Graduate Macroeconomics

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Graduate Macroeconomics

• Introduction to Macroeconomics

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Macroeconomicsby N. Gregory Mankiw

• Instructor Prof. John M. Veitch

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US Real Output
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Growth of US Money and Prices
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Macroeconomics

• The Long Run - Economic Growth

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Economic Growth

• Economic growth is a complex process that is
  jointly determined by several important factors.
• 1. Investment in Human and Physical Capital Both
  types of capital expand the productive capacity
  of workers, thus leading to increases in per
  capita output.
• Technological Progress Enhances productive
  capacity of workers and an economys productive
  capacity.
• Progress encompasses both invention, discovery of
  new products or processes, and innovation, the
  practical and effective adoption of new
  techniques.
• 3. Efficient Economic Organization The economic
  organization of an economy must provide
  incentives and economic infrastructure, legal,
  monetary, educational, transportation, and
  communication, necessary for efficient operation
  of the economy.

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Govt and Economic Growth

• Government has role in providing correct
  environment to foster economic growth.
• Security of Property Rights Political
  Stability Both promote production and trade and
  move economy towards allocative efficiency.
• Competitive Markets Competition as a
  disciplinary force to ensure producers provide
  goods at lowest cost serve consumer interests.
• Stable Money and Prices Instability in money and
  prices generates uncertainty, particularly in
  investment, undermines contractual terms.
• International Trade an Open Economy Nations
  firms specialize in their comparative advantage,
  increasing world output competition.
• Open Capital Markets Provides strong incentives
  to evaluate projects and allocate funds to
  projects expected to yield highest returns.
• Avoidance of High Marginal Tax Rates High
  marginal tax rates distort incentives for
  individuals to work and for firms to undertake
  profitable investments. High tax rates also
  distort economic decisions and reduce allocative
  efficiency of a nation.

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Optimal Size of Govt

• Government fosters economic growth when it
  protects property rights provides public goods
  needed for markets.
• As government grows, it uses more resources set
  politically rather than economically, likely to
  harm economic growth.
• Higher taxes and/or additional borrowing impose
  an increasing burden of deadweight loss on the
  economy, as government expands.
• As government grows relative to market sector,
  there will be diminishing returns to funds
  diverted for use in the government sector.
• Political process is less dynamic than market
  process. Less incentive to discover productive
  activities or refrain from unproductive
  activities
• As government grows more likely to be involved in
  income redistribution or regulatory activism. Can
  impair efficiency of market.
• It is likely there is an optimum size for
  government that enhances the prospects for
  economic growth.
• Nations with governments that are significantly
  smaller or larger than this level are likely to
  suffer from inferior economic growth.

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Macroeconomics

• 2. The Brave New Business Cycle

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Business Cycle Economic Sectors
Economic Slowdown
Slowdown/ Recovery
Economic Expansion
Expansion/ Peak
Economy Slowing Slow Growing
Decelerating Monetary Policy Neutral Easy
Neutral Tight Interest Rates
Falling Falling Rising
Rising Profits Slowing Falling Rising
Decelerating
Sector Groups Cons. Staples Consumer
Basics Utilities Finance
Cyclicals Capital Goods Health
Care Tech. Energy Stock
Non-Cyclical Econ. Sensitive Cyclical
Non-cyclical Characteristics Blue Chip
Visible Earnings Leveraged Visible
Earnings High Yield Growth
Oriented High Growth High Yield
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The New Business Cycle

• Fundamental changes in the US economy may have
• Dampened US economic growth cycles, resulting in
  longer-lived economic expansions.
• Potentially more financial volatility in
  recessions and consequently longer, more subdued
  recoveries.
• The fundamental changes responsible
• Heightened competition forces firms to manage
  costs more aggressively, reduces risk of
  imbalances in production versus demand.
• Just-in-time inventory of materials, and
  increasingly labor, allows firms to respond more
  quickly to increases or decreases in demand.
  Shorter delivery lags for capital equipment allow
  expansions to run longer.
• Deregulation and competition in US financial
  markets has lowered volatility of housing
  activity and its sensitivity to interest rates.
• Internationalization of the US has diversified
  supply and demand, less volatility in production,
  and fewer bottlenecks late in the expansion.

