Intro macro

What does gdp stand for

Gross: doesn’t subtract depreciation

Domestic: activity in economy regardless of ownership

Product: one way to measure GDP, as value of production of final goods/services

Approaches to gdp

production

expenditure

income

GDP caveats

• measures aggregate income at market prices

• doesn’t account for natural resource depreciation/environmental damage

• doesn’t talk about inequality/income distribution

• doesn’t measure national wellbeing

Nominal gdp

GDP for one time period/country

Nominal gdp formula

real gdp (quantity index) x gdp deflator (price index)

consumer price index

Measures the cost of purchasing a given basket of goods and services relative to a base year

inflation

the price index rising over time

deflation

the price index falling over time

Measurement issues of inflation

Substitution bias

Quality bias

Quality bias

increased quality of products can mean consumers get more for expenditure, making fixed basket CPI misleading

Substitution bias

consumers may choose substitutes for goods that are too expensive, so fixed basket CPI overstates consequences of inflation

Costs of inflation

If nominal income is unchanged, reduced real income

redistributes wealth, since loans are nominal

bracket creep

menu costs

noise in price system

Bracket creep

Inflation pushes wages to higher income brackets

Menu costs

Cost associated with price changes

What is noise in the price system

Less info about underlying demand/supply fundamentals

Rba inflation target

2-3% per year

Underutilisation of workers

Unemployment + underemployment

Steady state labour market

unemployment is stable over time

When flows into employment = flows out of unemployment

Types of unemployment

Frictional

structural

cyclical

Frictional unemployment

unemployment due to job matching process

Structural unemployment

Unemployment due to the underlying structure of the economy

e.g. because of technological advances/changing tastes

cyclical unemployment

unemployment due to business cycle fluctuations

Full unemployment

when the labour market is at capacity, cyclical unemployment = 0

Trends

Long run and fluctuate over multiple decades

Business cycles

Short run, fluctuates over periods of 4-5 years

Seasonal cycles

Very short-run, fluctuate at regular/predictable time periods within a year

peak

high-point of economic activity prior to downturn, marks end of expansion

trough

low-point of economic activity prior to upturn, marks end of contraction

recession

two consecutive quarters of negative real GDP growth, but this is just a ’rule of thumb’

Okun’s law

Cyclical unemployment is negatively associated with output gap

What does business cycle theory identify

shocks hitting the economy

propagation mechanisms that transmit shocks to the rest of the economy

Basis of Keynesian theory

At the macro level, government interventions can stabilise business cycle fluctuations by stabilising aggregate demand

Fiscal policy

Decisions that the government makes on how much to spend, raise revenue, collect debt

Types of expenditure

government purchases of goods/services

transfers to households/firms

interest payments to holders of government debt

Pros and cons of fiscal policy for demand management

Pros: stabilises business cycle, helps govt engage in counter cyclical spending

Cons: may distort incentives to work/invest, may push up interest rates from deficit financed spending

Practical concerns of fiscal policy

waste

tension between timing and worthwhile spending

lags between decision and time spending effects

lags in making/implementing decisions

When can governments keep accumulating debt

if it is backed by the present value of future primary surpluses.

When does the budget move into deficit

automatic stabilisers: more unemployed, more newstart etc

recipients, less tax collected from individuals and businesses

(in boom, automatic stabilisers work in reverse, reduce deficit)

discretionary spending: one-off transfer payments, new

infrastructure projects etc

Relationship between debt and deficits

Positive deficit: increased debt

Negative deficit: decreased debt

Why does saving more reduce output

In the keynesian model,

• short run output is demand determined

• more saving = less consumption demand, less out

• So, public dissaving (deficit spending) can usefully offest an increase in private savings

What does paradox of thrift omit

THe long run supply side benefits of savings

Main elements of keynesian theory

prices and wages do not fully adjust in short run (‘sticky prices ’)

– output can be demand-determined

– importance of expectations, confidence, ’animal spirits’

– recessions can be fought by policies that stimulate demand

Goals of monetary policy

• stability of currency - meeting the inflation target

• full employment - unemployment at natural rate

• economic prosperity and welfare of the people of Australia - broadly stable macro environment

Key points of inflation target

• low average level of inflation

• allows for variation over time

Reasons for inflation target

Economic reasons:

– average low enough not to significantly distort decisions

– provides ‘anchor’ for inflation expectations

Institutional reasons:

