ECO LECTURE 28 1 WELL, HERE WE ARE AGAIN TODAY. WE WANT TO CONTINUE DISCUSSING THAT KEYNESIAN MACROECONOMICS MODEL WHICH WE WERE

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1 ECO LECTURE 28 1 WELL, HERE WE ARE AGAIN TODAY. WE WANT TO CONTINUE DISCUSSING THAT KEYNESIAN MACROECONOMICS MODEL WHICH WE WERE DOING LAST TIME. LET ME GIVE YOU KIND OF A QUICK REVIEW AND THEN WE'LL DO A FEW WORD -- PROBLEMS, I SHOULD SAY. WE'VE GOT DIFFERENT SYMBOLS, OF COURSE, THAT WE'RE USING DOWN HERE BUT THEY ALL REPRESENT MACROECONOMIC OUTPUT IN THE ECONOMY. WHAT WE WANT TO DO IS DRAW THE FORTY-FIVE DEGREE LINE AND WE'VE CALLED THAT THE TOTAL PRODUCTION CURVE. IT'S BASICALLY THE VALUE OF TOTAL PRODUCTION. IF REAL GDP IS A HUNDRED DOLLARS, WHAT'S THE VALUE OF TOTAL PRODUCTION? WELL, IT'S A HUNDRED DOLLARS. AND SO THE SLOPE OF THIS CURVE IS ONE. OKAY. WE ALSO THEN LAST TIME PUT IN A TOTAL EXPENDITURE CURVE, AND WE START THE CURVE OFF -- AH, MAYBE I'LL EVEN USE A DIFFERENT COLOR HERE. TOTAL EXPENDITURES EQUAL CONSUMPTION PLUS INVESTMENT SPENDING PLUS GOVERNMENT SPENDING -- GOVERNMENT PURCHASES, I SHOULD SAY, PLUS NET EXPORTS. THIS AMOUNT OF SPENDING IS CALLED AUTONOMOUS SPENDING AND IT'S CALLED AUTONOMOUS -- IT'S UNRELATED TO INCOME OR PRODUCTION. IT'S JUST A CERTAIN AMOUNT. AND THEN WHAT WE ALSO SEE, THOUGH, IS IF THERE'S A SLOPE TO THE CURVE THAT -- AS INCOME GOES UP, PEOPLE SPEND MORE AND WHATEVER, AND SO THIS CURVE HAS THIS INDUCED COMPONENT TO IT. INDUCED SPENDING VERSUS AUTONOMOUS SPENDING.

2 ECO LECTURE 28 2 ANYWAY, EQUILIBRIUM OCCURS AT THE POINT WHERE TOTAL EXPENDITURES EQUAL TOTAL PRODUCTION. QE OR YE, DEPENDS ON THE SYMBOLS THAT YOU WANT TO USE TO REPRESENT THAT, BUT BASICALLY THAT'S THE EQUILIBRIUM LEVEL OF INCOME. OKAY. NOW, HOW MUCH IS THIS, THIS LEVEL OF INCOME? THERE'S A FORMULA FOR THAT. EQUILIBRIUM LEVEL OF INCOME IS EQUAL TO AUTONOMOUS SPENDING TIMES A MULTIPLIER, WHICH IS ONE OVER ONE MINUS THE MPC, MARGINAL PROPENSITY TO CONSUME. SO THIS LEVEL OF INCOME IN THE DIAGRAM THAT I'VE CALLED THE EQUILIBRIUM, WE CAN CALCULATE THAT IF WE KNOW TWO PIECES OF INFORMATION. ONE PIECE OF INFORMATION, WHAT IS TOTAL AUTONOMOUS SPENDING? AND THE OTHER PIECE OF INFORMATION IS WHAT'S THE MARGINAL PROPENSITY TO CONSUME? AND, OF COURSE, THE SLOPE OF THE TOTAL EXPENDITURES CURVE IS EQUAL TO THE MARGINAL PROPENSITY TO CONSUME. OKAY. SO ON TEST DAY, WHAT I WOULD DO IS TELL YOU SOMETHING LIKE THIS: OH, TOTAL AUTONOMOUS SPENDING IS A HUNDRED DOLLARS. THE MPC IS EQUAL TO POINT SEVEN FIVE. AND THEN I WOULD SAY TO YOU, "HEY, CALCULATE THE EQUILIBRIUM LEVEL OF INCOME FOR THE ECONOMY, THE EQUILIBRIUM PRODUCTION LEVEL FOR THE ECONOMY." AND THEN WHAT YOU WOULD DO IS, YOU WOULD COME ALONG HERE AND SAY, "OKAY. A HUNDRED DOLLARS TIMES ONE OVER ONE MINUS POINT SEVEN FIVE IS EQUAL TO A HUNDRED DOLLARS TIMES ONE OVER POINT TWO FIVE IS EQUAL TO A HUNDRED DOLLARS TIMES FOUR OR FOUR HUNDRED DOLLARS." THIS IS

3 ECO LECTURE 28 3 QE. AND SO IF WE KNOW THIS AMOUNT, ONE HUNDRED DOLLARS, AND WE KNOW THE SLOPE IS POINT SEVEN FIVE OF THE TOTAL EXPENDITURES CURVE, WE KNOW THAT EQUILIBRIUM LEVEL OF INCOME IS FOUR HUNDRED DOLLARS. LET ME MENTION SOMETHING TO YOU. THIS FORMULA HERE FOR THE MULTIPLIER, THIS ONE MINUS THE MPC, THAT'S ALSO EQUAL TO THE MARGINAL PROPENSITY TO SAVE. IF YOU'LL REMEMBER, THE MARGINAL PROPENSITY TO CONSUME PLUS THE MARGINAL PROPENSITY TO SAVE EQUALS ONE OR ONE HUNDRED PERCENT. AND SO WHEN I SAY ONE MINUS MPC, THAT'S ALSO JUST EQUAL TO THE MARGINAL PROPENSITY TO SAVE. SO I COULD'VE SAID THE MULTIPLIER IS ONE OVER THE MPS. YOU SHOULD ALSO BE FAMILIAR -- AND WE DID, I THINK, SOME OF THESE PROBLEMS THE OTHER DAY -- YOU SHOULD BE FAMILIAR WITH JUST CALCULATING MULTIPLIERS. IF I TELL YOU THAT THE MARGINAL PROPENSITY TO CONSUME IS TWO-THIRDS, WHAT'S THE MULTIPLIER? IF I TELL YOU THE MARGINAL PROPENSITY TO CONSUME IS POINT FIVE FIVE, WHAT'S THE MULTIPLIER? AND YOU NEED TO BE FAMILIAR WITH SORT OF PUTTING THAT NUMBER TWO-THIRDS IN RIGHT HERE. IF IT'S TWO-THIRDS, ONE OVER ONE MINUS TWO-THIRDS IS EQUAL TO ONE OVER ONE-THIRD IS EQUAL TO THREE. SO THE MARGINAL PROPENSITY TO CONSUME IS TWO-THIRDS; THE MULTIPLIER IS THREE. AND SO YOU NEED TO BE COMFORTABLE WITH DOING THAT, THOSE TYPES OF CALCULATIONS.

4 ECO LECTURE 28 4 THEN THIS TYPE OF CALCULATIONS GOES BEYOND JUST THE MULTIPLIER. THIS TELLS ME THAT THE MULTIPLIER IS EQUAL TO FOUR -- THAT IS, THE MPC DOES -- BUT I ALSO NEED TO MULTIPLY THAT FOUR BY TOTAL AUTONOMOUS SPENDING. LET'S EXPAND THIS EXAMPLE A LITTLE BIT. TOTAL AUTONOMOUS SPENDING EQUALS -- LET'S ADD SOME THINGS TOGETHER. C0. THIS IS AUTONOMOUS CONSUMPTION SPENDING PLUS IO -- THIS IS AUTONOMOUS BUSINESS INVESTMENT, SPENDING, BUSINESSES PURCHASING CAPITAL GOODS AND SO FORTH. AND, BY THE WAY -- OH, I WON'T GO INTO THAT. GO, AUTONOMOUS GOVERNMENT SPENDING. THAT ZERO IS TELLING US IT'S AUTONOMOUS, THAT IT'S OVER HERE. IF THE LEVEL OF INCOME IS ZERO, THEN HOW MUCH WOULD THE SPENDING BE? PLUS NET EXPORTS, 0. AND ONE MORE THING THAT WE HAVEN'T REALLY TALKED ABOUT BEFORE: MINUS MPC TIMES T. AND I'M ONLY TELLING YOU ABOUT THIS NOW BECAUSE IN THE NEXT CHAPTER OR UNIT OF MATERIAL WE'LL BE TALKING ABOUT FISCAL POLICY, BUT THIS IS TAX COLLECTIONS. I SHOULD SAY PERSONAL TAX COLLECTIONS. AND THE MPC -- YOU KNOW WHAT THAT IS: MARGINAL PROPENSITY TO CONSUME. SO WE NEED TO TAKE INTO ACCOUNT, OR AT LEAST WE EVENTUALLY WILL -- AND I DON'T WANT TO GIVE YOU A FORMULA THAT'S INCOMPLETE RIGHT NOW JUST 'CAUSE WE HAVEN'T YET GOTTEN TO TALKING ABOUT TAXES. BUT LATER ON WE WILL COME BACK AND PUT IN TAXES INTO THIS FORMULA. SO THIS WILL BE OUR AUTONOMOUS SPENDING FIGURE.

