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Introduction to Macroeconomics
Transcript of Introduction to Macroeconomics
National Account and Circular Flow
Growth and Potential Growth
Employment and Unemployment
Money and monetary policy
The Open Economy
The object of study is the entire economy
It (aims to) explain the economic changes that affect households, firms and markets simultaneously
It helps understanding the world
It helps understanding how the world affects our dayly life
It helps understanding our policymakers
Explain the economic changes that affect people
Help in shaping the way toward stable growth avoiding fluctuations and inequalities
Sir. John Maynard Keynes
The birth of Macroeconomics
the Human Factor?
Why is average income high in some countries and low in others?
Why do prices rise rapidly in some time periods while they are more stable in others?
Why do production and employment expand in some years and contract in others?
In order to understand whether an economy is doing well or poorly we must be able to count its present and future capacity of producing goods and services
We need figures and models
Gross Domestic Product
Probably the most relevant argument of all macroeconomic discipline
Growth = well being
Why are there rich and poor countries?
How can a country's economy grow?
What is the difference between short and long run?
Very hot topic, especially in these days
Why are we concerned with unemployment?
What are the causes of unemployment?
How can it be reduced?
The rise of the general level of prices in an economy over a period of time
Why should we worry?
What is the magnitude of this phenomenon?
How does it work?
Who’s in charge of controlling inflation? How?
the financial system
What is money? Why do we use money?
Who creates money?
What is the monetary policy?
How does it work?
This is not about what you can do for your country, but about what your country can do for (the economy and therefore for ) you
The most capable policy instrument
Short vs Long run policies
Does it work?
Why should we worry in these days?
We live in a globalised word
and economy is the lead of globalisation
Balance of payments
Today's hot topic in
Is it possible to prevent crisis?
Is it possible to forsee crisis?
What are the possible cures?
The present economic situation
GDP - Definition
GROSS DOMESTIC PRODUCT
the market value of all
final goods and services
produced in a given period of time
within a country
we compare apples and oranges
just by considering their market prices
GDP aims at being comprehensive so it accounts for all items produced and sold in markets
nevertheless there are some limitations (see later)
It includes only the values of final goods!
since intermediate products value is included in the prices of the final product
don't forget that almos 80% of our economy is made up by intangible products (services) such as transportation, retail, telecomunication or heath provision
GDP refers to given period of times, years or quarters
production that took place within national boundaries (regadless of the nationality of the producer)
The circular flow
if the flow is measured
at the Firms = GDP
at the Market for Goods and services = Aggregate Demand
at the Households = Income
GDP=Aggregate Demand = National Income
Aggregate Demand Y
Y = C + I + G + X - M
National Income = C + S + T -Tr
I = S + ( T - G -Tr ) + ( M - X )
Nominal vs Real GDP
Nominal GDP =
items produced * prices (every year)
Real GDP =
items produced * prices (reference year)
Copyright © 2004 South-Western
GDP - Shortcomings
1 - Accounting
Estimations, prices, new products, ...
2 - Scope
It does not take into account non-market production
3 - Sustainability
It's the measure of the income, but it does not take into consideration the capital
"Too much and too long, we seem to have surrendered community excellence and community values in the mere accumulation of material things. Our gross national product ... if we should judge America by that - counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for those who break them. It counts the destruction of our redwoods and the loss of our natural wonder in chaotic sprawl. It counts napalm and the cost of a nuclear warhead, and armored cars for police who fight riots in our streets. It counts Whitman's rifle and Speck's knife, and the television programs which glorify violence in order to sell toys to our children.
"Yet the gross national product does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages; the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage; neither our wisdom nor our learning; neither our compassion nor our devotion to our country; it measures everything, in short, except that which makes life worthwhile. And it tells us everything about America except why we are proud that we are Americans."
how was it produced?
how was it producedconsumed?
how was it paid?
Today's world - population
Income and Life expectancy 200y of history
All the rules and techniques implemented in order to produce a STATISTICAL PICTURE of the economy
Who grew faster?
Who experimented the highest inflation?
Where is external trade more relevant?
