1 Modern Macroeconomics

Transcription

1 University of British Columbia Department of Economics, International Finance (Econ 502) Prof. Amartya Lahiri Handout # 1 1 Modern Macroeconomics Modern macroeconomics essentially views the economy of a country as a collection of rms and households who interact with each other in order to produce goods and services that are valued in the economy. The object of the exercise is then to determine how these agents determine what to produce, how much to produce, how much of a good/service to consume/purchase, at what prices do these transactions get done etc.. The key organizational principle that de nes modern macroeconomics is that all the represented rms and households are conceptualized as entities who pursue their own goals. This takes the form of households who maximize their lifetime welfare, rms who maximize the presnt discounted stream of pro ts, etc.. Moreover, these agents pursue these goals using all the information that is available to them to the fullest extent possible even in an uncertain world. This latter idea is formally described by the assumption that agents have rational expectations. Lastly, modern macroeconomics explicitly recognizes that aggregate outcomes in any economy are dependent on the joint actions of a number of di erent actors. All of them must also be satis ed with their individual decisionsfor the aggregate outcome to describe an equilibrium for the economy as a whole. Thus, modern macroeconomics is grounded deeply in general equilibrium theory. Modern macroeconomics therefore studies a number of di erent questions of interest taking dynamics seriously, the nature of information seriously as well as the nature of interaction across economic actors. This is the reason why most of this course will be organized around Dynamic, Stochastic, General Equilibrium (DSGE) models of the macroeconomy. 1

2 Naturally, from time to time we shall relax one or more of these requirements to make points in as simple a way as possible. 1.1 Questions in macroeconomics Since macroeconomics is an applied a number of the questions that are asked are essentially about potential explanations for the particualr patterns that we observe in macroeconomic variables. These facts are often about the dynamic behavior of levels of variables: the level of unemployment, the disparity in the levels of incomes across countries, etc. Other questions are about the dynamic evolution of growth rates of variables: the growth rate of output over time (e.g, business cycles), in ation rate (the growth rate of prices), volatility of asset prices (e.g., exchange rate volatility). A number of the questions related to these variables are usually recast in terms of the statistical moments of these variables. Thus, discussions about the business cycle are often about explaining persistence of output growth, or its deviation from some trend level. This then becomes an issue about the autocorrelation of output. Discussions about the volatility of asset prices are usually cast in terms of an examination of, say, the variance of the exchange rate, or the variance of the stock price index. Business cycle studies are also often concerned with trying to understand the comovements of output and other variables like consumption, investment, wages etc. These are usually cast as studying the covariances of the two variables of interest. Questions regarding the level of development of countries typically boil down to a study of the mean levels of per capita income across countries and their distribution. The primary goal of most of the macroeconomic models that we shall see and develop in this course will be to explain some of these data moments. More explicitly, we will often end up evaluating the strengths and weaknesses of models by trying to compare the moments produced by the models to the their data counterparts. Model evaluation therefore is not going to be an exact science. All models are abstractions. They abstract from a number of facets of any economy in order to focus on particular aspects of it. Hence, model evaluation has to take into account not just the moment comparisons but also the abstractions: we 2

3 need to evaluate the strengths and weaknesses of the underlying assumptions of the model. 1.2 Key Variables There are a number of variables that macroeconomists pay attention. Some of the ones that we will be concerned with are outlined in this section Real GDP A key focus of macreoconomic study is on the behavior of real GDP over time. This interest lies in both movements of real GDP in a country from quarter to quarter (business cycles) as well as comparing real GDP levels of countries both over long periods time as well as across countries. This is the study of the determinant of growth and development. The following pictures, taken from Krueger (2005), show some of these variables and how they have behaved over time. Figure 1 shows the evolution of real GDP in the US from 1967 to Clearly the US has been growing on a sustained basis during this entire period. Figure 2 shows the path of detrended real GDP in the US. Essentially, it shows whether the US was above or below trend during this period, i.e., it shows the cyclical behavior of output. as Another variable that we are often interested in is the unemployment rate. This is de ned Unemployment rate = Number of unemployed people Labor force Figure 3 shows the path of the unemployment rate in the US during this period. A key point of interest to macroeconomists is the behavior of the unemployment rate over the business cycle. Determinants of in ation and the interest rate in the economy and their behavior over the cycle are another focal point for macroeconomists. Figures 4 shows the behavior of the in ation rate in the US during the period As is clear the 1970s were a period of very high in ation. Since the 1980s there has been a steady decline in the in ation rate. Similarly, 5 depicts the behavior of a key interest rate in the US the Federal Funds rate. 3

4 This is the rate that the US Federal Reserve typically targets while choosing its monetary policy stance. Movements in this interest rate typically lead to concerted changes in a number of other market interest rates as well. Hence, changes in this interest rate captures the changes in the stance of monetary policy. A lot of research in macroeconomics is also focused on the issue of growth and development. This re ects the pervasive poverty around the world as well as the fact that we do tend to see economic miracles in some pplaces while there are economic disasters that occur in others. Explaining these remains a big challenge for economists. Figure 6 shows the distribution of per capita incomes across the world in Incomes are all computed relative to the US. As is obvious from the picture there is enormous disparity in the world income distribution. Figure 7 shows the distribution of growth rates of per capita GDP across the world between 1960 and Interestingly, most of the world appears to have grown at around 2% per annum on average during this period. However, the presence of countries at the two tails makes this a fascinating area of research. These outliers are the miracles and diasters. Can we explain these events? 2 National Income Accounting We start our analysis of open economies with a quick look at some national income accounting identities. These identities serve a dual purpose. They highlight the key di erence between closed and open economies along with establishing some key open economy accounting identities. A familiar national income decomposition is Y = C + I + G + X M where Y is GNP, C is private consumption, I is private investment, G is government spending, and X M denotes net exports (exports minus imports). This identity can be rewritten 4

5 as Y T = C + I + G T + X M Letting Y T C = S p and T G = S g, this can be rewritten as S p + S g I = X M where S p is private saving and S g is public saving. S = S p + S g, the identity reduces to Since total saving for this economy is S I = X M But, an economy s current account is de ned as the di erence between exports and imports of goods and services. Hence, X M = CA. This implies that we must have CA = S I (1) There are two key insights that emerge from equation 1. First, in a closed economy there are no exports or imports. Hence, domestic investment must equal domestic saving at all times in a closed economy. In an open economy, on the other hand, there is no similar constraint. Domestic investment can be greater or less than national saving. The di erence between saving and domestic investment determines the current account imbalance for an open economy with a current account surplus indicating that some national saving is being invested abroad while a de cit implies net capital in ows from abroad which are nancing domestic investment. Second, the fact that a current account de cit indicates that foreigners are nancing some part of domestic investment puts the debate about current account imbalances in perspective. While trade restrictions imposed by foreign countries might de nitely play a role in depressing our exports to them thereby worsening our current account balance, the ip side of the coin is that foreigners are helping us by augmenting our saving in order to nance our planned investment. If not, domestic investment would have to be nanced by a cut in consumption. 5

6 Figure 1: US Real GDP Figure 2: Business Cycles in the US 6

7 Figure 3: Unemployment rate in the US: Figure 4: US in ation rate 7

8 Figure 5: Interest rates in the US Figure 6: World Income Distribution 8

9 Figure 7: Distribution of growth rates: