1 - Introduction to Global Economics.pdf

Introduction to Global Economics. MIM – Economics and the Global Environment Fall 2024 Term Prof. Jordi Vives – [email protected] Prof. Josep Comajuncosa – [email protected] 01 The National Accounts GNP (Gross National Product): M...

Introduction to Global Economics. MIM – Economics and the Global Environment Fall 2024 Term Prof. Jordi Vives – [email protected] Prof. Josep Comajuncosa – [email protected] 01 The National Accounts GNP (Gross National Product): Market value of the production of final goods and services carried out, in one year, by domestically owned productive factors. Real GNP: Value of the production of final goods and services carried out in one year, by domestically owned productive factors, using the prices of a base year. In the base year: Nominal GNP = Real GNP GDP (Gross Domestic Product): Market value of the production of final goods and services carried out in an economy, in one year, by the productive factors located in the country.  GDP = GNP + Income of Foreign factors located in the country - Income of National factors located abroad. Economic Growth: Rateof increase in real GDP (Increased production of goods and services). Yt − Yt −1 gY = Yt −1 Economic Cycles: Expansions: positive growth periods. Recessions: negative growth periods. Economic Growth: National Income (NI): Gross remuneration of all the productive factors of the economy over the course of a year. Circular Flow Goods and Services Goods and Services MARKETS Money Flow: FOR GOODS Money Flow: Expenses & SERVICES Revenues Money Flow: FACTOR Money Flow: Income MARKETS Costs (e.g. labor Factors of Production market) Factors of Production Circular Flow Goods and Services Goods and Services MARKETS Money Flow: FOR GOODS Money Flow: Expenses & SERVICES Revenues Transfers Subsidies Taxes Taxes Money Flow: FACTOR Money Flow: Income MARKETS Costs (e.g. labor Factors of Production market) Factors of Production National Income (NI) = GNP - Depreciation of capital (K) - Indirect Taxes + Subsidies Origin of Income: From Labor: salary, wages, payments in kind... From Capital: profits, dividends, interest... From Land: rental income, capital gains... Disposable Income = NI - Direct Taxes + Public Sector Transfers to Families Yd =C+S Private saving is defined as the portion of disposable income that is not consumed. Aggregate Expenditure: GDP = C + I + G + NX Gross Domestic Product: The Expenditure Approach Aggregate Supply and Demand: GDP = C + I + G + NX In the short term: GDP depends on the evolution of the components of demand. In the long term: It depends on the evolution of supply conditions (technological innovations, productivity of labor and capital...) GDP Trend t  Long Term: it depends on the ability to produce goods and services GDP In the short term: (productivity) it depends on the Aggregate Demand AD=C+I+G+NX Trend t Value Added = Value of Sales - Cost of Embedded Intermediate Goods Measures the contribution of capital and labor to production. GDP = Sum of the added value of all sectors of the economy.  Expenditure Production Income (Demand) ∑ Value ∑ Earned C + I + G + NX Added Income By definition, total production of final goods and services is equivalent to the sum of value added, the sum of earned incomes and total expenditures.  