The consecuences for human welfare in [economic growth] are simply staggering: once one starts to think about them, it is hard to think about anything else"
Growth and potential growth
Spanish GDP 1850 - 2003
1995 constant pesetas
growth is not constant over time
PATTERNS appear over long periods (e.g. 1850-1935; 1960-1990)
there are FLUCTUATIONS around the pattern during these periods
these patterns correspond to the POTENTIAL GROWTH of the economy
they change slowly over LONG periods of time
their level is influenced by the potentiality of the economy (to produce goods and services)
potential growth is therefore the growth experimented over the LONG TERM
FLUCTUATIONS around the potential growth are called BUSINESS CYCLES
fluctuations are irregular and unpredictable
normally all macro quantities fluctuate together
business cycles are therefore the growth experimented over the SHORT TERM
Spanish GDP growth rate
annual 1970-2011 (quarterly data)
The LONG RUN
What are the determinant of potential (long run) growth?
Factors affecting productivity
the quantity of goods and services that a worker can produce for each hour of work
What can we do to foster potential growth?
SAVINGS & INVESTMENTS
also called Long Term policies
The SHORT RUN
What are the determinant of BUSINESS CYCLES?
Difficult to identify factors producing fluctuations in the short run
They occur mainly because of lack of synchronicity between demand and supply
Consumption, savings, investments and production do not adjust to each others simultaneously
The economy is hardly in equilibrium over a stable path
Growth leads to more growth – Decreases lead to more decreases
What can BE DONE to foster stabilise growth?
also called Short Term policies
Potential growth inflation and unemployment
When the economy grows faster than its potential growth it heats = inflation
When the economy grows slower than its potential growth rate there is abundance of productive factos = unemployment
Some words about the present situation
Spain, September 2010
unemployed is a person not currently working and currently looking for a job
Unemployment rate =
To the society
not produced GDP
lower levels of consumption
loss of social development
loss of social cohesion
To the person
not perceived salary
lost opportunity for personal development
loss of social relations
Reasons behind Unemployment
it's all about salaries:
in A salaries are at market prices (S) and supply of labour = demand of labour => no unemployment
if for any reasons salaries are above market prices supply of labour > demand of labour => unemployment
Why should salaries be above their market clearing level?
minimum wages, unions
theory of efficiency wages: higher salaries correspond to
lower levels of turnover
higher workers' efforts
higher workers quality
According to this vision, during the Great Depression salaries were cut in order to face unemployment. Wages cuts leaded toward lower consumptions levels and therefore toward less production and increase in unemployment
it's all about the aggregate demand:
the problem is a lack of demand
policies increasing the aggregate demand need to be implementes
Different kinds of Unemployment
the economy is always changing
people change job, city, sector, consumption habits
no policy actions
non accelerating inflation rate of unemployment
POTENTIAL GROWTH = > NAIRU
also called structural unemployment
long term (supply) policies
keynesian unemployment, depending on the business cycles
short term (demand) policies
A raise in the level of prices
A raise in the general level of prices of goods and services in an economy over a period of time reflecting an erosion in the purchasing power of money
The speed at which this raise takes place
How do we measure it?
CPI Consumer Price Index
1 - a sample of goods and services purchased by final consumers is chosen and weighted (the Basket)
Spanish basket composition 2007-2010
2 - prices for each good and services are computed
3 -the whole basket cost is calculated for a base year (and the value of 100 is given to that reference year)
4- the relation between the cost of the basket in each year and the cost of it in the reference year represent the rate of inflation
Other indexes are used in order to measure the price level evolution
PPI Producer Price Indexes
Why do we fear inflation?
0 - 2 %. Not a big deal
a mechanism that can turn moderate inflation into
monthly rate > 50% (12.900 % annual rate)
an economic tragedy
no one wants money
(market) economy PARALISIS
the cost of reducing (hiper)inflation is very high
Economy cools down
Possible recessions here!
activity rate =
tot. population 16 or older
employemnt rate =
n. of employed
unemployement rate =
n. of unemployed
The meaning of money
By CONVENTION, as social costume, we decided to use
medium of exchange
unit of account
store of value
A monetarist vision
The more money around the less the portion of GDP that can be bought (the higher the prices)
=> controlling the quantity of money we can control the level of prices
Several studies confirmed that this relation is unstable. Using the quantity of money to control prices it's not so straight forward
How was money born?
