Chapter 1: Introduction to Macroeconomics

Size: px

Start display at page:

Download "Chapter 1: Introduction to Macroeconomics"

Coral Sutton
6 years ago
Views:

1 Chapter 1: Introduction to Macroeconomics Cheng Chen School of Economics and Finance The University of Hong Kong (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 1 / 29

2 Chapter Outline What Macroeconomics Is About? What Macroeconomists Do? Why Macroeconomists Disagree? Three central concepts around which this course is organized: The short run: What happens to the economy from year to year. The medium run: What happens to the economy over a decade or so. The long run: What happens to the economy over a half century or longer. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 2 / 29

3 Chapter 1 Introduction to Macroeconomics (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 3 / 29

4 What macroeconomics is about? Macroeconomics: The study of structure and performance of national economies and government policies that aect economic performance. Issues addressed by macroeconomists: Long-run economic growth Business cycles Unemployment Ination The international economy Macroeconomic policy Aggregation: from microeconomics to macroeconomics. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 4 / 29

5 Long-run economic growth Figure 1.1: Output of United States since (Note decline in output in recessions; increase in output in some wars.) Two main sources of growth: Population growth (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 5 / 29

6 Long-run economic growth Figure 1.1: Output of United States since (Note decline in output in recessions; increase in output in some wars.) Two main sources of growth: Population growth Increases in average labor productivity (e.g., increased capital use) Total Factor Productivity (TFP) Average labor productivity: Output produced per unit of labor input. Fig. 1.2 shows average labor productivity for U.S since Average labor productivity growth: 2.5% per year from 1949 to 1973; 1.1% per year from 1973 to 1995; 1.7% per year from 1995 to (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 5 / 29

7 Long-run economic growth Figure 1.1: Output of United States since (Note decline in output in recessions; increase in output in some wars.) Two main sources of growth: Population growth Increases in average labor productivity (e.g., increased capital use) Total Factor Productivity (TFP) Average labor productivity: Output produced per unit of labor input. Fig. 1.2 shows average labor productivity for U.S since Average labor productivity growth: 2.5% per year from 1949 to 1973; 1.1% per year from 1973 to 1995; 1.7% per year from 1995 to No drop in labor productivity in nancial crisis. Why? (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 5 / 29

8 Long-run economic growth Figure 1.1: Output of United States since (Note decline in output in recessions; increase in output in some wars.) Two main sources of growth: Population growth Increases in average labor productivity (e.g., increased capital use) Total Factor Productivity (TFP) Average labor productivity: Output produced per unit of labor input. Fig. 1.2 shows average labor productivity for U.S since Average labor productivity growth: 2.5% per year from 1949 to 1973; 1.1% per year from 1973 to 1995; 1.7% per year from 1995 to No drop in labor productivity in nancial crisis. Why? Unemployment and Labor hoarding. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 5 / 29

9 Long-run economic growth Figure 1.1: Output of United States since (Note decline in output in recessions; increase in output in some wars.) Two main sources of growth: Population growth Increases in average labor productivity (e.g., increased capital use) Total Factor Productivity (TFP) Average labor productivity: Output produced per unit of labor input. Fig. 1.2 shows average labor productivity for U.S since Average labor productivity growth: 2.5% per year from 1949 to 1973; 1.1% per year from 1973 to 1995; 1.7% per year from 1995 to No drop in labor productivity in nancial crisis. Why? Unemployment and Labor hoarding. Selection eect. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 5 / 29

10 Long-run economic growth Figure 1.1: Output of United States since (Note decline in output in recessions; increase in output in some wars.) Two main sources of growth: Population growth Increases in average labor productivity (e.g., increased capital use) Total Factor Productivity (TFP) Average labor productivity: Output produced per unit of labor input. Fig. 1.2 shows average labor productivity for U.S since Average labor productivity growth: 2.5% per year from 1949 to 1973; 1.1% per year from 1973 to 1995; 1.7% per year from 1995 to No drop in labor productivity in nancial crisis. Why? Unemployment and Labor hoarding. Selection eect. Productivity isn't everything, but in the long run it is almost everything. (Paul Krugman, The Age of Diminished Expectations, MIT Press, (1994)) (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 5 / 29

Figure 1.1 Output of the U.S. economy, 1869-2011 Sources: Federal spending and receipts for 1869 1929 from Historical Statistics of the United States, Colonial Times to 1970, p.

