Download Introduction to Macroeconomics

Introduction to Macroeconomics
Prof Mike Kennedy
A word about the course
• Everybody wants to pass.
• Question is: how do you do it?
• Turns out the answer is easy and not surprising:
–
–
–
–
–
Study
Do the assignments
Come to the lectures
Avoid the post mid-term drop in attendance
Ask for help when you need it – we’re here for that
Why study macroeconomics and why now?
• If not now, when?
• The world economy, and with it the Canadian
economy, experienced a once-in-several-generations
downturn in 2008-09. While a recovery is underway,
there continue to be weak spots (like Europe and
now emerging markets)
• The US recovery has been gaining strength but here
as well there are weak spots
• But even without this, the subject remains very
important – what happens to the aggregate economy
affects everybody, most importantly by your chances
of finding employment.
What is Macroeconomics About?
• Macroeconomics is the study of the structure and
performance of national economies and of the
policies that governments use to try to affect
economic performance.
• Perhaps more interestingly, it is about how markets
interact – what happens in one market affects what
happens in another, sometimes in surprising ways.
• Microeconomics is more concerned with individual
markets and how they function.
• The two branches are related – macro needs good
micro foundations.
Issues Addressed by Macroeconomists
• The subject is empirical in nature.
– It seeks to answer what we observe in the
economy at large.
• For example:
– What determines a nation’s long-run economic
growth?
– What causes a nation’s economic activity to
fluctuate?
– What causes unemployment?
Issues Addressed by Macroeconomists
(continued)
– What causes prices to rise and to fall and does this
matter?
– How are interest rates determined?
– How does being a part of a global economic
system affect national economies?
– Why do some countries do well and others not?
– Can government policies be used to improve
economic performance?
Relevance of the course
• The models studied in this course are, at their
core, those used by professional and academic
economists.
• They are designed to try and answer the
questions just raised as well as others.
• Of note here is that when we use models it
means some math is required.
• But the advantage is that models help to
organize our thinking.
• Empirical verification is very important.
Prior to discussing growth, a
reminder: What is a growth rate?
Yt  Yt 1 
g  
 100
 Yt 1 


 Yt

g  
1 100
Yt 1

Yt
1 g' 
Yt 1
where g’ = g/100
Long-Run Economic Growth
• Rich nations have experienced extended periods
of rapid economic growth.
• Canada’s experience is typical of many advanced
economies.
• Some poor nations either have never experienced
them or economic growth has been offset by
economic decline.
• Others have managed to enter new periods of
strong growth – Brazil, Russia, India and China
(the BRICs) stand out, until recently.
• China has set the record for lowering poverty.
The Level of Canadian Output:
The series is indexed at 1.0 in 1961:Q1
6
1
0.9
5
0.8
0.7
4
0.6
3
0.5
Recession Canada
2
Real GDP
0.4
0.3
Poly. (Real GDP)
0.2
1
0.1
0
0
The level of US output:
The series is indexed at 1.0 in 1961:Q1
6
1
0.9
5
0.8
0.7
4
0.6
3
0.5
Recession US
2
Real GDP
0.4
0.3
Poly. (Real GDP)
0.2
1
0.1
0
0
Increased Output
• Total output is increasing because of increasing
population, i.e. the number of available workers.
• Increasing average labour productivity: the
amount of output produced per unit of labour
input or per hour worked.
• Productivity is key to determining living standards.
• More recently, economists have been focusing on
income distribution as well as political structures.
Canada’s GDP over the long haul
10
ln(RGDP)
9
Trend RGDP
8
7
6
5
4
Trend estimated using Hodrick-Prescott filter
Labour productivity has recently slowed
with consequences for income
2.9
2.7
2.5
2.3
2.1
1.9
1.7
* Defined as log differences
Labour productivity*
Labour productivity has recently slowed with
consequences for income
2.9
Labour productivity
2.7
Trend labour productivity
2.5
2.3
2.1
1.9
1.7
Defined as log differences, trend is calculated using a Hodrick-Prescott filter
Rates of Growth of Output
• Rates of growth of output (or output per
worker) are determined by:
– rates of saving and investment;
– rates of technological change;
– rates of change in factors of production.
• We will be studying this in Chapter 6.