5 ECO LECTURE 28 5 SO I MAY SAY SOMETHING TO YOU LIKE THIS: CONSUMPTION SPENDING, TWENTY DOLLARS -- AUTONOMOUS CONSUMPTION. AUTONOMOUS INVESTMENT, TWENTY-FIVE; GOVERNMENT, THIRTY; NET EXPORTS, MINUS TEN; TAXES -- OH, WHAT DO WE MAKE IT? LET'S SAY TEN DOLLARS ALSO. MPC, POINT SEVEN FIVE. SO I WOULD GIVE YOU THESE AMOUNTS AND THESE ARE ALL DOLLAR AMOUNTS. THIS MINUS TEN FOR NET EXPORTS, THAT'S TELLING US THAT -- NET EXPORTS OR EXPORTS MINUS IMPORTS. AND IF THIS IS A NEGATIVE NUMBER, THAT SAYS THAT OUR IMPORTS ARE GREATER THAN OUR EXPORTS. WE'RE RUNNING A BALANCE OF TRADE DEFICIT. MORE ON THAT LATER IN THE SEMESTER. BUT ANYWAY, WHAT'S TOTAL AUTONOMOUS CONSUMPTION SPENDING? TWENTY AND TWENTY-FIVE IS FORTY-FIVE, SEVENTY-FIVE MINUS TEN, SIXTY-FIVE, MINUS -- SO TAXES ARE GONNA LOWER AUTONOMOUS SPENDING BUT MINUS SEVENTY-FIVE PERCENT OF TEN DOLLARS, SO THAT WOULD BE SEVEN FIFTY. WHAT WOULD THAT BE? FIFTY -- SEVEN FIFTY? SO GIVEN THESE NUMBERS -- AND THE ONLY REASON I'M DOING THIS IS TEST DAY I WILL GIVE YOU SOME NUMBERS LIKE THIS. THEY'LL BE A LITTLE BIT DIFFERENT BUT THE IDEA IS THERE. WE'VE GOT FIFTY-SEVEN DOLLARS AND FIFTY CENTS WORTH OF AUTONOMOUS SPENDING. THE MULTIPLIER IS FOUR AND SO THE EQUILIBRIUM LEVEL OF GDP IS FIFTY-SEVEN FIFTY DIVIDED -- OR TIMES FOUR, TWO HUNDRED AND THIRTY DOLLARS. I WOULD URGE YOU TO PRACTICE THAT. WHAT'S THAT -- TWO HUNDRED AND THIRTY DOLLARS. OKAY. OH, I

6 ECO LECTURE 28 6 KNOW WHAT I WANTED TO DO NEXT. OUR NEXT THING IS TO COME ALONG AND SAY SUPPOSE THERE IS A SHIFT IN THIS CURVE, TE2. WELL, HOW MUCH DID IT SHIFT? WELL, LET'S SAY SOMETHING LIKE THIS HAPPENED. AUTONOMOUS INVESTMENT SPENDING WENT UP TO FORTY-FIVE DOLLARS. THEN THAT WOULD MEAN THIS TOTAL EXPENDITURES CURVE SHIFTED UPWARD BY TWENTY DOLLARS 'CAUSE ONLY ONE COMPONENT CHANGED BY THAT MUCH. NOW THAT'S SEVENTY-SEVEN FIFTY. IS THAT RIGHT? SEVENTY- SEVEN FIFTY TIMES FOUR IS THREE HUNDRED AND TEN DOLLARS. AND WHAT WE CAN SEE AGAIN IS WE'VE GOT AN EXTRA TWENTY DOLLARS WORTH OF SPENDING AND THAT RESULTED IN AN EXTRA EIGHTY DOLLARS WORTH OF EQUILIBRIUM GDP OR INCOME. AND SO THE RELATIONSHIP BETWEEN THOSE TWO OF TWENTY DOLLARS LEADS TO EIGHT DOLLARS WORTH OF INCOME, AND THAT GOES ALONG WITH OUR MULTIPLIER OF FOUR. LET ME DO A LITTLE ERASING AND DRAW YOU THE AGGREGATE DEMAND CURVE THAT GOES ALONG WITH THIS. IF YOU'LL REMEMBER, KEYNES ASSUMED THIS AGGREGATE SUPPLY CURVE THAT WAS HORIZONTAL. THIS IS -- WE'RE GONNA DRAW AN AGGREGATE DEMAND CURVE. THERE'S OUR AGGREGATE SUPPLY. AND SO IN THIS PARTICULAR CASE WHERE THERE'S A TWENTY DOLLAR INCREASE IN SOME AUTONOMOUS COMPONENT OF SPENDING AND THEN THE EQUILIBRIUM INCOME INCREASES BY EIGHTY DOLLARS, HERE'S WHAT WE'RE SAYING IS HAPPENING. THE AGGREGATE DEMAND CURVE WAS IN ONE PARTICULAR POSITION TO BEGIN WITH, EQUILIBRIUM WAS TWO HUNDRED AND THIRTY DOLLARS -- THAT WAS

7 ECO LECTURE 28 7 GDP, AND THEN WHEN THIS AUTONOMOUS INVESTMENT SPENDING WENT UP, THE AGGREGATE DEMAND CURVE SHIFTED TO THE RIGHT TO AD2 AND THE EQUILIBRIUM LEVEL OF INCOME WOULD NOW BE THREE HUNDRED AND TEN DOLLARS. SO WHAT WE ARE LEARNING FROM THIS PICTURE -- THIS IS THE ONE THAT KEYNES DID BACK -- WELL, ACTUALLY KEYNES NEVER DREW ANY DIAGRAMS. HE DID IT ALL MATHEMATICALLY. BUT THE KEYNESIANS WHO CAME ALONG AND FOLLOWED HIM, THEY TOOK THE MATHEMATICS, TRANSFORMED IT INTO DIAGRAMS. THEIR DIAGRAM ASSUMES THIS PASSIVE AGGREGATE SUPPLY. ALL YOU HAVE TO DO IS DEMAND MORE AND IT WILL PRODUCE MORE. AND SO UNDER THAT ENVIRONMENT -- AND THAT'S WHAT THIS CURVE SHOWS ALSO, THIS FORTY-FIVE DEGREE LINE. IT SAYS, "HEY, IF YOU WANT US TO PRODUCE MORE, WE CAN. IF YOU WANT US TO PRODUCE OUT HERE OR HERE OR HERE, WE DON'T CARE. WE'LL PRODUCE ALL YOU WANT." SO ANYWAY, IN THIS SITUATION, AN INCREASE IN TOTAL EXPENDITURES THROUGH THIS -- I'VE GIVEN AN EXAMPLE OF INVESTMENT SPENDING GOING UP -- THAT WOULD CAUSE EQUILIBRIUM LEVEL OF INCOME TO RISE BY EIGHTY DOLLARS. UNDER THAT SITUATION OF PASSIVE AGGREGATE SUPPLY. IN REALITY, WE DO NOT FACE THIS PASSIVE AGGREGATE SUPPLY CURVE. I SHOULDN'T SAY "IN REALITY." DURING KEYNES'S REALITY WE DID. BUT THE POINT IS, IN REALITY MAYBE TODAY WE FACE AN AGGREGATE SUPPLY CURVE THAT'S UPWARD SLOPING. VERY