11 Figure 1.1 Output of the U.S. economy, Sources: Federal spending and receipts for from Historical Statistics of the United States, Colonial Times to 1970, p. 1104; GNP from Christina D. Romer, The Prewar Business Cycle Reconsidered: New Estimates of Gross National Product, , Journal of Political Economy, 97, 1 (February 1989), pp ; GNP for 1929 from FRED database, Federal Reserve Bank of St. Louis, Research.stlouisfed.org/fred2/ series/gdpa; Federal spending and receipts as percentage of output, from Historical Tables, Budget of the U.S. Government, Table 1.2 Copyright 2014 Pearson Education, Inc. All rights reserved. 1-5 (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 6 / 29

12 Figure 1.2 Average labor productivity in the United States, Sources: Employment in thousands of workers 14 and older for from Historical Statistics of the United States, Colonial Times to 1970, pp ; workers 16 and older for 1948 onward from FRED database, Federal Reserve Bank of St. Louis, research.stlouisfed.org/fred2/seri es/ CE16OV. Average labor productivity is output divided by employment, where output is from Fig Copyright 2014 Pearson Education, Inc. All rights reserved. 1-8 (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 7 / 29

13 Solow Paradox and IT Revolution Reference: (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 8 / 29

14 Solow Paradox and IT Revolution Reference: Explanations for productivity puzzle: Mismeasurement of outputs and inputs. Lags due to learning and adjustment. Mismanagement of information and technology: rm organization (e.g., decentralization and exceptions). (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 8 / 29

15 Solow Paradox and IT Revolution Reference: Explanations for productivity puzzle: Mismeasurement of outputs and inputs. Lags due to learning and adjustment. Mismanagement of information and technology: rm organization (e.g., decentralization and exceptions). Eventually disappeared after middle 1990s: Reference: (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 8 / 29

16 Business cycles Business cycle: Short-run contractions and expansions in economic activity. Downward phase is called a recession. During a recession, national output may be falling or perhaps growing only very slowly. Macroeconomists put a lot of eort into trying to gure out what causes business cycles and deciding what can do or should be done about them. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 9 / 29

17 Explanations for Business cycles Marxist view: inevitable disease of capitalist systems. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 10 / 29

18 Explanations for Business cycles Marxist view: inevitable disease of capitalist systems. Technology view: Negative productivity (how about recent nancial crisis?) (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 10 / 29

19 Explanations for Business cycles Marxist view: inevitable disease of capitalist systems. Technology view: Negative productivity (how about recent nancial crisis?) Financial accelerator and sectoral (and cross-border) linkages. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 10 / 29

20 Explanations for Business cycles Marxist view: inevitable disease of capitalist systems. Technology view: Negative productivity (how about recent nancial crisis?) Financial accelerator and sectoral (and cross-border) linkages. Animal spirit, sentiment and condence (Keynes): (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 10 / 29

21 Explanations for Business cycles Marxist view: inevitable disease of capitalist systems. Technology view: Negative productivity (how about recent nancial crisis?) Financial accelerator and sectoral (and cross-border) linkages. Animal spirit, sentiment and condence (Keynes): Uncertainty shocks and delayed investment and hiring: Option value of delaying (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 10 / 29

22 Unemployment Unemployment: the number of people who are available for work and actively seeking work but cannot nd jobs. The best-known measure of unemployment is the unemployment rate. U.S. experience shown in Fig Recessions have led to signicant increases in the unemployment rate in the postwar period. Labor participation rate is important as well. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 11 / 29

23 Figure 1.3 The U.S. unemployment rate, Sources: Civilian unemployment rate (people aged 14 and older until 1947, aged 16 and older after 1947) for from Historical Statistics of the United States, Colonial Times to 1970, p. 135; for 1948 onward from FRED database Federal Reserve Bank of St. Louis, research.stlouisfed.org/fred2/series /UNRATE. Copyright 2014 Pearson Education, Inc. All rights reserved (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 12 / 29

24 Ination Ination: The prices of goods and services are rising over time. U.S. experience shown in Fig Deation: when prices of most goods and services decline. Ination rate: the percentage increase in the average level of prices. Hyperination: an extremely high rate of ination. High ination also means that the purchasing power of money erodes quickly. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 13 / 29

Figure 1.4 Consumer prices in the United States, 1800-2011 Sources: Consumer price index, 1800 1946 (1967 = 100) from Historical Statistics of the United States, Colonial Times to 1970, pp.