Gross Domestic Product: The 3 methods Theoretically, GDP can be viewed in three different ways: The production approach sums the “value-added” at each stage of production, where value-added is defined as total sales less the value of intermediate inputs into the production process. For example, flour would be an intermediate input and bread the final product; or an architect’s services would be an intermediate input and the building the final product. The expenditure approach adds up the value of purchases made by final users—for example, the consumption of food, televisions, and medical services by households; the investments in machinery by companies; and the purchases of goods and services by the government and foreigners. The income approach sums the incomes generated by production—for example, the compensation employees receive and the operating surplus of companies (roughly sales less costs). Gross Domestic Product: The Value Added  Gross Domestic Product: The Income Approach Origin of Income: From Labor: salary, wages, payments in kind... From Capital: profits, dividends, interest... From Land: rental income, capital gains... Gross Domestic Product: GDP per capita  Gross Domestic Product: GDP per capita GDP is not a perfect measure of the overall standard of living or well-being of a country. Although changes in the output of goods and services per person (GDP per capita) are often used as a measure of whether the average citizen in a country is better or worse off, it does not capture things that may be deemed important to general well-being.  Gross Domestic Product: GDP per capita GDP is not a perfect measure of the overall standard of living or well-being of a country. Although changes in the output of goods and services per person (GDP per capita) are often used as a measure of whether the average citizen in a country is better or worse off, it does not capture things that may be deemed important to general well-being. Growth Projections (IMF): Growth Projections (IMF): 02 Inflation Inflation: Theaggregate increase in the level of prices in the economy. The percent increase in CPI. CPI (Consumer Price Index): Weighted average price of a list of more than three hundred goods and services. Calculated relative to a base year. Inflation: The percent increase in CPI. 𝐶𝐶𝐶𝐶𝐶𝐶𝑡𝑡 −𝐶𝐶𝐶𝐶𝐶𝐶𝑡𝑡−1 𝜋𝜋𝑡𝑡 = ×100 𝐶𝐶𝐶𝐶𝐶𝐶𝑡𝑡−1 The rate of inflation is the percentage change in the overall level of prices. It varies greatly over time and across economies. It affects purchasing power of economic agents (costumers, firms and governments). The inflation target for developed economies is set at around 2% by Central Banks in order to guarantee price stability. Central Banks have ultimate control over the rate of inflation through the use of Monetary Policy (covered in Topic 3). Demand-driven Inflation: Caused by an expansion of aggregate demand. Supply-driven Inflation: Caused by a contraction of the aggregate production. Core Inflation: Inflation rate eliminating the price of imported raw materials, fuel and unprocessed food.  The Costs of Inflation: It reduces the purchasing power of wages (not in a homogeneous or “fair” way). It makes economic planning difficult for families and companies. Prices may lose informative value (market economy is less efficient). It mainly hurts money holders and favors debtors (if unexpected). It creates uncertainty. It harms economic activity.  GDP deflator -> Measuring Inflation Inflation rate: the percentage increase in the overall level of prices. One measure of the price level: GDP deflator. Definition: Nominal GDP GDP deflator = 100 × Real GDP The surge in Inflation (2021-2023) 03 Hyperinflation and Deflation Hyperinflation: A very high inflation rate (above 10% annually). Hyperinflation: Hungary 1945-46: 4.19 x 1016% monthly. 207% daily. Zimbabwe 2007-08: 7.96 x 1010% monthly. 98% daily. Hyperinflation: 100 trillion (1012) Zimbabwean dollars Deflation: A negative inflation rate. Deflation generates a negative spiral: Deflation-recession-deflation... Deflation should be avoided at all costs! 