Business Cycles
• Business cycles are short-run (we hope) contractions
and expansions of economic activity.
• The most volatile period in the history of Canadian
output was between 1914 and 1945.
• In the post WWII period, the recessions of ’53-54,
’81-82, ‘90-92 and ’07-08 stand out.
• An interesting question is whether or not the nature
of the business cycle is changing.
• Currently Canada, along with the world, is emerging
from the most severe post-war recession on record –
this one will go into the history books.
A look at the Canadian business
cycle in a historical context
20
15
Business cycle
10
5
0
-5
-10
-15
-20
Straight lines = +/- 2 standard deviations
Another look at the most recent
recession…
Output gaps*
5
4
3
AUS
2
CAN
1
FRA
0
DEU
ITA
-1
JAP
-2
ESP
-3
GBR
-4
USA
EUR
-5
OECD
-6
2002
2003
2004
2005
2006
2007
2008
* OECD estimates from Economic Outlook 95 June 2014
2009
2010
2011
2012
2013
2014
2015
… and its aftermath
Output gaps*
5
AUS
4
CAN
3
FRA
2
DEU
1
ITA
0
JAP
-1
ESP
-2
GBR
-3
USA
-4
-5
EUR
-6
OECD
2002
2003
2004
2005
2006
2007
* OECD estimates from Economic Outlook 95 June 2014
2008
2009
2010
2011
2012
2013
2014
2015
Recessions and Recoveries
• Recession is the downward phase of
a business cycle when national
output is falling or growing slowly.
• It is measured as the distance from
the previous peak to the trough.
• Recovery is the period starting just
after the recession trough.
The 2008-09 Canadian recession (green line)
compared with more recent ones
(GDP from peak)
1.01
Three Canadian recessions
1
0.99
0.98
1981-82
0.97
1990-92
0.96
2007-09
0.95
-2
-1
0
1
2
3
4
5
6
Quarters
7
8
9
10
11
12
13
14
The 2007-09 US recession (green line) compared with
recent downturns
(GDP from peak)
1.01
Three US recessions
1
0.99
0.98
1981-82
1990-92
0.97
2007-09
0.96
0.95
-2
-1
0
1
2
3
4
5
6
Quarters
7
8
9
10
11
12
13
14
Unemployment
• Recessions are usually accompanied by rising
unemployment: the number of people who are
available for and are actively seeking work but
cannot find jobs.
• Not counted are people who want to work but have
stopped looking – discouraged workers.
Unemployment rate = Unemployed/Labour Force
Labour Force = Total Employed plus Unemployed
Labour Force = Participation Rate × Source Population
The Unemployment Rate
• The unemployment rate can stay high even
when the economy is starting to do well.
• After fifteen plus years of economic growth, in
mid-2007, the unemployment rate in Canada
was near 6%.
• Unemployment has rose in the wake of the
recent recession hitting a peak of over 8½%.
• Currently it has eased back to around 6.8%
(Nov 2014)
Unemployment Rate from the ‘60s
onward
14.0
1
0.9
Recession Canada
12.0
Unemployment rate
0.8
0.7
10.0
0.6
8.0
0.5
0.4
6.0
0.3
0.2
4.0
0.1
2.0
Dec-55
0
Dec-59
Dec-63
Dec-67
Dec-71
Dec-75
Dec-79
Dec-83
Dec-87
Dec-91
Dec-95
Dec-99
Dec-03
Dec-07
Unemployment rate in the United
States
14.0
1
Recession US
0.9
12.0
0.8
Unemployment
rate
10.0
0.7
0.6
8.0
0.5
0.4
6.0
0.3
0.2
4.0
0.1
2.0
Dec-55
0
Dec-59
Dec-63
Dec-67
Dec-71
Dec-75
Dec-79
Dec-83
Dec-87
Dec-91
Dec-95
Dec-99
Dec-03
Dec-07
When countries suffer a banking crisis,
the employment recovery is very slow
The effect of the US recession on
employment over past three recoveries
1.02
US employment in three recessions
1.01
1
1981-82
0.99
1990-92
0.98
2007-08
0.97
0.96
0.95
0.94
-6 -4 -2 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 52 54 56 58 60 62 64 66 68 70
Months
How Canadian employment did during the past
three recessions
1.02
Canadian employment in three recessions
1.01
1
1981-82
0.99
1990-92
2007-08
0.98
0.97
0.96
0.95
0.94
-7 -5 -3 -1 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 61 63 65 67 69 71
Months
Inflation
• When prices of most goods and services are rising over
time it is inflation. When they are falling it is deflation.