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Macroeconomics

• Stabilization Policy, Output, and Employment

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Active or Passive Policies?

• Active Policy (Discretion not Rules)
• Economy is inherently unstable, shocks to AD
  AS.
• Macroeconomic policy should lean against the
  wind
• Fiscal monetary policy should fine-tune
  economy.
• Passive Policy (Rules not Discretion)
• Economy is inherently stable.
• Govt policies often produce economic
  fluctuations.
• Policy-makers should limit interference in
  economy.

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The Issues in the Policy Debate

• Lags in Inherent in Macroeconomic Policy
• Recognition Lag The time period after a policy
  change is needed but before the need is
  recognized by policymakers.
• Administrative Lag The time period after the
  need for a change is recognized but before a
  policy change is actually implemented.
• Impact Lag The time period after the policy
  change is implemented but before the change
  begins to exert its primary effects on the
  economy.
• Combined duration of these effects is 12 to 18
  months for monetary policy and even longer for
  fiscal policy.
• Activist policymakers must act before problem
  develops to have the appropriate policies taking
  effect when needed.
• Requires correctly forecast turning points in the
  economy.
• Automatic Stabilizers Policy rules that reduce
  lags.

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Economic Forecasting

• Leading Indicators move ahead of rest of
  economy.
• Economic Computer Models
• Lucas Critique must know how people will react
  to policy.
• Index of leading indicators composed of eleven
  variables forecast 6-9 months ahead.
• Average workweek of production workers in
  manufacturing.
• Average initial monthly claims for state
  unemployment insurance.
• New orders for consumer goods and materials
  adjusted for inflation.
• Vendor performance in deliveries.
• Contracts and orders for plant equipment
  adjusted for inflation.
• New building permits issued.
• Change in manufacturers unfilled orders.
• Change in sensitive materials prices.
• Index of stock prices.
• Money supply (M2) adjusted for inflation.
• Index of consumer expectations.

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Economic Forecast Performance

• Main problem with economic forecasts is that they
  are often not very reliable.
• Graph shows consensus forecasts for unemployment.

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Policy Rules or Discretion?

• Distinct from debate of active versus passive.
• Can have both passive and active policy rules,
  i.e.
• Money Growth 3 (Unemployment rate - 5)
• Discretion Political Business Cycles
• Distrust competency of policymakers.
• Political process prone to erratic or simplistic
  behavior.
• Distrust ethics of policymakers.
• Opportunism leads to policy for political, not
  economic, ends.
• Time Inconsistency Discretion
• Policymakers often choose to be inconsistent over
  time.
• Announce one policy but do something else after
  people take actions based on original announced
  policy.
• Rules make policy credible in way discretion
  cannot.

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Types of Policy Rules

• Monetary Policy Rules
• Money Growth Target Money growth should be
  determined by Quantity Theory (Monetarists).
• Nominal GDP Target Money growth adjusted to keep
  Nominal GDP growing at target rate.
• Price Level Target Money growth adjusted to
  keep Price level within some target range of
  growth.
• Fiscal Policy Rules
• Balanced Budget Rule Fiscal Policy sets Budget
  Deficit 0. Problem is makes economy more
  unstable.
• Stabilizing GDP Fiscal policy sets automatic
  stabilizers (income taxes, transfers). Cyclical
  Deficits and Surpluses.

