Macroeconomic Goals - Topic 8 PDF

TOPIC 8 Macroeconomic goals Fundamentos de Economía 1 Topic 8. Macroeconomic goals Full employment: concepts, indicators and types of unemployment. Price stability: concept, meanings, indicators, causes and consequences of inflation. Economic growth and econom...

TOPIC 8 Macroeconomic goals Fundamentos de Economía 1 Topic 8. Macroeconomic goals Full employment: concepts, indicators and types of unemployment. Price stability: concept, meanings, indicators, causes and consequences of inflation. Economic growth and economic fluctuations. Balance in the external sector: the balance of payments and the exchange rate. 1. Relationship between objectives: the Phillips curve. Fundamentos de Economía 2 1. Full employment and unemployment Let's clarify some basic definitions: Active population: all those individuals who are in the labor market, that is, all those who have the legal age to work really look for work. It is comprised of all those individuals who are either working - employed population - or are looking for work - unemployed, unemployed or unemployed population. Inactive population: it is one that either does not have legal age to work -such as children or retirees- or does not look for work for different reasons -such as students or housewives-.  Unemployed: any individual who, being willing to work, wants to do so and cannot find work. Fundamentos de Economía 3 1. Full employment and unemployment https://www.youtube.com/watch?v=znq3ql6wqnE Fundamentos de Economía 4 1. Full employment and unemployment Activity rate = (Labour force / Working age population) 100 Unemployment rate = (number of unemployed / Labour force) x 100 Fundamentos de Economía 5 1. Full employment and unemployment  It is important to keep in mind that the unemployment rate may overestimate the problem. There is always a frictional unemployment rate that is due to the time it takes for workers to find employment: It is the result of the constant process of creating and destroying jobs, as industries expand and contract at the pace of the emergence of new technologies, changes in consumer tastes...  In addition, there is a regular entry of new workers into the labour market. Fundamentos de Economía 6 1. Full employment and unemployment  But the unemployment rate can also underestimate the problem, since it is not computed:  The discouraged population, who can and want to work, but have stopped looking for work in the face of the state of the labor market. What profile do you think people in this situation have? Fundamentos de Economía 7 1. Full employment and unemployment This link takes you to the INE website that collects unemployment data in Spain. From the selected information graphs and tables can be elaborated. Fundamentos de Economía 8 1. Full employment and unemployment And this other link allows you to access the statistical information of the OECD on unemployment Fundamentos de Economía 9 1. Full employment and unemployment Unfortunately the problem of unemployment in Spain is very worrying: OECD (2022), Unemployment rate (indicator). doi: 10.1787/52570002-en (Accessed on 26 October 2022) Fundamentos de Economía 10 2. Price stability  Understanding the causes of inflation and the opposite phenomenon, deflation, is another concern of macroeconomics:  Inflation is the generalized increase in the price level. Deflation is the generalized decline in the price level.  Both are problematic:  If the price level rises, the amount of goods and services that can be purchased with a certain amount of cash decreases. - And if it goes down, cash gains value over time so holding cash may be more attractive than consuming or investing... Let's take which a closer look can at the aggravate costs of a crisis. inflation... Fundamentos de Economía 11 2. Price stability  Costs in shoe soles High inflation forces people to hold less cash because the purchasing power of cash erodes as prices rise. For example, time is spent going to the bank to move money to accounts that offer enough interest to offset inflation or to withdraw cash whenever a payment needs to be made... During German hyperinflation (1921-23), merchants hired runners to go several times a day to banks to convert cash into something that retained its value, such as a stable foreign currency. Fundamentos de Economía 12 2. Price stability  Menu change costs Inflation forces us to assume the real costs of having to change price lists. For example, in the early 90s in Brazil, supermarket employees spent half their working day changing price labels... Fundamentos de Economía 13 2. Price stability  Account unit costs Inflation makes