Macroeconomics. Typical macro questions (I) Typical macro questions (II) Methodology of macroeconomics. Tasks carried out by macroeconomists

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1 Macroeconomics Macroeconomics is he area of economics ha sudies he overall economic aciviy in a counry or region by means of indicaors of ha aciviy. There is no essenial divide beween micro and macroeconomics, since he relaionships beween he aggregae indicaors are he resul of he decisions made by individuals. Modern macroeconomics is macroeconomics wih microfoundaions: heories of aggregae economic aciviy rely on individual behaviour. Typical macro quesions (I) Why is he average Spaniard in more han en imes richer han he average Spaniard in 9? Why is he average Spaniard more han a 5% poorer han he average American? Why he Spanish proporion of unemployed workers nearly riplicaes he German proporion? Why have prices been rising in Spain for a leas he las 5 years bu fell in 9? Why he economy booms and slumps? Typical macro quesions (II) Are slumps unavoidable? Can economic policy alleviae slumps? Why is he Spanish governmen currenly so concerned wih is budge defici? Why no before? Would a depreciaion of he euro wih respec o he dollar be favourable o he Spanish economy? Is a rade defici good or bad news? When has he European Cenral Bank o rise or lower he ineres rae? Why is i so low now? Mehodology of macroeconomics Macroeconomiss answer he above quesions by: describing he siuaion and he facs o be explained; developing a formal model of he siuaion in which he facs occur; solving he model; comparing he predicions of he model wih he facs; reformulaing he model, if necessary, and/or exending i o cover addiional siuaions. 3 4 Tasks carried ou by macroeconomiss Describe he economy (definiion of variables, measuremens of such variables, ideniies). Consruc models o explain. Models link variables o esablish how endogenous variables (hose he model explains) depend on he exogenous ones (deermined ouside he model: he parameers). Formulae and evaluae economic policies using he models predicions o conrol he economy. The course is organized according o hese 3 asks. Ouline of he course Task : summary and descripion of an economy. Main variables are defined and linked Fundamenal macroeconomic ideniies Separaion of he real side from he financial side Task : consrucion and soluion of hree models. Two on he final side (liquidiy & exchange rae) One on he real side (he overall AS-AD model) Task 3: analysis of basic economic policies and a summing up of policy debaes (and macro schools). 5 6

2 Gross domesic produc (GDP) Nominal GDP (GDP n ) GDPis he value of all he final goods ( goods will always mean goods and services ) produced in an economy (or erriory) wihin a given period. Final good = no used o produce oher goods Value = marke value The rae y a which GDP varies is he growh rae of he economy, where GDP is he GDP from he previous period y = GDP GDP (o ge a percenage, add ). GDP GDP n, or GDP a curren prices, is he value of he final goods produced in an economy during a given period when he value is compued using curren prices (he prices of he period). GDP n is obained by adding up he quaniies of final goods muliplied by heir curren prices. GDP n may vary because prices change or because he quaniies of final goods produced change. 7 8 Compuing GDP n : an example Real GDP (GDP r ) ime p 4 9 q 6 5 GDP n a = is p q + p q = = 4 (moneary unis of = ). GDP n a = is p q + p q = = 6 (moneary unis of = ). From = o =, GDP n has increased a 5% = (6 4)/4 muliplied by. p 3 q GDP r, or GDP a consan prices, is he value of he final goods produced in an economy during a given period when he value is compued using he prices of a given fixed period (he base period). GDP r is obained by adding up he quaniies of final goods muliplied by heir prices in he base period. GDP r is also called GDP adjused for inflaion or GDP in he moneary unis of he base period (for insance, real GDP of in 5 euros). Compuing GDP r : an example Coninuing wih he GDP n example, GDP r in = a consan prices of period = is p q + p q = = 4 (moneary unis of = ). So GDP r = GDP n a he base period (his always happens). GDP r in = a consan prices of period = is given by p q + p q = = 3 (moneary unis of = ). Hence, GDP r has fallen a 5%. If he base period is =, GDP r in = is p q + p q = = 78 and GDP r in = is p q + p q = = 6. Now, GDP r has fallen a 3%. Objecions o real GDP Theoreical: depends on he prices of he base period, which is always an arbirary choice. Pracical: excludes black marke aciviies (underground economy) and does no value goods ha are no exchanged in markes, like poliical insiuions (democracy vs dicaorship) social and culural insiuions (people s values) he qualiy of educaion or of he environmen he leisure ime he way wealh is disribued among people

