Lecture 5. Measuring the economy. Stocks and Flows.!

Transcription

1 Lecture 5. Measuring the economy. Stocks and Flows.!

2 What I want you to learn! Measurement in economics is hard. Data difficulties abound. Forces us to be careful about the quality of our knowledge. Low quality information leads to low quality testable properties of our models. Noisy data leads to difficulties in reducing errors within our models. Forces simplistic assumptions (linearity/ Gaussian distributions, etc).

3 Measurement in Economics! We measure loads of things as economists. (Most of the time don t find anything out. ) Really interested in: Employment/ Unemployment Economic Growth ( GNP) Money ( M3) Population change ( n) Saving and Investment New firm creation/ destruction Interest rates (Short, Long, Domestic, Interbank, discount) Credit Provision Debt Levels External Imbalances Taxes/Revenues/Surplus/ Deficits Regulations &

4 Recall the circular flow model.!

5 Labour, Capital (Quantities, Gross National Product) Transfers Transfers Households Taxes Government Taxes Businesses Wages, Rents (Factor Payments & National Income) Capital Markets Withdrawals Savings Imports Taxation Rest of World Government Exports Expenditure Investment Injections Income Households Businesses Consumption

6 Another way of looking at things. Yes, it s a balance sheet.!

7 National Income Matrix! Business Households Current Capital Government Total Consumption -C +C 0 Government Expenditure +G -G 0 Investment + I -I 0 [GDP] [Y] Wages +WB -WB 0 Profits +F -F 0 Taxes net of transfers -T +T 0 Total SAVING 0 INVESTMENT GOVT SURPLUS/ DEFICIT 0

8 Ireland s Assets/Liabilities End 2010! Assets bn Liabili-es bn A. Cash 16.2 E. Govt securi-es/ borrowings B. Non- bank NPRF 15 F. Promissory notes 30.9 C. Non- bank fin. Assets 31.2 Anglo Irish bank 25.3 D. NPRF investment in banks 9.4 Irish Na-onwide 5.3 Total financial assets (C+D) 9.4 EBS 0.3 G. Special investment shares EBS/INBS 0.7 GGD (E+F+G) Net govt. debt ggd- non.fin. Assets, C Loan assets of NAMA 30.7 Bonds issued by NAMA 30.7 Source: NTMA

9 2005 ( %) 2006 ( %) 2007 ( %) 2008 ( %) 2009 ( %) Av. % Consumption Govt Exp Investment Exports Imports GDP Value, m 162, GNP Value, m 138,

10 Flow way of looking at macroeconomy! C + I + G = Y = WB + T Consumption Investment Government Expenditure National Income/Output/Expenditure Wage Bill Taxes

11 Stocks, Flows, Market Clearing! Another feature of macroeconomic models, which can be associated with the principle of effective demand, is that market clearing through prices does not usually occur except in financial markets. The real markets, those for products and labour, are assumed to be demand-led. Full employment of labour is not assumed, nor is full employment of capacity, although, in the later chapters, where the possibility of inflation is introduced, high levels of employment or capacity will be assumed to generate inflationary pressures. Godley and Lavoie, 2007, Chapter 2.

12 Supply and Demand! Quantity Demanded at each price, Quantity Supplied at each price Price of Items at a point in time Supply at each Price, S(p) Demand at each Price, D(p) 10

13 Flows, Stocks, and Feedbacks! Meadows (2001). Thinking in Systems. If information-based relationships are hard to see, functions or purposes are even harder. A system's function or purpose is not necessarily spoken, written, or expressed explicitly, except through the operation of the system. The best way to deduce the system's purpose is to watch for a while to see how the system behaves.

14 Bathtubs, obviously.!

15 Stocks and Flows.! A stock is the foundation of any system. Stocks are the elements of the system that you can see, feel, count, or measure at any given time. A stock is the memory of the history of changing flows within the system.

16 System Dynamics! If you understand the dynamics of stocks and flows-their behavior over time-you understand a good deal about the behavior of complex systems. And if you have had much experience with a bathtub, you understand the dynamics of stocks and flows

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19 Important to note:! As long as the sum of all inflows exceeds the sum of all outflows, the level of the stock will rise. As long as the sum of all outflows exceeds the sum of all inflows, the level of the stock will fall. If the sum of all outflows equals the sum of all inflows, the stock level will not change; it will be held in dynamic equilibrium at whatever level it happened to be when the two sets of flows became equal.