money a less reliable unit of measurement, which worsens the quality of economic decisions. This is best understood with an example that shows the fiscal implications of inflation: A company buys an asset for €100,000 and resells it the following year for €110,000. If inflation is 10%, you have not actually gained anything from the operation, but you will have to pay taxes on an apparent capital gain. This leads to abandoning productive investment projects to avoid paying taxes on non-existent profits... More generally, inflation discourages 14long-term Fundamentos de Economía 2. Price stability In order to estimate the inflation rate in an economy we must calculate the evolution of the aggregate price level.  For this we have the price index, which will be better understood from the following example:  Suppose that a DANA (Isolated Depression at High Levels) destroys part of the citrus crop in the Spanish east.  As a result, prices rise  In the case of oranges from €0.20 to €0.40  In the case of grapefruits from € 0.60 to € 1 And in the case of lemons from € 0.25 to € 0.45 How much has the price of citrus fruits risen? Fundamentos de Economía 15 2. Price stability  To measure the average price changes of goods and services consumed, changes in the cost of a consumption basket – shopping basket – of a typical consumer are calculated.  The following table shows us the evolution of the cost of that basket, if a typical consumer buys 200 oranges per year; 50 grapefruits and 100 lemons: Before DANA After DANA Price of one orange 0,20 € 0,40 € Price of one grapefruit 0,60 € 1€ Price of one lemon 0,25 € 0,45 € Cost of the shopping cart (200 x 0,20) (200 x 0,40) + (50 x 0,60) + (50 x 1) + (100 x 0,25) + (100 x = 95 € 0,45) = 175 € Fundamentos de Economía 16 2. Price stability This is how changes in the general price level are measured: changes in the cost of buying a given shopping basket are calculated. For this, a base year is chosen, which will be the reference year with which the others will be compared.  Thus the price index in a given year will be: Shopping basket cost ∈a 𝑔𝑖𝑣𝑒𝑛 𝑦𝑒𝑎𝑟 × 100 Shopping basket cost of the base year In our example: The price index before DANA will be 100 And the price index after DANA will be 184.2 (175/95 x 100)  The average price of citrus fruits has risen by 84.2% Fundamentos de Economía 17 2. Price stability  Price indices are the basis for calculating inflation.  Thus, the inflation rate reflects the percentage change of an official price index: 𝑃𝑟𝑖𝑐𝑒 𝐼𝑛𝑑𝑒𝑥 𝑖𝑛 𝑌𝑒𝑎𝑟 2− 𝑃𝑟𝑖𝑐𝑒 𝐼𝑛𝑑𝑒𝑥 𝑖𝑛 𝑌𝑒𝑎𝑟 1 𝑥 100 ( 𝑃𝑟𝑖𝑐𝑒 𝐼𝑛𝑑𝑒𝑥 𝑖𝑛 𝑌𝑒𝑎𝑟 1) In Spain, these data are provided by the INE: Fundamentos de Economía 18 2. Price stability Link to the INE page that allows you to customize tables and graphs on the CPI Fundamentos de Economía 19 2. Price stability On the INE website we also find the weightings of the different goods and services consumed in the CPI basket CPI weights in 2022 (%) 01 Food and non-alcoholic beverages 22,1 02 Alcoholic beverages and tobacco 3,0 03 Clothing and footwear 5,9 04 Housing, water, electricity, gas and other fuels 13,9 05 Furniture, household items and articles for the current maintenance of the home 5,7 06 Health 4,3 07 Transport 13,2 08 Communications 3,5 09 Leisure and culture 5,1 10 Teaching 1,6 11 Restaurants and hotels 14,4 12 Other goods and services 7,4 Fundamentos de Economía 20 check if it has been understood... You are worried about the rising prices of the textbooks you have to buy. The average student buys three books on Law, two on International Relations and four on Economics each year. These are their prices in the last three years: Price 2019 € Price 2020 € Price 2021 € Handbook of Law 50 55 57 Handbook of II.RR 70 72 74 Handbook of 80 90 100 Economics Taking 2019 as the base year, calculate the price index of handbooks in all three years. 1. What is the percentage change in the price index between 2019 and 2020 and between 2020 and 2021 ("inflation")? Fundamentos de Economía 21 2. Price stability (Difference CPI - GDP) Imported Exported Inflation by CPI Inflation by GDP Good 1 Good 2 Good 3 Consumer price index GDP deflactor P1 Q1 P2 Q2 P3 Q3 Numerator Denominator Index Variation Nominal GDP Real GDP Deflactor Variation I 7 11 6 6 11 9 78 108 0,722 135 213 0,634 II 6 11 10 5 15 9 96 108 0,889 23,1% 185 203 0,911 43,8% III 8 6 10 6 17 10 108 108 1,000 12,5% 230 230 1,000 9,7% IV 10 5 9 12 19 11 114 108 1,056 5,6% 317 307 1,033 3,3% 1 Economy CPI: GDP Deflactor: 3 goods: 1 is produced abroad, 1 Is fixing a basket of Is fixing prices in a is produced and goods for several given period. It consumed locally, 1 periods. It includes includes all is produced locally, imported goods and domestic goods and but consumed excluded exported do not include abroad. ones imported ones All is calcullated based on period III Fundamentos de Economía 22 3. Economic growth  One of the main concerns of Macroeconomics is the uneven pace of economic progress that gives rise to the emergence of business cycles: Fundamentos de Economía 23 3. Economic growth  Recessions or contractions are periods of economic downturn, in which output and employment decline. The most common criterion for defining them is that there are two consecutive quarters of decline in aggregate production.  