25 Figure 1.4 Consumer prices in the United States, Sources: Consumer price index, (1967 = 100) from Historical Statistics of the United States, Colonial Times to 1970, pp ; 1947 onward ( = 100) from FRED database, Federal Reserve Bank of St. Louis, research.stlouisfed.org/fred2/series/cpiaucsl. Data prior to 1971 were rescaled to a base with = 100. Copyright 2014 Pearson Education, Inc. All rights reserved (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 14 / 29

26 The international economy Open vs. closed economies Open economy: an economy that has extensive trading and nancial relationships with other national economies. Today, every major economy is an open economy. Closed economy: an economy that does not interact economically with the rest of the world. An important topic in macro: How international trade and borrowing relationships can help transmit business cycles from country to country. Trade imbalances. U.S. experience shown in Fig Question: Are they bad for U.S. or for the economies of this country's trading partners? Trade surplus: exports exceed imports. Trade decit: imports exceed exports. Two views: macro view and trade view. Mystery behind number: Global Value Chains (GVCs) and fragmentation. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 15 / 29

Figure 1.5 U.S. exports and imports, 1869-2011 Sources: Imports and exports of goods and services: 1869 1959 from Historical Statistics of the United States, Colonial Times to 1970, pp.

27 Figure 1.5 U.S. exports and imports, Sources: Imports and exports of goods and services: from Historical Statistics of the United States, Colonial Times to 1970, pp ; 1960 onward from FRED database, Federal Reserve Bank of St. Louis, research.stlouisfed.org/fred2/series/b OPX and BOPM; nominal output: from Christina D. Romer, The Prewar Business Cycle Reconsidered: New Estimates of Gross National Product, , Journal of Political Economy, 97, 1 (February 1989), pp ; 1929 onward from FRED database, series GDPA. Copyright 2014 Pearson Education, Inc. All rights reserved (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 16 / 29

28 Macroeconomic policy Quote by John Maynard Keynes: Practical men who believe themselves to be quite exempt from any intellectual inuence, are usually the slaves of some defunct economist. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 17 / 29

29 Macroeconomic policy Quote by John Maynard Keynes: Practical men who believe themselves to be quite exempt from any intellectual inuence, are usually the slaves of some defunct economist. Macro policies aect the performance of the economy as a whole. Fiscal policy: government spending and taxation. It is determined at the national, state, and local levels in the U.S. Eects of changes in federal budget. U.S. experience in Fig Relation to trade decit? Monetary policy: growth of money supply or a nominal interest rate (the federal fund rates); determined by central bank (the Fed in U.S). (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 17 / 29

30 Figure 1.6 U.S. Federal government spending and tax collections, Sources: Federal spending and receipts for from Historical Statistics of the United States, Colonial Times to 1970, p. 1104; GNP from Christina D. Romer, The Prewar Business Cycle Reconsidered: New Estimates of Gross National Product, , Journal of Political Economy, 97, 1 (February 1989), pp ; GNP for 1929 from FRED database, Federal Reserve Bank of St. Louis, Research.stlouisfed.org/fred2/s eries/gdpa; Federal spending and receipts as percentage of output, from Historical Tables, Budget of the U.S. Government, Table 1.2. Copyright 2014 Pearson Education, Inc. All rights reserved (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 18 / 29

31 Aggregation Aggregation: summing individual economic variables to obtain economywide totals. Micro: focuses on individual consumers, workers, and rms, each of which is too small to have an impact on the national economy. Macro focuses on national totals. Distinguishes microeconomics (disaggregated) from macroeconomics (aggregated). (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 19 / 29

32 What Macroeconomists Do What macroeconomists do? Macroeconomic forecasting. Forecasting is a minor part of what macroeconomists do. Relatively few economists make forecasts. Forecasting is very dicult: (1) our understanding of how the economy works is imperfect; (2) it is impossible to take into account all the uncertain factors (many of them are not strictly economic) that might aect future economic trends. Rather than predicting what will happen, most macroeconomists are engaged in analyzing and interpreting events as they happen (macro analysis) or in trying to understand the structure of the economy in general (macro research). (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 20 / 29

33 What Macroeconomists Do Macroeconomic analysis Macroeconomic analysis Private sector economists: try to determine how general economic trends will aect their employers' nancial investments, their opportunities of expansions, the demand for their products, and so on. Public sector (national and regional governments and international agencies) economists: to assist in policymaking for example, by writing reports that assess various macro problems and by identifying and evaluating possible policy options. The world bank, international money fund, and the federal reserve banks. Does having many economists ensure good macroeconomic policies? No, since politicians, not economists, make major decisions. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 21 / 29