– transparency and accountability

• criteria to evaluate policy success/failure

natural rate hypothesis

• push actual unemployment far below natural rate

• increase inflation without further reducing unemployment

• threatens inflation target reducing unemployment

Monetary neutrality

Short run: not neutral, neutral, increases inflation, nominal GDP, AND real gdp

Long run: neutral, increases inflation, nominal GDP, NOT real gdp

Assumptions of quantity theory of money

(i) long-run monetary neutrality, Yt = Yt* , independent of Mt

(ii) velocity is constant, Vt = ¯V

(iii) money supply Mt, is controlled by the central bank

Difficulties with quantity theory of money

• Monetary policy DOES influence output in short run

• Velocity ISN’T constant

• Mt BROADLY measures monely supply, but cash and bank reserves is a NARROW measure

Monetary vs fiscal policy

• Monetary policy is more nimble

• Fiscal policy is more direct, powerful but slower

  • used in deep recessions

Corridor system

Floor: 10% below target

Ceiling: 25% above target

Demand for ESA balances

• from banks

• from customers

Supply of esa balances

• purchases/sales of govt bonds

• repurchase agreements

Connections within rates

Movements in short-term rates transmit to long-term rates

Cobb douglas properties

• positive marginal product

• diminishing returns to output

• constant returns to scale

Constant returns to scale

Scaling all inputs by the same amount

Needed in production function

Diminishing vs constant returns

Diminishing: returns to each input individually

Constant: All scaled the same way

Why does the ‘invisible hand’ maximise welfare

• incentivises specialisation of labour > maximises output

• act of freely trading shows you’re better off

Ricardo’s insight

Even if one country has absolute advantage, it can still face scarcity

comparative advantage matters

Price level

average measure of prices in the economy

gdp deflator

an index of prices of all goods and services GDP

Difference between CPI and GDP deflator

GDP is only domestic (gross DOMESTIC product)

CPI only measures consumer behaviour, GDP measures all

output gap

The difference between actual and potential gdp

animal spirits

exogenous changes in consumption and investment

( ¯C and ¯I)

Paradox of thrift

if output is demand determined, individual households

being thrifty may paradoxically be harmful to the economy overall.

Relationship between public/private savings

Public dissaving offsets the paradox of thrift.

Note that public savings decrease while private savings increase.

Relationship between public savings and fiscal policy

– positive, government has fiscal surplus (T > G)

– negative, government has fiscal deficit (T < G)

What is government deficit

The change in government debt

Money neutrality

monetary stimulus is non-neutral in the ’short run’ but neutral in

the ’long run’

neutrality

effect on real variables (real GDP, real interest

rates, real wages etc

Exchange settlement account (esa)

Banks and financial institutions credit/debit ESAs to settle payment

obligations

Axes of AD-AS curve

X axis: real output Y

Y axis: inflation π

Components of aggregate supply curve

Relationship between unemployment, inflation/real output

Short run: upward sloping between π/Y

Long run: no relationship

Components of aggregate demand curve

Relationship between interest, inflation/real output

Short run AD-AS equilibrium

Includes demand/supply shocks, π^e treated as exogenous

Long run AD-AS equilibrium

Demand/supply shocks = 0, π^e = π since actual = expectations

Demand vs supply shocks in AD-AS

Demand: π and Y in same direction

Supply: π and Y in opposite direction`

Slope of AD curve

-1/ay

Saving formula

Income - spending on current needs

Saving rate

saving/income

Key motives for saving

life cycle

precuationary

bequests

Difference between stock and flow

Flow: per unit of time e.g. wage per fortnight

Stock: measured at a point in time e.g. value of my assets

Relationship between stock and flow

Stock_t-1-Stock_t = Flow_t

Link between capital and investment

Saving curve

S(r ) = supply curve

Investment curve

I(r ) = demand curve

Facts on economic growth

1. Sustained global growth is new in history

2. Large differences in income in countries

3. Large differences in living standards

Important properties of cobb-douglas function

Positive marginal products

diminishing returns to each input

constant returns to scale

Key assumptions of Solow-Swan model

Saving/consumption isn’t a dynamic household decision (No animal spirits)

Investment = savings

Constant fraction of output saved each period

constant fraction of stock depreciates each period

Net change in capital stock

investment - deprecitation

Capital movement based on investment, depreciation

I>d, capital increase
I<d: capital decrease
I=d, capital no change

Steady state

Capital doesn’t change

What sustains long run growth (short/long run)

Short run, if Kt<K*
- yes but diminishing returns to capital

Long run:

• slows down to 0 because people save more money

Difference between level and growth effects

Level effects: output goes up permanently, new steady state

Growth effects: peaks and then goes back down

Convergence hypothesis

Economy grows faster when far below steady state

Economy grows slower when close to steady state

Conditional convergence

Parameters are conditional to get to steady state

But independent of k0, initial capital

Unconditional convergence

economies have same long run output regardless of parameters