Once upon a time...
there were no banks, financial systems and there was no money. People used to exchange goods with goods
Than it seemed to be a good idea to decide that one of these goods could be the "base" good on which all the exchanges could be based
The need to deposit some of this commodity money arose
commondity money with intrinsic value
The Holder sooner become a lender
and understood that he could lend commodity money as well as "promises" in pieces of papers
The present fiat money was born
The process of money creation
Money is created by the Financial System: The Central Bank and financial intermediaries
Central bank Balance Sheet
(public and private)
currencies and liquid assets
Commercial bank Balance Sheet
corresponding to the loan
This value is the legal limit of the reserve and it's set up by the Central Bank
Banks will always lend money for the remaining 98% (it's their business!)
This 2 - 98 relation works as a multiplier.
The central bank can then lend money to the banks and the banks will lend more money
e.g. a bank holds 2 millions in deposits
therefore it can lend 98 millions
CB gives the bank 1 extra million
the bank can lend 150 millions (2% of 150 is 3)
=> The Central Bank can CONTROL
the AMOUNT of money in the economy
the LOANS in the economy
the PRICE at which money is lent in the economy
This affects the inflationary processes
This affects the level of investments in the economy and therefore the aggregate demand = GDP
How can inflation be moderated
This is the role of the Central Bank
The ECB European Central Bank aims at maintaining inflation between 0 and 2%
By the means of the Monetary Policy
Central Banks aims at moderating inflation (and help the economy to grow at its potential growth rate)
This is done by the means of Monetary Policy
The Central Bank can boost or cool down the economy
The level of the economic activity affect the prices level
Long and Short run Policies
Long Run Policies aim at increasing the potential growth rate
Short run policies aim at STABILISING the growth rate as close as possible to its potential
The role of the state
What is the role of the state in the economy?
Why do we pay taxes
Providing goods and services of public interest
Fostering potential growth
Stabilizing the economy around its potential growth rate
Short term policies implemented by the country administration
Aimed at stabilizing the GDP growth around its potential growth rate
By the means of influencing the aggregate demand
when G => Y
when Y => Income
when Income => C
Income = C + S
when C => Y
THE MULTIPLIER EFFECT
An expansionary fiscal policy has a much larger effect on the aggregate than the initial impulse
the effect of the multiplier depends on the marginal propensity to consumption and on the propensity for imported consumption
it's only useful when the economy is below its potential growth rate
basically an increase in G today means a decrease of G sometime in the future
public expenditure is not flexible
very low margins of increasing G
very slow process
when G => Y
most of public expenditure cannot be changed overnight
when t => C
when C => Y
less direct that public expenditure
tax changes are not flexible at all
no changes in taxes represent an automatic stabiliser
someone says that new tax collection due to the rise of Y could overcome the cuts induced by a reduction of t (Laffer curve)
Incentives exist for political leaders to implement policies that disperse costs widely over large groups of people and benefit relatively small, politically powerful groups of people.
Incentives exist for political leaders to favor programs that entail immediate benefits and deferred costs. Few incentives favor programs promising immediate costs and deferred benefits, even though the latter programs are sometimes economically more effective than the former programs
=> Monetary policy instruments
open market operations
required reserves ratio
The balance of payments
all transactions between one country and the rest of the world are recorded here
Good and services
2 BASIC RULES
1. When money comes in
when money go out
2. Sum of G&S,
apital are always
it's the instrument we use to keep the account of exchanges
If you buy something you pay for it
+value of the product received
- value of money payed
Balance of trade -80
Factors income -20
Cash Transfers -10
Financial account 50
inflow FDI 20
outflow FDI -40
Financial assets 70
BALANCE OF PAYMENTS 0
Reserve account 60
earnings from foreign investments
-payments to foreign investors
gifts, immigrant cash transfers
we consumed 110 of GDP we did not produce
how can this happen?
since Reserves Money
remember the Central Bank Account
since Money Prices
=> there is a "natural" force acting balancing trade imbalances
but it's slow and unpredictable
The exchange rate
=> the balance of payments influence the level of prices
today we live in a world with mainly flexible exchange rates (and capital movement)
it's a recent phenomenon!
