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Transcript
Macroeconomic Review
in preparation for API-120
Prof. Jeffrey Frankel
MPA/ID program
August 18-19, 2016
• Lecture (i) -- GDP definitions
Reading on growth decomposition:
Krugman, 1994, “The Myth of the Asian Miracle.”
• Lecture (ii) -- More identities:
• Balance of Payments accounting
• The National Saving identity
Readings on accounting: WTP, Chapters 15 & 17.2.
• Lecture (iii) -The Keynesian multiplier model.
Reading on the Keynesian model: WTP, Ch. 17.1 &17.3.
Lecture (i) - GDP
•
•
•
•
•
Definitions of national output
Potential output 𝑌
Growth decomposition
Some historic theories, as examples
How are 𝑌 & the output gap
measured in practice?
• Other ways to decompose GDP.
Definition of Gross Domestic Product
• GDP ≡ The value of all goods & services
produced in the economy in the year.
o GNP ≡ GDP + income from investments abroad.
o Gross National Income ≡
GNP + income from unilateral transfers.
o Net National Income ≡ GNI – depreciation of capital stock.
• Real GDP ≡ Nominal GDP / GDP deflator.
• We will use Y to denote real GDP or real income.
• GDP is not a comprehensive welfare measure:
– It omits environmental externalities, leisure, & lots more.
Potential output and the output gap
• 𝑌 ≡ Potential output = A F(K, N, Land);
– F( ) ≡ an aggregate neoclassical production function;
– K ≡ the capital stock
• when operating at the capacity it was designed for;
– N ≡ labor force
• when employed fully or at least at the natural rate;
– A ≡ Total Factor Productivity.
• Output gap ≡ (𝑌 - Y), as a percentage.
• 𝑌 is in the realm of growth theory
or economic development.
• (𝑌 - Y) is in the realm of macroeconomics (API-120):
– Goods and labor markets may not clear in the short run.
A simple functional form: Cobb-Douglas
• 𝑌 = F( ) = A (Kα Nβ Landγ).
• Most common special case -–
–
Constant returns to scale:
α + β + γ = 1.
Diminishing returns to each factor of production:
α < 1; β <1; γ <1.
• Growth decomposition:
– Growth rate
𝑑𝑦
𝑑𝑡
=
𝑑𝑎
𝑑𝑡
+ α
𝑑𝑘
𝑑𝑡
+ β
𝑑𝑛
𝑑𝑡
.
Growth decomposition, continued
• K grows through fixed investment (net of depreciation).
• N grows through population growth,
•
•
•
•
including immigration.
Also rises in labor force participation (e.g., women entering);
rural-urban migration; and
human capital accumulation (education & training).
• Total Factor Productivity
• grows through technological progress & economic efficiency.
Some historic theories, as examples
• Malthus (1798): A fixed supply of arable land & γ>0
=> Y rises more slowly than population.
– But he underestimated TFP growth.
• Solow (1957): Growth decomposition numbers say
TFP explains far more than capital accumulation does.
• Endogenous growth theory,
– e.g., P. Romer (1986): α = 1.
– Technical change is embodied in capital.
• “The Myth of the Asian Miracle”
– A.Young (1994, 1995) & P.Krugman (1994):
– The success of Singapore & other Asian countries can
be explained by factor accumulation, not TFP growth.
How is potential output 𝑌 computed in practice ?
Three ways:
1. Aggregate production function Y = F(K,N)
– Plug in the labor force employed at natural rate: N=𝑁,
–
"
capital stock K working at full capacity.
– Conceptually the right definition.
• But less practical.
2. Time trend
– E.g., H-P filter.
3. Estimate 𝑌 as
value of Y above
which inflation
tends to accelerate.
IMF estimates of output gap, as percentage of GDP, 2009
Jpn
UK
US
France
Ir
In 2009, after the global financial crisis, advanced countries suffered
much larger output gaps than in preceding recessions: Y << Y .
Source: IMF, via Economicshelp, 2009
API-120 - Prof.J.Frankel, Harvard University
Inflation everywhere fell in 2008-09,
in response to the output gap of the great recession.
