Macroeconomics Lecture Notes PDF

MACROECONOMICS Lecture 1 Introduction & Macroeconomic Accounts (Ch 1 & 2) 0 Objectives Learn terminology Ex: GDP, government deficit, monetary policy, … Analyze macroeconomic questions using models Ex: How does an increase in the...

MACROECONOMICS Lecture 1 Introduction & Macroeconomic Accounts (Ch 1 & 2) 0 Objectives Learn terminology Ex: GDP, government deficit, monetary policy, … Analyze macroeconomic questions using models Ex: How does an increase in the interest rate affect output? Interpret data Ex: Yearly data on GDP across the world Understand current macroeconomic issues 1 Practical information: course material All practical information, including those about grading, exams, schedules, can be found on Canvas TEXTBOOK: Burda & Wyplosz, 2012 Macroeconomics: A European Text 7th or 8th edition, Oxford University Press Lectures slides: Posted each week on Canvas under “Modules”è“Week” 2 Practical information: exams Midterm exam (30% of final grade): – Open questions (fill in blanks, definitions, simple calculations…) Final exam (70% of final grade): – Multiple choice questions (4 possible answers each) Resit exam: – Resit for the final exam in July (midterm result still valid) 3 Roadmap 1. What is Macroeconomics? 2. Macroeconomic Accounts 4 What is Macroeconomics? Microeconomics studies the behavior of individuals Macroeconomics (Greek makro = ‘big’) studies the aggregate behavior and performance of an economy Macroeconomics look at the economic performance of whole countries/regions Most macroeconomic theories have microeconomic foundations Economic agents: consumers, producers, government, banks, foreign countries Markets: demand ⬄ supply Goods markets, labor market, money market, financial markets 5 Questions that Macroeconomics addresses Why some countries grow faster than others? (economic growth, long-run) Why does economic activities expand in some years and contract in others? (business cycle, short-run) What causes unemployment? What causes prices to change? (inflation) What can the government do to promote rapid growth in income, stable prices (low inflation), and high employment rate? (monetary and fiscal policies) How being part of a global economic system affects production, employment and prices? 6 How to measure aggregate economic performace? Gross domestic product (GDP) is one of the most important indicators of aggregate economic activity. GDP Definition: Total value of all final goods and services produced within a specific period (per year/quarter) in a specific area (country/region). 7 GDP = well-being? GDP measures the economic activity of a whole economy; GDP is NOT a perfect indicator for the well-being. GDP does not capture: income inequality (GDP is average!) gender equality, human rights, environmental protection, and more. However, GDP is often highly correlated with well-being,… readily available and comparable across countries and time. 8  GDP highly correlated with well-being 4.25 3.75 LATIN AMERICAN 3.25 NL: Rich and happy 2.75 2.25 1.75 Subjective Well- being 1.25 Mexico: Poor but happy 0.75 0.25 EX- –0.25 COMMUNIST –0.75 Russia: Poor and unhappy –1.25 🙁 –1.75 –2.25 0 5 10 15 20 25 30 GDP per capita in thousands of dollars, five years before survey Fig. 2. Subjective well-being (SWB), per capita gross domestic product (GDP), and different types of societies. Well-being index is based on reported life satisfaction and happiness, using mean results from all available surveys conducted 1995–2007 (cubic curve plotted; r5.62). PPP-purchasing power parity estimates. Source: Inglehart, Foa, Peterson, Welzel (2008) Listen: The Indicator, “Beyond GDP” 9 GDP variations across countries and time 10 Long run vs. short run economic performance Real GDP, Netherlands: 1955-2016 10.5 10 long-run growth Natural Log trend 9.5 9 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 11 Long run vs. short run economic performance LONG RUN (trend): the behaviour of the economy over decades Economic growth measures the rate at which real output of a nation increases over time. It is one of the most important long-run phenomena. SHORT RUN (business cycles): temporary output fluctuations around long-run trend Business cycles can be of various lengths and magnitudes and consist of Booms and Recessions 12 Long run vs. short run economic performance Real GDP, Netherlands: 1955-2016 10.5 10 cyclical (short-run) deviation/ business cycles long-run growth Natural Log trend 9.5 9 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 13  Business cycle: deviations from trend Recessions the period from peak to trough Booms the period from trough to peak Output Gap, Netherlands: 1955-2016 Peak Peak 5 Recession om Natural Log Bo 0 -5 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 Trough 3 14 Economic growth 𝑌! = GDP of a country in year 𝑡 𝑌!"# = GDP of the same country in year 𝑡 − 1 GDP growth ratet (𝐠𝐫. 𝐫𝐚𝐭𝐞𝐭 ) = 𝒀𝒕 / 𝒀𝒕"𝟏 − 𝟏 GDP growth can also be approximated as first-difference of GDP using logarithmic scale 𝑌! = 𝑌!"# ⋅ ( 1 + 𝐠𝐫. 𝐫𝐚𝐭𝐞𝐭 ) → ln 𝑌! = ln 𝑌!"# + ln( 1 + 𝐠𝐫. 𝐫𝐚𝐭𝐞𝐭 ) → ln 𝑌! − ln 𝑌!"# = ln( 1 + 𝐠𝐫. 𝐫𝐚𝐭𝐞𝐭 ) ≈ 𝐠𝐫. 𝐫𝐚𝐭𝐞𝐭 The approximation holds for 𝐠𝐫. 𝐫𝐚𝐭𝐞 closed to zero, e.g., 0.01, 0.05, -0.06. è Yearly %Y growth = (ln Yt - ln Yt-1)*100 15  Longoutput Long-run Run: How do we measure growth? growth When we study the long-run economic performance, we are interested in the long-run trend growth = average growth rate over a period of time (𝐥𝐧 𝒀𝑻 − 𝐥𝐧 𝒀𝒕 ) /(𝑻 − 𝒕) ∗ 𝟏𝟎𝟎 Real GDP, Netherlands: 1955-2016 10.5 10 Natural Log long-run growth trend 9.5 Average annual % GDP growth (1955-2016) = (ln Y2016 – ln Y1955) / (2016-1955) *100 9 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 16 Short-run output gap When we study the short-run economic performance or business cycles, we are interested in the output gap = short-run output deviation from trend = % difference between current and trend output (𝐥𝐧 𝒀𝒕 − 𝐥𝐧 𝒀𝒕𝒓𝒆𝒏𝒅,𝒕 ) ∗ 𝟏𝟎𝟎 Real GDP, Netherlands: 1955-2016 10.5 cyclical (short-run) deviation 10 Natural Log 9.5 % Output gap in 1985 Ygap, 1985 = (ln Y1985 – ln Ytrend, 1985)*100 9 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 17 Roadmap 1. What is Macroeconomics? 2. Macroeconomic Accounts 18 Flow vs. stock variables – Flow variable: quantity measured over a unit of time – Stock variable: quantity measured at a given point in time Stocks are the cumulative of the flows. GDP measures economic activity in a geographical location over a time interval GDP is a flow variable NOT a stock variable Other examples of flow vs. stock variables: – Investments flow vs. capital stock – Wage flow vs. wealth stock 19 Three definitions of GDP There are three definitions of GDP, each associated with one approach to calculate GDP 1 Expenditure approach 2 Production approach 3 Income approach 20  Definitions of GDP (1/3) 1 First definition = expenditure approach GDP = the sum of final sales within a geographical location (country, region, EU, …) during a period of time (year, quarter, …) – Final sales of goods and services sold to consumers or firms that ultimately use them – Intermediate sales and used goods are excluded