Chapter 7 The U.S. Labor Market PDF

Chapter 7  The U.S. Labor Market The unemployment rate The fraction of the labor force that is unemployed !"#$%&'(#) !"#$%&'(#) unemployment rate = × 100ment rate = × &*+', -'...

Chapter 7  The U.S. Labor Market The unemployment rate The fraction of the labor force that is unemployed !"#$%&'(#) !"#$%&'(#) unemployment rate = × 100ment rate = × &*+', -',.# &*+', -',.# 100 A person is unemployed if he or she does not have a job that pays a wage or salary, has actively looked for a job in the last 4 weeks, and is available to work. 7.3 Supply and Demand Downward-sloping labor demand Diminishing marginal product of labor (MPL) Upward-sloping labor supply curve Price of leisure is higher when wages are higher. The intersection of labor supply and demand determines: level of employment wage rate The Labor Market A Change in Labor Supply If the government collects a tax on wages the labor supply curve shifts left. a worker receives less money and supplies less labor—this applies to any wage. To be in equilibrium, Eirms must raise wages. An Income Tax at Rate 𝝉 A Change in Labor Demand If the government creates regulations making it harder to fire workers, firms will demand fewer workers. labor demand shifts left, o wages and employment fall. Initially, the unemployment rate rises o but recovers as discouraged workers drop out of the labor force. A Reduction in Labor Demand Wage Rigidity Wage rigidity Wages fail to adjust after a shock to labor demand or supply. What happens if wages do not fall in the above demand shock example? The labor market will not clear; this results in a larger fall in employment. A Reduction in Labor Demand with Wage Rigidity DiDerent Kinds of Unemployment Cyclical unemployment: Associated with short-run fluctuations in output The natural rate of unemployment: The rate that would prevail with no cyclical unemployment Frictional unemployment: o Workers between jobs in the dynamic economy Structural unemployment: o Labor market failure to match workers and firms 𝑎𝑐𝑡𝑢𝑎𝑙 𝑢𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡 = 𝑓𝑟𝑖𝑐𝑡𝑖𝑜𝑛𝑎𝑙 + 𝑠𝑡𝑟𝑢𝑐𝑡𝑢𝑟𝑎𝑙 + 𝑐𝑦𝑐𝑙𝑖𝑐𝑎𝑙 natural 7.4 The Bathtub Model of Unemployment Bathtub model States how employment and unemployment evolve over time (1) Et + Ut = L$ Where Et = the number of employed people Ut = the number of unemployed people L̅ = the number of people in the labor force Bathtub Model of Unemployment (1 of 3) Bathtub model equation (2) ∆𝑈!"# = 𝑠𝐸 ̅ ! ̅ ! − 𝑓𝑈 Where ∆𝑈!"# : change in unemployment over time 𝑠:̅ job separation rate 𝑓:̅ job finding rate Bathtub Model of Unemployment (2 of 3) Solving the model: Set the change in unemployment to zero 0 = 𝑠𝐸̅ ! − 𝑓𝑈 ̅ ! = 𝑠(L̅ ̅ - Ut)- 𝑓𝑈 ̅ ! = 𝑠L̅̅ - (𝑓 ̅ + 𝑠)̅ 𝑈! Solve the equation for 𝑈! gives the number of people unemployed in steady state U*: # ̅ $ L U* = ̅ %&#̅ Bathtub Model of Unemployment (3 of 3) The unemployment rate is the fraction of the labor force that is unemployed: * '∗ #̅ u≡ = ̅ #̅ )( %& To alter the natural rate of unemployment: Change the job-finding rate. Change the job separation rate. Policies along these lines can have unintended consequences. 7.6 How Much Is Your Human Capital Worth? The present discounted value of your lifetime income is likely greater than $1 million. Present discounted value: The value of money you would need to put in the bank today to equal a given future value Tells how much a future payment or a future Elow of payments is worth today 𝑓𝑢𝑡𝑢𝑟𝑒 𝑣𝑎𝑙𝑢𝑒 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡𝑒𝑑 𝑣𝑎𝑙𝑢𝑒 = (1 + 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒)$ Present Discounted Value (1 of 2) To calculate the value of a stream of equal payments over a given number of years: Arrange the sum of each periodʼs present discounted values into a geometric series. Use the formula for a sum of a geometric series to calculate the present discounted value of the stream of payments. If a is some number between 0 and 1, then calculating a geometric series is: "#$ * + ,-. 