Introduction to Macroeconomics IMacroeconomics I · Introduction to Macroeconomics IMacroeconomics I Fi i l P i d P li iFinancial Programming and Policies Vang Vieng, Lao PDR May
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Introduction to Introduction to Macroeconomics IMacroeconomics IMacroeconomics IMacroeconomics I
Fi i l P i d P li iFinancial Programming and PoliciesVang Vieng, Lao PDR
May 5 – 16, 2014
Jan Gottschalk
TAOLAMTAOLAM
OutlineOutline
I. Defining Macroeconomics
II. Long-Run Economic Growth
III. Economic Fluctuations
IV. Principles of Macroeconomics
2This training material is the property of the International Monetary Fund (IMF) and is intended for the use in IMF courses. Any reuse requires the permission of the IMF.
Defining MacroeconomicsDefining Macroeconomics
Macroeconomics takes a top-down view:• Macroeconomics is about the whole economy or economy-wide aggregates such as gg gGDP, CPI, or the current account;• Microeconomics, in contrast, looks at the b h i f i di id lbehavior of individuals and small players whose actions do not affect the economy at large but set prices and quantitiesset prices and quantities in their individual markets;• It’s all fairly abstract but it does matter for
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but it does matter for the well-being of many people …
Defining MacroeconomicsDefining Macroeconomics
Practical applications:• Macroeconomic management:
Avoid crisis!
Support economic growth
Keep inflation moderately low
• Economic forecasting:
Macroeconomic forecasts are an input into macroeconomic managementmacroeconomic management
But they are also of interest to businesses, financial markets etc.
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Defining MacroeconomicsDefining Macroeconomics
Two main issues:
• Determinants of long-run economic growth
Enormously important for economic well being
Last 200 years were very successful
We don’t really understand sources of growth very y g ywell …
• Sources of economic fluctuations:
Business cycles
Economic crises
5
OutlineOutline
I. Defining Macroeconomics
II. Long-Run Economic Growth
III. Economic Fluctuations
IV. Principles of Macroeconomics
6
LongLong--Run Economic GrowthRun Economic Growth
Even small growth rates can have enormous output impact if maintained o er long timeimpact if maintained over long time:
• A quantity growing at 1%/year doubles in 72 years...
• A quantity growing at 2%/year doubles in 36 years...
• A quantity growing at 3%/year doubles in 24 years...
• A quantity growing at 0.1%/year doubles in 720 years...
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• A quantity growing at 0.01%/year doubles in 7200 years...
Source: Brad DeLong: Econ 2, Spring 2014, Long-run economic growth
LongLong--Run Economic Growth: The World in 1800Run Economic Growth: The World in 1800
8Source: Brad DeLong: Econ 2, Spring 2014, Long-run economic growth
LongLong--Run Economic Growth: Run Economic Growth: The Great Divergence to 1968The Great Divergence to 1968gg
9Source: Brad DeLong: Econ 2, Spring 2014, Long-run economic growth
LongLong--Run Economic Growth:Run Economic Growth:Convergence PostConvergence Post--1968?1968?gg
10Source: Brad DeLong: Econ 2, Spring 2014, Long-run economic growth
LongLong--Run Economic GrowthRun Economic Growth
What happened since 1800?Remember:
• We are not (really) smarter than our ancestorsthan our ancestors
• It is doubtful that we progressed much in cultural terms
• The only areas where we distinguished• The only areas where we distinguished ourselves from our ancestors 200 years ago is
We have a lot more ‘stuff’
We are healthier and live longer
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LongLong--Run Economic GrowthRun Economic Growth
What happened since 1800?Th i d t i l l ti• The industrial revolution
happened—clearly a large part of economic progress is due to technical progress;p g ;
• But rise of modern market economy over large parts of the globe played a key role too:globe played a key role too:
Underpinned technological progress (funds, incentives, stability)stability)
Enabled deep specialization (global trade)
H l d t d lth (
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Helped to spread wealth (a bit) more widely
OutlineOutline
I. Defining Macroeconomics
II. Long-Run Economic Growth
III. Economic Fluctuations