to avoid double counting 21 Definitions of GDP (1/3) On the expenditure side (definition 1 of GDP): GDP (Y) = Consumption (C) + Investment (I) + Government Spending (G) + Exports (X) - Imports (Z) – Recall: GDP = Sum of final sales of goods and services produced within a country during a period of time – Exports = Purchases of domestically produced goods by foreigners. DO NOT appear in C, I or G, BUT should be taken into account. – Imports = Purchases of goods and services produced outside the country but consumed by residents. Appear in C, I or G, BUT should NOT be taken into account since it is produced outside the country. 22  Definitions of GDP (1/3) GDP components, Netherlands, 2004 Exports-Imports 7,2 % Government spending: purchases 24,3 % of goods and services Consumption: spending by 49,3 % by the governments, households in salaries of government durable goods, non- workers durable goods and 19,1 % services Investment: spending by firms on goods that will be used in the future to produce more goods and services Source: Mankiw and Taylor, Macroeconomics 23 Definitions of GDP (2/3) 2 Second definition = production approach GDP = the sum of value added within a geographical location (country) during a period of time (year) Value added: difference between sales and the costs of raw material and intermediate goods Raw material and intermediate goods are excluded to avoid double counting (consistent with the expenditure approach) 24 The equivalence between the expenditure and production approach: an example Consider an economy that produces a single final good, cotton shirts, which are sold to consumers for €100. The shirt industry buys cloth for €80, which in turn buys cotton from the raw cotton industry for €50. How much is the GDP of this economy? Expenditure approach: The final sales = GDP = €100, sale value to the final consumers Production side: summing up the value-added of all three industries 1. raw cotton industry’s value added: €50 (no inputs) 2. cloth industry’s value added: €80 − €50 = €30; and 3. shirt industry’s value added: €100 − €80 = €20. The total value added =GDP = €50 + €30 + €20 = €100. GDP = Total Final Expenditure = Total Value Added 25  Definitions of GDP (3/3) 3 Third definition = income approach GDP = the sum of incomes earned from economic activity within a geographical location (country) during a period of time (year) – Labor income (wages, income from self-employment) + Capital income (land, interest, dividends, profits) + Government income (taxes net of transfer) – GDP includes all incomes earned within a country’s borders (by residents and non-residents alike). 26 Which economic activities are not included in GDP? GDP only measures officially recorded transactions! It DOES NOT measure: Home production: Leisure, domestic childcare, cooking, subsistence farming Shadow or underground economy: Activities not reported to avoid taxes (e.g. domestic help) or because of illegality (e.g. drug dealing) 27  Missing in GDP: the ‘shadow’ economy Listen: The Indicator, “Weed GDP: What happens to a country's economy when a popular drug goes from being illegal to being legal?” 28 The nuances of different GDPs Until now, we have talked about GDP as a single concept. There are different GDPs, for examples captures both growth in output captures growth in the per person & population growth output volume (Total) GDP Real GDP vs vs GDP per capita: GDP/population Nominal GDP captures only growth in captures both growth in the output per person output volume and prices 29 GDP : prices & quantities “You can’t add apples and oranges.” GDP uses prices to convert quantities (numbers of apples and oranges) into values (final sales of apples and oranges) When GDP increases from one year to the next, either: 1. The economy is producing more goods and services, 2. Goods and services are selling at higher prices. Need to separate these two effects! 