8 ECO LECTURE 28 8 STEEP, PERHAPS. SO WE DON'T ACTUALLY MOVE ALL THE WAY OUT TO THREE HUNDRED -- AND I'LL JUST KIND OF DRAW THIS HERE, AS. WE DON'T ACTUALLY MOVE WITH THIS GIVEN -- WITH THE INCREASE IN INVESTMENT SPENDING THAT WE HAD HERE, WE DON'T ACTUALLY MOVE ALL THE WAY OUT FROM TWO HUNDRED AND THIRTY TO THREE HUNDRED AND TEN DOLLARS LEVEL -- THREE HUNDRED AND TEN DOLLARS WORTH OF INCOME. WE DON'T ACTUALLY MAKE THAT FULL TRIP FROM POINT A TO B. WE GO UP TO POINT C, AND THE REASON FOR THAT IS: AS DEMAND STARTS TO GROW, THE UNEMPLOYMENT RATE IS GOING DOWN. AS WE START MOVING THIS DIRECTION, THERE'S MORE PEOPLE WITH JOBS. WAGES START TO RISE. AND SO THIS CURVE DOESN'T LOOK HORIZONTAL. IT'S GOT AN UPWARD SLOPE TO IT DUE TO THE FACT THAT WAGES AND FACTOR PRICES AND SO FORTH ARE RESPONDING TO THIS INCREASED DEMAND. BUT THE POINT IS, IS THAT ALL KEYNES IS REALLY TELLING US WITH THIS STORY IS NOTHING ABOUT THIS POINT C IN THIS NEW EQUILIBRIUM. HE DOESN'T GET TO THAT. WHAT HE'S DOING IS SHOWING US THE SIZE OF THE AGGREGATE -- OF THE SHIFT IN THE AGGREGATE DEMAND CURVE. AND IF WE HAD AN EIGHTY DOLLAR INCREASE HERE, THAT MEANS THAT THE AGGREGATE DEMAND CURVE IS SHIFTING TO THE RIGHT BY EIGHTY DOLLARS. AND THEN IT'S -- WE ALSO HAVE TO INVESTIGATE WHAT'S GOING ON WITH AGGREGATE SUPPLY TO KNOW WHERE THE NEW EQUILIBRIUM IS. KEYNES'S EQUILIBRIUM -- HERE IS -- LET ME PUT A AND B. KEYNES'S EQUILIBRIUM FROM POINT A TO POINT B, THAT'S GREAT IF WE HAVE THIS

9 ECO LECTURE 28 9 PASSIVE AGGREGATE SUPPLY. WE MOVE FROM POINT A TO POINT B. BUT I'M SAYING THAT IN REALITY, IN OUR REALITY, THAT'S NOW THE AGGREGATE SUPPLY CURVE SO THAT'S NOT THE END OF THE STORY, THIS POINT B. NEVERTHELESS, WHAT WE ARE TRYING TO DO IS UNDERSTAND WHAT'S GOING ON WITH AGGREGATE DEMAND. AND WE COULD COME BACK HERE AND COULD'VE DONE THE SAME THING. IT COULD'VE BEEN GOVERNMENT SPENDING OR AUTONOMOUS CONSUMPTION SPENDING THAT COULD'VE RISEN BY TWENTY DOLLARS, AND WE WOULD'VE HAD EXACTLY THESE SAME SHIFTS AND EXACTLY THAT SAME RESULT WITH RESPECT TO EQUILIBRIUM INCOME. ANY QUESTIONS ABOUT THIS? A LOT OF WHAT WE'RE DOING HERE IS REVIEW, BUT NOT ALL OF IT. OKAY. HERE'S A QUESTION FOR YOU. WHAT CAUSES THESE THINGS TO SHIFT: CHANGE IN AUTONOMOUS CONSUMPTION, CHANGE IN AUTONOMOUS INVESTMENT, AND SO FORTH? WHAT CAUSES THOSE TO HAPPEN? WE'VE TALKED ABOUT SOME OF THESE ALREADY. AUTONOMOUS CONSUMPTION SPENDING? THAT COULD CHANGE DUE TO, OH, WHAT? CHANGES IN EXPECTATIONS. I'LL PUT A DELTA SIGN THERE. CHANGES IN EXPECTATIONS OF PRICES. FOR EXAMPLE, IF YOU THINK PRICES ARE GONNA GO UP, IT'S A GOOD TIME TO GO OUT AND SPEND YOUR MONEY TODAY BEFORE THE PRICES GO UP. AND IF YOU GO OUT AND SPEND THAT MONEY TODAY BEFORE THE PRICES GO UP, CONSUMPTION SPENDING RISES. CHANGE IN WEALTH OF HOUSEHOLDS. HERE'S A GOOD EXAMPLE FOR

10 ECO LECTURE YOU. THIS IS TAKING PLACE AND HAS BEEN FOR SEVERAL YEARS. WHAT HAPPENS IS THE STOCK MARKET GOES UP, STOCK PRICES GO UP. IT WAS GOING UP THIS MORNING BEFORE I CAME IN. SO STOCK PRICES GO UP, PEOPLE SAY, "GOSH, YOU KNOW, I MADE TEN THOUSAND DOLLARS LAST YEAR IN THE STOCK MARKET." I DIDN'T ACTUALLY MAKE THAT; I'M SAYING PEOPLE SAY THAT. SO SOMEBODY SAYS, "I MADE TEN THOUSAND DOLLARS IN THE STOCK MARKET," AND THEN THEY START SAYING, "I KIND OF FEEL PRETTY WELL OFF, YOU KNOW. THAT'S KIND OF LIKE GETTING A RAISE IN PAY." AND THEN WHAT THEY MIGHT SAY IS SOMETHING LIKE THIS: "HECK, I THINK I'M GONNA GO OUT AND BUY A NEW CAR." A NEW CAR? YOU CAN'T BUY A NEW CAR WITH TEN THOUSAND DOLLARS. "NO, BUT NEXT YEAR I'LL MAKE ANOTHER TEN THOUSAND DOLLARS AND THE YEAR AFTER THAT ANOTHER TEN THOUSAND -- YOU KNOW, THE STOCK MARKET IS GONNA GO UP FOREVER. SO I'LL JUST GO OUT AND BUY A NEW CAR AND THEN EACH YEAR I'LL TAKE A LITTLE BIT OF MY GAINS FROM THE STOCK MARKET AND I'LL PAY FOR THAT CAR." THAT'S HAPPENING IN THE UNITED STATES AND HAS BEEN FOR SEVERAL YEARS. PEOPLE ARE SAVING VERY LITTLE IN TERMS OF SAVING OUT OF THEIR CURRENT INCOME. THEY SPEND OUT OF THEIR CURRENT INCOME BECAUSE THEY SAY, "MY SAVINGS ARE GROWING ANYWAY. THE STOCK MARKET IS GOING UP." PEOPLE FEEL A WEALTH EFFECT. AND I HAVEN'T WRITTEN THAT TERM DOWN HERE, BUT THERE'S A WEALTH EFFECT FROM THE STOCK MARKET.

11 ECO LECTURE I WANT TO BE CAREFUL AND NOT JUST LEAVE IT AT THAT. THERE'S NOT ALWAYS A WEALTH EFFECT -- WELL, THERE'S ALWAYS A WEALTH EFFECT. SOMETIMES IT'S NEGATIVE, THOUGH. STOCK MARKET CAN GO DOWN. IT HAS GONE DOWN MANY TIMES. AND SO IF THE STOCK MARKET GOES DOWN, THEN WE SAY, "OH, MAN. I FEEL MISERABLE. I LOST TEN THOUSAND DOLLARS." AND THEN SOMEBODY SAYS, "HEY, LET'S TAKE A VACATION," AND YOU GO, "OH, NO, MAN. I CANNOT TAKE A VACATION. I AM SUFFERING HERE. I LOST TEN THOUSAND DOLLARS." THAT WILL TEACH YOU NOT TO GET IN THE STOCK MARKET. NO. THE STOCK MARKET GOES UP OVER LONG PERIODS OF TIME AND IT GOES DOWN SOME DAYS. OTHER DAYS IT GOES UP. BASICALLY, OVER THE LONG RUN, THE STOCK MARKET WILL GO UP TWO DAYS FOR EVERY DAY IT GOES DOWN. AND SO OVER THE LONG RUN, THE STOCK MARKET IS GOING UP. AND SO OVER THE LONG RUN, WE HAVE MORE AND MORE OF THIS WEALTH THAT'S GROWING AND SO THAT ENCOURAGES US TO SPEND MORE AND MORE. LET'S TALK ABOUT INVESTMENT SPENDING, WHAT COULD AFFECT THAT. HERE'S ONE THING: A CHANGE IN INTEREST RATES. YOU KNOW, BUSINESSES FINANCE A LOT OF THEIR INVESTMENT -- AND BY "INVESTMENT," YOU KNOW, WE'RE NOT TALKING ABOUT BUYING STOCKS AND BONDS. I WANTED TO DRAW THAT DISTINCTION SINCE WE WERE JUST A MOMENT AGO TALKING ABOUT STOCKS. WHAT WE'RE TALKING ABOUT WITH RESPECT TO INVESTMENT HERE, WE'RE TALKING ABOUT BUYING CAPITAL EQUIPMENT, BUILDINGS, NEW STRUCTURES, NEW TOOLS, INVESTING IN INVENTORIES AND