IMF, April 2016, WORLD ECONOMIC OUTLOOK
http://www.imf.org/external/pubs/ft/weo/2016/01/pdf/text.pdf
Source: IMF WEO Oct. 2015
The euro zone looks the region with the highest gap now.
Alternative estimates of the output gap in the euro area, 1993-2015
%
points
Jarocinski
& Lenza,
ECB, 2016
1995
2000
2005
2010
2015
The euro area output gap is estimated as the common factor underlying the business cycle fluctuations in a set of real activity indicators and core inflation. The criterion
used to rank the different output gap estimates is their ability to forecast inflation in an evaluation which takes into account the data releases available in real-time.
Alternative views of trend real GDP in the euro area, 1993-2015
Trend, model 4
Trend, model 6
Log
scale
GDP: log level
1995
2000
2005
2010
2015
M. Jarocinski and M. Lenza (2016): “An inflation-predicting measure of the output gap in the euro area”,
Jarocinski & Lenza, ECB, 2016
http://www.ecb.europa.eu/pub/economic-research/resbull/2016/html/rb160701.en.html,
ECB Working Paper, Chart 3a.
Other ways to decompose GDP
• To whom the goods & services are sold (expenditure side of GDP):
–
–
–
–
C
+I
+G
+ X-M .
• How the income is used:
– Taxes net of transfers, T, leaving disposable income :
– Consumption C
Yd
– + Saving S.
}
• Allocation of income shares according to factors of production:
– Wages & salaries
– Capital income.
End of Review Lecture (i):
• GDP definitions
To be followed by:
• (ii) More identities
– Balance of payments accounting
– The National Saving Identity
• (iii) The Keynesian multiplier model
Lecture (ii) –
More identities
• Balance of Payments accounting
• The National Saving identity
Balance of payments accounts
• Definition:
The balance of payments is the year’s record
of economic transactions between domestic
and foreign residents.
• The rules:
– If you have to pay a foreign resident -normally in exchange for something that you bring into
the country -- then the something counts as a debit.
– If a foreign resident has to pay you
for something, then the something counts as a credit.
“Primary income,” mainly investment income
≡ “secondary income”
NOW CALLED “FINANCIAL ACCOUNT”
Examples of a debit on the current account:
• You, an American, buy DVDs from India
=> import appears as debit on US merchandise account.
• You import services (electronically) of an Indian software firm =>
debit appears on US services account (“overseas outsourcing”).
• You buy the services, instead, from a subsidiary that the Indian
software firm set up last year in the US. This is not an
international transaction, and so does not appear in the accounts.
– But assume the subsidiary then sends profits back to India
=> US reports payments of investment income.
It is as if the US is paying for the services of Indian capital.
• Employees of the subsidiary in the US (or any other US resident
entities) send money to relatives back in India
=> US reports paying unilateral transfers .
API-120 - Prof.J.Frankel, Harvard University
Examples of debits on the financial account
(previously “capital account”), long-term
 Instead of buying DVDs from India,
you buy the company in India that makes them.
=> acquisition of assets (debit) under Foreign Direct Investment (FDI).
 Instead of buying the entire company in India,
you buy some stock in it
=> acquisition of portfolio investments (equities).
 Instead of buying stock in the company,
you lend it money for 2 years
=> acquisition of portfolio investments (bonds or bank loans).
API-120 - Prof.J.Frankel, Harvard University
Examples of debits on the financial account, short term:
 You lend to the Indian company in the form of 30-day
commercial paper or trade credit
=> acquisition of short term assets
(Debit: You have “imported” a claim against India.)
 You lend to the Indian company in the form of cash dollars,
which it doesn’t have to pay back for 30 days
=> acquisition of short term assets .
 You are the Central Bank, and you buy securities of the
Indian company (an improbable example for the Fed –
but some central banks now diversify international investments)
=> increase in US official reserve assets.
API-120 - Prof.J.Frankel, Harvard University
The rules, continued
• Each transaction is recorded twice:
– an import of a good or security has to be paid for.
E.g., when an importer pays cash dollars, the import on
the merchandise account is offset under short-term capital:
the exporter in the other country has, at least for the
moment, increased holdings of US assets, which counts
just like any other portfolio investment in US assets.