30  Nominal vs. real GDP 𝑷𝒕,𝒐 : price of an oranges in year t; 𝑸𝒕,𝒐 : quantity of oranges sold in year t; 𝑷𝒕,𝒂 : price of an apple in year t; 𝑸𝒕,𝒂 : quantity of apples sold in year t Nominal GDP is computed using the actual selling price in year t: 𝑵𝒐𝒎𝒊𝒏𝒂𝒍 𝑮𝑫𝑷𝒕 = 𝑷𝒕,𝒐 ⋅ 𝑸𝒕,𝒐 + 𝑷𝒕,𝒂 ⋅ 𝑸𝒕,𝒂 Real GDP is computed using the price of a given base year 𝝉: 𝑹𝒆𝒂𝒍 𝑮𝑫𝑷𝒕,𝝉 = 𝑷𝝉,𝒐 ⋅ 𝑸𝒕,𝒐 + 𝑷𝝉,𝒂 ⋅ 𝑸𝒕,𝒂 Prices are kept fixed in real GDP. Thus, real GDP changes over time only if the physical quantity sold changes over time. 31 Nominal vs. real GDP: an example 𝑵𝒐𝒎𝒊𝒏𝒂𝒍 𝑮𝑫𝑷𝒕 = 𝑷𝒕,𝒐 ⋅ 𝑸𝒕,𝒐 + 𝑷𝒕,𝒂 ⋅ 𝑸𝒕,𝒂 𝑹𝒆𝒂𝒍 𝑮𝑫𝑷𝒕,𝝉 = 𝑷𝝉,𝒐 ⋅ 𝑸𝒕,𝒐 + 𝑷𝝉,𝒂 ⋅ 𝑸𝒕,𝒂 In 2015 (base year): Oranges: price of 1kg: €2.0; quantity sold: 150,000 kg Apples: price of 1kg: €1.3; quantity sold: 250,000 kg In 2016: Oranges: price of 1kg: €2.1; quantity sold: 200,000 kg Apples: price of 1kg: €1.3; quantity sold: 250,000 kg Nominal & Real GDP in 2015: €2.0(150,000) + €1.3(250,000) = €625,000 Nominal GDP in 2016: €2.1(200,000) + €1.3(250,000) = €745,000 Real GDP in 2016: €2.0(200,000) + €1.3(250,000) = €725,000 Real GDP in 2016 < nominal GDP in 2016, as the increase in nominal GDP from 2015 to 2016 is partly due to the increase in oranges’ price. 32 Nominal vs real GDP: US 2000Q1-2010Q1 33 Measurements of price changes 1 GDP deflator 2 Consumer prices index (CPI) 34  GDP deflator One important measure of price level is the GDP deflator GDP deflator = Pt = ( Nominal GDPt ) / ( Real GDPt ) – Measures price of output relative to its price in the base year – Average prices of final goods where each good implicitly weighted by their share in the GDP. As shares change over time, so do the weights Inflation rate: change of prices over time GDP deflator inflation = growth rate of GDP deflator %GDP deflator inflationt = (𝑷𝒕 / 𝑷𝒕"𝟏 − 𝟏)*100 ≈ % 𝚫 𝐍𝐨𝐦𝐢𝐧𝐚𝐥 𝐆𝐃𝐏𝐭 − % 𝚫 𝐫𝐞𝐚𝐥 𝐆𝐃𝐏 The approximation holds for small changes. See the textbook for the derivation. 35 GDP deflator: an example Consider the following values between 2010 (base year) and 2011: – Nominal GDP 2010 = €625 & 2011 = €703 – Real GDP 2010 = €625 & 2011 = €685 Compute inflation, nominal and real GDP growth – GDP Deflator 2010 = 1 & 2011 = €703 / 685 = 1.026 – % Inflation using GDP deflator (1.026/1 – 1)*100 = 2.6 – % Nominal GDP Growth (703/625 - 1)*100 = 12.5 – % Real GDP Growth (685/625 - 1)*100 = 9.6 %Δ GDP Deflator (prices, 2.6%) ≈ %Δ nominal GDP (12.5%) - %Δ real GDP (9.6%) = 2.9% 36 Consumer price index (CPI) Measures the general level of prices Changes in UK CPI basket that consumers have to pay for goods and services. The basket of goods and services reflects the spending of a typical household. Goods and services in the basket are weighted according to the fraction of household spending they account for. CPI inflation approximates changes in the ‘cost of living’. Source: http://www.cityam.com/207022/uk-inflation-what- basket-goods-looked-last-time-it-was-low-2000 37 CPI vs GDP deflator Consumer Price Index GDP Deflator Weighted by goods & services Weighted by goods and services that BOUGHT by the consumers are PRODUCED domestically Includes imported goods (Toyota, Includes exports but not imports iPhone), but not exported goods Laspeyres Index: fixed weights of Paasche Index: Weight of goods goods; weights only