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Costs Benefits of Regulation

• Potential Costs of Regulation
• 1. Reduce competitiveness in the industry in
  short run.
• 2. Higher operating costs due to burden imposed
  by regulation.
• 3. Higher prices due to increased costs, less
  competition.
• 4. Lower output of the good or service. Lower
  levels of efficiency as a result of production
  procedures and minimum standards.
• 5. Lower future profitability in the industry.
• Potential Benefits of Regulation
• 1. Increase competitiveness in the industry in
  long run.
• 2. Improved reputation with consumers.
• 3. Lower legal costs.
• 4. Greater levels of efficiency as a result of
  new capital investment.
• Often treat regulation as imposing a tax on the
  market.
• Regulation may also attempt to set prices or
  limit production.

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Macroeconomicsby N. Gregory MankiwChapter 2
The Data of Macroeconomics

• Instructor Prof. John M. Veitch

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Measuring a Nations Income

• We measure well-being by nations income.
• GDP measures both total income and expenditure in
  the economy.
• Circular flow diagram shows transactions between
  households and firms.
• Compute GDP two ways by adding total expenditure
  or by adding up total income.

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The Circular Flow
Revenue (GDP)
Spending (GDP)
Markets for
Goods Services
Flow of
Dollars
Firms
Households
Flow of
Goods Services
Markets for
Factors of Prodn
Wages, Rent, Profit
Income (GDP)
(GDP)
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Defining GDP

• GDP is the market value
• of all
• final
• goods and services
• produced
• within a country
• in a given period.

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Real vs. Nominal Quantities

• Rise in total spending for two reasons
• producing larger quantity of output.
• output being sold for higher prices.
• Nominal GDP values goods and services using
  current prices.
• Real GDP values goods and services using prices
  from a fixed base year.
• Real quantities measure output, Nominal
  quantities measure output prices.

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Real Nominal GDP

• Nominal GDP
• (Apple Price1997 x Apple Quantity1997)
  (Orange Price1997 x
  Orange Quantity1997) ...
• Real GDP
• (Apple Price1995 x Apple Quantity1997)
  (Orange Price1995 x
  Orange Quantity1997) ...
• GDP Price Deflator1997
• Nominal GDP1997/Real GDP1997 x 100
• measure of the average level of prices in the
  economy relative to a base year.
• started to use chain-weighted measures of Real
  GDP.

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Components of GDP

• Identity YCIGNX
• C - Consumption spending by Households
• I - Investment spending by Firms and HHs
• G - Government spending
• NX - Exports less Imports
• Exports domestically produced, sold abroad
• Imports produced abroad, purchased domestically.

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Measuring the Cost of Living

• Consumer Price Index (CPI) calculates the cost of
  living for a typical consumer by
• Fix the basket of goods.
• Find the prices of these goods.
• Compute the Cost of the basket of goods.
• Choose a base year and compute the index.
• Compute the inflation rate from the index.
• Many other indexes can be calculated using this
  methodology, i.e. Producer Price Index (PPI)

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Problems with CPI

• CPI measures how incomes must change to maintain
  a constant standard of living.
• Problem 1 Substitution Bias
• higher prices mean buy less of those goods.
• Problem 2 Introduction of New Goods
• greater variety not reflected in fixed basket.
• Problem 3 Unmeasured Quality Change
• quality improves with price unchanged.

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Measuring Unemployment

• BLS unemployment survey of households.
• Employed, Unemployed, Not in Labor Force.
• Labor Force Employed Unemployed
• Unemployment rate Unemployed/Labor Force
• Participation Rate Labor Force/Adult Population
• Natural rate of unemployment is the rate of
  unemployment in the Long Run.
• Cyclical Unemployment is deviation of actual
  unemploy. rate from the Natural rate.
• Okuns Law

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Problems in Measurement

• Difficult to measure unemployment.
• Movements into and out of labor force very common
  and often difficult to interpret.
• May claim unemployed tho not looking for work.
• Discouraged workers have given up looking for
  work.
• May be forced to work part-time instead of
  full-time..
• Most unemployment episodes last for short periods
  but at any given time most observed unemployment
  is long term.