• At the end of each quarter, credits & debits
are added up within each line-item;
• and line-items are cumulated from the top
to compute measures of external balance.
API-120 - Prof.J.Frankel, Harvard University
Some balance of payments identities
• CA ≡ Rate of increase in net international investment position.
– A CA surplus country accumulates claims against foreigners
– A CA deficit country borrows from foreigners.
• BoP ≡ CA + KA
• => BoP ≡ excess supply of FX coming from private sector,
which central banks absorb into reserves
(if they intervene in the FX market, e.g., to keep exchange rate fixed).
– A BoP surplus country adds to its FX reserves (esp. US T bills).
– A BoP deficit country runs down its FX reserves,
unless it is lucky enough (US) that foreign central banks finance its deficit.
• A floating country does not intervene in the FX market
• => BP ≡ 0;
• Exchange rate E adjusts to clear private market FX supply & demand.
API-120 - Prof.J.Frankel, Harvard University
The National Saving identity
• Useful for many purposes.
• In lecture (iii) we will use it to express
the Keynesian multiplier model.
• To derive the national saving identity,
– first, consider two ways of decomposing GDP.
Two ways to decompose GDP
• To whom the goods & services are sold (expenditure side of GDP):
–C
– +I
– +G
– + X-M.
• How the income (Y) is used:
– Taxes net of transfers, T,
– leaving disposable income Yd:
• Consumption C
• + Saving S.
}
= Yd
Derivation of National Saving Identity
Income ≡ Output
(assuming no transfers or investment income)
Y ≡ GDP
/C + S + T ≡ C/ + I + G + X -M
S + (T-G) ≡ I + X – M
NS ≡
S + BS ≡ I + CA
API-120 - Prof.J.Frankel, Harvard University
National
Saving
Identity
Household savings
Corporate savings
Government savings*
* Excludes govt. investment spending
Eswar Prasad, 2009,
“Rebalancing Growth in Asia,”
Finance and Development,
IMF, December, p.21.
API-120 - Prof.J.Frankel, Harvard University
End of: Definitions & Accounting
API-120 - Prof.J.Frankel, Harvard University
Lecture (iii) –
Keynesian multiplier model
• Consumption function.
• Trade balance.
• Determination of income Y.
–
–
(i) algebraic
(ii) graphical
• The multipliers in an open economy
•
for an increase in spending 𝐴 ,
–
•
e.g., due to a fiscal expansion;
for an increase in exports 𝑋,
–
e.g., due to a devaluation.
The Keynesian consumption function:
Consumption depends less-than-proportionately on income
• C = 𝐶 + cY.
• What determines 𝐶 ? Three approaches -– Financial approach: Wealth, spread over a lifetime.
– Intertemporal optimization:
An estimate of permanent income ≡ Y in a normal year.
– Behavioral economics (e.g., habit formation):
• Level of consumption to which one has become accustomed.
• Marginal propensity to consume, c, can be derived:
– from the probability that an observed fluctuation in Y is permanent,
– or as a function of an impatience parameter,
– and perhaps the interest rate.
Imports depend similarly on income:
M = Md(E, Y)
= 𝑀 + mY
X = Xd(E)
=𝑋
where E ≡ exchange rate
assuming E fixed, for now.
=> TB = 𝑋 − (𝑀 +mY)
TB
+
0
-
…and rises in contractions
Y
TB falls in expansions…
where slope = -m ≡
- marginal propensity
to import
That is, the trade balance is counter-cyclical.
Prof. J. Frankel, Harvard University
Determination of equilibrium income
in open-economy Keynesian model
Y ≡ A + TB
≡ (C + I + G) + (X – M)
= (𝐶+cY + 𝐼 + 𝐺) + (𝑋 - 𝑀 - mY).
Now solve:
Y - cY + mY = 𝐶 + 𝐼 + 𝐺 + (𝑋 - 𝑀)
𝐶+𝐼+𝐺 + 𝑋 − 𝑀
𝑌=
1−𝑐+𝑚
𝐴+𝑋−𝑀
𝑌=
𝑠 + 𝑚
where 𝐴 = 𝐶+𝐼+𝐺 and s ≡ 1 – c.