3 Underground economy (esimaion) Real GDP per capia Real GDP provides a measure of he size of an economy. Real GDP per capia is defined as he raio of real GDP o he populaion of he economy. Real GDP per capia is a measure of he average sandard of living in he economy. Source: Mankiw 3 Real GDP per capia is posievely correlaed wih many indicadors of economic developmen and he qualiy of life: life expecancy, subjecive wellbeing, educaion, healh care expendiure 4 GDP per capia & life expecancy GDP per capia & adul lieracy Source: Mankiw Source: Mankiw 5 6 GDP per capia & Inerne usage GDP per capia (8-8) 3 3 USA FRA SPA WORLD Source: Mankiw Source: Maddison 8

4 Source: Maddison GDP per capia (95-8) LATIN AMERICA WESTERN EUROPE SPAIN CHINA AFRICA ASIA 9 Growh in he long run Even hough i is no a perfec measure of economic developmen, real GDP per capia growh provides a reasonable esimae. Economic developmen (how o increase a naion s wealh) was probably he main opic addressed by he firs modern economiss in he XVIII cenury. This course does no address economic growh in he long run (when periods are measured in generaions). I focus on growh in he shor run (periods measured in monhs or quarers). Price indices A price index is a measure of he general price level of an economy, which can be hough of as a weighed average of he prices of all he goods. By assuming he ficion ha here is a unique good in he economy (domesic produc), if GDP measures he quaniy of his good, hen he price level would represen he price of ha good. As disinguished from GDP, price indices have no unis and he value by iself means nohing. I is he rae of change of he index ha is informaive. GDP (implici price) deflaor The GDP deflaor is a price index defined as GDP deflaor = Nominal GDP Real GDP I measures he changes in prices in all he goods produced in an economy beween he base period used in he real GDP and he curren period. If GDP n 9 =, GDPr 9 = 8, GDPn = 35, and GDP r = 9, hen GDP 9 deflaor = 5 and GDP deflaor = 5, indicaing a price increase.. Consumer price index (CPI) The CPI is a measure on he cos of purchasing a fixed baske of goods of a consumer considered represenaive. The CPI a period is defined as Value of he baske a prices in period CPI =.. Value of he baske a prices in he base period For he index o have base, jus muliply he righ-hand side by. Difference beween CPI & deflaor The CPIgenerally includes impored goods. The GDP deflaor does no: i only includes he goods produced in he economy, no abroad. The baske of goods in he GDP deflaor may vary from period o period. The baske in he CPI generally does no. Despie his boh indices are srongly correlaed. 3 4

5 GDP deflaor and CPI, Spain Compuing a CPI: an example The baske is given by (x, y, z) = (3,, ). ime p x p y p z V = value of he baske a period = = = = Taking = as he base period, CPI = V /V = ; CPI = V /V = 6/6 = ; CPI 3 = V 3 /V = /6 =.75; and CPI 4 = V 4 /V = /6 =.5. Source: Penn-Table 5 6 Inflaion rae Inflaion rae, Spain (Feb8 Nov) The inflaion rae π associaed wih he price index P is he rae of change in he price index P: π = P P P where P is he price index in he curren period and P is he one in he immediaely preceding period. To express in he inflaion rae as a percenage, he righ hand mus be muliplied by. For insance, if P = 5 and P = 4, hen π = ¼ = 5 (= 5%): he price index has been pushed up a 5%. 7 8 Inflaion rae: an example Le π be he inflaion rae associaed wih he CPI of he previous example. In his case: π is no defined (since here is no CPI ) π = (CPI CPI )/CPI = ( )/ = π 3 = (CPI 3 CPI )/CPI = (.75 )/ =.5 = 5% π 4 = (CPI 4 CPI 3 )/CPI 3 = (.5.75)/.75 = 66.6%. If π is calculaed, for insance, from = o = 4, hen π = (CPI 4 CPI )/CPI = (.5 )/ = 5%. 9 Inflaion conceps As an economic phenomenon, inflaion refers o he susained increase of he CPI. I occurs for periods during which he inflaion rae is posiive. Deflaion is he opposie phenomenon: susained decrease of he CPI (negaive inflaion raes). Disinflaion akes place when, during inflaion, he inflaion rae diminishes (bu remains posiive). Hyperinflaion occurs wih asronomical inflaion raes (monly inflaion raes of a leas 5%). Under hyperinflaion, inflaion is ou of conrol. 3

