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I. Macroeconomics and Economic Policy I.1 Macroeconomics Scope of Interest, Essential Data I.1.1 Long-term economic growth • Differences among countries/regions • Factors of growth • Growth of what? (see Lecture II) – GDP vs. Wealth – Real vs. nominal Real GDP p.c., 1870 – 2009: USA, CND, AUS, J 1990 International Geary – Khamis dollars 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 1870 1880 1890 1900 1910 USA 1920 1930 Canada 1940 1950 Australia 1960 1970 Japan 1980 1990 2000 Real GDP p.c., 1870 – 2009: USA, CND, AUS, J 1990 International Geary – Khamis dollars, log scale 100,000 10,000 1,000 100 1870 1880 1890 1900 1910 USA 1920 1930 Canada 1940 1950 Australia 1960 1970 Japan 1980 1990 2000 Real GDP p.c., 1870 – 2009: F, D, I, UK 1990 International Geary – Khamis dollars 25,000 20,000 15,000 10,000 5,000 0 1870 1880 1890 1900 1910 1920 France 1930 1940 Germany 1950 Italy 1960 1970 UK 1980 1990 2000 Real GDP p.c., 1870 – 2009: F, D, I, UK 100,000 1990 International Geary – Khamis dollars, log scale 10,000 1,000 1870 1880 1890 1900 1910 1920 France 1930 1940 Germany 1950 Italy 1960 UK 1970 1980 1990 2000 Real GDP p.c., 1900 – 2009: ARG, S 1990 International Geary – Khamis dollars 30,000 25,000 20,000 15,000 10,000 5,000 0 1900 1910 1920 1930 1940 1950 Argentina 1960 Sweden 1970 1980 1990 2000 Real GDP p.c., 1900 – 2009: ARG, S 1990 International Geary – Khamis dollars, log scale 100,000 10,000 1,000 1900 1910 1920 1930 1940 1950 Argentina 1960 Sweden 1970 1980 1990 2000 GDP p.c. in 1900 and 2009 and average growth rate 35,000 1990 International Geary-Khamis dollars 30,000 3.0% 2.5% 25,000 2.0% 20,000 1.5% 15,000 1.0% 10,000 0.5% 5,000 0 0.0% 1900 2009 AGR(%) I.1.2 Economic cycle • • • • Short-term fluctuations of GDP growth Factors of the cycle Is the cycle inevitable? Boom vs. recessions, link to politics and election cycle • Economic crisis, depressions • After last (2008-2009) depression: crisis of macroeconomics both as theory and as policy guidance Real GDP, %yoy 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 1980 1984 1988 1992 1996 EU USA 2000 2004 2008 2012 Inflation • Different measures: CPI (prevailing), GDP deflator and others (see different Lectures later) • What´s so wrong about inflation? • The specter of hyperinflations (see Lecture V) • Is low inflation always desirable (see discussion on recent macroeconomic problems) • A crucial change in inflation since 1950s: almost always positive (compared to previous periods) Inflation (CPI), %yoy 16 12 8 4 0 1980 1984 1988 1992 1996 -4 EU USA 2000 2004 2008 2012 Unemployment • See your macroeconomic textbook (e.g., Dornbush, Fischer, Mankiw or Blanchard) for definitions (and also see Lecture II) • Unemployment and negative social phenomenon • Link between inflation and unemployment – is there a negative correlation in the shortterm („trade-off“)? – Almost no correlation over the long-term Unemployment, % 12.0 10.0 8.0 6.0 4.0 2.0 0.0 1991 1995 1999 Euro area 2003 UK 2007 USA 2011 Inflation vs. unemployment, % short-term 4.5 12.0 4.0 10.0 3.5 3.0 8.0 2.5 2.0 6.0 1.5 1.0 4.0 0.5 0.0 1991 1995 1999 2003 2007 2011 2.0 -0.5 -1.0 0.0 EMU Inf US Inf EMU Unemp (r.h.) US Unemp (r.h.) UnRate CPI (rhs) 2010 2008 2006 2004 2002 2000 1998 1996 1994 1992 1990 1988 1986 1984 1982 1980 1978 1976 1974 1972 1970 1968 1966 1964 1962 1960 1958 1956 1954 1952 1950 Inflation vs. unemployment, % US, long-term 12.0 16.0 14.0 10.0 12.0 8.0 10.0 8.0 6.0 6.0 4.0 4.0 2.0 2.0 0.0 0.0 -2.0 Governments: Deficits and Debts • Deficit: the difference between revenues and expenditures of a particular government – Easy said, difficult to define and statistically cover – Net vs. Gross (interest payments) • Debt: on most general level – a public finance debt (total for the country) to both private and public creditors – Net or Gross again • Definitions and some data – see Lecture II Government Net Deficit, %GDP 10.0 5.0 0.0 -5.0 -10.0 -15.0 -20.0 -25.0 -30.0 -35.0 1991 1993 1995 1997 D 1999 E 2001 IRL 2003 GRE 2005 USA 2007 2009 2011 Government Net Debt, % GDP 120.0 100.0 80.0 60.0 40.0 20.0 0.0 1991 1995 1999 D 2003 E GRE 2007 US 2011 Current Account Deficit (CAD) • Each country has (today immense) economic (trade, financial, etc.) relations with the rest of the world • CAD: the difference between total exports and total imports of goods and services of a particular country – For more details see Lecture II Current Account Deficit, %GDP 10.0 5.0 0.0 -5.0 -10.0 -15.0 -20.0 1991 1993 1995 1997 1999 2001 D 2003 GRE 2005 2007 2009 2011 I.2 Macroeconomics Descriptive (Positive) Theory Macroeconomics • Describes the economy on the highest level of aggregation • Focus on macroeconomic aggregates, namely GDP (GNP), consumption, savings, investment, money, inflation, unemployment, public finance deficit, current