Download Lecture II Evolution of Macroeconomics: from the

Lecture II Evolution of Macroeconomics:
From Classicists to Keynes
Stephen Silver, Ph.D.
The Citadel
Shandong University, November 2010
The macro economy and its
performance
Before there was a Keynes, there was an
economics
And it was good
And it was found useful for explaining
economic fluctuations
And then a Great Depression fell upon the
Land, and economics was at a loss to
explain the events that befell the Land
Natural Log of Industrial Production:
United States, 1790 - 2009
12
10
6
4
y = 0.0427x + 1.7867
2
0
17
90
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00
18
10
18
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18
30
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40
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50
18
60
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70
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80
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90
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00
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10
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30
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40
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50
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60
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70
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80
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90
20
00
Ln(IP)
8
Year
Industrial Production with
polynomial trendline
Natural Log of Industrial Production: 1790-2009
12
y = 0.0448x + 1.6877
10
Ln(IP)
8
y = 3E-09x4 - 2E-06x3 + 0.0002x2 + 0.0409x + 1.4245
6
4
Ln(IP)
Linear (Ln(IP))
Poly. (Ln(IP))
2
0
90
17
00
18
10
18
20
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30
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40
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50
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60
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70
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Year
10
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29
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39
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49
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59
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69
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79
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89
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99
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09
20
Why look at Ln(IP)?
• We use IP as it is available monthly and for
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•
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much longer period than GDP, which also is
now published quarterly and only since 1929
If Yt = Y0*ert, then ln(Yt) = A + rt, where A =
ln(Y0);
so ln(Yt) is linear in t and eA approximates Y0
Thus the slope of the ln(Y) is the annual rate of
change of the series
Furthermore, r = [ln(Yn) - ln(Y0)]/n
Stylized Facts of US Growth
• Growth of industrial production in the U. S.
•
averaged 4.3% from 1790 to 2009 (the slope over
that period)
The growth rate of industrial production has
slowed considerably
– As seen on the graph, the ln(IP) has begun to
flatten out
– The last several years, U. S. industrial
production has leveled off significantly.
– And as manufacturing unemployment has
become very important in the political arena as
well, the series has added importance beyond
its relative importance in US GDP
– For China, which has come to symbolize the
source of our manufacturing job losses, this
perception in the US is very important
U.S. Gross Domestic Procduct;
1960-2009
U.S. GDP; 1960-2009
11
US GDP: 1960-2009
10
Linear (US GDP: 1960-2009)
Year
20
00
19
90
19
80
19
70
9
19
60
LN(Real GDP)
y = 0.0279x + 9.5917
• GDP growth has slowed over the past five
decades to under 3%
• And very recently, real GDP actually
declined as the financial crisis recession
deepened
• This has led to a great deal of
dissatisfaction with Washington and with
those trading partners that are perceived
to be the “cause” of U. S. economic woes
• Many have resorted to such tactics as
“China bashing”
Historical world growth trends
Level and Rate of Growth of GDP per capita; world and major regions, 0-1998 AD
Year
0
GDP per capita
1000
1820
1998
GDP per capita growth rates
0-1000 1000-1820 1820-1998
Regions
Western Europe
Western Off-shoots
Japan
450
400
400
400
400
425
1232
1201
669
17921
26146
20413
-0.01%
0.00%
0.01%
0.14%
0.13%
0.06%
1.50%
1.73%
1.92%
Group A
443
405
1130
21470
-0.01%
0.13%
1.65%
Latin America
Eastern Europe & CIS
Asia
Africa
400
400
450
125
400
400
450
416
665
667
575
418
5798
4354
2936
1368
0.00%
0.00%
0.00%
0.12%
0.06%
0.06%
0.03%
0.00%
1.22%
1.05%
0.92%
0.67%
Group B
444
440
573
3102
0.00%
0.03%
0.95%
World
444
435
667
5709
0.00%
0.05%
1.21%
Based on the work of Angus Maddison, The World Economy in Millenial Perspective (2001)
Comparative Growths
Per Capita Growth for High and Low Growth Countries
25000
Group A
Group B
World
20000
15000
10000
5000
0
0
1000
1820
1998
Growth graphs for five rates
DIfferential Growth Rates over 50 Years
12
0.50%
1%
2%
3%
5%
10
Value
8
6
4
2
0
1
6
11
16
21
26
Time
31
36
41
46
Rule of 70 (69.3 really)
Let Y = Y0 * ert; if Y0 = 1 and Yt= 2, we get
ln[Yt/Y0] = ln(Yt – ln(Y0))= ln(2) = .693
Thus, the annual rate r = [ln(Yt– ln(Y0))/t = .693/t,
so rt = .693t If r is expressed in percent,
then 100rt = 69.3 or about 70
Example 1: A bond pays me 5% for 20 years. How long
will it take to double my money? Since 70/5 = 14,
so 14 years
Example 2: What rate will I need to double my money in
10 years? 70/10 = 7, so 7%.
