Principle of Economics: Macroeconomics, IRGA 2nd semester, Appunti di Economia

Scarica Principle of Economics: Macroeconomics, IRGA 2nd semester e più Appunti in PDF di Economia solo su Docsity! MACROECONOMICS STUDY GUIDE CHAPTER 14: THE NATIONAL ECONOMY OVERVIEW - nominal vs real GDP = nominal doesn’t account for changes in the price level ⇾ measures GDP at current prices; real focuses on real values (i.e. quantity) ⇾ adjusts for inflation - hyperinflation means something is wrong: government prints money to solve short term issues - GDP vs GNY: • GDP = income/output in the physical national boundary • GNY = all nation income, including that earned abroad (accounts for remittances) - current account: imports and exports need to balance • X > M = surplus, can be bad because it means that too many goods for exports are produced and too little goods that are fundamental— X only brings cash, not food/ services/… • X < M = deficit, bad - issues with measuring GDP only: • nothing on living standards • nothing on welfare— externalities, distribution of income • non-marketed items— ex. babysitting vs. stay-home mom • underground markets— good & bad - good: solidarity— friend who’s a doctor ⇾ informal market - bad: black market and illegal market - purchasing power parity, ppp = measures how much of the local currency is needed to buy a foreign good denominated in foreign currency (big mac index) CIRCULAR FLOW OF INCOME - injections (J): investment (I), government expenditure (G), export expenditure (X) - withdrawal (W): net savings (S), net taxes (T), import expenditure (M) MEASURING GDP i. product method: go sector by sector and add up the (P x Q ) of each product • issue: double counting ⇾ solved by counting for value added, i.e. the value retained by the previous stage of production (GVA= gross value added) of 1 28 MACROECONOMICS STUDY GUIDE ii. income method: add up all factors earnings ⇾ wages/salaries + rent + profits iii. expenditure method: (nothing is created nor destroyed) the circular flow of income ⇾ Y= C+I+G+(X—M) • can measure both GDP and GNY with this, for GNY add profits from abroad (remittances) SHORT TERM GROWTH AND THE BUSINESS CYCLE - in the short run some factors are fixed (ex. capital), in the long run factors are all mobile the business cycle: - full capacity is unrealistic: means that all factors are employed ⇾ can’t happen: people always move, change jobs, unemployed, … - actual output: GDP fluctuates ⇾ business cycle, ups and downs - Keynes is concerned with the short run ⇾ need to fix the problems of today because in the long run we are all dead LONG TERM GROWTH - not necessarily dependent on GDP: growth must be socially sustainable in the LR - economic causes of long term growth a. increase in the quantity of factors of production (land, labor, capital) - issues: diminishing returns (after a point, profits fall when factors increase), misuse of factors of production (ex. land for export goods like coffee instead of food) - pros: economies of scale (P fall when Q goes up), knowledge (ex. technology) b. technology: allows increases in productivity c. effects of actual growth on potential growth: as people see growth they will invest more ⇾ I is an J, hence Y will rise - issue: poverty trap— the opposite: people see recession and don’t invest - cultural and institutional causes of long term growth a. deep determinants of economic preferences - inter-temporal (short and long term): ex. borrow for a car (lr) or spend for a holiday/i- phone (sr) - the culture of work - environmental culture— respect for environment b. economics and politics: inclusive vs exclusive institutions (Acemoglu Robinson) - inclusive: bring success vs. exclusive: bring failure 
 of 2 28 MACROECONOMICS STUDY GUIDE II. cost-push inflation_ may be temporary or permanent, ex. oil shocks (temporary)— the costs of the factors of production rise, hence P rise and Q falls • cost-push inflation causes GDP to fall (recession) I. II. III. interactions amongst the two relationship between inflation and unemployment - there is a negative relationship (Phillips curve): as inflation goes up, unemployment goes down BALANCE OF PAYMENTS - balance of payments = sum of inflows and outflows, is the record of transactions between a country and the rest of the world over given time (1 year) • uses nominal values (i.e. prices no adjusted for inflation) - stocks vs flows— the BOP measures flows • stock= measurement of something at a given moment (ex. money in the account) • flow= measurement of something over a given period (ex. monthly salary) - flows