04 Unemployment Balance of Payments BALANCE OF PAYMENTS Balance of Payments: Accounting record of all economic transactions in an economy with the rest of the world over a given period of time (usually one year). All entries are in the national currency. Uses the double-entry bookkeeping accounting principle: transactions are annotated as inflows or outflows. The balance (net flows) = inflows - outflows BALANCE OF PAYMENTS Balance of Payments Scheme: Current Account (CA) Balance: record of all economic operations that are initiated and finalized (settled) during the period of reference Financial and Capital Account (FA) Balance: record of all economic transactions that start in the period of reference but have repercussions in the future (purchase of physical and financial assets) BALANCE OF PAYMENTS Balance of Payments Scheme: Current Account Balance: Trade Balance Trade in goods: Exports – Imports Trade in services: Exports – Imports Income Balance Investment income: Receipts – Payments Dividends: Receipts – Payments Transfers Balance (e.g. remittances)  BALANCE OF PAYMENTS Balance of Payments Scheme (continued): Capital and Financial Account Balance: Capital transfers balance (ex. debt forgiveness) Financial account balance Direct Investment: e.g. acquisition of a foreign firm Portfolio Investment: e.g. purchase of foreign shares Other Investment: e.g. bank loans to foreign consumers Reserve Assets (held by the Central Bank): Gold and Foreign Exchange  Receipts Payments Balance Explanations CURRENT ACCT. Trade in goods 5 15 -10 Imports>Exports Trade in services 0 4 -4 Imports>Exports Investment income 11 9 2 Income earned by domestic citizens from assets they purchased purchased abroad in previous periods > Income paid to foreigners related to assets they purchased in purchased in previous periods Transfers 0 0 0 -12 the country finances some of its imports with net income earned earned by assets owned abroad by domestic citizens, the rest the rest needs to be financed from other sources (See below) below) FIN. ACCT. Change in Change in Balance Liabilities Assets Direct Investments 20 7 13 The country has increased its foreign liabilities from direct direct investment (foreigners invested more in the country) country) Portfolio Investments 0 3 -3 Shares & bonds bought by domestic citizens abroad > those those bought by foreigners in the home country Other Investments 0 0 0 Reserve assets 2 The central bank sells some of its FX reserves and is paid 2 in 2 in home country currency. 12 the CA deficit is financed by “exporting” assets worth 12 (10 in 12 (10 in shares & bonds of domestic businesses sold to foreign foreign investors and 2 in foreign reserves). The proceeds are proceeds are used to finance imports (-12)  Receipts Payments Balance Explanations CURRENT ACCT. Trade in goods 25 15 10 Exports>Imports Trade in services 4 4 0 Balanced trade in services Investment income 21 9 11 Income earned by domestic citizens from assets they purchased purchased abroad in previous periods > Income paid to foreigners related to assets they purchased in purchased in previous periods Transfers 0 0 0 21 CA surplus, the country is a net lender to other countries countries (finances their imports) FIN. ACCT. Change in Change in Balance Liabilities Assets Direct Investments 20 27 -7 The country increases its net foreign assets from direct investment and pays 7 for these assets Portfolio Investments 0 3 -3 Shares and bonds bought by domestic citizens abroad > Shares Shares and bonds bought by foreigners in the home country country Other Investments 0 0 0 Reserve assets -11 The domestic central bank increases foreign reserves, valued at valued at 11 units of domestic currency. -21 the domestic country “imports” assets from abroad, (21=7 in FDI (21=7 in FDI + 3 in shares & bonds + 11 in foreign reserves), thus reserves), thus helps finance the imports of other countries countries BALANCE OF PAYMENTS Balance of Payments Analysis: Balance of Payments Deficit: The economy's