1+𝑎+𝑎 +⋯ +𝑎 = ,-. Present Discounted Value (2 of 2) The series for $100 initial payment for 20 years: 𝑝𝑑𝑣 = 𝑝𝑑𝑣0 + 𝑝𝑑𝑣1 + 𝑝𝑑𝑣2 + ⋯ + 𝑝𝑑𝑣19 $,00 $,00 $,00 = $100 + + ! + ⋯+ (,&2) (,&2) (,&2)"# , , , = $100 × [1 + + ⋯+ ] ,&2 ,&2 ! (,&2)"# From the previous slide: If a = 1/(1 + R), then: " ,-[ ]!& "$% 𝑝𝑑𝑣 = $100 × " ,- ("$%) Chapter 8 Inflation (1 of 2) Inflation Percentage change in the overall price level Hyperinflation Episode of extremely high inflation Greater than 500 percent per year Inflation (2 of 2) Inflation rate: annual percentage change in the price level 6)$" -6) 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 = ×100 6) where 𝑃𝑡 is the price level in year t The Consumer Price Index (CPI) Price index for a bundle of consumer goods Measures of the Money Supply (1 of 2) The monetary base includes currency and accounts (reserves). Banks hold accounts with the economyʼs central bank. Under the Ample Reserves Framework, seen in the US and most major economies, the banking system holds ample reserves and earns interest on reserve balances. Measures of the Money Supply (2 of 2) The Quantity Equation Connects money and inflation Velocity of money The average number of times per year that each piece of paper currency is used in a transaction The amount of money used in purchases is equal to nominal GDP. 𝑀: 𝑉: = 𝑃: 𝑌: Money Velocity Price Real supply of money level GDP The Classical Dichotomy and Constant Velocity (1 of 2) The classical dichotomy: In the long run, the real and nominal sides of the economy are completely separate. In the quantity theory of money: Real GDP assumed as exogenously given Determined by real forces In other words: 𝑌! = 𝑌B! The Classical Dichotomy and Constant Velocity (2 of 2) The velocity of money: Exogenously given constant Assumed to be constant over time 𝑉! = 𝑉 The money supply: Determined by the central bank Monetary policy exogenously given 𝑀! = 𝑀 t The Quantity Theory of Money The Quantity Theory for the Price Level To solve the model Plug in all the exogenous variables. Solve for the price level. =! 𝑉> 𝑀 𝑃!∗ = 𝑌>! Prices will rise as a result of Increases in the money supply Decreases in real GDP In the long run, the key determinant of the price level is the money supply. The Quantity Theory for Inflation (1 of 2) %∆𝑀 + %∆𝑉 = %∆𝑃 + %∆𝑌 We can express the quantity equation in terms of growth rates 𝑔. 𝑔̅7 + 𝑔̅8 = 𝑔6 + 𝑔̅9 Where: 𝑔8 = 0 and 𝑔: = 𝜋 We assume 𝜋 ∗ = 𝑔̅7 − 𝑔̅9 The Quantity Theory for Inflation (2 of 2) Quantity Theory of Money: 𝜋 ∗ = 𝑔̅7 − 𝑔̅9 Changes in the growth rate of money lead to one-for-one to changes in the inflation rate. Empirically, holds up both in U.S. and worldwide data Deflation: Occurs when inElation rates are negative 𝑔& ̅ < 𝑔'̅ 8.3 Real and Nominal Interest Rates The real interest rate is equal to the marginal product of capital. is paid in goods. The nominal interest rate is the interest rate on a savings account. is paid in dollars. The Fisher Equation (1 of 2) The Fisher equation 𝑖≈𝑅+ 𝜋 where 𝑖: nominal interest rate 𝑅: real interest rate 𝜋: inflation rate The nominal interest rate is generally high when inflation is high. The Fisher Equation (2 of 2) If 𝑖 ≈ 𝑅 + 𝜋 then 𝑅 ≈ 𝑖 − 𝜋 Empirically The real interest rate has been negative. This implies that in the short run the real interest rate need not equal the MPK. Real and Nominal Interest Rates in the United States 8.4 Costs of Inflation Individuals who are hurt during inflation: An individual who has a pension that is not indexed to inflation A bank that issues loans at fixed rates but that pays interest rates that move with the market An individual with a variable rate mortgage 8.5 The Fiscal Causes of High Inflation The government budget constraint 𝐺 = 𝑇 + ∆𝐵 + ∆𝑀 Where G government uses of funds T tax revenue ∆𝐵 change in