Prof. J. Frankel, Harvard University
Keynesian Consumption Function: C = 𝐶 + cYd .
or, expressed as a saving function:
S = Yd - C = Yd - 𝐶 - cYd .
= - 𝐶 + sYd where s ≡ 1 – c.
Now we do it graphically.
}I
ITF220 - Prof. J. Frankel, Harvard University
Closed economy: NS – I = 0
Fiscal Expansion
1 < Closed-economy multiplier 1/s < ∞
Prof. J. Frankel, Harvard University
Open economy: NS – I = TB
=X–M
Imports: M = 𝑀 + mY for simplicity
Exports: X = 𝑋 for simplicity.
=> TB = 𝑋 − (𝑀+mY)
Prof. J. Frankel, Harvard University
Open economy
Fiscal Expansion
slope = s
G
ΔY =
1
𝑠+𝑚
Δ𝐺
1
𝑠
< Δ𝐺
Prof. J. Frankel, Harvard University
Fiscal
multiplier
𝑨↑, e.g., due to fiscal stimulus: 𝑮 ↑.
“Twin deficits”:
ΔG leads to both a fiscal deficit & trade deficit (US in 1980s & 2001-07).
But if the exogenous rise is ΔI, BD & TD move opposite directions (US in 1990s).
Example: Eurozone fiscal austerity has been contractionary.
Source: P.Krugman
May 10, 2012.
What about the critique that fiscal policy responded endogenously to the magnitude
of the countries’ difficulties? See Blanchard graph in Appendices.
Export
multiplier
𝑿 ↑, e.g., due to a devaluation: 𝑬 ↑.
The X-M line up by Δ𝑿. (See Lecture 1, for elasticities model).
But the rise in TB is partially offset by higher imports.
SUMMARY OF MULTIPLIERS
NS  I  X  M
+
Keynesian model of S + M
AXM
Y 
sm
=>
where A  C  I  G
Fiscal Expansion
Devaluation
1
Y 
A
sm
1
Y 
X
sm
open-ec. multiplier = 1/(s+m)<1/s
ΔTB  ΔM  - m Y
m

ΔA .
sm
ΔTB  ΔX  m Y
s

ΔX  ΔX .
sm
Note misprint in Equation (17.11), 10th ed. of WTP.
End of Macro Review
Lecture (iii):
The Keynesian
Multiplier Model
Prof. J. Frankel, Harvard University
Appendix 1: EU fiscal austerity, continued
The bigger the fiscal contraction, the bigger the GDP loss
relative to what had been officially forecast
=> true multipliers > than multipliers that IMF had been using.
Europe: Growth Forecast Errors vs. Fiscal Consolidation Forecasts
Source: Olivier
Blanchard &
Daniel Leigh, 2014,
“Learning about Fiscal
Multipliers from Growth
Forecast Errors,”
fig.1, IMF Economic
Review 62, 179–212.
Note: Figure plots forecast error for real GDP growth in 2010 and 2011 relative to forecasts made in the spring of
2010 on forecasts of fiscal consolidation for 2010 and 2011 made in spring of year 2010; and regression line.
Appendix 2: Goals & instruments
Policy Goals
• Internal balance: Y = Y
Y < Y ≡ ES ≡ “output gap” => unemployment > u
Y > Y ≡ ED => “overheating” => inflation
or asset bubbles.
• External balance:
e.g., CA=0 or BP=0.
Policy Instruments
• Expenditure-reduction,
e.g., G ↓
• Expenditure-switching,
e.g., E ↑ .
API-120 - Prof.J.Frankel, Harvard University
The principle of goals & instruments
• Can’t normally hit 2 birds with 1 stone
• Do you have n targets?
• => Need n instruments,
and they must be targeted independently.
• Have 2 targets: CA = 0 and Y = 𝑌?
• => You need 2 independent instruments:
expenditure-reduction &
expenditure-switching.
API-120 - Prof.J.Frankel, Harvard University
ADJUSTMENT DILEMMA
Starting from
current account deficit
at point N,
policy-makers can
adjust either by
(a) cutting spending, 
or
(b) devaluing.
●
A
●
 X 
Achieving both goals, CA & Y,
would require both instruments.
API-120 - Prof.J.Frankel, Harvard University
●
●