infrequently = share in the GDP, varies over updated. the years 38  CPI vs GDP deflator: the Netherland 1960 - 2022 Differences between CPI & GDP deflator can be significant when import prices behave differently from domestic goods Source: World Bank, Inflation, consumer prices for the Netherlands [FPCPITOTLZGNLD], Organization for Economic Co-operation and Development, National Accounts: National Accounts Deflators: Gross Domestic Product: GDP Deflator for Netherlands [NLDGDPDEFQISMEI]. Both retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org, December 27, 2023. 39 Gross national income (GNI) Gross national income (GNI) considers a country’s economic activity attributable to its residents, both people and firms they own, regardless of where the economic activities take place (resident / owndership – based) Balance on primary international income income earned by resident broad – income generated by non- residents GNI = GDP + balance on primary international income 40 Gross disposable national income Gross National Income(GDNI) (GNI) Balance on secondary international income various foreign payment ‘without consideration’ (not directly associated with production). Examples: gifts, foreign aids GDNI = GNI + balance on secondary international income = GDP + balance on primary and secondary international income (International Account Balance) IAB is usually relatively small compared to GDP. For simplicity, we will assume it to be negligible for now (IAB = 0). 41 A key accounting identity Using the expenditure approach (1) Y=C+I+G+X–Z Viewing from the income approach, The total income = Y in a country can be spend on consumption (C), or savings (S) or taxes net of transfers (T) (2) Y=C+S+T Thus, C+S+T=C+I+G+X–Z Which implies (3) (S - I) + (T - G) = (X - Z) Main economic Private Govern- Rest of actors: sector ment the world 42 Interpreting the key accounting identity (S - I) + (T - G) = (X - Z) Private Govern- Rest of sector ment the world The private sector (households and firms) If (S-I) > 0 private sector is a net saver If (S-I) < 0 private sector is a net borrower The government If (T-G) > 0 the government is saving If (T-G) < 0 the government is borrowing The rest of the world If (X-Z) > 0 the country exports more than it imports: net exporter If (X-Z) < 0 the country imports more than it exports: net importer 43 Interpreting the key accounting identity (S - I) + (T - G) = (X - Z) Private Govern- Rest of sector ment the world If trade is balanced or a closed economy 𝑿 − 𝒁 = 𝟎 𝑺 − 𝑰 = −(𝑻 − 𝑮) Net saving of the private sector = net borrowing by the government Otherwise, if (𝑺 − 𝑰) + 𝑻 − 𝑮 > 𝟎 , i.e., domestic economic actors (private sector + government) is net savers ↔ 𝑿 − 𝒁 > 0 the country is a net exporter. And vice versa: the country is a net borrower ↔ it is also a net importer 44  The accounting identity in 2010 (% of GDP) S-I T-G X-Z USA : USA 5.6 -8.8 -3.2 Japan 10.3 -6.7 3.6 Twin deficit: (T-G) and (X-Z) Belgium 3.9 -2.6 1.3 both negative è Pay for government debt via foreign Denmark 4.7 0.8 5.5 borrowing France 2.6 -4.8 -2.2 Germany 8.1 -2.5 5.6 Italy -1.3 -2.2 -3.5 Netherlands: Netherlands 11.5 -3.8 7.7 Spain 0.7 -5.2 -4.5 Budget deficits (T-G), i.e., the government is borrowing, but Sweden 4.7 1.6 6.3 net exports (X-Z) in surplus UK 5.8 -8.3 -2.5 thanks to even larger net private Euro area 4.1 -3.9 0.2 savings 45 Taking stock What is Macroeconomics Long-run economic growth, short-run business cycles GDP and its three definitions, GNI, GDNI Real and nominal GDP GDP deflator, CPI BoP, CA, KA, FA (self-study, tutorial) 46