the stock of government debt ∆𝑀 change in the amount of new money issued by government The Inflation Tax (1 of 2) Seigniorage and the inflation tax Names for the revenue that the government obtains from printing more money (ΔM) The inflation tax Shows up as a rise in the price level. Is paid by people holding currency. The Inflation Tax (2 of 2) If a government runs large budget deficits, as debt rises, lenders may worry government will have trouble paying back loans. they may stop lending to the government altogether. Debt solution: Raising taxes? May not be politically feasible. The government may resort to printing currency to finance its budget. Lenders to the government will be paid back in currency that is worth less than the dollars lent. Chapter 9 9.2 The Long Run, the Short Run, and Shocks The long-run model is a guide to how the economy behaves on average. Determines potential output and long-run inflation Potential output Amount of production if all inputs were utilized at their long-run sustainable levels At any given time, the economy is unlikely to exactly equal the long-run average. The short-run model: Determines current output and current inflation Trends and Fluctuations Actual output Yt is equal to the long-run trend Y̅t plus short-run fluctuations Ỹt: Yt = Y̅t + Ỹt Short-Run Fluctuation “Detrended output” or short-run output: The difference in actual and potential output, expressed as a percentage of potential output: 9) -9() 𝑌a! ≡ 9() Economic Fluctuations and Short-Run Output Short Run A recession begins when actual output falls below potential. o Short-run output becomes negative. ends when short-run output starts to rise. o Short-run output becomes less negative. Typically, during a recession, output is below potential for approximately 2 years. o Loss of about $3,000 per person between 1.5 million and 3 million jobs are lost. 9.3 The Short-Run Model The short-run model is based on three premises: The economy is constantly being hit by shocks. o Shocks: factors that cause >luctuations Monetary and Eiscal policies affect output. o Policymakers can neutralize shocks to the economy. There is a dynamic trade-off between output and inElation. o Shown by the Phillips curve The Phillips Curve A Graph of the Short-Run Model The Phillips curve shows a boom increases inElation. a recession decreases inElation. a positive relationship between the change in inElation and short-run output. Empirically, the slope is about 1⁄3. If output exceeds potential by 3 percent, the inElation rate increases one percentage point. Works in a “Cycle” Firms raise prices. The inflation rate increases. There is less demand for products. Firms cut costs and lay off workers. Inflation rate falls to previous levels. 9.4 Okunʼs Law: Output and Unemployment Natural rate of unemployment: The rate of unemployment that exists in the long run Cyclical unemployment: Current unemployment minus the natural rate of unemployment Okun’s Law Cyclical unemployment " 𝑢 − 𝑢# = − × 𝑌' # Current rate of unemployment Natural rate of Short-run unemployment output Chapter 10 10.1 Introduction In the past two decades, the global economy experienced two once-in-a-lifetime shocks: The global financial crisis of 2008–2009 The Covid-19 pandemic that began in 2020 These shocks introduce new concepts into the macroeconomics toolbox: Balance sheets and leverage The economic value of life 10.2 The Great Recession of 2007–2009 What was the global financial crisis? A catastrophic near-collapse of the world’s financial system resulting from a systemic failure to properly assess balance sheet risk which led to cessation in the flow of credit between financial institutions. The global financial crisis led to the Great Recession of 2007– 2009. Causes of the Global Financial Crisis What shocks to the macroeconomy caused the global financial crisis? Housing prices Global saving glut Subprime lending