• The inflation rate is the percentage increase in the
average level of prices.
• Inflation rates vary widely across countries from
deflation in Japan and Switzerland to hyper inflation in
Zimbabwe.
• Canada has seen both deflation (in the Great
Depression) and high inflation (in the late 1970s).
• Recently (between June and September of 2011)
Canada saw mild deflation.
• Currently the rate is positive and low.
Recent inflation in Canada
14.0
1
Recession Canada
12.0
0.9
Inflation rate
0.8
10.0
0.7
8.0
0.6
6.0
0.5
0.4
4.0
0.3
2.0
0.2
0.0
-2.0
Dec-55
0.1
0
Dec-59
Dec-63
Dec-67
Dec-71
Dec-75
Dec-79
Dec-83
Dec-87
Dec-91
Dec-95
Dec-99
Dec-03
Dec-07
Recent inflation in the US
14.0
1
0.9
12.0
Recession US
0.8
Inflation rate
10.0
0.7
8.0
0.6
6.0
0.5
0.4
4.0
0.3
2.0
0.2
0.0
-2.0
Dec-55
0.1
0
Dec-59
Dec-63
Dec-67
Dec-71
Dec-75
Dec-79
Dec-83
Dec-87
Dec-91
Dec-95
Dec-99
Dec-03
Dec-07
Inflation Among Developed Economies
% change
United States
25
Japan
Germany
United Kingdom
20
France
Italy
15
Canada
Spain
Australia
10
Belgium
Netherlands
Sweden
5
Norway
Denmark
0
y-1960y-1963y-1966y-1969y-1972y-1975y-1978y-1981y-1984y-1987y-1990y-1993y-1996y-1999y-2002y-2005y-2008y-2011
Austria
Finland
-5
Average
Canadian Inflation vs. the Average
16.0
14.0
Inflation = 0.88×(Average)
R² = 0.86
12.0
Canada
10.0
8.0
6.0
4.0
2.0
0.0
0.0
2.0
4.0
6.0
8.0
Average
10.0
12.0
14.0
US Inflation vs. the Average
14.0
Inflation = 0.83×(Average)
R² = 0.71
12.0
10.0
United States
8.0
6.0
4.0
2.0
0.0
0.0
2.0
4.0
6.0
8.0
-2.0
Average
10.0
12.0
14.0
German Inflation vs. the Average
14.0
12.0
Inflation = 0.85 + 0.42×(Average)
R² = 0.62
10.0
Germany
8.0
6.0
4.0
2.0
0.0
0.0
2.0
4.0
6.0
8.0
-2.0
Average
10.0
12.0
14.0
Effects of Inflation
• Inflation can erode incomes, especially of those
people on pensions or other fixed incomes.
• When the inflation rate reaches an extremely
high level, economies tend to function poorly
and growth stalls due to the distortions it
causes.
• Inflation can also damage investment by creating
uncertainty.
• Determining the right level of inflation is a big
policy issue but we know the right level is low.
Effects of Inflation con’t
The International Economy
• An economy which has extensive trading and
financial relationships with other national economies
is an open economy.
• An economy with no relationships is a closed
economy.
• International trade and borrowing relationships can
transmit business cycles from country to country.
– In the recession of 2007-09, this was an important
transmission mechanism for Canada.
Exports and Imports
• Canadian exports are goods and services
produced in Canada and consumed abroad.
• Canadian imports are goods and services
produced abroad and consumed in Canada.
• Trade imbalances (trade surplus and deficit)
affect output and employment.
– Trade surplus: exports exceed imports.
– Trade deficit: imports exceed exports.
Exports and Imports over time
45
20
Net exports (% GDP) Right hand scale
Exports (% GDP)
40
Imports (% GDP)
15
35
10
30
5
25
0
20
-5
Why Trade is Important: Shocks in the US (and
the world) get transmitted quickly to Canada
4.00
1
0.9
2.00
0.8
0.7
0.00
0.6
-2.00
0.5
0.4
-4.00
0.3
Recessions in Canada
-6.00
USA
-8.00
0.2
Canada
0.1
0
The Exchange Rate
• The trade balance is affected by the exchange rate.