foreign exchange reserves are reduced. Balance of Payments surplus: The economy's foreign exchange reserves increase. The goal of any economy is to have a stable Balance of Payments (at least on average and in the medium term). BALANCE OF PAYMENTS Balance of Payments balance types: Current account deficit offset by a financial account balance surplus. Typical of developing (and some developed) Current account surplus that allows a deficit of the financial account. Typical of developed economies / export-driven developing economies (also oil exporters) BALANCE OF PAYMENTS  Balance of Payments equilibrium implies: CA balance + FA balance (including change in foreign exchange reserves) =0  Current Account Deficit Exp < Imp Financial Account Surplus Inflow of Capitals (loans received from rest of the world) The country cumulates External Debt  Exp > Imp Current Account Surplus Financial Account Deficit Outflow of Capitals (Loans to the rest of the world) The country becomes External Creditor  BALANCE OF PAYMENTS Current Account Imbalances across countries Source: IMF Global Current Account Imbalances BALANCE OF PAYMENTS Cumulative Current Account Balance (1980- 2008) Source: IMF Identities IDENTITIES Important Identities (1): (with public sector, without external sector) S=I Private saving is critical in determining the investment and the growth potential of the economy. IDENTITIES Important Identities (2): (with public sector, no external sector) S = I + Public Deficit givena level of savings, the larger the public deficit, the smaller private investment, and the lower the growth potential of the economy. 1. IDENTITIES Important Identities (3): (with public sector and external sector) S = I + Public Deficit + Current Account Balance or S + Financial Account Balance = I + Public Deficit  given a volume of savings, the greater the public deficit, the smaller the private investment, and the lower the growth potential of the economy. Unemployment: Labor force: people who by age and health can work and are looking for a job. Employed – have a job. Unemployed – do not have job, looking for one. Population not in the labor force. Unemployment Rate: = (Unemployed / Labor Force) x 100 LaborForce Participation Rate: = (Labor force / Population of working age) x 100 Only those looking for work are counted as unemployed. Those not working and not looking for work are not in the Labor force. People without jobs who give up looking for work are known as discouraged workers. The Public Sector  The Functions of Government  Preserve market competition.  Regulate monopolies, mergers AND acquisitions.  Correct suboptimal market outcomes.  Provide public goods, correct externalities, etc.  Redistribution.  Ensure a more equitable society.  Fight recessions.  Steer the economy in the long run.  Investment in strategic sectors, basic research, etc.  The Public Budget A record of all revenues and expenditures of the public sector. Revenues: Taxes (excises, levies): Direct: e.g., income tax. Indirect: e.g., VAT, corporate taxes. Expenditures: Public Spending (including public investment). Transfers to Private Sector.  The Public Budget Public Budget Balance: Revenues - Expenditures Balance > 0 (Surplus) Balance < 0 (Deficit) Primary Budget Deficit: Public Budget Deficit excluding public spending towards interest payments related to public debt. The Public Budget The Public Budget The Public Budget The Public Budget The Public Budget The Public Budget 2.25 General government expenditures by function as a percentage of GDP, 2019 Housing and Recreation, The Public Budget General public Public order Economic Environmental Social Defence community Health culture and Education services and safety affairs protection protection amenities religion Australia 4,0 2,3 2,0 4,9 