and rise in interest rates Previous financial turmoil The Financial Turmoil of 2008–2009 Securitization Pooling a group of Einancial instruments, dividing them up, and selling in pieces Intended to diversify risk Bank lending standards decreased. Securitization Homeowners loans Purchase home Banks loans Package loans Third parties loans Sell loans Investors MBS Repackage loans Investors CDO or SIV 10.3 The Covid-19 Pandemic Economic and humanitarian disaster Over 7 million people died worldwide 1 out of every 300 people in the United States, Brazil, and parts of Europe died Costs have disproportionately affected o Elderly o People already in poor health o Minorities o Essential Workers 10.4 Macroeconomic Outcomes since 2007 The Great Recession of 2008–2009 and the Covid-19 Pandemic show up in macroeconomic statistics. Employment GDP InElation Nonfarm Employment in the U.S. Economy  $ U.S. Short-Run Output, 𝒀 10.5 Fundamentals of Financial Economics Balance sheet Accounting tool o Left side: assets o Right side: liabilities and net worth The two sides sum to the same value. Balance Sheets Assets Item of value that an institution owns Liability An amount that is owed to someone else Equity (net worth or capital) Difference between total assets and total liabilities Represents the value of an institution to its shareholders or owners Banking Regulations Banks are also subject to financial regulations. The reserve requirement Mandates that banks keep a certain percentage of deposits on reserve The capital requirement Mandates that capital be a certain fraction of assets Hypothetical Bank’s Balance Sheet Leverage (1 of 2) Leverage The ratio of total liabilities to net worth Magnifies any changes in the value of assets and liabilities This principle also applies to homeowners. Leverage (2 of 2) If a bank is highly leveraged, it may have large gains off a small increase in market prices. large losses off a small decrease in prices. Insolvency Liabilities > assets Before the Einancial crisis, many investment banks were highly leveraged. Chapter 11 Introduction The Federal Reserve influences the level of economic activity in the short run. The Fed targets the federal funds rate. The Fed is highly correlated with the short-term nominal interest rate at which people borrow and lend in financial markets. The basic story is as follows: ↑ interest rate ⟹ ↓ investment ⟹ ↓ output The IS curve Illustrates the negative relationship between interest rates and short- run output 11.2 Setting Up the Economy The national income accounting identity Implies that the total resources available to the economy equal total uses One equation and six unknown variables 𝑌! + 𝐼𝑀! = 𝐶! + 𝐼! + 𝐺! + 𝐸𝑋! where o 𝑌! output o 𝐼! investment o 𝐼𝑀! imports o 𝐺! government purchases o 𝐶! consumption o 𝐸𝑋! exports Setting Up the Economy Five additional equations to solve the model: 𝐶! = 𝑎B< 𝑌B! 𝐺! = 𝑎B= 𝑌B! 𝐸𝑋! = 𝑎B>? 𝑌B! 𝐼𝑀! = 𝑎B@A 𝑌B! B) B ! − 𝑟)̅ = 𝑎B@ − 𝑏(𝑅 9() where a bar denotes an exogenous variable The Investment Equation Investment Equation B) B ! − 𝑟)̅ = 𝑎B@ − 𝑏(𝑅 9() where 𝑎$! share of potential output that goes to investment 𝑏$ parameter weighting the difference between the real interest rate and the MPK 𝑅" real interest rate 𝑟̅ marginal product of capital MPK Marginal Product of Capital (MPK) (1 of 2) Amount of additional output the Eirm can produce by investing in one more unit of capital In the long run, MPK = 𝑟, and 𝑟 is Exogenous Time invariant Recall the equation for investment: B) B ! − 𝑟)̅ = 𝑎B@ − 𝑏(𝑅 9() Multiply each side by 𝑌! and 𝑏B through the parentheses: 𝐼! = 𝑎B@ 𝑌B! − 𝑏B 𝑌B! 𝑅! + 𝑏B 𝑌B! 