• The exchange rate is the amount of Canadian dollars
it takes to buy a unit of foreign currency.
– Relative to the US$, the rate has fluctuated widely over the
past number of decades from a low of $1CAN = $0.62US
in Jan 2002 to a high of $1CAN = $1.10US in Nov 2007. It
is now below par with the US dollar ($0.85US as of Friday).
• Some of this weakness may be due to the fall in the
price of oil.
Exchange rate since 1971:
An increase is an appreciation
1.1
1
1.1
0.9
Canadian recession
1.0
0.8
Exchange rate: US$ per C$
1.0
0.7
0.9
0.6
0.9
0.5
0.8
0.4
0.8
0.3
0.7
0.2
0.7
0.1
0.6
Dec-66
0
Dec-70
Dec-74
Dec-78
Dec-82
Dec-86
Dec-90
Dec-94
Dec-98
Dec-02
Dec-06
The effect of oil prices on the
Canadian dollar
Macroeconomic Policy
• A nation’s economic performance depends on:
–
–
–
–
–
natural and human resources;
capital stock;
technology;
economic choices made by citizens; and
macroeconomic policies of the government.
• Macroeconomic policies:
– Fiscal policy: government spending and taxation at all levels.
– Monetary policy: the central bank’s control of short-term interest
rates and the money supply.
– The two can can interact as developments by one can cause
difficulties for the other and vice versa.
– We now worry about something called macro-prudential policy
policy, something that arose in the wake of the current recession.
Budget Deficits
• The economy is affected when there are large budget
deficits: the excess of government spending over tax
collection.
• The large budget deficits of the 1980s and early
1990s were unusual.
– Borrowing from the public might divert funds from more
productive uses – called crowding out.
– Federal budget deficits might be linked to the decline in
productivity growth – firms may not want to invest
because of concerns of future tax increases.
– After 10 plus years of surpluses the budget is once again in
deficit because of the recent recession.
– The more recent projections now call for a small surplus.
Canada had government surpluses
until the great recession
10
1
0.9
5
0.8
0.7
0
0.6
-5
0.5
0.4
-10
0.3
Recessions
-15
0.2
Government saving (% GDP)
0.1
-20
0
Components of government balances
28
1
Recessions
0.9
Government spending as % GDP
26
Government revenues as % GDP
0.8
24
0.7
0.6
22
0.5
20
0.4
0.3
18
0.2
16
0.1
14
Q1-1981
Q3-1983
Q1-1986
Q3-1988
Q1-1991
Q3-1993
Q1-1996
Q3-1998
Q1-2001
Q3-2003
Q1-2006
Q3-2008
Q1-2011
0
Q3-2013
Government debt as per cent of GDP
Federal government starts
aggressive deficit reduction
Non-central government debt % GDP
100
Central government debt % GDP
80
60
40
20
0
y-1991
y-1993
y-1995
y-1997
y-1999
y-2001
y-2003
y-2005
y-2007
y-2009
y-2011
y-2013
Aggregation
• Macroeconomists ignore distinctions between
individual product markets and focus on
national totals.
• The process of summing individual economic
variables to obtain economy wide totals is
called aggregation.
– We will be discussing this in the next lecture.
What Macroeconomists Do?
•
•
•
•
Macroeconomic forecasting
Macroeconomic analysis
Macroeconomic research
Data development
Forecasting
• Macroeconomic forecasting – prediction of future
economic trends - has some success in the short run.
• In the long run too many factors are highly uncertain
to provide anything more than an idea of trends.
• Still it is useful in a ceteris paribus sense.
The Forecasting Record of Business
Economists
Forecasters can get it wrong sometimes:
A look at the record at forecasting the recession
(total OECD GDP)
What we said at each point in time
• June/2007
“The expansion should remain on track”
• Dec/2007
“The expansion should ease somewhat”
• June/2008
“Growth is slowing sharply”
• Dec/2008
“Growth is plunging”
Forecasting long-term interest rates
Another look at forecasting long-term interest
rates: What markets were expecting
Macroeconomic Analysis
• If we’re not good at forecasting, why do it?