account deficit, public debt, exchange rate, interest rate and others • Confines the analyses to following five sectors Sectors on macroeconomic level (1) • Households: all population, own and provide factors of production (labour, land, capital) to the firms, receive payments (income) from them and generate expenditures for goods and services (for final consumption) • Firms: “own” technology, employ factors, produce goods and services for final consumption (households, government, export) or for intermediate use (other firms, incl. foreign) Sectors on macroeconomic level (2) • Government (state): – Collects taxes – Manages activities that society expects from it: • spends on goods and services for public purpose (e.g. defence), on employees in state administration, even owns some firms (that produce goods and services) – “produces” public services • finances transfers and social benefits • Financial sector: provides transmission services that channel money from savers to borrowers (incl. government) • Foreign sector: purchases goods and services (exports), sells goods and services (imports), generates flows of capital out and into the domestic country (FDI in or out, debt financing, equity capital) Theory and models • Formalized relationship among economic variables (linked to statistical indicators) – Forms: verbal, graphical, mathematical • Building blocks: – Markets and agents – Focus of the model: endogenous variables – External environment: exogenous variables Structure • Structure of the model (based on theory): system of equations (functional forms, parameters) • Solution of the system: equilibrium values of endogenous variables • Concept of equilibrium: in some models/theories, equilibrium as a state of the rest, on some markets supply does not have to equal demand • Disturbance to equilibrium: change in exogenous variables, behavioural and structural changes (change in parameters or functional forms) or a random shock Time, static and dynamic models • Static model – Equilibrium: given exogenous variables, the model determines endogenous variables in a specific time moment – Comparative statics: given the change in exogenous variable(s), the endogenous variables adjust between two specific time moments, multipliers – Time length between the two moments: short, medium or long term adjustment • Dynamic (growth) model – determines the development of endogenous variables in time (growth trajectory) – Initial conditions – Assumptions about the time development of exogenous variables • Most of our course: static models and comparative statics I.3 Economic policies Normative Theory Towards “the norms” (1) • Descriptive theory tells us what is, normative theory tells us what ought to be • No formalization of normative theories here, but intuitively, what is “desired”? – Stable improvement of society’s welfare – Fair distribution of the welfare among the members of the society – In today’s globalized world, convergence of standards of living in the different regions of the world – Respect to future generation • Externalities (like environment) • Avoid excessive today’s debts being repaid in the future • Policies, executed by state, as a tool to achieve the norm (“a desired situation”) Potential confusion I • Differentiate: happiness, well-being, welfare, living standard, economic level • Macroeconomic policies, focused on production of goods and services (GDP)and employment, decisively affect only last two terms – They do significantly affect other three as well, but more as necessary, but not sufficient condition – Many other factors do influence people’s happiness and well-being Role of the state • Different role of the state • In modern history – 3 approaches how to meet the norms Adam Smith • 1723 – 1790 • Political economist and philosopher • 1751 – professor of logic at Glasgow University • 1759 – Theory of Moral Sentiments • 1776 - An Inquiry in the Nature and Causes of the Wealth of Nations Laissez faire capitalism • Free market and political democracy • Price as basic signal for production decisions (what, how, for whom) • Private ownership of means of production • Small government and minimal governmental policies/interventions • Efficient allocation of the resource assumed to be achieved via market efficiency Karl Marx • 1818 - 1883 • Philosopher, sociologist, historian, political economist, political theorist, revolutionary socialist • Communist Manifesto (1848, with Friedrich Engels) • Das Kapital (volume I 1869, volume II and III published posthumously) • Ideological founder of Marxism Central planning (socialism) • Consumption decided and resources allocated through the planning system, not according price signals • State ownership of productive means • Equal distribution of the wealth • Inconsistency with political democracy, need for centralized political power John