𝑟̅ Marginal Product of Capital (MPK) (2 of 2) Now, we can use the following equation for investment to understand how the gap between MPK and the real interest rate helps determine investment: In the short run, MPK and 𝑟 can be different. If MPK= 𝑟̅ < 𝑅! Firms should save and not invest in capital. Investment will decline. If MPK= 𝑟̅ > 𝑅! Firms should borrow and invest in capital. Investment will increase. The Setup of the Economy for the IS Curve 11.3 Deriving the IS Curve Begin with the national income accounting identity, and divide both sides by potential output: XC YC ZC [C \]C Z^C X> = X> + X> + X> + X> − X> C C C C C C Substitute the five remaining equations into the equation above: X _>DX>C > C`c)̅ _>E `a(b _>FX>C _>GHX>C _>EIX>C X>C = X> + X>C + X> + X> − X> C C C C C Simplifying yields: 9) = 𝑎B< + 𝑎B@ − 𝑏B 𝑅! − 𝑟̅ + 𝑎B= + 𝑎B>? − 𝑎B@A 9() Deriving the IS Curve (1 of 2) Recall the definition of short-run output: 9 -9 ( 𝑌a! ≡ ) ( ) 9) Subtract 1 from both sides of the equation: 9() − 1 = 𝑎B< + 𝑎B@ + 𝑎B= + 𝑎B>? − 𝑎B@A −1 − 𝑏B 𝑅! − 𝑟̅ 9() After simplifying: B ! − 𝑟)̅ 𝑌a! = 𝑎B − 𝑏(𝑅 Deriving the IS Curve (2 of 2) Equation for the IS curve: B ! − 𝑟)̅ 𝑌a! = 𝑎B − 𝑏(𝑅 The gap between the real interest rate and the MPK is what determines output fluctuations. The parameter 𝑎$ is called the aggregate demand shock. Note: When 𝑌! = 𝑌>! , then 𝑎> = 0 and 𝑅! = 𝑟̅ 11.4 Using the IS Curve A Change in the Interest Rate A change in the real interest rate moves the economy along the IS curve. An Increase in the Real Interest Rate to R′ A Change in the Interest Rate B were higher: If the sensitivity to the interest rate (𝑏) The IS curve would be flatter. A change in the interest rate would be associated with larger changes in output. An Aggregate Demand Shock (1 of 2) Suppose that information technology improvements create an investment boom. An Aggregate Demand Shock (2 of 2) 11.5 Microfoundations of the IS Curve Microfoundations: Explain the microeconomic behavior that establishes the demands for 𝐶, 𝐼, 𝐺, EX, and 𝐼𝑀 Theories of consumption behavior: Individuals prefer to smooth their consumption spending over time. o The permanent-income hypothesis: People will base their consumption on an average of their income over time rather than on their current income. o The life-cycle model of consumption suggests that consumption is based on average lifetime income rather than on income at any given age. Consumption Consider you are given the choice between Option A and Option B: Option A: Consumption: one piece of cake ($3) every day Monday through Friday Income: $15 on Friday, but you may borrow $3 a day (at no interest) to consume during the week. Option B: Consumption: five pieces of cake ($15) on Friday Income: $15 on Friday Permanent income hypothesis predicts people will choose Option A. Multiplier Effects Suppose we conclude that consumption also depends on temporary changes in income. This yields a multiplier effect. Consumption equals J) = 𝑎B< + 𝑥̅ 𝑌a! 9() where x̅ is a parameter that determines how much consumption rises when the economy expands. We assume x̅ is between 0 and 1. Multiplier Effects The new IS curve: , s𝑌 𝑡 = ╳ 𝑎B − 𝑏B 𝑅! − 𝑟̅ ,-? multiplier original IS curve Multiplier Effects Positive AD shock ↑ 𝐶! ↑ 𝑎( ↑ 𝑌*! J Note: In this case, ! = 𝑎B 𝐶 + 𝑥̅ 𝑌a 𝑡 , and consumption is affected 9! by changes in short-run output. Agency Problems Investment spending can be financed through: Cash flow Borrowing (which tends to be more costly) Borrowing introduces agency problems. Asymmetric information between individuals involved in a transaction Two main types of agency problems: o Adverse selection o Moral hazard Fiscal Policy Automatic stabilizers Transfer spending programs (e.g., unemployment insurance, Medicare) The impact of fiscal policy depends on timing. the “no free lunch” principle. Ricardian Equivalence Analogous to the permanent-income hypothesis According to Ricardian equivalence: The timing of tax changes does not matter for consumer behavior. The present value of government tax collection determines behavior. Consider an example: Suppose Congress decides to hire more teachers, increasing government purchases by $500 million. OR