Download Lecture 10 - UCSB Economics

Introduction to Economics
The US Economy
Economics in the News
Los Angeles Times
October 29, 2002
Page A-1
California State Budget
and the UC Budget,
Lecture Nine
Wall Street Journal
October 30, 2002
Page
Chapter 25
• Keynesian Economics
Determining GDP
• GDP is determined
where the C + I line
intersects the 45line.
• At that level of output,
y*, desired spending
equals output.
Chapter 30
• The Dynamics of Inflation and
Unemployment
Money Growth, Inflation,
and Interest Rates
• When the public holds expectations of
inflation, real and nominal rates of interest
will differ.
Nominal rate of
interest
Real rate of
= interest
+
Expected rate
of inflation
• In the long run, changes in the money supply do
not affect real variables, including the real
interest rate. But nominal rates, which depend
on the rate of inflation, will be affected by the
growth of the money supply.
The Quantity Equation
• The equation of exchange, or quantity equation,
links the money supply and velocity to nominal
GDP: money supply x velocity  nominal GDP
MxV Pxy
• If velocity is predictable, we can use the quantity
equation and the supply of money to predict nominal
GDP, or the value of spending, on the right side of the
equation.
Chapter 27
• Money, the Banking System and the Fed
The Role of the Federal Reserve
in the Money Creation Process
• Open market purchases: The Fed’s
purchase of government bonds, which
increases the money supply.
• Open market sales: The Fed’s sales of
government bonds to the public, which
decreases the money supply.
Using Concepts to Illustrate the
US Economy in Fall 2002
• Production Possibility Frontier Tool:
Illustrate the War on Terrorism
– Lecture Eight
Guns or Butter
War Front:
“Guns”
This year
Last Year
Production Possibility
Frontier: Real GDP
Govt.: Tax it away
or borrow to buy
it away
Opportunity
cost of war
in“butter”
Home Front: “Butter”
Using Concepts to Illustrate the
US Economy in Fall 2002
• Production Possibility Frontier Tool:
Illustrate that the Government wants more
guns and butter, and spends on both
increasing nominal GDP faster then real
GDP
– Lecture Eight
Guns or Butter
War Front:
“Guns”
Government. Wish
Nominal GDP
Production Possibility
Frontier: Real GDP
Govt.: Tax it away
or borrow to buy
it away
Home Front: “Butter”
Is Inflation on the Way?
• Measure GDP in current (nominal) $
• But how much of the change from year to
year is a change in output and how much is a
change in prices?
• GDP(nominal) = GDP Deflator x GDP(real)
GDP Deflator: Percentage Change
Source: http://www.yardeni.com
Lecture Eight
Lecture 5
Inflation
Http://stats.bls.gov/eag/eag.us.htm
Using Concepts to Illustrate the
US Economy in Fall 2002
• Production Possibility Frontier: Real GDP
Could be Getting Ready to Decline-Double
Dip Recession?
Less Guns and Butter?
War Front:
“Guns”
Production Possibility
Frontier: Real GDP
Home Front: “Butter”
Lab Five: Http://www.economagic.com
Using Concepts to Illustrate the
US Economy in Fall 2002
• What are the Policy Options to Fight
Recession
– Fiscal Policy: Lecture Seven
Bust
Consumption, C
Investment, I
GDP
Income = expenditure
I.e. Y = GDP
GDP = C + I +G
Total
Expenditure
GDP Line
Aggregate
Expenditure
Unemployment
Rate Oct. 2000
= 3.9%
45
0
Unemployment Rate
Sept 2001 = 4.9 %
GDP = Y
National
Income, Y
Bust
Consumption, C
Investment, I
GDP
Income = expenditure
I.e. Y = GDP
GDP = C + I +G
Total
Expenditure
GDP Line
Aggregate
Expenditure
45
0
GDP = Y
Lecture Seven
National
Income, Y
National Income and Product
Accounts (NIPA)-Ch. 20
Percent Change in Real (Constant $) GDP with Component
01 II 01 III 01 IV
02 I
02 II
Consumption 1.4
1.5
6.0
3.1
1.8
Investment
-17.6
-5.2
-17.3
18.2
7.9
Government
5.6
-1.1
10.5
5.6
1.4
Net Exports
-
Total: GDP
-1.6
-0.3
2.7
5.0
1.3
Federal Government Spending
Source: http://www.yardeni.com
Federal Government Surplus or Deficit in Billions of $
300
200
Billions of $
100
0
1965
1970
1975
1980
1985
-100
-200
-300
-400
Year
1990
1995
2000
2005
Personal Savings Rate: Income = Consumption + Savings
Source: http://www.yardeni.com
Retail Sales in Trillions of Dollars
Source: http://www.yardeni.com
Policy Option: Reassure the Public
“The only thing we have to fear is fear itself”
Franklin Delano Roosevelt
Lecture Seven
Bust
Consumption, C
Investment, I
GDP
Income = expenditure
I.e. Y = GDP
GDP = C + I +G
Total
Expenditure
GDP Line
Aggregate
Expenditure
Unemployment
Rate Oct. 2000
= 3.9%
45
0
Unemployment Rate
Sept 2001 = 4.9 %
GDP = Y
Lecture Seven
National
Income, Y
Using Concepts to Illustrate the
US Economy in Fall 2002
• What are the Policy Options to Fight
Recession
– Monetary Policy: Lecture Nine
The Federal Reserve System: Purposes & Functions
http://www.bog.frb.fed.us/
PDF format: Adobe Acrobat
The Federal Reserve System: Purposes & Functions
http://www.bog.frb.fed.us/
PDF format: Adobe Acrobat
Impact of the Supply of Reserves
on the Federal Funds Rate
FFR,
price of
reserves
Demand for Reserves by Banks
Supply of Reserves: Fed
quantity of reserves
Fed: Lender of Last Resort to Banks at Discount Rate, 00-02
Source: Federal Reserve Bank of Minneapolis
The Federal Reserve
• Maintaining Liquidity: The Growth of the
Money Supply
The Annual Rate of Growth of M1
Source: http://www.yardeni.com
Definitions of Money
• M1(a measure of media of exchange) =
– currency held by the public, outside of banks
– checkable deposits
• demand deposits
• NOW (negotiable order of withdrawal) accounts
– savings & loans, mutual savings banks
– traveler’s checks
• M2 = M1 +
Lecture Nine
– money market accounts at banks
– money market mutual fund accounts
– certificates of deposit, CD’s, less than $100,000
• M3 = M2 + CD’s over $100,000
Consumer Credit Outstanding as a % of
Disposable Personal Income (Ch. 25)
Source: http://www.yardeni.com
Using Concepts to Illustrate the
US Economy in Fall 2002
• What has been the economic impact of the
“War on America”?
