Download 1 - [MPC(1-t) – MPI]

Gross Federal Government Debt
$20,000
130%
Source: Office of Management and Budget
Dollar Amount
Percent of GDP
18,350
$18,000
17,440
120%
16,566
15,674
$16,000
14,456
$14,000
110%
100%
12,867
90%
80%
9,986
$10,000
8,951
8,451
$8,000
$6,000
$4,000
$2,000
70%
7,905
7,355
60%
6,760
6,198
5,770
5,606
5,629
5,478
5,369
5,181
4,921
4,643
4,351
4,002
3,598
3,206
2,868
2,601
2,346
2,121
1,817
1,565
1,372
1,137
995
909
829
777
706
629
542
484
466
408
436
369
366
381
303
310
3 1322
6 328
340
260
271
257
253
257
255
259
266
271
274
273
272
280
287
291
293
252
204
515879143
50%
40%
30%
20%
$0
40
44
48
52
56
60
64
68
72
76
80
84
88
92
96
00
04
08
12
Percent
$ Bilions
$12,000
Federal Government Debt
Held by Public
$20,000
$19,000
Dollar Amount
Source: Congressional Budget Office,
http://www.cbo.gov/doc.cfm?index=10014
120%
Pe rce nt of GDP
110%
$18,000
$17,000
100%
$15,000
14,541
14,181
13,820
13,473
13,169
12,840
12,463
12,148
11,773
$14,000
$13,000
$ Bilions
$12,000
11,153
$11,000
90%
80%
10,164
$10,000
70%
9,019
8,531
$9,000
60%
$8,000
$7,000
$6,000
$5,000
$4,000
$3,000
$2,000
$1,000
5,803
50%
5,035
4,829
4,592
4,296
3,913
3,772
3,734
3,721
3,6323,540
3,604
3,433
3,41
0
3,320
3,248
3,000
2,689
2,412
2,191
2,052
1,890
1,741
1,507
1,307
1,137
925
71789
2
607
640
549
477
395
322
341
344
267
290
278
283
303
235
242
224
9 21
222
21226
9235
237
238
248
254
257
261
264
185
2121
6 21
4 21
4 21
5 224
8227
434868128
40%
30%
20%
$0
40
44
48
52
56
60
64
68
72
76
80
84
88
92
96
00
04
08
12
16
20
Percent
$16,000
Options to Reduce Public Deficits to 3% of GDP by 2014
Persistent deficits lead to:
Rising interest rates which crowds out private spending
Future tax uncertainty which reduces business/consumer confidence/spending
Spending Options:
$ bn
Raise Social Security retirement age to 70 (eligibility of 67 by 2027 currently)
4
Change benefit inflation index to one less upwardly biased
10
Reduce starting Social Security benefit for most workers
7
(initial benefit indexed to wages for low income, inflation for others)
Raise Medicare age to 67 from 65
3
Convert Medicaid share to block grants (to reduce distorted state cost incentives) 47
Reduce Medicaid share to wealthy states (eliminate 50% floor on federal share) 22
Reduce highway funding and farm assistance
8
Total:
$101
Options to Reduce Public Deficits to 3% of GDP by 2014
Other tax options:
Implement 5% VAT (Value Added Tax at each stage of production)
324
Cap employer health-insurance deduction to average premium
70
Raise federal fuel tax by 50 cents a gallon to 68 cents
62
Carbon-emissions tax (or Cap-and-Trade system)
National sales tax (to reduce dependence on income tax which penalizes work and
investment)
The U.S. tax system needs less complexity, more bias towards taxing consumption and
elimination of loopholes to broaden income-tax base which will allow for the lowering
of tax rates.
A Closer Look at the Multiplier
Key Macroeconomic relationships
C = C + MPC(1-t)Y
t = marginal tax rate
I=I
G=G
X=X
M = MPI(Y)
Consumption function
Planned Investment function
Government purchases function
Export function
Marginal Propensity to Import, (DM/DY)
AE = C + MPC(1-t)Y + I + G + X - MPI(Y)
Y = AE = C + I + G + X – M
Equilibrium Condition
Assume: YE < YPOT => excess capacity => fixed price level => flat SRAS curve
An Expression for Equilibrium Real GDP
Y = C + MPC(1-t)Y + I + G + X - MPI(Y)
Y – MPC(1-t)Y + MPI(Y) = C + I + G + X
Equil level of GDP
Y* =
1
[C + I + G + X]
1 - [MPC(1-t) – MPI]
An Expression for Equilibrium Real GDP
Y* =
1
[C + I + G + X]
1 - [MPC(1-t) – MPI]
Change in Variables
DY* =
1
[DC +DI +DG + DX]
1 - [MPC(1-t) – MPI]
Government Purchases Multiplier
DY* =
1
DG 1 - [MPC(1-t) – MPI]
The Circular Flow Diagram
Employment Cost Index
(Most Comprehensive Measure of Labor Costs)
Web address: www.stats.bls.gov/news.release/eci.toc.htm
Annual revisions with release of first quarter data which can go back several years.