20 GDP/GNP are flows.!

21 Stocks generally change slowly, even when the flows into or out of them change suddenly. Stocks act as delays or buffers or shock absorbers in systems. The time lags that come from slowly changing stocks can cause problems in systems, but they also can be sources of stability.

22 Stocks and Flows in Banks! Think of an interest-bearing savings account in a bank. The total amount of money in the account (the stock) affects how much money comes into the account as interest. That is because the bank has a rule that the account earns a certain percent interest each year. The total euros of interest paid into the account each year (the flow in) is not a fixed amount, but varies with the size of the total in the account.

23 Loans/Deposits/ Interest

24 1,600,000 1,400,000 1,200,000 1,000, , , , ,000 - Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Total LiabiliHes m (LHS) Deposits (Irish Residents) m (RHS) , , , , , , ,000 50,000 -

25 Feedbacks! A feedback loop is a closed chain of causal connections from a stock, through a set of decisions or rules or physical laws or actions that are dependent on the level of the stock, and back again through a flow to change the stock.

26 Example: Ireland s current crisis! Impaired banks lead to a contraction of credit, which slows business investment and economic growth, which worsens the fiscal situation for the government, which undermines the guarantees on new funding for the banking system, which causes a contraction of credit and country level insolvency.

27 Here we meet a very important feature. It would seem as if this were circular reasoning; profits fell because investment fell, and investment fell because profits fell. -Jan Tinbergen

28 Feedbacks in Wages! The more prices go up, the more wages have to go up if people are to maintain their standards of living. The more wages go up, the more prices have to go up to maintain profits. This means that wages have to go up again, so prices go up again.

29 6.00 % Changes in Wages and Prices, Consumer Price Index: All Items for Ireland, Index 2005=100. Benchmarked Unit Labor Costs - Total for Ireland

30 Aside: Inflation and Unemployment! Recall the Phillips curve, which shows the relationship between the change in unemployment and the change in inflation. If govt wants to lower unemployment by spending must deal with higher rates of Inflation. Feedback is from Govt spending - > UE -> Inflation. Change in InflaHon Change in unemployment

31 Phillips! Phillips (1954, 1957) draw upon his background as an engineer. His papers are the first to apply feedback control methods to the stabilization of a macroeconomy. Idea: government can control unstable multiplier/accelerator processes using policy, that is, influence the dynamic path of the economy through time.

32 Phillips showed that low unemployment was associated with high inflation, presumably because tight labour markets stimulated wage inflation. A 1960 study by Solow and Samuelson replicated these findings for the US Policy faced a tradeoff: Lower unemployment could be achieved, but only at the cost of higher inflation

33 Findings rubbished empirically post 1970, Friedman/Phelps reformulation! Inflation today = Inflation yesterday expected change in Unemployment*speed of adjustment. Becomes Inflation today = expected inflation tomorrow expected change in Unemployment*speed of adjustment.

34 Philips Curve Ireland y = x R² = Change in Infla-on Change in Unemployment

35 7.0 Philips Curve Change in Infla-on , Change in Unemployment

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37 Recall: Loops"! Balancing Reinforcing Competing/Balancing

38 Example: Moniac!

39 In Class Exercise! Draw the relationship between the volume of water in the bathtub through time when the plug is pulled. Volume of Water (litres) Time (mins)

40 Dynamic Equilibrium. Consider the coffee cup.!

41 Lesson:! Stocks change over time as a result of the actions of a flow. Dynamic equilibrium is where rate of change of stock = rate of change of flow

42 Example: Housing in Ireland! 100,000 90,000 80,000 New House Units Built 70,000 60,000 50,000 40,000 30,000 20,000 10,

43 Summary. Is the macroeconomy a Yes. set of loops?! The greater the stock of physical capital (K) (machines and factories) in the economy and the efficiency of production (output per unit of capital, Y/K), the more output (goods and services) can be produced each year. Thus productivity matters for growth. Like a living population, economic capital has a reinforcing loop (investment of output I/K) governing growth and a balancing loop (depreciation, ) governing decline. The more output that is produced, the more can be invested to make new capital.