12 ECO LECTURE SO FORTH. BUT IF INTEREST RATES GO UP, BUSINESSES THEN SAY -- BUSINESS MANAGERS SAY, "GOSH, THAT MEANS I'M GONNA HAVE TO MAKE A HIGHER PAYMENT EVERY MONTH IF I WANT TO BUILD A NEW FACTORY. IF IT'S A TEN MILLION DOLLAR BUILDING I WANT TO BUILD AND THE INTEREST RATE GOES UP FROM EIGHT PERCENT TO NINE PERCENT, THEN THAT'S GONNA COST ME AN EXTRA ONE PERCENT OF TEN MILLION DOLLARS. THAT'S GONNA -- OH, BOY. CAN I DO THAT? ONE PERCENT OF TEN MILLION DOLLARS IS A HUNDRED THOUSAND DOLLARS A YEAR. IT'S GONNA COST ME AN EXTRA HUNDRED THOUSAND DOLLARS A YEAR IN INTEREST." AND THEN, "AH, I DON'T KNOW IF I'M GONNA GO AHEAD AND BUILD THAT FACTORY." AND SO ANYWAY, HIGHER INTEREST RATES, LOWER INVESTMENT. THERE'S A NEGATIVE RELATIONSHIP HERE BETWEEN INTEREST RATES AND INVESTMENT. THE INTEREST RATE'S UP, THE INVESTMENT DOWN. NEGATIVE RELATIONSHIP. AND, BY THE WAY, INTEREST RATES COME DOWN, INVESTMENT WILL GO UP. SO VERY OFTEN WHAT WE'LL SEE IS INTEREST RATES ARE -- MAYBE THE FEDERAL RESERVE IS CAUSING INTEREST RATES TO COME DOWN WITH ITS POLICIES AND THEN BUSINESS INVESTMENT WILL RESPOND BY GOING UP. WHAT ELSE? HOW ABOUT CHANGE IN PESSIMISM -- I'LL SAY MOOD, AND THEN I'LL WRITE DOWN PESSIMISM AND OPTIMISM. BY THE WAY, KEYNES THOUGHT THIS WAS EXTREMELY IMPORTANT. HERE'S WHAT HE SAID. HE SAID, "YOU KNOW, THESE CAPITALISTS, THEY LOOK LIKE THE CAPTAINS OF INDUSTRY BUT THEY'RE KIND OF TIMID PEOPLE INSIDE. AND

13 ECO LECTURE SOMETHING CAN GO WRONG AND THEY JUST GET CHICKEN AND JUST RUN AWAY AND THEY REFUSE TO INVEST. AND AT OTHER TIMES THEY FEEL REAL AGGRESSIVE AND, YOU KNOW, LIKE 'OH, I'M READY TO INVEST.'" AND SO WHAT HE SAID IS INVESTMENT VERY OFTEN IS RESPONDING TO THESE SORT OF MOODS THAT RUN THROUGH THE BUSINESS COMMUNITY. OPTIMISM, PESSIMISM. AND HE SAYS THAT THOSE SWINGS IN THE MOOD, THAT CAN HAVE A MUCH BIGGER IMPACT ON INVESTMENT SPENDING THAN CHANGES IN INTEREST RATES OR REALLY ANYTHING ELSE. AND HE SAID THAT WHAT HAPPENED DURING THE DEPRESSION WAS BUSINESS -- AND, IN FACT, HE SAID THIS IS WHAT STARTED THE DEPRESSION. YOU MAY WANT TO THINK ABOUT THIS. AND, BY THE WAY, I DON'T AGREE WITH HIM. BUT KEYNES SAID WHAT STARTED THE DEPRESSION IS REALLY BUSINESSES BECAME PESSIMISTIC AND THEY JUST WERE RELUCTANT TO INVEST. LET'S FOLLOW THAT THROUGH. LET'S SAY THAT OUR ORIGINAL -- LET ME GET RID OF THESE A'S AND B'S BECAUSE WE DON'T NEED THOSE. LET'S SAY THAT OUR ORIGINAL TOTAL EXPENDITURE CURVE WAS THIS -- THE TOP CURVE, WHICH I BELIEVE WILL TE2, AND SUPPOSE THEN BUSINESSES -- BUSINESS MANAGERS BECOME PESSIMISTIC AND SAY, "OH, MAN. I'M AFRAID TO INVEST." AND SO THIS CURVE SHIFTS DOWNWARD. THERE'S LESS AUTONOMOUS INVESTMENT SPENDING. THE CURVE SHIFTS DOWNWARD. AND THEN THE ECONOMY SHRINKS BY, IN THIS PARTICULAR CASE, EIGHTY DOLLARS.

14 ECO LECTURE AND SO IF THE ECONOMY BEGAN AT, LET'S SAY, FULL EMPLOYMENT, NATURAL REAL GDP, ALL OF A SUDDEN WE'RE IN A RECESSIONARY GAP. AND SO THAT'S WHAT KEYNES SAID HAPPENED TO BASICALLY GET THE RECESSION OR THE DEPRESSION -- IN ENGLAND IN THE '20S AND '30S AND IN THE UNITED STATES THE DEPRESSION OF THE '30S. BUT HE SAID IT WAS THESE TIMID BUSINESS MANAGERS. THEY WOULDN'T INVESTMENT. THE CURVE -- THE TOTAL EXPENDITURES CURVE SHIFTS DOWN, EQUILIBRIUM GDP FALLS, AND THEN WE'RE JUST STUCK IN A RECESSION. STUCK. WHAT DO WE DO ABOUT IT? WELL, YOU COULD COME ALONG, YOU KNOW, AND CHEER UP THESE BUSINESS MANAGERS. "C'MON, C'MON. THINGS AREN'T AS BAD AS YOU THINK." BUT THAT WON'T WORK. IN FACT, THAT WAS REALLY MY IDEA TO CHEER 'EM UP. NOBODY'S EVER MENTIONED DOING THAT BEFORE. SOME KIND OF MAYBE A GETAWAY THING, A LOVEBOAT CRUISE IN THE CARIBBEAN. ANYWAY. I DON'T KNOW WHAT I'M TALKING ABOUT HERE. BUT I THINK THAT WOULD BE A GOOD IDEA FOR A NEW POLICY. KEYNES SAYS THESE GUYS BECAME PESSIMISTIC AND THE ECONOMY FELL APART. IF YOU CAN'T COME OUT HERE AND JOLLY THESE GUYS UP AND SOMEHOW GET 'EM TO REVERSE THEIR DECISION TO NOT SPEND, HE SAID, "WE'RE JUST GONNA STICK BACK HERE IN THIS DEPRESSED SITUATION." AND THEN OUR NEXT UNIT OF MATERIAL, WE'LL COME BACK TO WHAT HE SAID TO DO ABOUT THAT. HEY, IT'S THE GOVERNMENT'S JOB TO COME IN AND OFFSET THOSE SHIFTS IN INVESTMENT. IF YOU SEE BUSINESS INVESTMENT