we can buy and sell Foreign Currencies
their price is set by the market
the prices of currencies are given by
the bilateral foreign exchange rates
The € $
is the quantity of $ that can be bought with 1 €
Factors affecting exchange rates
In a world with no capital movement
only trade affects exchange rates
Current Account surplus => evaluation
Current Account deficit => devaluation
when the amount of $ we can buy with 1€
the € APPRECIATES (evaluation)
when the amount of $ we can buy with 1€
the € DEPRECIATE (devaluation)
that started around the 70s-80s
In today's world, where capitals face less and less barriers in crossing borders
CAPITALS MOVEMENTS is the most important factor influencing the exchange rate
Financial account surplus => evaluation
Financial account deficit => devaluation
Factors influencing international investments
national i foreign i
EXPECTATIONS play an important role here
RISK plays an important role here
if inflation the return on investments (in real terms)
Growth and Productivity
when the country GDP it attracts investments
It can affect foreign exchange mainly controlling i
(and i affects the interest rate of national investments)
WHAT CAN WE DO?
WHAT CAN WE DO?
WHAT CAN WE DO?
Costs of inflation
Misallocation of resources
Inflation-induces Tax distortions
Y = C + I + G + X - M
Country % of GDP
United Kingdom 36,2
Czech Republic 28,7
Slovak Republic 27,9
Russian Federation 26,7
Egypt, Arab Rep. 24,8
Korea, Rep. 22,7
United States 17,0
European Union 35,1
North America 17,1
High income 23,0
Upper middle income 19,8
Low & middle income 18,7
Revenue is cash receipts from taxes, social contributions, and other revenues such as fines, fees, rent, and income from property or sales. Grants are also considered as revenue but are excluded here.
What is the weight of the state worldwide?
if taxes are progressively set (rich pay more)
an increase in GDP will make more people better off; but these people will have to pay more taxes and therefore cool down their consumption
a decrease in GDP will make people worse off; but these people will pay less taxes and therefore limit the reduction in consumption
Levels of Internationalization
© 2010Pankaj Ghemawat
We're not so globalised
Goods and services
Two ways of international interaction
Goods and Services
Goods and Services
X > M Trade Surplus
X < M Trade Deficit
International Capital Flows
2 kinds of capital Flows
Financial asset exchange
Want to know something more about economic wealth? Check this out
Crisis and Bubbles
Crisis is the situation of a complex system (family,
, society) when the system
, an immediate decision is necessary, but the causes of the dysfunction are not known.
Definition of Crisis
The dot-com bubble
NASDAQ index 1994 - 2005
Financial short term phenomena of sudden RISE & FALL
(Minsky) 5 Phases
2 - Boom / Overtrading
3 - Euphoria
4 - Profit taking - distress
5 - Panic
An asset get trendy (fairly or not...), people want it, its price start rising
It seems reasonable to
money to buy the asset
No caution at all
People start selling
Fears appears, people dislike the asset (and other assets too)
House prices in Spain
€ per sq.m
Can we prevent Bubbles?
, with a restrictive monetary policy,
affects negatively the GDP
could increase unemployment
takes away the punch bowl just as the party gets going
Can we "cure" Bubbles?
, with a expansionary monetary policy,
a functioning financial systems is needed
moral hazard (we save the bad guys)
fostering other bubbles
From Wall st. to Main st.
(real) Economic crisis
Commercial bank Balance Sheet
Toxic asset value
Example: Housing bubble
People and companies borrow money to buy houses and land at high prices (the asset is the collateral, guarantee)
People and companies cannot pay back
The bank get the house
But the prices are falling, the value is lower than expected
the bank lost money
the bank lost lending capacity, Loans , Investments , GDP
households lost their consumption capacity, Consumption , GDP
when the country productivity
if we want to have an idea of the evolution of the housing market we might have a look at the evolution of the gdp too
House prices in Spain and GDP
left, € per sqm
rigth, ten thousands of €
Defaulting people leave the bank with
Contagion: several assets
Financial institution lend the money and accept the asset as guarantee