build stocks up - investment is a flow— is an addition to the capital stock, done by firms - BOP = CA + KA + FA ⇾ must be = 0 (i) current account: based on something that tends to be repeated (‘current’) a. trade in goods and services: measures the (X—M) — balance of trade b. international flows not based on trade: current transfers, income flows of 5 28 MACROECONOMICS STUDY GUIDE • CA = current transfers + income flows + trade balance - the current account is cyclical: country can be a debtor, then become a creditor (surplus vs deficit) (ii) capital account: not flows that are current in nature— involves trading in real stocks (houses) (iii) financial account: trading financial assets (not concrete goods/services), ex. bonds, equities a. Investments: FDI (buy a share to get control), portfolio (buy shares without control) b. other financial flows, ex. banking accounts c. flows to/from reserves — CB’s foreign currency reserves • FDI + portfolio + other I + balance of derivatives + reserves balance EXCHANGE RATES - exchange rate, E= the amount of one currency needed to buy another ⇾ key to interdependence • E are not arbitrary ⇾ determined by the market: for 70 countries, you only need 69 E - Exchange rate Index = weighted average of E of one country with the others determination of the E - 1.60 is the Pe determined by the market; 1.80 is the P set by the UK • a policy decision: an increase in P causes a fall in foreign demand for domestic currency • at an exchange rate of 1.80, Qd < Qs ⇾ excess supply of GBP ⇾ depreciation of GBP • at an E of 1.40, Qd > Qs ⇾ shortage of GBP ⇾ appreciation of GBP - to avoid either, the CB must intervene by buying/selling official reserves balance of payments= current account + capital account + financial account bop = CA balance + KA balance + FA balance - balance of trade (in goods and services) - income flows - current transfers - trade in real financial stocks - net FDI - net portfolio - other I - financial derivatives - reserve assets of 6 28 MACROECONOMICS STUDY GUIDE - Big Mac Index is a tool to get a fell of E and if they are balanced ⇾ PPP • find cost of BM in the US in $ and the cost of a BM in IT in € ⇾ convert $ into € - if the two BM have the same price once converted in the same currency, ppp is satisfied - if not, one currency may be under/over- valued - China keeps the YEN quite undervalued ⇾ export led economy: keeps X cheap for the US to sell more 
 of 7 28 MACROECONOMICS STUDY GUIDE CHAPTER 17: SHORT-RUN MACROECONOMICS EQUILIBRIUM OVERVIEW: MACROECONOMIC EQUILIBRIUM, AS=AD - in the short run the economy follows Keynes: prices are sticky, quantity produced adjusted to the quantity demand [horizontal AS] • the Keynesian model is a SR model: AD determines AS in the short run because firms produce only what they expect to sell - in the long run the economy follows the classical view: prices are flexible and so P adjust so that AD = AS [vertical AS] THE SIMPLEST ECONOMY: A CLOSED ECONOMY, Y=C+I - equilibrium is where output, Y is equal to consumption + investment • this equilibrium requires that savings = investment, S=I - this is because of the circular flow: any injection must be = by withdrawal - I is an injection, S is a withdrawal ⇾ we are in a closed economy hence S = I consumption function: C = a +bY - a is the fixed part of consumption ⇾ people have basic needs to satisfy - b is the part of the consumption function that is dependent on income: people’s consumption is based off of how much they earn ⇾ they will consume b and save 1-b • b is the «marginal propensity to consume», mpc • 1—b is the «marginal propensity to save», mps - since consumption depends on income, consumption is endogenous of the model - since Y = C + I and S = I • i can infer that Y = C + S ⇾ hence S = Y — C closed economy model: the consumption & the savings functions Y = C + I , S = Y — C C = 10 + 0.8 I: exogenous to the model ⇾ given S = Y — C ⇾ S = Y — (10 + 0.8Y) ⇾ S = —10 + 0.2Y of 10 28 MACROECONOMICS STUDY GUIDE the keynesian multiplier - an increase in D of one product will increase C - this rise in C will cause Y to rise - as a result of the rise in Y, people will consume even more (so C rises more) but they will also save and invest more (S, I rise too) • an increase in spending will cause a multiplier effect on the whole economy • hence you just need to increase labor demand to kickstart a positive virtuous cycle THE COMPLETE KEYNESIAN MODEL: THE OPEN ECONOMY, Y = C+I+G+(X—M) - includes the public and private sector, and the rest of the world (i.e. X and M) the circular flow equilibrium: Y = C + I + G + (X — M) government finances - budget surpluses/deficits depend on the balance between G and T • to «finance» a deficit: G > T - government must sell bonds - monetary financing (inflation!!) - national debt (a stock) - public-sector net borrowing (a flow) • the government as well as all institutions in the public sector have a budget— if they go above need to borrow public sector: G and T - G is in injection, T is a withdrawal - if G — T > 0 ⇾ you have a government budget deficit, because G > T • in the short run: you need savings, ie. people voluntarily buying government bonds • in the long run: if government keeps the debt ⇾ unsustainable public debt, ie. no voluntary buying of public debt ⇾ crisis of 11 28 MACROECONOMICS STUDY GUIDE - it follows that in the SR, the government can sell its debt because people are willing to buy it off via bonds, but in the LR people lose trust in the government and thus do not buy bonds ⇾ all based on trust, credibility the components of Y in a complex closed economy - my identity is Y = C + I + G ⇾ it follows that savings are now S = I + G (we don’t consider taxation yet) • S is a withdrawal, I and G are injections - if we add taxation: (Y — T )= C + I + (G — T) and I know that S = (Y — T) — C - hence S = [C + I + (G — T)] — C ⇾ S = I + (G — T) - S, I, T, G are all flows - S, I, (G—T) are stocks • S is a stock of wealth • I is a stock of real capital • (G—T) is a stock representing the change of debt the components of Y in an open economy: the complete model - adding the Current Account: Y = C + I + G + (X — M) - if we also account for taxation: (Y — T )= C + I + (G — T) + (X—M) • we also know that S = (Y — T) — C • hence if I move C to the left ⇾ (Y — T ) — C = I + (G — T) + (X—M) - hence, S = I + (G — T) + (X—M) - if we further rearrange it we find that J = W • I + G + X = S + T +M withdrawals: endogenous (depend on Y) — W = S + T + M - net savings are given by the savings function: mps = ΔS/ΔY - net taxes are given by the tax functions— the tax rate: mpt = ΔT/ΔY - imports are given by the import function: mpm= ΔM/ΔY • we know that S + T + M = W • hence, the withdrawal function: mpw = mps+mpt+mpm = ΔW/ΔY injections: exogenous — J = I + G + X - Investment: depends on increased consumer demand, expectations, cost and efficiency of capital, rate of interest, … - government expenditure: politically and institutionally determined - exports: depend on foreign conditions (foreign Y and preferences) of 12 28 MACROECONOMICS STUDY GUIDE CHAPTER 18: BANKING, MONEY, AND INTEREST RATES OVERVIEW: MONEY the functions of money - money as a «language» to convey economic meanings: i. medium of exchange: quick, money is the most liquid of assets ii. means of storing wealth: issue with storing cash— inflation decreases the value iii. unit of accounting: means of evaluation iv. means of establishing value of future claims/payments - economies of scale of money: the more common it is, the more people use it, the more people will use it the attributes and definitions of money - money can be broadly or narrowly defined • narrow: M0 ⇾ currency • broad: M1/2/3/4 ⇾ includes banking accounts/bonds/… - the attributes of money: a. durability, b. divisibility, c. transportability, d. non-counterfeitability - holding money has an opportunity cost ⇾ holding money vs. interest bearing assets • hence, the price of money is the interest rate - inflation changes the value of money: if you borrow now, and inflation happens ⇾ the borrower is favored because the value of money will fall, but the price you’ll pay is set now • inflation erodes debt the history of money - coins were made in gold (then copper+lead) ⇾ emperor puts face on them (=seniorage) • emperor established their value, regardless of how much gold is actually in the coin • issue: not tradable ⇾ foreigners don’t care about seniorage, they care about gold - banknotes: started with letters of credit ⇾ pay with a letter instead of gold - bank deposits: banks manage deposits/withdrawals ⇾ prudent banks will manage deposits efficiently so that people don’t go withdraw all at once THE FINANCIAL SYSTEM - money is different from «finance»: • money: about today ⇾ pay now, no more future obligations • finance: about time— LR payments ⇾ an exchange of future promises— intertemporal contracts - however they are both transactions - the banking system: • retail/wholesale/universal banks; building societies; monetary financial institutions (MFIs) of 15 28 MACROECONOMICS STUDY GUIDE • the banking system goes through waves of regulation and deregulation - 1929: regulation + institutionalization | 1990s: deregulation | 2008: regulation - financial institutions— provide expert advice, expertise, maturity and risk transformations • the Central Bank, CB: only one that prints money; the only depositor for commercial banks, foreign CB and the government; provides liquidity to banks - tasks: operates monetary policy (i.e. decides how much currency to create), operates the exchange rates and manages reserves, oversees activities of cbs and other institutions, is the «lender of last resort» in financial distress (saves the ‘good banks’ suffering because of general consumer behavior) • it’s role can be politicized ⇾ in the 90s there was the divorce of CB from govs the financial system - houses make deposits ⇾ banks are prudent • some of the deposits are put in the reserves ⇾ crucial to avoid failure - crisis: all customers withdraw money ⇾ issue for cbs - they are regulated by the CB— establishes a minimum • others used for loans money markets - trading of SR financial instruments (even overnight) • this is the means through which CBs conduct monetary policy • provides lending and borrowing for MFIs - ex. «quantitative easing»: a technique to increase the Ms— lower the r for loans so that banks will borrow ⇾ allows to lift out of crisis • interbank lending: crucial ⇾ all banks maintain a minimum of liquidity based on expected consumer demand, but this is never accurate— cbs lend to each other MONEY SUPPLY - Ms can be defined narrowly (i.e. monetary base) or broadly • in the UK: cash + M4 | in the Eurozone: M1/2/3 of 16 28 MACROECONOMICS STUDY GUIDE the money multiplier: the creation of credit 1. household/firms increase deposits • cbs keep some as reserve requirements, and loan the rest 2. clients use credits to buy goods/services • hence households/firms earn money ⇾ back to 1: they increase their deposits - this process goes on until all liquidity is kept as Bank’s liquidity reserves - the least cash there is, the more credit is used ⇾ the bigger is the multiplier - this creation of credit is what causes inflation the money multioplier, graphical representation money supply - to increase the Ms • banks lower their liquidity ratio + houses/firms hold less cash ⇾ bigger money multiplier • CB makes access to money easier for cbs (lowers r, ex. quantitative easing) • inflows from abroad (ex. when CB converts foreign reserves to domestic currency) • CB finances the public sector deficit— print more money ⇾ illegal in the EU exogenous money supply: narrow Ms - the CB has full control ⇾ Ms is not determined by Md or r [unrealistic] • stable private sector behavior of 17 28 MACROECONOMICS STUDY GUIDE CHAPTER 19: THE GOODS MARKET & THE MONEY MARKET OVERVIEW - goods market and money market are intertwined ⇾ interest rate is the link • this works in the SR, not in the LR ⇾ in the LR the goods market drives the economy EFFECTS OF MONETARY CHANGES ON NATIONAL INCOME: CLOSED ECONOMY - two different views: (a) classical— focus on the LR: an increase in Ms causes inflation and no change in Y - in the LR all factors are flexible ⇾ an increase in Ms will cause prices to rise (b) Keynesian— focus on the SR: an increase in Ms stimulates production and employment - this may work in the LR as well— but P must be stable ⇾ you must not be at Yf classical theory: «quantity theory of money» (LR) - based on the equation of change — MV = PY • M = money supply • V= velocity of circulation of money • P= prices • Y= income - V is how many times money changes pockets: based on habits and customs ⇾ is stable - because we are in the LR: V is stable, Y if fixed (because we are at Yf) ⇾ P = M(V/Y) • because of fixed V and Y ratio ⇾ P and M will move proportionately • hence: ΔP/P = ΔM/M ⇾ if you increase Ms in the LR you will cause the same increase in prices Keynesian theory (SR) - assumptions that prices are stable (sticky) because of institutional rigidities • hence, the real side of the economy will interact with the monetary side • connection: interest rates, i interest rate transmission mechanism: (1) stage 1: money and i link ⇾ i is the opportunity cost of money (2) stage 2: i and investment (I) link ⇾ to invest you need to borrow— you will not borrow if i are higher than expected profits • this also affects savings (S): you will decide to save if i are high enough you make your deposit worthwhile (3) stage 3: multiplier effect (since investment is an injection ⇾ has a multiplier effect) of 20 28 i ↓ Ms ↑ I ↑ S ↓ AD ↑ GDP (Y) ↑ prices, P ↑ MACROECONOMICS STUDY GUIDE graphical representation of the interest rate