IV. Principles of Macroeconomics
13
Economic Fluctuations: Business CyclesEconomic Fluctuations: Business Cycles
Unemployment in the United States
14Source: Brad DeLong: Econ 2, Spring 2014, Budgeting & Macro Policy
Economic Fluctuations: Business CyclesEconomic Fluctuations: Business Cycles
Unemployment in the United States
• Very high unemployment: economic recession
• Falling unemployment: recovery
• Very low unemployment: boom times
• Increasing unemployment: slowdown
• Note that peaks and troughs in unemployment are fairly regular—this is why it’s called a ‘business cycle’
• But it’s not exactly a cycle: unemployment tends to rise rapidly—a recession is more akin to a crash than a gradual, regular decline in economic activity
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gradual, regular decline in economic activity
Economic Fluctuations: Business CyclesEconomic Fluctuations: Business Cycles
What is the source of economic fluctuations?• Mostly fluctuations in aggregate demand (as opposed to aggregate supply)• Mostly fluctuations in aggregate demand (as opposed to aggregate supply)
• Aggregate demand refers to spending of domestic households, government, businesses as well as foreigners (exports)—system of National Income and Product Accounts was designed to capture these demand componentsAccounts was designed to capture these demand components
• Aggregate demand is also seen as driving force behind inflationforce behind inflation
• Key objective for macroeconomic policy is to keep aggregateis to keep aggregate demand stable and inflation moderately low
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low
Source: Brad DeLong: Econ 2, Spring 2014, Budgeting & Macro Policy
Economic Fluctuations: Business CyclesEconomic Fluctuations: Business Cycles
Fluctuations versus Average Growth Levels• Business cycles are about economic fluctuations visible in the peak and troughs• Business cycles are about economic fluctuations, visible in the peak and troughs in unemployment and economic growth
• Average h l lgrowth levels
vary between cycles
• Difference in average growth rates is a long runis a long-run growth issue and not part of business-
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of businesscycle theory
Source: Brad DeLong: Econ 2, Spring 2014, Budgeting & Macro Policy
Economic Fluctuations: Business CyclesEconomic Fluctuations: Business Cycles
Fluctuations versus Average Growth Levels• From a long-From a longrun perspective, it is the average growth rate that
f hmatters for the standard of living
• Underlying• Underlying growth rate is also called potential GDPpotential GDP, referring to the supply potential of the economy
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y
Source: Brad DeLong: Econ 2, Spring 2014, Introduction to Macroeconomics
Economic Fluctuations: Business CyclesEconomic Fluctuations: Business Cycles
Fluctuations versus Average Growth Levels: Potential GDP
• There is no• There is no unique estimation procedure for
14,000.0
15,000.0
16,000.0
procedure for potential GDP (which implies considerable 11,000.0
12,000.0
13,000.0
uncertainty!) • Estimate shown here is
9,000.0
10,000.0
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based on HP filter, which generates results i il t
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Real GDP (billions of 2009 US$)
l (b ll f $)
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similar to a moving average
Potential output (billions of 2009 US$)
Economic Fluctuations: Business CyclesEconomic Fluctuations: Business Cycles
Fluctuations versus Average Growth Levels: Output Gap
• Business cycle 3 0%• Business cycle fluctuations are captured in the output gap
• Alternative measure to1.0%
2.0%
3.0%
• Alternative measure to fluctuations in the unemployment rate
• Most popular measure-2.0%
-1.0%
0.0%
• Most popular measure for aggregate demand conditions
• Macroeconomic policy
-4.0%
-3.0%
Q1
Q2
Q3
Q4
Q1
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Q3
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Q1
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• Macroeconomic policy is about keeping the output gap small
A i id bl
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Output gap (in % of potential GDP)
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• Again, considerable uncertainty on size of gap!