Maynard Keynes • 1883-1946 • Cambridge, UK • Thinker – economics, logic, probability • Practitioner – Treasury during WWI, advisor to the War Cabinet at WWII, crucial role at the birth of IMF/WB Mixed capitalist economy. • Prevailing private ownership, cohabitating with the state ownership of certain assets • Free market cohabitating with governmental policies to cope with the deficiencies of the free market • Welfare state policies. General role of the state (1) • State executes different policies/interventions that affect general welfare of the society • Different groups (with different vested interests) may have different thoughts about the role of state here, examples: – Efficient allocation of the resources ⇒ cultivating the markets, regulatory and competition policies – Provision of essential services (e.g. basic education, defence) – Attempting to achieve a fair distribution of wealth across the society ⇒ welfare policies – Ensuring society’s needs (police, defence, legal system, coping with the externalities, etc.) ⇒ general role of state, not a policy General role of the state (2) – Transfer payments, providing minimal living standards (social policies, e.g. unemployment benefits) – Long-term social policies, e.g. securing the stable health care and pension systems – Regulation of natural monopolies – External social costs (e.g. drugs) and benefits (e.g. free vaccination) of the society – Support to industry and commerce Macroeconomic policies (1) • Fundamental measure of the economy: income(output), expressed as gross domestic product (GDP, see next lecture) • GDP development over time - GDP growth: – Over long period: long term growth • In search policies the determine the long-term differences in economic level among the countries – Over shorter period: business cycle • In search policies that help to overcome the fluctuations of GDP Macroeconomic policies (2) • Other basic economic variables, closely interlinked with/influencing both short- and longterm GDP growth (all the concepts will be shortly explained in Lecture II and III) – – – – – – – – (un)employment inflation Interest and exchange rate Components of aggregate demand: household consumption, private investment, expenditure of the state, exports, imports Factors, determining the aggregate supply: amount of capital and labor available, general productivity of country’s economy Public finance deficit Debt of public and private sector (and sum of both) Current account deficit and balance of payments Macroeconomic policies (3), but … • When translated into policies, this entails – – – – Fiscal policy Monetary policy Exchange rate policy International trade policy • However, since WWII, many other policies emerged – – – – Supply-side policy Price and income policies Employment policy … and maybe some other policies (according the ideology, political inclination and maybe populism of policy-makers) • in this course we almost exclusivelly cover only the policies above Some examples (1) Best illustrated by following examples: • Was the growth difference between 0-1800 and 1801-2000 result of some organized „governmental“ activities? – The power of markets? – Adam Smith, invisible hand • Was the Great Depression a result of the market failure? – Many believe yes (but not all). • Was an extraordinary growth after WWII a result of a careful economic policy of the governments? – Many macroeconomists 40 years ago convinced that yes (but in reality, it was not) Some examples (2) • Was the state intervention responsible for the high US inflation in 60‘s, EU high unemployment till today or Japanese problems in the 90‘s? – Very probably yes. • Was the unexpected outbreak of global financial and economic crisis after 2007 a failure of macroeconomics as a basis of proper policy formation? – Many people believe yes, your teacher not … Literature to Lecture I Prerequisite - microeconomics: • Any text from VSE or IES FSV UK • Varian, H.R.: Microeconomic Analysis. W.W.Norton&Company, New York, 1984 (2nd and subsequent editions plus Czech translation). • Henderson, J.M., Quandt, R.E.: Microeconomic Theory. McGraw Hill, 1958 (and subsequent editions). Prerequisite - macroeconomics: • Any text from VSE or IES FSV UK. • Mankiw, G.N.: Macroeconomics, Worth Publishers, New York, 1992 (and subsequent editions). • Blanchard, O.: Macroeconomics, Prentice Hall, 1997 (and subsequent editions). Data: • Maddison, A.: The World Economy, A Millennial Perspective, OECD, 2001. • Main sources: – IMF (World Economic Outlook (www.imf.org/external/data) – Eurostat (http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/themes) – Ameco, data base of the European Commission (http://ec.europa.eu/economy_finance/db_indicators/ameco/index_en.htm) – National Statistical Offices and Central Banks (ECB, FED, but also CNB) – In the US, also US Burreau of Labor Statistics