0,9 0,6 7,3 0,9 5,8 9,8 Austria 5,7 0,6 1,3 5,8 0,4 0,3 8,3 1,2 4,8 20,1 Belgium 6,9 0,8 1,7 6,7 1,3 0,3 7,6 1,3 6,2 19,4 Chile 3,0 1,1 2,0 2,3 0,2 0,9 4,4 0,3 5,5 5,9 Colombia 4,9 1,2 2,1 3,1 0,5 0,5 5,1 0,7 4,2 8,7 Czech Republic 4,4 0,9 1,9 6,1 0,8 0,7 7,6 1,4 4,9 12,6 Denmark 6,0 1,1 1,0 3,1 0,4 0,2 8,2 1,6 6,3 21,4 Estonia 3,5 2,1 1,8 3,9 0,7 0,4 5,3 2,0 6,0 13,2 Finland 7,9 1,2 1,2 4,2 0,2 0,3 7,1 1,5 5,6 24,0 France 5,5 1,7 1,6 6,0 1,0 1,1 8,0 1,4 5,3 23,9 Germany 5,7 1,1 1,6 3,3 0,6 0,4 7,4 1,0 4,3 19,7 Greece 7,9 2,0 2,1 4,0 1,4 0,2 5,3 0,8 4,0 19,8 Hungary 8,2 1,0 2,1 8,0 0,5 0,8 4,5 3,0 4,7 12,7 Iceland 7,2 0,1 1,5 4,9 0,6 0,5 7,8 3,0 7,0 10,9 Ireland 2,7 0,2 0,9 2,3 0,4 0,7 4,7 0,5 3,1 8,9 Israel 4,2 5,3 1,6 2,9 0,5 0,2 5,4 1,5 7,0 11,1 Italy 7,5 1,3 1,8 4,0 0,9 0,5 6,8 0,8 3,9 21,1 Japan 3,8 0,9 1,2 3,7 1,1 0,7 7,7 0,4 3,3 16,1 Korea 4,0 2,4 1,2 4,4 0,8 1,0 4,7 1,0 4,8 6,9 Latvia 3,8 1,9 2,2 5,3 0,6 1,0 4,2 1,5 5,8 12,1 Lithuania 3,5 1,6 1,4 3,0 0,4 0,5 6,2 1,2 4,6 12,3 Luxembourg 5,0 0,4 1,2 5,2 0,9 0,6 5,0 1,3 4,7 18,0 Netherlands 4,1 1,3 1,8 3,8 1,4 0,4 7,7 1,2 5,0 15,4 Norw ay 4,8 1,9 1,2 6,0 0,9 0,8 8,7 1,8 5,6 19,7 Poland 4,2 1,6 2,1 4,8 0,5 0,5 4,9 1,3 5,0 16,7 Portugal 6,7 0,8 1,7 3,6 0,6 0,5 6,6 0,9 4,4 16,9 Slovak Republic 5,4 1,1 2,3 5,1 0,8 0,5 7,7 1,2 4,2 14,4 Slovenia 5,2 1,0 1,6 4,5 0,6 0,4 6,7 1,4 5,5 16,5 Spain 5,5 0,8 1,8 4,0 0,9 0,4 6,1 1,1 4,0 17,4 Sw eden 6,9 1,2 1,3 4,4 0,5 0,7 7,0 1,3 6,9 19,0 Sw itzerland 4,2 0,8 1,6 3,9 0,6 0,2 2,1 1,0 5,4 12,9 United Kingdom 4,3 2,0 1,8 3,5 0,6 0,8 7,7 0,6 4,9 14,8 United States 5,8 3,4 1,9 3,4 0,0 0,5 9,3 0,3 5,9 7,6 OECD 5,4 2,2 1,7 3,9 0,5 0,6 7,9 0,7 5,1 13,3 OECD-EU 5,8 1,2 1,7 4,4 0,8 0,6 7,0 1,2 4,7 19,3 Costa Rica 3,7 0,0 2,5 3,2 0,4 0,8 5,9 0,2 7,7 8,3 Romania 4,2 1,7 2,2 4,7 0,7 1,1 5,0 1,0 3,6 11,9 Sources: OECD National Accounts Statistics (database); Eurostat Government finance statistics (database). Financing The Public Budget Deficit Monetization: Central Bank purchases public debt directly from the government. Forbidden in most developed countries to ensure independence of Monetary Policy (many developing ones too). Selling Public Debt in bond markets to investors. Financing The Public Budget Deficit The Public Debt The Public Debt The Public Debt The Public Debt The Public Debt The Public Debt The Public Debt  The Downside of Public Debt  Every extra euro of public debt typically generates additional interest payments (adding to the public budget deficit).  Public budget surpluses are eventually needed to keep the debt in check.  If public debt is in foreign currency, a depreciation / devaluation of the national currency will increase the burden of debt repayment (debt value in national currency goes up).  Generates crowding out effect: Public debt lowers private investment and thus the potential growth of the economy. The Public Debt The Public Debt  The Risk Premium Risk Premium: The difference between the interest rate paid by a “risky” bond relative to one that is perceived as risk free (e.g., US Treasuries, German bonds). Negative economic outlook may increase the risk of default and therefore the premium investors require to hold public debt.  The Risk Premium Interest rate paid by sovereign bonds in the EU The Risk Premium The Risk Premium The Risk Premium  The Fiscal Policy  All the policies that directly affect the public budget:  Taxes (T), Transfers (TR), Public Spending (G).  Expansionary Fiscal Policy: ↓ taxes, ↑ transfers & public spending.  Target: Stimulate output and lower unemployment.  But … higher public budget deficit, crowding out of private investment, higher inflation.  Contractionary Fiscal Policy: ↑ taxes, ↓ transfers & spending.  Target: Lower public budget deficit and inflation.  But … reduces output and increases unemployment.