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

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

3

but it does matter for the well-being of many people …


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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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

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OutlineOutline





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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 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


LongLong--Run Economic Growth:Run Economic Growth:Convergence PostConvergence Post--1968?1968?gg



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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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





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Economic Fluctuations: Business CyclesEconomic Fluctuations: Business Cycles

Unemployment in the United States

14Source: Brad DeLong: Econ 2, Spring 2014, Budgeting & Macro Policy


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


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


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


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


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

5Q

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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$)


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%

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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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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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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


Selected examples: Mexico (1994-95)

100 0%120.0%

8 00

10.00


6.0%8.0%


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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-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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Peso per US dollar, left 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


Selected examples: Russia (1998-99)

300.0%350.0%

25 00

30.00


10 0%

15.0%


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%

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1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 26Q

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Rubble per US dollar, left 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


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


Selected examples: Global Financial Crisis—UK

120 00

130.00

140.00

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120.00

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Selected examples: Global Financial Crisis—Spain

120 00

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140.00

Spain: Real GDP

90 00

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OutlineOutline





28

Principles of MacroeconomicsPrinciples of Macroeconomics

Managing macroeconomic fluctuations

Brad DeLong:

29Source: Brad DeLong: Econ 2, Spring 2014, Guiding Principles


Role of Markets



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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Role of Government—The Good



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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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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