The employment cost index (ECI) is an early warning system for rising inflation which can push interest rates higher and stock prices lower. ECI is
the best harbinger of pricing pressures and is a forerunner of inflation.
Labor costs typically make up 70% of a firm’s operating costs. Employment costs = wages/salaries and fringe benefits.
Rising compensation costs can result in various responses by firms:
Raise retail prices => inflation.
Absorb expense and maintain prices => falling profits => falling stock prices.
Increase capital investment to raise productivity and reduce workforce.
Reallocating production facilities by decreasing domestic production and increasing foreign production => increasing unemployment and
unemployment insurance costs => increasing government spending and deficits.
Wage-price spiral (a vicious cycle the Federal Reserve will try to stop)
 labor expenses =>  retail prices =>  workers demand for wages/salaries =>  retail prices (self-perpetuating inflation escalation)
Every quarter the BLS surveys 8,500 private and 800 public sectors (local and state only) on labor cost issues. Survey is done for the pay period that
includes the 12th day of March, June, September, December.
Wage and salary data include bonuses, incentive pay, commissions, and cost of living adjustments.
Benefits data include insurance benefits, retirement savings benefits, paid vacations, sick leave, holidays, premium pay for overtime, shift
differentials, social security, Medicare, federal-and state mandated social insurance programs.
Data is converted to index where June 1989 = 100
Labor Costs relative to Productivity
If annual compensation costs are rising (tight labor markets) faster than annual changes in non-farm productivity (falling marginal product of labor),
then economy may be facing inflationary pressures.
Strong productivity growth =>  profits =>  wages and salaries.
The monthly Employment Report’s average hourly earnings (AHE) is another good indicator of wage inflation. But AHE covers only workers who
receive hourly pay (not salaries) and does not include benefits, whereas the ECI covers both hourly and salaried workers.
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Market Analysis:
Bonds: Unexpected big  ECI without big  in productivity => (DP/P)Et+1=>  DBonds =>  iBonds
=>  fed funds rate by Fed to stop wage-price spiral
Stocks: Unexpected big  ECI without big  in productivity and economy operating above potential =>  business costs =>  profits =>  PStocks
Dollar: Unexpected big  ECI without big  in productivity and economy operating above potential =>  interest rates => capital inflows => increase value of dollar.
But an  ECI =>  U.S. export competitiveness =>  exports/ imports=>  trade deficit =>  exchange rate.
Employment Cost Index
(% change from quarter one year ago)
Civilian Workers
10
10
9
9
8
8
7
7
6
6
5
5
4
4
3
3
2
2
1
Recession
Total Compensation
Wages & Salaries
Benefit Costs
0
1
0
83Q1 85Q1 87Q1 89Q1 91Q1 93Q1 95Q1 97Q1 99Q1 01Q1 03Q1 05Q1 07Q1 09Q1 11Q1 13Q1
Source: http://w w w .bls.gov/new s.release/eci.nr0.htm
Federal Government Surplus/Deficit
(Billions of Dollars)
$500
236
$250
126
128
69
$0
80
82
-74-79
-128
-$250
84
86
88
90
92
94
96-22 98
-107
-150
- 153
- 155
-164
-185
-203
-208
-212
-221
-221
-255
-269
-290
00
02
04
06
-158
10
12
14
-248
-318
-322
-380 -402
-459
-623
-$750
•Bank stock purchases (TARP)
•Stimulus plan
•Mortgage bailout plan
•Income-support programs
•Recession-induced falling revenues
-$1,000
-1,100
-$1,250
Source: Congressional Budget Office.
-$1,500
$53 Trillion
unfunded liabilities
16
-161
-378
-413
-$500
08
-1,284
-1,294
-1,400