This is done to avoid qualifying a minor economic setback as a recession. But it may be too strict a definition: - For example, a quarter of significant decline in output, followed by another quarter of slight rebound and a subsequent quarter of sharp contraction: shouldn't it be seen as a nine-month recession? In the US, the decision rests with the independent panel of experts of the National Bureau of Economic Research. 24 Fundamentos de Economía 3. Economic growth Business cycles are an international phenomenon that usually produce rhythmic movements in the economies of different countries. Fuente: Krugman, Wells y Graddy (2013). Fundamentos de Economía 25 3. Economic growth Fuente: Krugman, Wells y Graddy (2020). Fundamentos de Economía 26 https://www.brookings.edu/articles/a- most-unusual-recovery-how-the-us-re bound-from-covid-differs-from-rest-of- g7/ Fundamentos de Economía 27 3. Economic growth  Long-term growth: the rule of 70 or 72 70 Years required to duplicate a variable = Annual growth rate of the variable The rule of 70 helps investors determine the value of their investment right now and what it might be in the future. While this is a rough estimate, the rule can be very effective. It's easier to figure out how many years it would take for that investment to double in size. Fundamentos de Economía 28 3. Economic growth https://www.youtube.com/watch? v=CbRHxms6ylU Fundamentos de Economía 29 3. Economic growth  Sources of long-term growth https://youtu.be/mT3P0YSNonE Fundamentos de Economía 30 3. Economic growth  Sources of long-term growth Sustained growth occurs when the amount of output produced by the average worker increases ⇨ when productivity increases and this happens if Man-made resources Increases physical Investment in buildings, machinery ⇨ capital importance of domestic and foreign savings Increased workforce prowess Increases human Outcome of education, training and capital experience Technical means for the production of goods Technological and services progress Not only eye-catching advances, but also thousands of small innovations Fundamentos de Economía 31 3. Economic growth  Diminishing returns on physical capital Fundamentos de Economía 32 3. Economic growth  Diminishing returns on physical capital  Diminishing returns to physical capital can disappear if human capital per worker increases, technology improves, or both. Total factor productivity is the quantity that can be produced with a given quantity of factors of production. When factor productivity increases, the economy can obtain a higher output with the same amount of physical, human and labour capital. ⇨ These increases in total factor productivity reflect the effect of technological progress. Fundamentos de Economía 33 3. Economic growth  Technological progress Fundamentos de Economía 34 3. Economic growth  The role of governments Governments and Infrastructure construction physical capital Promotion of private investment and savings Essential role of public expenditure on Governments and education human capital Latin America vs. Southeast Asia Governments and An important part of the R+D activity is technological carried out in public centers progress Political stability Institutional Rule of Law framework Appropriate regulatory framework Fundamentos de Economía 35 3. Economic growth  The personal role ? https://knowsdgs.jrc.ec.europa.eu/cfc Fundamentos de Economía 36 4. Balance in the external sector The balance of payments is the "statistical statement summarizing transactions between residents and non-residents over a period"  It informs about the international position of a country, its possible external imbalances. ⇨ Tool for economic policy. ⇨ Follow the double entry method. ⇨ Resident: any legal person established in that country and any natural person who carries out his activity in that country for 1 Link year or more.  