Rule of 70 applied to our growth rates
So what’s the difference between 1% and 5%
growth over the 50 years?
Since 5% doubles every 14 years, after 42 years it
will have doubled three times and we have
another 8 years of 5% growth, so it’s clearly
over 10
The 1% growth path requires 70 years to double,
so it’s not there yet, so the 5% growth path is
well over 10/2 = 5 times as big
In fact, e.05*50/(e.01*50) = e2.5/e.5 = e(2.5-.5) = e2 =
7.389
How long until 中国 GDP > 美国的？
• Right now percapita GDP in US is about
•
•
•
•
US$50,000
China per capita GDP is maybe US$5000
With 4 times the population, therefore, USGDP/China-GDP is about 2.5
Letting China’s GDP grow at 8% and the US at
3%, on average, China closes the gap by 5%
per year. Since it must more than double, it will
take 70/5 = 14 years or more
Let’s say by the year 2025
How long until 中国 GDP per capita > 美国的？
• Never! Why?
• Some people back in the 1970’s were even
predicting that Japanese GDP would
overtake the US GDP
• But on a PPP basis even the per capita
GDP of Japan remains below that of the
US. Why?
Factors of production
• A country with limited resources, even
with a highly-skilled labor force, will have
a very difficult time passing the US, which
is relatively under-populated; that is, with
much more resources per person
• So let’s look at a nation’s “aggregate
production function”
Aggregate Production Functions
for U.S. and China
120
Y = AF(K,L) China
100
Y = AF(K,L) U.S.
80
Q
YChina
60
Y U.S.
40
20
0
0
0.2
0.38 0.56 0.72 0.88 1.02 1.16 1.28
1.4
1.5
1.6
1.68 1.76 1.82L
Cobb-Douglas Production Function
The Cobb-Douglas ProductionFunction is Y = f(L,K)
= ALbKc
If we think of K as representing all other inputs to
production, then doubling all inputs will necessarily
double output
Thus, we can use the following constant returns to
scale (CRS) function Y = f(L,K) = ALbK1-b
Note that if we substitute 2K and 2L for K and L we
get Y = A(2L)b(2K)1-b = ALbK1-b*2b+(1-b) = 2ALbK1-b
In Per Capita Terms
Now Y/L = ALb-1K1-b = A(K/L)1-b = g(K/L)
So if K/L in a country is much less than in another country,
then A, which is commonly referred to as total factor
productivity, must be much greater in the resource poor
country
We can now plot against K/L or as is often done, we take K as
given and plot Y against L
This is how we got the plot we showed earlier; the reason
China’s PF lies below that of the U.S. is that with less other
factors per worker, each worker will be less productive
The derived demand for labor
• In the function Y = g(L),the Marginal product of
•
•
labor MPL = dY/dL is the slope of the PF
The marginal cost of labor MCL, in real terms, is
W/P, where W is the “wage rate” and P is the
price level
So long as MPL > MCL the economy should hire
more labor and stop at the point MPL = W/P;
thus the demand for labor is the slope of the
aggregate production function
Aggregate Production Function
2
Y* = A*F(K,L)
1.8
Y = AF(K,L)
1.6
1.4
Q1
Q
1.2
1
0.8
Qf
0.6
0.4
Q2
0.2
0
L2
L
L1
(W/P)
Demand for Labor Curves
2.5
MPL = W/P
2
DL1 = MP1
DL2 = MP2
1.5
1
(W/P)1
0.5
(W/P)2
0
L2
L1
L
Walras and Pareto
• The Swiss economist Leon Walras showed that
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general equilibrium will occur in all markets
simultaneously at their equilibrium prices and
quantities as market forces bid up or down
prices in response to excess demand and supply
conditions in those markets
The Italian economist Wilfredo Pareto also
showed that in general equilibrium, no individual
in the market can be made better off without
necessarily making someone else worse off
This is called Pareto optimality
Aggregate versus micro
