Download Lecture 2 PPT - Kleykamp in Taiwan

Lecture 2
on the US Economy – 1st Hour
Lots of Dilemmas to Consider
How is the US Doing on Growth,
Unemployment, and Inflation?
These are the Big Three
indicators of how well the
economy is doing.
This Graph Assumes that US Potential Output
Growth Fell Substantially After 2009
Average or Natural Growth was about
2.5-3.0% for the US from 2000 - 2008
The US is in recovery now but growth is not
very high – only about 2.2% annualized rate
2010Q1-2014Q2.
Why has this happened? Many Possible
Reasons – Here are Two.
(1) Discouraged Worker Problem
Ex. 2 Workers where 1 has Job and the Other is
Unemployed
U-Rate = ½ = 50%
Now Suppose that the Unemployed Worker Leaves
the Labor Force. This means only 1 Worker in
Labor Force
U-Rate = 0/1 = 0%
This example shows a big drop in U-Rate, but NO
change in output.
(2) Part-Time Worker Problem
Ex. 2 Workers – 1 has Job the Other is Unemployed
U-Rate = ½ = 50%
Now Suppose that the Unemployed Worker Gets a
Part-Time Job (say 2 hours per week). This means
only 2 Workers in Labor Force and Both Have Jobs
U-Rate = 0/2 = 0%
This example shows a big drop in U-Rate but SMALL
change in output.
Unemployment Rate is Not a Good Measure of Progress
Forecasting Growth with
Constant Okun Coefficient
Forecasting Growth with
Declining Okun Coefficient and
Natural Growth
Okun’s Law is Weakening. Changes in Unemployment Generate Much
Weaker Changes in Economic Growth
It is very difficult for government to
create stable new jobs.
By
definition, the government is trying
to use temporary methods to restart
the economy.
Only private business can create
millions of jobs. Business needs to
see a permanently positive business
environment.
By the way, China is not really taking all that
many jobs from the US. The US is losing
manufacturing jobs, but not so much because
of cheap imports. Low priced imports are
helping to keep the real value of wages in
manufacturing high. That’s a good thing. The
real issues are productivity growth, exports,
and the change in demand towards services
Natural Unemployment
(5%-6%)
(0.5%)
Total US Unemployment Rate = 5.5 % + 0.6% = 6.1%
Lecture 2
on the US Economy – 2nd Hour
More Dilemmas to Consider
How about inflation in the US?
The costs of low and steady inflation are not really that high
Here is a short list of costs typically mentioned by economists
Unanticipated inflation can redistribute income between lenders
and borrows.
Inflation hurts people on fixed nominal incomes, especially the elderly.
Inflation makes it harder for firms to replace depreciated capital.
Inflation can increase real tax burdens, if rates are not indexed.
Inflation causes firms to waste real resources in re-labeling prices
and in forecasting future rates of inflation.
Unanticipated inflation can alter exchange rates and increase risk.
Inflation is often confused with all important changes in relative prices.
Inflation is a surreptitious tax on real money balances.
Many People are Arguing that We Should Increase
Inflation as a Means of Stimulating the Economy
Who are these people – Bernanke, Krugman, Yellen,
The argument is that the demand for money is too
high....people want to hold money and not goods and
services....this is slowing aggregate demand and
hampering a full expansion of the economy
....so, if people want more money, just give it to
them....give them so much that they will not want to
hold it anymore and will begin to spend it....and if they
wish to buy bonds -- they will not hold T-Bills (which are
like cash at the zero lower bound) but will try to buy
long term bonds, driving down long term interest rates
and stimulating investment...the increase in spending
will inflate the economy and things will begin to
expand...
But, what if there is a liquidity trap? Won’t people
just continue to hold the money after all. How can
that be inflationary or expansionary? They don’t
spend it.
Krugman, Summers, and others say that this is the
role of fiscal policy. Greater government spending
can drive the economy forward and can be
financed by the money creation. Governments can
borrow at extremely low interest rates and don’t
need to raise taxes. If that sounds inflationary...well
a little inflation can be good for the economy. The
cost is low compared to the social cost of
continued recession.
Thus, if people want money and do not want goods you merely issue
bonds, let the central bank buy these bonds and create money for the
government to spend and this will generate more money satisfying the
public’s demand to hold, while also creating greater spending by
government for business to supply. Doing this enough will make inflation
rise and raise the cost of holding money.
Keynes was a big believer in this excessive demand for liquidity theory
of recession...as can be seen from Chapter 17 Section 3 of the General
Theory.
“Unemployment develops, that is to say, because people want
the moon; — men cannot be employed when the object of
desire (i.e. money) is something which cannot be produced and
the demand for which cannot be readily choked off. There is
no remedy but to persuade the public that green cheese is
practically the same thing and to have a green cheese factory
(i.e. a central bank) under public control.”
Some Criticisms of This Policy
(1)It is not “people” but commercial banks that want to sit on trillions of
dollars of money (reserves held at the Fed). They do this because of
simple Keynesian liquidity preference – they expect higher rates will
prevail in the future and do not want to lend now at low rates.
(2)Pushing short term rates to zero (and making them negative in real
terms) has decreased the return to private lenders at this segment of the
yield curve. The effect on private financing of wage bills and inventory
and cash management is difficult to sort out. The market has been
distorted and this is a supply effect. (see next 2 pages)
(3)Purposively inflating without collective bargaining or indexing is
tantamount to an income transfer from workers and the retired on
relatively fixed incomes to the owners of capital.
(4)QE policies are generating asset inflation rather than general price
inflation, but it is inflation all the same, and at some time the bubble must
burst.