Macroeconomics Vladimír Hajko 2016 Vladimír Hajko (FSS MU) Introduction to Economics 1 / 30 1 Measuring economic output GDP Inflation 2 Growth Economic Growth 3 Money and Inflation Money and Inflation 4 Economic policy Fiscal and monetary policy Vladimír Hajko (FSS MU) Introduction to Economics 2 / 30 Motivation Microeconomics shows how individuals respond to market conditions (and their changes) Government (or central bank) might want to change these conditions with certain economic policy We want to look at larger groups (aggregation) We want a simplified description of the economy (important for individuals - planning, forecasting) It is useful to measure general tendency of the development of prices (inflation/deflation), un/employment, and output (economic growth, note that output is also equal to income) Households own production factors, offer these to firms, firms produce goods that get consumed by households production factor markets (labor market, capital market/loanable funds market), as well as a representation of the whole economy - AS/AD model Vladimír Hajko (FSS MU) Introduction to Economics 3 / 30 Motivation Daily news headlines: Growth estimates - falling back into recession, overcoming the crisis etc. Central Banks throughout the world perform quantitative easing setting interest rates close to zero Europe faces deflation Economic growth in China - considerably slower from 14% to 8.5% Macroeconomic issues often part of policy debates Macroeconomic situation influence politics considerably (eg labeling politicians successful or not) Macro-economists try to explain quite complicated system of all firms, people and events (the economy) Predictions are often imprecise (“Q: Why did God create economists? A: In order to make weather forecasters look good.”) Vladimír Hajko (FSS MU) Introduction to Economics 4 / 30 Measuring economic output Outline 1 Measuring economic output GDP Inflation 2 Growth Economic Growth 3 Money and Inflation Money and Inflation 4 Economic policy Fiscal and monetary policy Vladimír Hajko (FSS MU) Introduction to Economics 5 / 30 Measuring economic output GDP GDP Definition Gross Domestic Product = market value of all final goods and services produced in a given economy in a given year expressed in money paid for the goods and services Flow variable (sum per period) We can (equivalently) measure it as: (Aggregate) Income (Aggregate) Expenditure In the whole economy Income = Expenditure because each $ you spend is income for someone else Estimated by national statistical offices four times a year Vladimír Hajko (FSS MU) Introduction to Economics 6 / 30 Measuring economic output GDP GDP Content What is included in GDP? Only the value of finished goods (byproducts don’t count) Only goods and services sold for the first time (re-selling the same car over and over is not generating value) Inventories What is not included in GDP Goods and services not sold on the market (e.g. household tasks valuable, but not sold on a market) (could be quite significant in certain developing countries (undeveloped services sector) Illegal activities ("black economy") Unreported activities ("gray economy") Vladimír Hajko (FSS MU) Introduction to Economics 7 / 30 Measuring economic output GDP Real x Nominal GDP GDP is measured in monetary terms (tons of steel vs. books sold vs. haircuts performed etc.) Nominal GDP = sum of the products of quantity and (current) price for all goods and services ⇒ change of either P or Q changes the product nominal GDP influenced by price level changes → might be misleading (↓ Q and more pronounced ↑ P →↑ GDPN) Real GDP = sum of the products of quantity and (constant) price for all goods and services ⇒ real GDP changes only with changes of Q, not P (prices fixed at the levels of certain year) GDP Deflator = Nominal GDP Real GDP ≈ price level change (there are also other measurements of price level changes, PPI, CPI etc.) Vladimír Hajko (FSS MU) Introduction to Economics 8 / 30 Measuring economic output GDP GDP Decomposition National income accounts identity: Y = C + I + G + NX Y Domestic product C Consumption, goods and services bought by households I Investment, goods bought for long-term production (machines, building etc.) G Government purchases (government expenditures) NX Net export or surplus