15 ECO LECTURE GO DOWN BY A CERTAIN AMOUNT -- HERE IT WAS TWENTY DOLLARS -- IF YOU SEE BUSINESS INVESTMENT SPENDING GO DOWN BY A CERTAIN AMOUNT AND THAT SLOWS DOWN THE ECONOMY, HE SAID, "WHY DON'T YOU HAVE THE GOVERNMENT COME BACK IN AND SPEND MONEY AND THEN DO SOMETHING ABOUT THAT?" SO IF THERE'S A DECREASE OF INVESTMENT SPENDING BY TWENTY DOLLARS, THEN HOW ABOUT LET'S INCREASE GOVERNMENT SPENDING BY TWENTY DOLLARS AND THE ECONOMY -- YOU KNOW, SO THE CURVE SHIFTS DOWN, TOTAL EXPENDITURE IS DOWN, AND THEN BACK UP -- HERE'S INVESTMENT DOWN, GOVERNMENT UP, AND THEN WE KEEP THE SAME OLD EQUILIBRIUM. AND THAT'S REALLY WHAT THE NEXT UNIT OF MATERIAL IS ABOUT, IS FISCAL POLICY. LET ME TALK ABOUT THIS FOR JUST A SECOND. CHANGES IN GOVERNMENT PURCHASES. DON'T FORGET, THIS IS NOT GOVERNMENT SPENDING 'CAUSE THE GOVERNMENT SPENDS SOME MONEY JUST AS TRANSFER PAYMENTS. THIS IS GOVERNMENT PURCHASES OF GOODS AND SERVICES. WHY WOULD THAT SHIFT? YOU KNOW, FOR TWO REASONS I CAN THINK OF. ONE REASON IS FISCAL POLICY, WHICH I WAS JUST TALKING ABOUT A MOMENT AGO. THERE CAN BE A CHANGE IN GOVERNMENT SPENDING BECAUSE THE GOVERNMENT SAYS, "WE WANT TO BASICALLY INFLUENCE THE ECONOMY. WE WANT TO STIMULATE THE ECONOMY" OR "WE WANT TO SLOW DOWN THE ECONOMY." THAT'S FISCAL POLICY. AGAIN, WE COME BACK TO THAT LATER ON.

16 ECO LECTURE THERE'S ANOTHER REASON THAT GOVERNMENT SPENDS, THOUGH. PUBLIC GOODS. SOMETIMES THE GOVERNMENT -- SOMETIMES. USUALLY WHEN THE GOVERNMENT'S SPENDING, IT'S NOT SPENDING TRYING TO MANIPULATE THE ECONOMY. USUALLY WHEN THE GOVERNMENT IS SPENDING IT'S DOING SO BECAUSE THEY THINK, YOU KNOW, THERE ARE GOODS THAT -- GOODS AND SERVICES, BUT THERE ARE GOODS AND SERVICES OUT THERE THAT THE PUBLIC WANTS. AND THIS TERM "PUBLIC GOODS," IT'S A TECHNICAL TERM. I DON'T MEAN TO SAY THE WAY IT JUST SOUNDED. I DON'T MEAN TO SAY WITH THIS TERM "PUBLIC GOODS," OH, GOODS AND SERVICES THE PUBLIC WANTS. I DON'T MEAN IT LIKE THAT. ECONOMISTS USE THIS TERM IN A TECHNICAL WAY. WHAT THEY MEAN BY PUBLIC GOODS IS GOODS THAT PROVIDE BENEFITS TO VIRTUALLY EVERYBODY IN SOCIETY. SIMULTANEOUSLY. OKAY. SO WHAT I'M SAYING IS THAT IF THE GOVERNMENT CAME OUT AND, LET'S SAY, WAS JUST LIKE -- OH, I DON'T KNOW -- BUILDING -- WHAT WOULD THEY BUILD? I DON'T WANT TO GET INTO BAD EXAMPLES. LET ME GET INTO A GOOD EXAMPLE. NATIONAL DEFENSE. NATIONAL DEFENSE IS AN EXAMPLE OF A PUBLIC GOOD. WHEN THE GOVERNMENT PURCHASES THAT GOOD AND PROVIDES IT TO ME, THEY PROVIDE THE SAME NATIONAL DEFENSE TO YOU. IT'S IMPOSSIBLE FOR ANOTHER NATION TO ATTACK ME IN MY HOME WITHOUT SIMULTANEOUSLY ATTACKING YOU. WHEN THE GOVERNMENT HAS NATIONAL DEFENSE SPENDING AND DETERS THE FOREIGN ATTACK AGAINST ME, THE GOVERNMENT'S ALSO DETERRING FOREIGN ATTACK AGAINST YOU AND

17 ECO LECTURE EVERYBODY ELSE IN THE UNITED STATES. AND SO PUBLIC GOOD IS THE GOOD THAT PROVIDES BENEFITS TO VIRTUALLY EVERYBODY IN SOCIETY. SIMULTANEOUSLY. AND SECONDLY, IT'S REALLY KIND OF HARD TO EXCLUDE THESE PEOPLE FROM CONSUMING THESE. THAT IS TO SAY, IF THE GOVERNMENT PROVIDES NATIONAL DEFENSE FOR ME AND THEN TURNS TO YOU AND SAYS, "WELL, WE'RE DEFENDING YOU, TOO. WHY DON'T YOU PAY US?" YOU COULD JUST SAY, "HEY, I DON'T WANT TO PAY. AND DON'T DEFEND ME IF YOU DON'T FEEL LIKE IT." WELL, THE THING IS IS THAT'S EASY TO SAY, BUT THE GOVERNMENT DOESN'T HAVE THAT CHOICE. ONCE THEY GET THE NATIONAL DEFENSE IN PLACE TO DEFEND ME, YOU'RE AUTOMATICALLY DEFENDED. SO PUBLIC GOODS HAVE THOSE TWO CHARACTERISTICS: PROVIDING BENEFITS FOR VIRTUALLY EVERYBODY IN SOCIETY SIMULTANEOUSLY AND WE CAN'T REALLY PUT A PRICE TAG ON IT WHERE WE CHARGE EACH INDIVIDUAL CONSUMER. IT'S NOT POSSIBLE TO EXCLUDE NON-PAYERS FROM CONSUMING. ANYWAY. SO THERE'S TWO REASONS THAT GOVERNMENT COULD BE SPENDING MONEY. IT COULD BE THAT ALL OF A SUDDEN THERE'S A BIG FOREIGN THREAT TO OUR NATION'S SECURITY. AND IF SO, THE GOVERNMENT WILL SAY, "OH, WE NEED TO HAVE MORE DEFENSE SPENDING," AND THE GOVERNMENT WILL GO OUT AND SPEND MORE AND THAT WILL AFFECT THE ECONOMY. BUT IT WILL NOT AFFECT THE ECONOMY SORT OF ON PURPOSE. THAT IS TO SAY, THERE WAS NO ATTEMPT IN THIS STORY TO

18 ECO LECTURE INFLUENCE THE ECONOMY. IT WAS JUST AN ATTEMPT TO DEFEND THE COUNTRY. FISCAL POLICY, WE'RE REALLY TALKING ABOUT WHETHER THE GOVERNMENT SPENDS OR DOESN'T SPEND, TRYING TO INFLUENCE THE ECONOMY. AND IT'S NOT LIKE, "WELL, WE NEED TO BE DEFENDED." IT'S MORE A CASE OF, "WELL, WE NEED TO GET OUT OF THIS RECESSION" OR "WE NEED TO FIGHT INFLATION," OR WHATEVER THE PROBLEM IS. THAT'S WHAT FISCAL POLICY DOES. SO ANYWAY, WE WERE REALLY GOING THROUGH THE LIST OF WHAT INFLUENCES EACH ONE OF THESE COMPONENTS OF AUTONOMOUS SPENDING, AND I'M SAYING THERE'S A COUPLE OF THINGS THERE. NET EXPORTS, WHAT INFLUENCES THAT? HOW ABOUT TWO THINGS IN PARTICULAR: CHANGES AND EXCHANGE RATES, THE VALUE OF THE DOLLAR RELATIVE TO THE VALUE OF OTHER CURRENCIES. LET'S GIVE AN EXAMPLE. SUPPOSE THE DOLLAR STRENGTHENS. SUPPOSE THE DOLLAR GETS MORE VALUABLE RELATIVE TO OTHER CURRENCIES. OKAY. IF THAT HAPPENS, THEN -- WELL, LET'S GIVE SOMETHING SPECIFIC HERE. LET'S SAY JAPAN -- THE UNITED STATES, JAPAN -- LET'S SAY THE EXCHANGE RATE IS A HUNDRED TO ONE. ONE HUNDRED YEN EQUALS ONE DOLLAR. OKAY. NOW, LET'S SAY THE DOLLAR STRENGTHENS. THEN IT MIGHT TAKE A HUNDRED AND TEN YEN TO BUY ONE DOLLAR. NOW THE DOLLAR IS TEN PERCENT STRONGER. AND WHAT I'M SAYING IS THIS: IF WE HAVE SOMETHING TO SELL, LET'S SAY AN AIRPLANE, FOR FIFTY MILLION DOLLARS TO JAPAN -- THIS MIGHT BE SOME AIRLINER THAT BOEING MANUFACTURES.