Record operations:  Of the real field or the financial field. ⇨ Commercial or without counterpart. Fundamentos de Economía 37 4. Balance in the external sector  Three main accounts FINANCIAL CURRENT ACCOUNT CAPITAL ACCOUNT ACCOUNT Balance of trade Direct investment Capital transfers Balance of services Portfolio investment Primary income Other forms of balance Transactions in non- investment (Old income balance) financial and non- Secondary income produced assets Change in reserve balance (Old transfer assets balance) Fundamentos de Economía 38 4. Balance in the external sector Income Payment Balance Trade X M X-M Services X M X-M CURRENT Primary income Entries Exits PIB = Entries-Exits ACCOUNT Entries Secondary income Exits SIB = Entries-Exits Current account X – M + PIB + SIB balance(CAB) CAPITAL KAB = Entries- Entries Exits ACCOUNT Exits VARIATION VARIATION OF OF ASSETS LIABILITIES Direct investments Entries Exits Portfolio Entries Exits investments FINANCIAL Other investments Entries Exits ACCOUNT Financial account balance SCF=∑VA-∑VL Reserve Net Reserve variations Entries (+) movement= (RV) Exits (-) Fundamentos de Economía 39 Entries-Ex 4. Balance in the external sector Indicates the extent to which export activity Trade balance makes it possible to finance imports It is justified by the growing specialization in Balance of goods and services and the greater openness of the sector services to international competition. A negative balance indicates that the economy Current account has spent more than its earning capacity allows balance ⇨ indebtedness or loss of foreign exchange Current account Capacity (+) or financing need (-) of the balance + capital economy account balance Consequences that the set of transactions with the Balance of liquid rest of the world has on the country's reserves assets Entries only in variation of assets: balance + implies increase in reserves Fundamentos de Economía 40 4. Balance in the external sector  The exchange rate  It is the price of one currency in terms of another. The evolution of the nominal exchange rate affects the competitiveness of the economy, but so does the price differential.  To measure both incidents, the real exchange rate is used: this is the nominal exchange rate adjusted for the difference in the price level: P* ERreal TC TC ERnom  P The change in the nominal ER coincides with the change in the actual ER if prices in the country (P) vary to the same extent as in the reference country (P*).  The country gains in competitiveness if its currency depreciates (nominal ER increase) or if foreign prices grow faster than local prices (P*increases more than P). Fundamentos de Economía 41 4. Balance in the external sector  Foreign exchange systems Fixed exchange rate: implies the commitment on the part of the authorities to maintain the value of their currency linked to a currency. The most frequent modality: adjustable fixed parity with fluctuation band (European Monetary System, for example). - It can be established unilaterally - if the authorities of the country with whose currency the parity is established do not assume any type of commitment - or imply reciprocal commitments to maintain the value of the TC by the two countries (European Monetary System). Floating change: implies that it is the market that sets the value of the currency. ⇨ We speak of "dirty floating" if the authorities intervene when they consider it necessary. Fundamentos de Economía 42 5. The Phillips curve  In topic 10 we will explain in more detail that societies must face a short-term dilemma between inflation and unemployment:  Thus, when economic authorities want to encourage economic activity in order to reduce unemployment, they help to accelerate price growth. And if, on the contrary, they intend to contain inflation, they will do so at the cost of a temporary reduction in aggregate output and an increase in unemployment in the short term.  This dilemma is the one that graphically represents the Phillips curve. Fundamentos de Economía 43 5. Phillips Curve "The Phillips curve is probably the most important macroeconomic relationship." Words of George Akerlof (1940-) when collecting the Nobel Prize in 2001. Fundamentos de Economía 44 5. The Phillips curve Inflation rate The Phillips curve (%) represents the negative relationship between the inflation rate and the 6% B unemployment rate. At point A, inflation is low, but unemployment is high. And in B the 2% A opposite happens; Inflation is high and unemployment is low. 4% 7% Unemploym ent rate (%) Fundamentos de Economía 45 Let’s wrap this up… What have we learned in this topic? Fundamentos de Economía 46 Referencia bibliográfica Krugman, P., Wells, R. y Graddy, K (2022). Fundamentos de Economía. Barcelona: Editorial Reverté. Fundamentos de Economía 47