with foreign countries (NX = IM − EX) Vladimír Hajko (FSS MU) Introduction to Economics 9 / 30 Measuring economic output GDP GDP’s Importance Good proxy variable to assess economic performance of a country Per capita x Total ⇔ Economic Power x Economic Level # Country GDP (mil $) GDP p/c ($) 1 USA 16,768,050 53,001 (#9) 2 China 9,469,124 6,959 (#82) 3 Japan 4,898,530 38,468 (#24) 4 Germany 3,635,959 44,999 (#18) 5 France 2,807,306 44,099 (#20) The more the better? Correlation between GDP and e.g. HDI (life expectancy, literacy etc.) at the same time, criticized for ignoring other important aspects of quality of life but GDP measurement was not developed to measure the quality of life... Vladimír Hajko (FSS MU) Introduction to Economics 10 / 30 Measuring economic output Inflation Inflation Overall increase of price level Terms: Inflation - increase Deflation - decrease Disinflation - inflation slowdown Vladimír Hajko (FSS MU) Introduction to Economics 11 / 30 Measuring economic output Inflation Measuring Inflation GDP Deflator Consumer Price Index (CPI) Arbitrary chosen prices important in standard consumer’s basket Including: Food, Transportation, Schools, Culture, Gasoline, Electricity. . . CPI aggregates price changes of selected goods in time CPI and Deflator similar but different CPI watch fixed basket of goods with fixed weights CPI updated only once a decade (because it needs to maintain consistency - otherwise the numbers are incomparalbe)⇒ is it still relevant? Vladimír Hajko (FSS MU) Introduction to Economics 12 / 30 Measuring economic output Inflation Unemployment Adult population: Labor force: Employed Unemployed Others Unemployment: u = Unemployed Labor force Labor force participation rate: Labor force Adult population Frictional x structural x cyclic unemployment Vladimír Hajko (FSS MU) Introduction to Economics 13 / 30 Growth Outline 1 Measuring economic output GDP Inflation 2 Growth Economic Growth 3 Money and Inflation Money and Inflation 4 Economic policy Fiscal and monetary policy Vladimír Hajko (FSS MU) Introduction to Economics 14 / 30 Growth Economic Growth Motivation If GDP really correlates with well-being then its growth its quite important Economy’s ability to grow is one of its main atributes Sustain relative wealth of rich countries Improve relative and absolute wealth of poor ones Convergence theory: The poorer you are, the quicker you grow (does it hold?) Vladimír Hajko (FSS MU) Introduction to Economics 15 / 30 Growth Economic Growth Determinants GDP growth is primarily affected by productivity Since GDP is sum of all production, producing more with the same population brings higher product (GDP) Productivity: product per one worker-hour It is not so simple. . . productivity usually measured as a residual ("what is left unexplained by other factors") Vladimír Hajko (FSS MU) Introduction to Economics 16 / 30 Growth Economic Growth Productivity Any change in productivity is conditioned by: Physical capital - tools, machinery etc. Human capital - knowledge, skills, experiences etc. Natural resources - climate for agriculture, oil. . . Technological knowledge - inventions, computers, management. . . Production function of an economy is thus expressed: Y = A.F(L, K, H, N) Vladimír Hajko (FSS MU) Introduction to Economics 17 / 30 Growth Economic Growth Pro-growth Public Policy What policies are considered to be good for growth? 1 Encouraging saving and investment 2 Foreign investment 3 Education 4 Property rights and political stability 5 Free trade 6 Control of population growth (poorer countries) 7 Research and Development Vladimír Hajko (FSS MU) Introduction to Economics 18 / 30 Growth Economic Growth Catch-up Diminishing returns theory: The larger the capital stock of a country, the smaller impact of investments on growth Example: 1960-1991 Country Invesment (% of GDP) Growth South Korea 23 % 7 % USA 21 % 2 % This imply a chance for poor countries ⇒theory of convergence Doesn’t always work however Vladimír Hajko (FSS MU) Introduction to Economics 19 / 30 Money and Inflation Outline 1 Measuring economic output GDP Inflation 2 Growth Economic Growth 3 Money and Inflation Money and Inflation 4 Economic policy Fiscal and monetary policy Vladimír Hajko (FSS MU) Introduction to Economics 20 / 30 Money and Inflation Money and Inflation Money An asset used to buy goods, does not equal to wealth Three basic functions: Medium of exange (making trade easier, avoiding barter) Unit of account Store of value Money is the most liquid asset Vladimír Hajko (FSS MU) Introduction to Economics 21 / 30 Money and Inflation Money and Inflation Money Commodity x fiat money Today’s money consists of: M1 - cash, deposits on demand M2 - M1 + long-term deposits, assets in mutual funds etc. M1:M2 ≈ 1:4 Vladimír Hajko (FSS MU) Introduction to Economics 22 / 30 Money and Inflation Money and Inflation Bank Sector Two-tier banking system Central Bank (ECB system, Czech National Bank, Federal Reserve System. . . ) Usually government-independent Regulates circulating money Its objective is either particular level of inflation or unemployment or both Tools: interest rates, open-market operations, reserves requirements Commercial Banks (all others: Sberbank, Sparkasse, Société Générale. . . ) Lend money and accept deposits Vladimír Hajko (FSS MU) Introduction to Economics 23 / 30 Money and Inflation Money and Inflation Money Multiplier How is money created? Assume 10% reserves requirement 1st Bank Assets Liabilities Reserves $ 10.00 Deposits $ 100.00 Loans 90.00 2nd Bank Assets Liabilities Reserves $ 9.00 Deposits $ 90.00 Loans 81.00 3rd Bank. . . Vladimír Hajko (FSS MU) Introduction to Economics 24 / 30 Money and Inflation Money and Inflation Money Multiplier Original deposit $ 100.00 induces additional $ 90.00, 81.00, 72.90. . . = $ 1,000.00 original deposit + ∑(1 − reserves) × (additional deposit) 100 + 0.9×100 + 0.9 × 90 + 0.9 × 81. . . = 1000 = 10 × 100 Multiplier in this example is 10 = 1 reserve requirement CB does not control money directly, but through commercial banks via money multiplier CB especially does not control household’s behavior, how much HH deposit bankers willingness to lend Vladimír Hajko (FSS MU) Introduction to Economics 25 / 30 Money and Inflation Money and Inflation Quantitative Money Theory M × V = P × Y M- money, V - velocity of money, P - price level, Y - real product or in marginal values: m.v = π.g m- money growth, v - velocity change, π - inflation, g - (economic) growth Explains inflation and deflation eg: Long lasting slight deflation between 1870-1914 Hyperinflations (e.g. Germany 1923, Zimbabwe - but in fact, nearly every decade there is a hyperinflation somewhere in the world) Recent fear of deflation in the West Vladimír Hajko (FSS MU) Introduction to Economics 26 / 30 Economic policy Outline 1 Measuring economic output GDP Inflation 2 Growth Economic Growth 3 Money and Inflation Money and Inflation 4 Economic policy Fiscal and monetary policy Vladimír Hajko (FSS MU) Introduction to Economics 27 / 30 Economic policy Fiscal and monetary policy Economic policy Fiscal policy - government expenditures in additon, governments may seek its goals by other means - taxation, regulation (e.g. minimal wage etc.), trade policy (tariffs, quotas), wealth/income redistribution typical (proclaimed) target: stabilizing policy / growth policy Monetary policy - actions of central bank Typical (proclaimed) target: inflation targeting, other goals: exchange rate, interest rates Impossible Trinity (Trilemma): pick two out of the following three: An independent monetary policy; Free capital movements; A fixed foreign exchange rate Vladimír Hajko (FSS MU) Introduction to Economics 28 / 30 Economic policy Fiscal and monetary policy Economic policy Macroeonomics heavily influenced by various assumptions of their models but real economy very complex - what is "right"? A basis of interventionism Popular in Keynesian schools of thought (Keynesians claim markets fail to clear (in SR) - so "somebody (government) has to intervene") today’s “mainstream economics = "neoclassical" microecnomics + "Keynesian" macroeconomics Other approaches valid, but central banks and governments are in general in favor of interventions government has to act (on macro-level) to restore the growth path... ("fighting recessions") Some argue that governments only make it worse Keynesian schools of thought favor demand side interventions Vladimír Hajko (FSS MU) Introduction to Economics 29 / 30 Economic policy Fiscal and monetary policy ASAD model Vladimír Hajko (FSS MU) Introduction to Economics 30 / 30