34 What Macroeconomists Do Macroeconomic analysis Macroeconomic analysis Private sector economists: try to determine how general economic trends will aect their employers' nancial investments, their opportunities of expansions, the demand for their products, and so on. Public sector (national and regional governments and international agencies) economists: to assist in policymaking for example, by writing reports that assess various macro problems and by identifying and evaluating possible policy options. The world bank, international money fund, and the federal reserve banks. Does having many economists ensure good macroeconomic policies? No, since politicians, not economists, make major decisions. Prevent economic disasters. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 21 / 29

35 What Macroeconomists Do Macro research Goal: to make general statements about how the economy works. Macro research proceeds primarily through the formulation and testing of theories. Economic theory: a set of ideas about the economy, organized in a logical framework. Economic model: a simplied description of some aspect of the economy. Theoretical and empirical research are necessary for forecasting and economic analysis. Usefulness of economic theory or models depends on reasonableness of assumptions, possibility of being applied to real problems, empirically testable implications, theoretical results consistent with real-world data. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 22 / 29

36 What Macroeconomists Do In touch with data and research: developing and testing an economic theory 1 State the research question. 2 Make provisional assumptions that describe the econ setting and the behavior of the economic actors. 3 Work out the implications of the theory. 4 Conduct an empirical analysis to compare the implications of the theory with the data. 5 Evaluate the results of your comparisons: If the theory ts the data well: Use the theory to predict what would happen if the economic setting or econ policies change. If the theory ts the data poorly: Starts from developing a new model and repeats steps 2-5. If the theory ts the data moderately well: Either do with a partially successful theory or modify the model with additional assumptions and then repeats steps 2-5. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 23 / 29

37 Why Macroeconomists Disagree Positive vs. Normative Analysis Positive analysis: examines the economic consequences of a policy but does not address the question of whether those consequences are desirable. Normative analysis: determines whether a policy should be used. For example, consider evaluating the eects on the economy of a 5% increase in the income tax. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 24 / 29

38 Why Macroeconomists Disagree Classicals vs. Keynesians. (1) The classical approach The economy works well on its own. The invisible hand (Adam Smith (1776): The Wealth of Nations): the idea that if there are free markets and individuals conduct their economic aairs in their own best interests, the overall economy will work well. Wages and prices adjust rapidly to get to equilibrium Equilibrium: a situation in which the quantities demanded and supplied are equal. Changes in wages and prices are signals that coordinate people's actions Result: Government should have only a limited role in the economy Representing schools: U. of Chicago and U. of Minnesota. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 25 / 29

39 Why Macroeconomists Disagree (2) The Keynesian approach The Great Depression: Classical theory failed because high unemployment was persistent. Keynes (1936): The General Theory of Employment, Interest, and Money. Keynes: Persistent unemployment occurs because wages and prices adjust slowly, so markets remain out of equilibrium for long periods. Conclusion: Government should intervene to restore full employment. Representing schools: Harvard/MIT and Princeton (in 1990s and early 2000s). (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 26 / 29

40 Why Macroeconomists Disagree The evolution of the classical-keynesian debate Keynesians dominated from WWII to Stagation led to a classical comeback in the 1970s. Last 30 years: excellent research with both approaches. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 27 / 29

41 Why Macroeconomists Disagree A unied approach to macroeconomics This course will use a single model to present both classical and Keynesian ideas. It draws heavily from both the classical and Keynesian traditions. Individuals, rms, and the government interact in three markets: goods, assets, and labor markets. The model's macro analysis: starts with microfoundations: individual optimizing behavior (consumer's utility maximization and rm's prot maximization). Both agree that in the long run: wages and prices are perfectly exible. Short run: Classical caseexible wages and prices; Keynesian casewages and prices are slow to adjust. These two assumptions can be incorporated into the model. This aspect allows us to compare classical and Keynesian conclusions and policy recommendations. (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 28 / 29

42 Why Macroeconomists Disagree Interesting Videos to Watch Free to Choose by Milton Friedman (1980): Website: (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 29 / 29

43 Why Macroeconomists Disagree Interesting Videos to Watch Free to Choose by Milton Friedman (1980): Website: Mankiw's 10 Principles, Translated by Yoram Bauman: Website: (Cheng Chen (HKU)) ECON2102/2220: Intermediate Macroeconomics 29 / 29

Chapter 1: Introduction to Macroeconomics

Chapter 1: Introduction to Macroeconomics Yulei Luo SEF of HKU September 1, 2017 Luo, Y. (SEF of HKU) ECON2220B: Intermediate Macro September 1, 2017 1 / 19 Chapter Outline What macroeconomics is about?