19 ECO LECTURE IF WE HAVE A FIFTY MILLION DOLLAR AIRLINE TO SEND TO JAPAN, TO SELL TO JAPAN, IN THE FIRST INSTANCE WHERE THE EXCHANGE RATE WAS A HUNDRED TO ONE, THEN THEY SAY, "OH, MAN" -- AND HOW MUCH IS THAT? I DON'T EVEN KNOW BILLIONS. BUT IN THE FIRST INSTANCE THE JAPANESE SAY, "OH, IT TAKES A HUNDRED YEN TO BUY EACH DOLLAR. WE NEED FIFTY MILLION DOLLARS," AND SO THAT'S A CERTAIN NUMBER OF YEN TO BUY THE AIRPLANE. BUT THE DOLLAR STRENGTHENS AND NOW IT TAKES A HUNDRED AND TEN YEN TO BUY THAT SAME DOLLAR, MORE YEN TO BUY THE DOLLAR SINCE THE DOLLAR IS STRONGER. NOW IT TAKES MORE YEN TO BUY THAT AIRPLANE. IT'S STILL FIFTY MILLION DOLLARS, BUT NOW IT'S TEN PERCENT MORE YEN THAN IT WAS A MOMENT AGO. SO WHEN THE DOLLAR STRENGTHENS, OUR EXPORTS GO DOWN. OUR PRODUCT BECOMES MORE EXPENSIVE, PEOPLE OVERSEAS ARE LESS WILLING TO BUY IT. SO A STRONGER DOLLAR -- STRONGER DOLLAR -- LEADS TO REDUCED EXPORTS BY THE U.S. AND ALSO TO INCREASED IMPORTS. OKAY. A SECOND THING: CHANGES IN FOREIGN GDP. HOW'S THAT WORK OUT? SUPPOSE THAT PEOPLE IN FRANCE HAD THEIR INCOMES GO UP, GROSS DOMESTIC PRODUCT. THEIR ECONOMY'S EXPANDING, THEIR INCOMES ARE GOING UP. SUPPOSE THAT HAPPENS. THEN THE PEOPLE IN JAPAN FEEL -- JAPAN -- FRANCE FEEL MORE PROSPEROUS. THEY SAY, "HEY, OUR INCOMES ARE GOING UP." THEY PROBABLY SAY THAT IN SOME FRENCH ACCENT. "HEY, OUR INCOMES ARE GOING UP. LET'S BUY THINGS." AND

20 ECO LECTURE SOME OF THE THINGS THEY BUY ARE FROM FRANCE, SOME ARE FROM GERMANY, SOME ARE FROM THE UNITED STATES. SO IF FOREIGN GDPS ARE RISING, U.S. EXPORTS ARE GONNA BE RISING. PEOPLE OVERSEAS ARE BETTER OFF, MORE PROSPEROUS, AND THEY CAN AFFORD TO BUY MORE THINGS FROM THEIR OWN COUNTRIES AS WELL AS FROM THE UNITED STATES. SO OUR EXPORTS RISE. OKAY. SO THAT IS A PARTIAL LIST. YOU CAN THINK OF ADDITIONAL THINGS TO PUT ON THE LIST. INTEREST RATES CHANGING. THAT WOULD PROBABLY ALSO AFFECT CONSUMER AUTONOMOUS CONSUMPTION SPENDING BECAUSE INTEREST RATES CHANGE AND THAT WOULD AFFECT THE AMOUNT OF A CAR PAYMENT YOU HAVE TO MAKE OR SOMETHING LIKE THAT, A HOUSE PAYMENT. AND SO YOU COULD ADD ADDITIONAL THINGS TO THE LIST BUT THOSE ARE GOOD THINGS RIGHT THERE. I DIDN'T GO AHEAD AND TALK ABOUT TAXES. BUT IF TAXES CHANGE, WHICH WE WILL TALK ABOUT IN THE NEXT UNIT OF MATERIAL, THAT WOULD ALSO AFFECT AUTONOMOUS SPENDING. SO ANY QUESTIONS ABOUT THIS? THAT'S WHERE I WANT TO STOP TALKING ABOUT THIS MATERIAL AND GO ON TO THAT NEXT UNIT OF MATERIAL AND TALK ABOUT FISCAL POLICY. GOSH, I FEEL LIKE WE'VE ALREADY GOTTEN PRETTY DEEP INTO IT 'CAUSE I'VE BEEN TALKING ABOUT TAXES AND GOVERNMENT SPENDING. AND SO WHY DON'T WE DO THAT, JUST GO ON AND TALK ABOUT FISCAL POLICY. I WILL ADD ONE THING. I THINK I MADE THAT CLEAR. BUT ALL THESE

21 ECO LECTURE THINGS WE'VE BEEN TALKING ABOUT, FOR THE MOST PART I'VE BEEN INCREASING TOTAL EXPENDITURES AND SHIFTING THE AGGREGATE DEMAND CURVE TO THE RIGHT AND SO FORTH. THIS ALL CAN WORK IN REVERSE. IF INVESTMENT SPENDING WENT DOWN, TOTAL EXPENDITURES FALL; AGGREGATE DEMAND DECLINES; GDP WOULD GO DOWN. SO ANYWAY, EVERYTHING CAN BE REVERSED FROM WHAT WE WERE DOING BEFORE -- OR I THINK IT CAN. EVERYTHING I REMEMBER CAN BE REVERSED. OKAY. FIRST OF ALL, FISCAL POLICY. LET'S DEFINE THAT. FISCAL POLICY IS THE DELIBERATE MANIPULATION, IF YOU LIKE, OF GOVERNMENT SPENDING AND TAXES TO INFLUENCE ECONOMIC ACTIVITY. IT'S THE MANIPULATE -- MANIPULATE -- DELIBERATE MANIPULATION -- I THINK THAT'S WHAT MANIPULATE MEANS -- DELIBERATE MANIPULATION OF GOVERNMENT SPENDING AND TAXES, THAT G AND T, IN ORDER TO BRING ABOUT A DESIRED CHANGE IN ECONOMIC ACTIVITY. SAY IT ONE MORE TIME? I'LL TRY, 'CAUSE I'M JUST MAKING THIS UP AS I GO, YOU KNOW, SO I HOPE I MAKE IT UP THE SAME. IT'S THE DELIBERATE MANIPULATION OF GOVERNMENT SPENDING AND TAXES, G AND T, IN ORDER TO BRING ABOUT DESIRED CHANGES IN ECONOMIC ACTIVITY. I'LL HAVE TO REMEMBER THAT AND PUT IT ON THE TEST. THE IDEA OF FISCAL POLICY -- YOU JUST SAW IT A MOMENT AGO BUT LET'S MAKE IT VERY CLEAR. HERE'S OUR TOTAL PRODUCTION CURVE, TOTAL EXPENDITURES CURVE, EQUILIBRIUM GDP. AND THE IDEA IS THAT THAT EQUILIBRIUM GDP MAY NOT BE NATURAL REAL GDP, QN. AND IF YOU'LL