transmission mechanism (i) stage 1: Ms rises, i falls (ii) stage 2: i falls, I rises (iii) stage 3: I rises, thus injections (J) increase ⇾ Y rises issues with the transmission mechanism: (I) issues with stage 1 (the money and interest rate link) (a) elastic demand curve: the link between Sm and Y depends on the elasticity of Dm - liquidity trap: occurs when the Dm is completely elastic ⇾ i has a floor: once this level is reached any rise in Sm will no cause any fall in i— Ms will be held in idle balances (b) unstable money demand: if the Sm is fixed ⇾ any fluctuation in Dm (=L) will cause a huge change in i — effect on i of a rise of Ms is unpredictable (II) issues with stage 2 (the interest rate and investment link) (a) inelastic demand for Investment: I is unresponsive to a change in i (b) unstable investment: the idea that a fall in i causes a rise in I is based on the assumption that a fall in i is = to a rise in business confidence ⇾ if business confidence falls, any rise in i will cause a fall in I of 21 28 MACROECONOMICS STUDY GUIDE issues with stage 1: issues with stage 2: EFFECTS OF MONETARY CHANGES ON NATIONAL INCOME: OPEN ECONOMY (CHECK INT. ECON.) - the exchange rate transmission mechanism has 3 stages 1. money supply (Ms) ⇾ interest rate (i) link 2. interest rate (i) ⇾ exchange rate (E) link 3. exchange rate (E) ⇾ import and export (M,X) link of 22 28 i ↓ Ms ↑ I ↑ S ↓ AD ↑ GDP (Y) ↑ prices, P ↑ D for foreign assets ↑ E ↓ E ↑ M ↓ MACROECONOMICS STUDY GUIDE deriving the IS curve the MP-curve: the money market equilibrium - authorities control the i (by controlling the M0) ⇾ «inflationary targeting», because: • high inflation— Y is above potential ⇾ inflationary gap (boom) • low inflation— Y is below potential ⇾ deflationary gap (recession) - since financial authorities may be politicized (ex. post- WWII IT’s government policy’s issue with capital flows to SW) ⇾ CBs became independent of the government - as we saw before, in the financial market: a rise in i/r causes lower L • because i is the price of money — if i rises it becomes less convenient to hold cash • however, L also depends on Y: if Y rises, L shifts up ⇾ hence i shifts too to get equilibrium money market of 25 28 MACROECONOMICS STUDY GUIDE deriving the MP: «inflation targeting» - if Y increases the economy booms ⇾ hence inflation 𝜋 increases above the target 𝜋* • in case of a boom— to lower 𝜋 ⇾ restrictive monetary policy: increase i and lower Ms • in case of recession— to increase 𝜋 ⇾ expansionary monetary policy deriving the MP - as Y rises, i increases too ⇾ 𝜋 rises - hence the CB will rise i (restrictive monetary policy) equilibrium in both the money and the goods markets - equilibrium is where IS = MP ⇾ the market will tend to move towards this equilibrium IS/MP analysis 1. suppose there is a rise in G (goods market) - G is an injection ⇾ Y will rise and the economy shifts at point (b) along the MP - in the money market, a rise in Y causes a rise in L ⇾ the economy booms and 𝜋 rises - the rise in 𝜋 will cause the CB to react by pushing i up • since the Y has risen (due to more G) the IS curve shifts up: the i rises allowing to meet the target of 𝜋* ⇾ equilibrium in both markets is restored however: - the rise in G causes i rises too because it causes Y to increase - the difference between the potential output that could be achieved at the initial i and the actual output achieved (with the i adjusting) is the «crowding out» • public expenditure partially crowds out I of 26 28 MACROECONOMICS STUDY GUIDE 2. suppose that the CB lowers i (money market) - lowering i causes the economy to shift to point (c) along the IS - the lower i stimulate expenditures ⇾ Y increases, the MP shifts up and hence a new equilibrium is found • this can work in the SR, but not in the LR ⇾ in LR inflation rate will rise inflation targeting in the SR and in the LR ADI = aggregate demand plotted against inflation - a rise in 𝜋 will cause i to increase and hence AD to fall - a rise in 𝜋 will also cause X to decrease, because your products become more expensive - ADI can shift due to changes in G, T, I, X • rises in G, I, X cause ADI to shift up • falls in T cause ADI to shift up taking inflation into account I. any exogenous increase in ADI (shift ADI) causes 𝜋 to rise as well • higher 𝜋 can be accepted in the SR but is unsustainable in the LR • in the LR, if 𝜋 is unchanged AD must be reduced to the previous level II. a temporary AS shock (temporary increase in AS) causes 𝜋 to fall below 𝜋* • this is not politically sustainable— it’s a temporary shock so it will go back of 27 28