• The APF in the classical model is just the
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•
summing up of all the markets, and it was
assumed that is all markets are at equilibrium,
where MPL = MCL, that that the APF will look
just like the individual market functions
It was Samuelson that showed in Foundations of
Economic Analysis that this is not necessarily
the case
This struck a hole in the case laid by the
classical economists and paved the way for
Keynes, who had assumed that not all markets
would clear at a point where MR = MC; in
particular, there could be less than full
employment equilibrium
Features of the Great
Depression
• Started at the end of 1929 – we just passed the
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81st anniversary of the beginning of the most
severe economic crisis in Western history.
Lasted an entire decade
At its worst more than 25% of the U. S.
population (with similar numbers throughout
Europe) was measured as unemployed
Counting the underemployed and discouraged
workers, it was perhaps more like 50%
Prices fell 30% between the end of 1929 and
1932
Industrial production fell over 60% from its peak
in 1929
The Dow Jones Industrial Average had lost 90%
of its value by 1932
3.5
3
2.5
2
1.5
1
0.5
0
n59
n54
Ja
Month
Ja
n49
Ja
n44
Ja
n39
Ja
n34
Ja
n29
Ja
Ja
n24
y = 0.0036x + 0.6755
n19
Ja
IP
U. S. Industrial Production: Natural Logs,
1919-1959
Stock Market Dow-Jones Industrial Avg.
Official Unemployment Rates:
Great Depression and Today
Following are scenes typical of the
Depression in the United States
“Soup Line”
Broken Down on the way to
California
“Shanty”
“Will work for food”
“Don’t Stop Here”
“Dust Bowl”
“Job Opening – one position
only”
John Maynard Keynes
• As we saw, Keynesian economics is based on the
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•
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idea that monetary policy may be useless in
creating jobs and increasing output
Fiscal policy was able to generate output directly
via government purchases of goods and services
Through the multiplier effect, this additional
demand and increased income increases
consumer demand further, thus generating still
more output
Keynes’ Law – Demand creates its own supply –
versus Says’ Law – Supply creates its own
demand
Key features and deficiencies of
Keynesian Theory
• Keynes’ general theory based on the principal that full-employment
equilibrium is a polar case of a more general macroeconomics in
which any employment level is possible
• Naming may have been influenced by Einstein’s general theory of
relativity of which was a more general form of the specific theory
most people were familiar with
• His analysis was based on the influence of expectations over
“animal spirits” that convinced entrepreneurs to invest; such
expectations cannot be considered “irrational” when the economy is
experiencing “debt deflation”, the term used by Irving Fisher to
describe a financial crisis
• At the same time, some aspects of the model are deficient; these
deficiencies include:
Deficiencies
- Not accounting for disincentives created by
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government “giveaway” programs
Not accounting for disincentives to productivity
of income taxation
Assumption that the government will act both
wisely and benevolently in its actions
Ignores both the Ricardian Equivalence theorem,
which points out that individuals may save more
today to pay for future tax liabilities, and the
monetarists’ “crowding out” effect.
Paul Solman Interviews Two
Keynesian Authorities: Robert
Skidelsky and Russ Roberts
http://www.youtube.com/watch?v=vwsjPZgBOdU