22 ECO LECTURE REMEMBER AT THIS NATURAL REAL GDP, THAT'S WHERE THE UNEMPLOYMENT RATE IS EQUAL TO THE NATURAL RATE. AND WHAT'S THAT NEIGHBORHOOD, FIVE PERCENT. SO IN THIS PARTICULAR CASE, WE HAVE SOMETHING CALLED A RECESSIONARY GAP. A RECESSIONARY GAP IS ACTUALLY THE DIFFERENCE BETWEEN THE EXISTING EQUILIBRIUM AND THE FULL EMPLOYMENT LEVEL OF REAL GDP. OKAY. SO THE IDEA ORIGINALLY WHEN KEYNES WROTE HIS BOOK, THIS GENERAL THEORY, THE IDEA WAS WE'RE IN A RECESSION. HOW DO WE GET RID OF THAT RECESSION? LATER ON WE CAN TALK ABOUT THE POSSIBILITY OF AN INFLATIONARY GAP. SUPPOSE THAT INSTEAD -- AND WE CAN ONLY HAVE ONE OF THESE, SO LET ME CROSS OUT THE ONE. SUPPOSE INSTEAD THAT NATURAL REAL GDP WAS THIS SMALLER AMOUNT. THEN WE WOULD SAY THAT, "OH, WE HAVE AN INFLATIONARY GAP." THE EQUILIBRIUM LEVEL OF GDP IS GREATER THAN NATURAL REAL GDP. THE ECONOMY WANTS TO PERFORM STRONGER THAN IT'S CAPABLE OF OVER THE LONG RUN. WE HAVE INFLATIONARY PRESSURES IN PLAY. SO ANYWAY, THE IDEA IS -- I'LL SAY IT AGAIN. FISCAL POLICY, DELIBERATE MANIPULATION OF G AND T, GOVERNMENT SPENDING AND TAXES, TO BRING ABOUT DESIRED CHANGES IN ECONOMIC ACTIVITY. EITHER TO STIMULATE THE ECONOMY OR TO SLOW DOWN THE ECONOMY. THAT'S ITS PURPOSE. LET'S TALK ABOUT A FEW TERMS. FIRST OF ALL, GOVERNMENT SPENDING HAS GOT TWO COMPONENTS: GOVERNMENT PURCHASES OF

23 ECO LECTURE GOODS AND SERVICES PLUS TRANSFER PAYMENTS. WE -- STRICTLY SPEAKING, WE ARE USUALLY NOT TALKING ABOUT TOTAL GOVERNMENT SPENDING. USUALLY WE DIVIDE THESE TWO THINGS OUT. AND WE TALK ABOUT GOVERNMENT PURCHASES OF GOODS AND SERVICES, AND G IS THE LETTER THAT I'VE ASSIGNED TO THOSE GOVERNMENT PURCHASES. AND TRANSFER PAYMENTS, THESE ARE DOLLARS, WHAT, SHIFTED FROM ONE PERSON TO ANOTHER. WHY DO I DISTINGUISH BETWEEN THOSE? AND HERE'S THE REASON FOR THIS. HERE THERE'S NO NEW PRODUCTION. THERE'S NO DEMAND FOR GOODS. WHAT HAPPENS IS, A DOLLAR COMES OUT OF MY POCKET AND IT GOES INTO YOUR POCKET. I WAS GONNA BUY A HAMBURGER FOR LUNCH WITH THAT DOLLAR BUT NOW THE DOLLAR'S GONE. I CAN'T BUY THAT HAMBURGER. BUT NOW YOU HAVE THAT DOLLAR AND YOU CAN BUY THAT HAMBURGER. SO REALLY, WHEN THERE'S TRANSFER PAYMENTS, IT MAY NOT HAVE A VERY BIG IMPACT ON TOTAL SPENDING. WE'RE TAKING MY MONEY AWAY. I SPEND LESS. YOU GET THE MONEY AND YOU SPEND MORE. THOSE ARE SOME OFFSETTING THINGS TAKING PLACE. BUT HERE I CONTINUE TO SPEND THE AMOUNT OF MONEY I WAS GONNA SPEND BEFORE. BUT ALL OF A SUDDEN GOVERNMENT'S SPENDING SOME ON TOP OF THAT PURCHASING GOODS AND SERVICES, AND SO THAT CONSTITUTES A LARGER INCREASE AND DEMAND FOR GOODS. SO WE WANT TO DISTINGUISH BETWEEN THESE TWO THINGS. THE TRANSFER PAYMENTS -- I'LL USE TR TO REPRESENT THAT. THE

24 ECO LECTURE GOVERNMENT PURCHASES THE GOODS AND SERVICES FROM THE TRANSFER PAYMENTS. AND SOMETIMES I'M A LITTLE SLOPPY AND I SAY GOVERNMENT SPENDING, BUT I USUALLY MEAN GOVERNMENT PURCHASES OF GOODS AND SERVICES. SO YOU SHOULD ALWAYS HAVE THAT IN MIND. THAT'S REALLY ALL I WANT TO DO HERE, THOUGH, IS DEFINE A FEW TERMS SO THAT WE'RE REAL CLEAR ON WHAT'S GOING ON. TAXES. I THINK EVERYBODY KNOWS WHAT TAXES ARE, BUT TAXES ARE UNILATERAL PAYMENTS BY PERSONS OR ORGANIZATIONS TO THE GOVERNMENT. AND THE KEY HERE IS THAT WORD "UNILATERAL." WELL, THE KEY IS TO THE GOVERNMENT. BUT THE WORD "UNILATERAL," HERE'S WHAT THAT MEANS. THEY JUST TELL YOU, "HEY, SEND US SOME MONEY." AND IF YOU SAY TO THEM -- WELL, YOU KNOW, IF A GROCERY STORE OWNER SAID TO YOU, "SEND US SOME MONEY," YOU WOULD SAY, "AND WHAT'RE YOU GONNA GIVE ME, YOU KNOW? SOME SODA, SOME HAMBURGER, SOME CHEESE? WHAT DO I GET FOR MY MONEY?" WITH THE GOVERNMENT THEY SAY, "SEND US MONEY" AND THAT'S THE END OF THE STORY. AND IF YOU SAY, "WELL, WHAT DO I GET BACK?" THEY SAY, "WE'LL TELL YOU. YOU KNOW, LIKE LATER ON IF YOU'RE DRIVING DOWN THE ROAD AND YOU SEE A ROAD, THAT'S WHAT YOU GET. BUT DON'T BE ASKING US THESE QUESTIONS, YOU KNOW." AND SO ANYWAY, UNILATERAL. IT'S NOT A "HERE'S SOME MONEY AND I GET BACK -- RIGHT THEN, AT THE TIME, IN A CLEAR WAY, I GET BACK GOODS AND SERVICES." IT'S NOT THAT WAY WITH TAXES. YOU DO GET GOODS AND SERVICES, BUT THERE'S NO RELATIONSHIP BETWEEN YOU AND THE

25 ECO LECTURE GOVERNMENT IN TERMS OF YOU HAND OVER THE MONEY, THEY HAND BACK THE SERVICES. YOU GET THE SAME SERVICES EVERYBODY DOES, THOSE PUBLIC GOODS THAT WE WERE TALKING ABOUT A FEW MINUTES AGO. GOVERNMENT BUDGET. YOU'LL HEAR PEOPLE TALKING ABOUT THE BUDGET THROUGHOUT YOUR LIFE AND REALLY ALL THEY MEAN IS GOVERNMENT SPENDING MINUS TAX REVENUES. I JUST TOLD YOU A MOMENT AGO I DON'T VERY OFTEN MEAN GOVERNMENT SPENDING BUT HERE I DO. I MEAN BOTH FORMS OF GOVERNMENT SPENDING, EITHER FOR TRANSFER PAYMENTS OR FOR PURCHASES OF GOODS AND SERVICES. SO LET'S SAY THE GOVERNMENT -- DOES ANYBODY KNOW HOW MUCH THE GOVERNMENT SPENDS IN A YEAR? CLOSE TO TWO TRILLION DOLLARS. IT'S NOT QUITE THERE, BUT IT'LL BE THERE BEFORE LONG. CLOSE TO TWO TRILLION DOLLARS. AND RIGHT NOW TAX REVENUES ARE ABOUT THE SAME, ONE POINT EIGHT TRILLION TOO, SOMEPLACE IN THERE. WHAT'S A COUPLE OF HUNDRED BILLION DOLLARS AMONG FRIENDS? ANYWAY, SO THE GOVERNMENT IS COLLECTING -- IS SPENDING AND COLLECTING ABOUT TWO TRILLION DOLLARS A YEAR HERE IN THE UNITED STATES, AND THAT'S ALL FORMS OF GOVERNMENT. ANYWAY, IF GOVERNMENT SPENDING IS GREATER THAN TAX REVENUES -- LET ME MOVE OVER HERE -- AND IF GOVERNMENT SPENDING IS GREATER THAN TAX REVENUES, THEN WE SAY THAT THERE'S A GOVERNMENT BUDGET DEFICIT. AND, ON THE OTHER HAND, IF GOVERNMENT SPENDING IS LESS THAN TAX REVENUES, WE SAY THERE'S A SURPLUS. THERE WAS A DEFICIT IN THE