6 Inflaion rae, Spain (96M M) Core inflaion rae The core inflaion rae is he inflaion rae compued, ypically from a CPI, by excluding he prices of food and energy prices, which end o be very volaile. I is a measure of underlying long-erm inflaion. I can also be used as an indicaor of fuure inflaion. Headline inflaion rae refers o he inflaion rae iniially defined (akes ino accoun all prices). Source: INE 3 3 Unemploymen rae Types of unemploymen Employmen = number of people having a job Unemploymen = number of people no having a job bu looking for one Labour force = Employmen + Unemploymen Unemploymen rae = Unemploymen Labour force Labour force Paricipaion rae = Toal populaion of working age 33 Acual unemploymen is divided ino 3 caegories (he firs wo define naural unemploymen ). Fricional. Occurs while workers are changing jobs. Srucural. Due o srucural changes in he economy ha creae & eliminae jobs and o he insiuions ha mach workers and firms (firing & hiring coss, minimum wages, unemploymen benefis, mobiliy resricions, lack of raining ). Cyclical. Generaed by he shor-run flucuaions of GDP (rises wih recessions, falls wih booms). 34 Unemploymen rae, Spain, Caalonia SPAIN Regisered unemploymen, Caalonia 65 TOTAL WOMEN CAT CAT WOMEN MEN 5 4 MEN CAT 5 5 I/ II/ III/ IV/ I/ II/ III/ IV/ I/3 Source: Idesca II/3 III/3 IV/3 I/4 II/4 III/4 IV/4 I/5 II/5 III/5 IV/5 I/6 II/6 III/6 IV/6 I/7 II/7 III/7 IV/7 I/8 II/8 III/8 IV/8 I/9 II/9 III/9 IV/9 I/ II/ III/ IV/ 35 jun-96 dic-96 jun-97 dic-97 jun-98 dic-98 Source: Idesca jun-99 dic-99 jun- dic- jun- dic- jun- dic- jun-3 dic-3 jun-4 dic-4 jun-5 dic-5 jun-6 dic-6 jun-7 dic-7 jun-8 dic-8 jun-9 dic-9 jun- dic- 36

7 Nominal variable Real variable A nominal variable is measured in erms of curren prices. A real variable measures physical quaniies. Real variables are no affeced by curren prices. Changes of curren prices may affec he nominal variable. Some real variables need no prices o be defined, like oal employmen or he unemploymen rae. The ypical nominal variable is measured in moneary unis. Examples: he GDP a curren prices, he sock of money, he (nominal) ineres rae, he (nominal) exchange rae, and he CPI. Ohers are defined by fixing prices, like GDP a consan prices, which measures producion using he prices of a base period. Sill ohers come from nominal variables by removing he effecs of prices, like he real ineres rae Sock variable & flow variable A sock variable is measured in levels raher han raes of change. A flow variable is measured in raes per uni of ime raher han levels. GDP is a flow variable, since i measures producion during a period of ime (so GDP is producion per uni of ime). 4 Main indicaors for Spain (INE) Y = 66 5 billions (III-) Unemploymen a a given momen of ime is a sock variable. 39 Y = % (III-9/III-) π = 3% (Dec9/Dec) u = 33% (IV-) Source: Tradingeconomics.com, accessed he 7h of February, 4 Source: CIA Facbook, accessed he 7h of February, 4