibrating supply and demandfor goods and services

r

Y

IS-curve

IS-curve

LM-curve

• When r increases, the opportunity cost of holding money increases, and the demand for money declines.

• When GDP increases, more money is demanded to facilitate the exchange of goods and services in the market

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Given stock of money, every piont of the LM-curve is an equilibrium point.

r

Y

LM-curve

The given stock of money is EXACTLY demanded.

IS-curve:

LM-curve:

Two equations that determine two variables, Y and r.

Question 4 page 309P&A no 1 page 309

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r

Y

LM

IS

FINANCIAL CRISIS

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Even while income inequality increased, consumption inequality has not increased commensurately…

What caused the financial crisis?

• Macro conditions: Global imbalances, falling long and short real interest rates, Great Moderation, underestimation of risk, credit expansion (Bean 2010 JEEA)

• Distorted incentives: Extreme leverage levels and risk-taking, lack of due diligence, low lending standards, securitization of mortgages, fraud

• Regulatory and supervisory failures: Underestimation or disregard of the fragility of the financial sector

• Information problems: Complex asset-backed securities, huge hidden balance-sheet liabilities

• Specific circumstances: US housing policy, subprime lending• These causes have little or nothing to do with monetary policy

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90 95 00 05 10

Austria NetherlandsNorway United KingdomUSA GermanySweden

Unemployment, selected countriesPercent of the labour force, seasonally-adjusted data

Sources: Bureau of Labor Statistics and Eurostat

GDP Sweden, Norway, US, and other countries

52Sources: Bureau of Economic Analysis, Eurostat, Federal Statistics Office Germany, OECD, SCB, Statistics Finland, Statistics Netherlands, Statistics Norway, and the Riksbank

More on the Euro Area

• Milder reforms prior to Euro accession• Southern Europe: Insider vs Outsider economies– High unemployment before Euro accession

• After Euro accession – booms– Housing (Spain)– Local government spending (Spain)– Federal government spending (Greece) – Cyclically adjusted government spending rises.

• Unit labor costs rise => competitiveness falls

Unemployment in Periphery

Post Crash Policies• Resolution means altering property rights.• Bank bailouts – could have imposed more costs on

shareholders and bondholders– Dividend restrictions– Capital raising rather than asset shrinkage– Moratorium on bonuses

• Increasing pressure to renegotiate other promises – pensions, social security, healthcare.

• Will property rights be differentially enforced? How will the public see this?

In sum, have the capitalists subverted democracy?

• Democracy created pressure to keep growth going.

• Populist policies produced fast-working but unsustainable solution– Easy credit– Government spending

• Private financiers were neither blameless nor unwilling tools.– Convergence between business

and politics• But to argue that policy was

solely elitist in origin and intent is a misreading of what happened.

Democracy and Capitalism• There is a growing tension between democracy and free

enterprise post-crisis.– When the masses do not see opportunity, they have little

incentive to support property and free enterprise.– When they see selective enforcement of property rights,

property becomes less sacrosanct• As capitalists get delegitimized, an important constraint on

arbitrary government also is weakened.– Russia under Putin

• Democracy suffers.

Restoring opportunity

• Restore opportunity and hope to the middle class.• Policies - pay clear dividends only in the long run.– Education and skills– Innovation

• Need to address distress in short run– How to get the unemployed, especially the young, into

the labor force?– How to retrain those in sunset industries? – How to engage the unemployable?

• How to persuade the working rich to go along?

Restoring faith in property

• What promises will governments keep?– What will be defaulted on?– What will be inflated away?– What will be bailed out?– Who will pay?

• How will decisions be made?• How legitimate will it appear?

Sissel testing slideshare Macro

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