– Destruction of income (flow)
– Destruction of wealth (stock)
The Direct Loss of Income
• 3000 fatalities
• @ $100,000 per year income
• $ 0.3 billion
The Indirect Loss of Income:
Potential GDP
• Full employment of labor
• Full employment of capital
Lab Three: National Income and
Product Accounts (NIPA)-Ch. 20
Billions of Current $, Seasonally Adjusted at Annual Rates
01 III
01 IV
02 I
02 II
Consumption 6983.7
7099.9 7174.2
7254.7
Investment
1574.9
1500.7 1559.4
1588.0
Government
1851.7
1896.8 1939.5
1959.8
Net Exports
-312.6
-344.5
-425.6
Total: GDP
10097.7 10152.9 10313.1
-360.1
10376.9
GDP is Gross Domestic Product
The Indirect Loss of Income:
Potential GDP
• Full employment of labor
– unemployment rate has gone from 4 % to 5%
– Say we lost 1 % of national income, 2002II
$10377 billion, would be $104 billion
• Full employment of capital
Capacity Utilization
Source: http://www.yardeni.com
How Much of the Loss is
Attributable to the Attack
• As of August 22, the Survey of Professional
Forecasters were still relatively optimistic
– Calling for a growth rate in real GDP of 2.4%
in 2002QIII
– calling for a growth rate in real GDP of 2.6% in
2002 QIV
Survey of Professional Forecasters
2002 Q3 2002 Q4 2003 Q1
Growth Rate
Real GDP
Inflation Rate
CPI
Unemployment
Rate
2.4%
2.6%
3.4%
2.0%
2.1%
2.3%
6.0%
6.0%
5.8%
http://www.phil.frb.org/
Survey of Consumer Confidence
• For October 79.4, down 14.3 point dive in
one month (1985 =100). Lowest index in
nine years
Index of Consumer Confidence
Lecture Six, updated
Midterms
• Essay Questions
Midterm Study Question
• Economists are expecting a decline in GDP
for the 3rd quarter of 2001, with perhaps
continuing decline in GDP for the fourth
quarter.
– What are some of the similarities in the decline
of expenditure components now and in the
1930’s?
– What is a major difference in the behavior of
expenditure components now and in the great
depression?
– How do economic policies differ between the
two periods?
Lecture Seven
1998 Midterm
Part IV ( 28 points) Answer both essay questions.
1. One reason for the Great Depression was a sharp drop in consumer
spending.
a. Assuming the economy was initially at the full employment
level of output, describe the effect of a drop in consumer
spending.
b. What was Keynes’ policy recommendation for escaping from
the Great Depression?
2. Opinions about the US economy have been quite changeable this Fall
quarter. At the moment, the rate of growth of the economy is slowing,
but growth is still positive. How would you satisfy yourself whether
a recession might be coming or not? How would you assess whether
the likelihood of a recession in 1999 is low? or high?
a. What conceptual framework would you use to answer this
question about a prospective recession?
b. What data and which economic measures or statistics would
you look at?
c. How would you deal with the fact that you need a “crystal
ball” to see into 1999 and the future?
Midterms
• Graphical Questions
Part III (20 points) Answer both questions.
1. This is a Keynesian economics diagram of the determination of
equilibrium GDP.
Aggregate
Expenditures
45 degrees
Full Employment
Income
Aggregate Income
a. Label the aggregate expenditures line
b. Label the equilibrium condition line, for which aggregate
expenditures equals aggregate income, i.e. GDP = Y.
c. On this diagram, indicate the equilibrium level of
aggregate income, Yeq .
d. Is this equilibrium level of income higher or lower than
the full employment level of income? ________________.
e. Given your answer to part d, does this indicate a
recession or an inflationary boom? ____________________.
2. This diagram illustrates the market for reserves and
the determination of the federal funds rate. This is the
rate which commercial banks charge one another for
borrowing, usually overnight.
Federal
Funds
Rate
Quantity of Reserves
a. Label the demand curve for reserves.
b. Which institution(s) demand(s) reserves?______________
c. Label the supply curve for reserves.
d. Which institution(s) affect(s) the supply curve for
reserves?_______________
e. If the Federal Reserve raises the ratio of required
reserves to deposits, which curve will shift to the right,
resulting in a _______________
federal funds rate? ____________..
Wall Street Journal
October 30, 2002
Page