– Perhaps because we make errors
• there is information in those errors about key aspects of the economy like
productivity or structure features of the economy.
– This is where economic analysis comes in.
• Macroeconomic analysis – analyzing and interpreting
events as they happen – helps both private sector decisions
and public policymaking.
• Here as well there are difficulties, partly because of politics
but they can be overcome.
– Examples here include trade, tax policy, environment, regional
concerns.
Macroeconomic Research
• Macroeconomic research – trying to
understand the structure of the economy
in general – forms the basis for
macroeconomic analysis and forecasting.
• There are a very wide variety of topics.
• Historical experience is important.
• It is the engine that pulls the train.
Theory
• How is research carried out?
• Economic theory: a set of ideas about the
economy to be organized in a logical
framework.
• Economic model: a simplified description
of some aspects of the economy.
Developing and Testing a Theory
• State the research question.
– Is this an interesting and useful line of enquiry?
• Make provisional assumptions.
– Are the assumptions reasonable and realistic?
• Conduct empirical analysis.
• Work out the implications of the theory.
– Does the theory have implications that can be tested by
looking at the real world?
• Evaluate the results – here forecasting can be helpful
but in addition, see how well the model fits the facts.
Data Development
• Macroeconomists use data to assess the state of the
economy, make forecasts, analyze policy alternatives,
and test theories.
• Most data is provided by the public sector but more
and more by the private sector as well.
• Providers of data must:
– Decide what types of data should be collected based on
who is expected to use the data and for what purpose.
– Ensure the measures of economic activity correspond to
economic concepts.
– Guarantee the confidentiality of data.
Why Macroeconomists Disagree
• A positive analysis examines the economic
consequences of an economic policy or other
development, but it does not address its
desirability.
• Normative analysis tries to determine whether a
certain economic policy should be used.
• Economists disagree:
– on normative issues due to differences in values.
– on positive issues due to different schools of thought.
The Classical Approach
• The invisible hand of economics: General
welfare will be maximized if:
– there are free markets, with no
impediments/frictions to adjustments;
– individuals act in their own best interest; and
– importantly this view took the distribution of
income as a given.
Hayek has often been considered
as the great classical rival to
Keynes
The Classical Approach (con’t)
• To maintain market equilibrium – the quantities
demanded and supplied must be equal:
– Markets must function without impediments – there are no
frictions.
– Wages and prices should be flexible over a reasonably
short time period.
• According to the classical approach, the government
should have a limited role in the economy – largely
because there is no need for it to do anything except
provide public goods like defense.
• The “least government is the best government”.
• It depends on markets not failing.
The Keynesian Approach
• In the Great Depression, the classical view did not
seem to fit the facts – markets were failing to do
their job or were taking too long to do it.
• Keynes (1936) assumed that wages and prices
would adjust slowly and then studied the
implications.
• Thus, markets could be out of equilibrium for
long periods of time and unemployment can
persist.
• According to the Keynesian approach, it may be
useful for governments to take actions to
alleviate unemployment.
Keynes virtually invented
macroeconomics
The Keynesian Approach (cont’d)
• The government can purchase goods and
services, thus increasing the demand for output
and (hopefully) reducing unemployment.
• Newly generated incomes would be spent and
would raise employment even further.
• His influence held sway for some time but
declined in final 30 years of the 20th century.
• It is now re-ascending in the wake of the great
recession.
Evolution of the Classical-Keynesian
Debate
• After stagflation – high unemployment and
high inflation – of the 1970s, a modernized
classical approach reappeared.
• Substantial communication and crosspollination is taking place between the
classical and the Keynesian approaches.
Unified Approach to Macroeconomics:
The strategy behind the book
• Individuals, firms and the government interact in
goods, asset and labour markets.
• Macroeconomic analysis is based on the analysis
of individual behaviour.
• Keynesian and classical economists agree that in
the long run prices and wages adjust to
equilibrium levels.
• Each group is working hard to shore up their
underlying views.
• The basic model can be used either with classical
or Keynesian assumptions about flexibility of
wages and prices in the short run.
Ever since the first universities, the question on each
students mind has been the same