26 ECO LECTURE UNITED STATES FROM 1969 THROUGH 1998 EVERY YEAR. ALMOST -- WELL, I GUESS THAT WOULD BE THIRTY YEARS IF YOU COUNT THE END POINT. FOR THIRTY YEARS, THE GOVERNMENT RAN DEFICITS YEAR AFTER YEAR AFTER YEAR. GOVERNMENT SPENDING EXCEEDED TAX REVENUES. WHAT DO WE HAVE HERE? DEFICIT IS THIS SITUATION RIGHT HERE. GOVERNMENT SPENDING EXCEEDED TAX REVENUE FOR THIRTY YEARS. BY THE WAY, IF YOU GO BACK BEFORE 1969, THERE WERE NO SURPLUSES IN '68, '67, '66, '65, '64, '63, '62. IN 1961 THERE WAS A SURPLUS. SO THERE WAS A SMALL SURPLUS IN '61, THERE WAS A SMALL ONE IN '69, AND, OTHER THAN THAT, REALLY FROM 1961, TWO YEARS OF SURPLUS ALL THE WAY UP TO SO A LOT OF DEFICIT. AND THEN WHAT WE HAVE IS SOMETHING CALLED THE NATIONAL DEBT AND THAT'S EQUAL TO THE ACCUMULATED DEFICITS. IF YOU TOOK ALL THE DEFICITS YEAR AFTER YEAR AFTER YEAR, AND THEN YOU SUBTRACT AWAY THE SURPLUSES, THEN THE TOTAL IS THE NATIONAL DEBT. SO WHAT WE HAVE IS THE BUDGET DEFICIT OR SURPLUS. THESE ARE ANNUAL MEASURES OR ONE-YEAR MEASURES, THE SURPLUS AND DEFICIT. OKAY. WE HAVE A SURPLUS FOR THIS YEAR OR A DEFICIT FOR THIS YEAR. BUT THE NATIONAL DEBT, THAT GOES BACK TO WHEN THE UNITED STATES FIRST STARTED. AND EVERY TIME THE GOVERNMENT BORROWED, WE ADDED TO THE DEBT. EVERY TIME THE GOVERNMENT RAN A SURPLUS AND PAID OFF, WE SUBTRACTED FROM THE DEBT. AND SO THE NATIONAL DEBT IS -- AND AGAIN, BALLPARK NUMBERS -- FIVE POINT SEVEN TRILLION DOLLARS. THAT'S KIND

27 ECO LECTURE OF A LOT, ISN'T IT? IF YOU THINK -- AND JUST TAKE A SECOND HERE TO THINK ABOUT THIS. IF THE INTEREST RATE WAS FIVE PERCENT -- AND THAT'S WHAT HAPPENS HERE WHEN I SAY WE HAVE A NATIONAL DEBT OF FIVE POINT SEVEN TRILLION. THE GOVERNMENT'S GOT THAT MUCH BORROWED. IF THE INTEREST RATE WAS FIVE PERCENT -- LET'S SEE IF I CAN DO THIS IN MY HEAD. I THINK THIS IS TWO HUNDRED AND EIGHTY-FIVE BILLION DOLLARS EACH YEAR IN INTEREST. AND SO THAT'S MORE THAN A THOUSAND DOLLARS FOR EVERY PERSON IN THE UNITED STATES. MORE THAN A THOUSAND DOLLARS FOR EVERY PERSON IN THE UNITED STATES, EVERY SINGLE YEAR, JUST TO PAY INTEREST ON THE DEBTS THAT HAVE ACCUMULATED IN THE PAST. AND THAT'S KIND OF A SIGNIFICANT AMOUNT, ISN'T IT? BEFORE KEYNES -- AND WE STILL HAVEN'T LEFT THE LAND OF KEYNES. WE'RE STILL TELLING HIS STORY. BEFORE KEYNES, THE UNITED STATES HAD -- OH, I'M SORRY. I WANTED TO MENTION ONE OTHER THING. WHERE WILL I WRITE OVER HERE? EXPANSIONARY POLICY CAUSES AN INCREASE IN REAL GDP AND THEN A CONTRACTIONARY POLICY CAUSES A REDUCTION IN REAL GDP. SO WHEN I USE THOSE TERMS, "OH, THAT'S AN EXPANSIONARY POLICY" OR "THAT'S A CONTRACTIONARY POLICY," WE'RE TALKING ABOUT HOW DOES IT AFFECT THE ECONOMY, REAL GDP. OKAY. SO BACK TO KEYNES. KEYNES WROTE HIS BOOK, THIS GENERAL THEORY OF EMPLOYMENT INTEREST IN MONEY, HE WROTE THAT BOOK IN I TOLD YOU ABOUT

28 ECO LECTURE THAT BEFORE. PREVIOUS TO THE TIME HE WROTE THAT BOOK, THERE WAS THIS UNDERSTANDING ABOUT FISCAL POLICY THAT WE CAN CALL THE OLD- TIME FISCAL RELIGION. BEFORE KEYNES -- AND THINGS ARE DIFFERENT SINCE KEYNES. BUT BEFORE KEYNES, THERE WAS THIS FEELING AND THIS FEELING HAD GROWN OVER THE DECADES -- THE CENTURIES, REALLY -- ABOUT HOW THE GOVERNMENT OUGHT TO MANAGE ITS FINANCES. FOR EXAMPLE, THE OLD-TIME FISCAL RELIGION? BALANCE THE BUDGET. "WE DON'T WANT THE GOVERNMENT GOING OUT AND RUNNING UP A BUNCH OF DEBT." AND I DON'T MEAN TO SAY WE TODAY, BUT I MEAN IN THESE OLDER TIMES. "WE DON'T WANT THE GOVERNMENT GOING OUT AND RUNNING UP A BUNCH OF DEBT." BALANCE THE BUDGET YEAR AFTER YEAR AFTER YEAR, EXCEPT FOR IN VERY EXTRAORDINARY TIMES. A SECOND THING: DO NOT MANAGE THE ECONOMY. THAT IS TO SAY, NO FISCAL POLICY. THE GOVERNMENT SHOULDN'T BE OUT THERE TRYING TO INCREASE OR DECREASE GDP. JUST IF WE NEED CERTAIN GOODS AND SERVICES, THE GOVERNMENT OUGHT TO BUY 'EM. PUBLIC GOODS, WE TALKED ABOUT THOSE A FEW MOMENTS AGO. IF WE NEED PUBLIC GOODS, LET THE GOVERNMENT PURCHASE THOSE. THAT'S A GREAT THING. BUT IF WE DON'T NEED 'EM, THOSE PUBLIC GOODS AND SERVICES, LET'S DON'T BE TRYING TO MANAGE THE ECONOMY AND GOVERNMENT SPENDING MONEY IN ORDER TO MANAGE THE ECONOMY. AND ANOTHER THING IS THAT WE LIKE TO -- INCREASES IN GOVERNMENT SPENDING SHOULD BE ACCOMPANIED BY INCREASES IN

29 ECO LECTURE TAXES. WE NEED TO HAVE A CLEAR UNDERSTANDING THAT EVERY TIME THE GOVERNMENT SPENDS SOME MONEY, WE'RE GONNA HAVE TO PAY TAXES. IF WE HAVE THE GOVERNMENT JUST GO OUT THERE SPENDING MONEY AND NO TAXES, THEN THAT STARTS PEOPLE THINKING, "OH, MAN. WE CAN HAVE THIS STUFF FOR FREE." AND YOU REMEMBER THAT TERM TNSTAAFL, THERE'S NO SUCH THING AS A FREE LUNCH. AND THE WAY WE MAKE THAT CLEAR TO EVERYBODY IS: IF WE'RE GONNA SPEND MONEY TO PUT A HIGHWAY GOING BY YOUR CITY, WE'RE GONNA HAVE TO TAX YOU. IF YOU WANT A HOSPITAL OR A SCHOOL, YOU HAVE TO PAY. THAT WAS THE UNDERSTANDING BEFORE KEYNES. KEYNES BROKE THESE RULES AND THAT'S WHAT WE WILL TALK ABOUT NEXT TIME. SO LONG.