Economic Fluctuations: Economic CrisesEconomic Fluctuations: Economic Crises
Economic crises have a major economic impacth h d l i h f i k d i fEven though underlying growth performance is key determinant of
long-run economic well being, economic crises occur relatively frequently and typically have a major negative impact on:
• Output level (large drop in output/deep recession)
• Value of currency (currency crisis depends on type of crisis)
• Inflation (often in the wake of a currency crisis depends on• Inflation (often in the wake of a currency crisis depends on type of crisis)
• Financial sector (not always but often depends on type of crisis)
• Asset prices (not always depends on crisis)
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Economic Fluctuations: Economic CrisesEconomic Fluctuations: Economic Crises
Selected examples: Thailand (Asian Crisis, 1997-98)
10 0%
15.0%
Annual Real GDP Growth
80 0%100.0%
40 00
50.00
Currency Depreciation
-5.0%
0.0%
5.0%
10.0%
0 0%20.0%40.0%60.0%80.0%
20.00
30.00
40.00
-20.0%
-15.0%
-10.0%
1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2
-40.0%-20.0%0.0%
0.00
10.00
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Annual change in % (y-o-y)
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Bath per US dollar, left axis
Annual change in % (y-o-y) right axis
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Annual change in % (y o y)Annual change in % (y o y), right axis
Economic Fluctuations: Economic CrisesEconomic Fluctuations: Economic Crises
Selected examples: Mexico (1994-95)
100 0%120.0%
8 00
10.00
Currency Depreciation
6.0%8.0%
Annual Real GDP Growth
20 0%40.0%60.0%80.0%100.0%
4.00
6.00
8.00
-4 0%-2.0%0.0%2.0%4.0%
-20.0%0.0%20.0%
0.00
2.00
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96 -12.0%
-10.0%-8.0%-6.0%4.0%
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 13Q
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3Q
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3Q
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4Q
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Peso per US dollar, left axis
Annual change in % (y-o-y) right axis
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Annual change in % (y-o-y), right axis
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Annual change in % (y o y), right axis Annual change in % (y o y), right axis
Economic Fluctuations: Economic CrisesEconomic Fluctuations: Economic Crises
Selected examples: Russia (1998-99)
300.0%350.0%
25 00
30.00
Currency Depreciation
10 0%
15.0%
Annual Real GDP Growth
50 0%100.0%150.0%200.0%250.0%300.0%
10.00
15.00
20.00
25.00
0.0%
5.0%
10.0%
-50.0%0.0%50.0%
0.00
5.00
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00 -15.0%
-10.0%
-5.0%
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 26Q
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Q2
6Q
36
Q4
7Q
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Q4
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Rubble per US dollar, left axis
Annual change in % (y-o-y) right axis
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Annual change in % (y-o-y), right axis
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Annual change in % (y o y), right axis Annual change in % (y o y), right axis
Economic Fluctuations: Economic CrisesEconomic Fluctuations: Economic Crises
Selected examples: Global Financial Crisis—U.S.A.United States Real GDP
120 00
130.00
140.00
United States: Real GDP
90.00
100.00
110.00
120.00
60.00
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80.00
1 4 3 2 1 4 3 2 1 4 3 2 1 4 3 2 1 4 3
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Real GDP, 2005=100
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Hypothetical GDP path based on average 1991-2005 growth
Economic Fluctuations: Economic CrisesEconomic Fluctuations: Economic Crises
Selected examples: Global Financial Crisis—UK
120 00
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140.00
United Kingdom: Real GDP
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110.00
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Real GDP, 2005=100
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Hypothetical GDP path based on average 1991-2005 growth
Economic Fluctuations: Economic CrisesEconomic Fluctuations: Economic Crises
Selected examples: Global Financial Crisis—Spain
120 00
130.00
140.00
Spain: Real GDP
90 00
100.00
110.00
120.00
60.00
70.00
80.00
90.00
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Real GDP, 2005=100
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Hypothetical GDP path based on average 1991-2005 growth
OutlineOutline
I. Defining Macroeconomics
II. Long-Run Economic Growth
III. Economic Fluctuations
IV. Principles of Macroeconomics
28
Principles of MacroeconomicsPrinciples of Macroeconomics
Managing macroeconomic fluctuations
Brad DeLong:
29Source: Brad DeLong: Econ 2, Spring 2014, Guiding Principles
Principles of MacroeconomicsPrinciples of Macroeconomics
Role of Markets
30Source: Brad DeLong: Econ 2, Spring 2014, Guiding Principles
Principles of MacroeconomicsPrinciples of Macroeconomics
Role of MarketsCentral role of markets for economy implies that macroeconomic policies typically prefer to act by influencing prices, especially
• Real interest rates (monetary policy; impact aggregate• Real interest rates (monetary policy; impact aggregate demand)
• Real exchange rates (monetary policy; impact aggregate demand & external competitiveness)
Fiscal policy affects aggregate demand directly through government spending and taxation powerful tool but g p g pprimary role for macroeconomic demand management typically falls to monetary policy
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Principles of MacroeconomicsPrinciples of Macroeconomics
Role of Government—The Good
32Source: Brad DeLong: Econ 2, Spring 2014, Guiding Principles
Principles of MacroeconomicsPrinciples of Macroeconomics
Role of Government—The Bad
33Source: Brad DeLong, Econ 2, Spring 2014; Principles of Economics – Moral Philosophy – Essential Principles
OutlookOutlook
Next up:• We will illustrate the circularity of income/spending flows, which is central for understanding how deep recessions can arise (this is also what makes macro special!)(this is also what makes macro special!)
• We will take a closer look at
aggregate demand (income-expenditure framework)
role of interest rates
aggregate supply
the link between aggregate demand supply and inflation the link between aggregate demand, supply and inflation
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