U. S. Productivity Growth:

Transcription

1 Macro Lecture 12: Late 1990s, the 2000s, and Mortgages Productivity Growth: Most economists expected the general decline in productivity growth occurring from 8 the 1950 s to the 1980 s to continue. To the surprise of nearly 6 everyone, however, productivity growth 4 rose in the 1990 s as illustrated in figure U. S. Productivity Growth: Decade averages also show the same reversal as seen in Table 12.1 and figure Productivity rose in the last decade of the 20 th century after declining in the previous four decades Figure 12.1: U.S productivity growth: Decade Growth (%) 1950 s s s s s 2.06 Table 12.1: Average U.S. productivity growth by decade (%) There is no consensus about why this has happened although there is much speculation. Some argue that personal computers have increased the productivity of workers. Many believe the arrival of made possible by the internet is also responsible s 1960 s 1970 s 1980 s 1990 s Figure 12.2: U.S productivity growth by decades

2 2 Clinton Years: Table 12.2 reports the data from the mid-1990 s. Once again, we apply the adaptive expectations principle to complete the expected inflation rate column. Adaptive Expectations: The expected inflation rate depends on the actual inflation rate in the recent past. More specifically, we assume that the expected inflation rate in a given year equals the actual inflation rate in the previous year. Unemp Real Actual Infl Expected Infl Govt Productivity Year Rate (%) GDP Rate (%) Rate (%) Purch Growth (%) , , , , , , , , Table 12.2: Clinton years macro data: We begin by considering the aggregate supply curves: Long run aggregate supply 2.25 (LRAS) curve: Table 12.2 AS 1995 reports that the economy experienced productivity growth during this period. The rise in productivity during the 1990 s increased potential 1.75 GDP. The long run aggregate supply (LRAS) curve, a place 1.50 mark for potential GDP shifted right as shown in figure AD 1995 Aggregate supply (AS) curve: Applying the adaptive expectations principle, the expected inflation rate fell modestly during this period from 2.1 to 1.7 percent as 9,500 10,000 10,500 11,000 11,500 reported in table Since Figure 12.3: Clinton years: the aggregate supply (AS) and long run aggregate supply (LRAS) curves intersect at the expected inflation rate, the point at which aggregate supply (AS) and long run aggregate supply (LRAS) curves intersect shifted down from 2.1 to 1.7. The movements of the aggregate supply (AS) and long run aggregate supply (LRAS) curves are illustrated in figure LRAS 1995 LRAS 1998 AD 1998 Next, we turn our attention to the aggregate demand (AD) curve. As reported in table 12.2, government purchases increased from 2,260 to 2,370 causing the aggregate demand (AD) curve to shift right during this period. Table 12.3 summarizes what occurred in the mid-1990 s: LRAS curve AS curve AD curve Productivity growth rate falls fiscal policy LRAS curve shifts right AS curve shifts down AD curve shifts right Table 12.3: Aggregate supply and demand ,000 AS 1998

3 3 Early 2000 s Table 12.4 reports the data for the early 2000 s. Once again, we apply the adaptive expectations principle to complete the expected inflation rate column. Unemp Real Actual Infl Expected Infl Govt Productivity Year Rate (%) GDP Rate (%) Rate (%) Purch Growth (%) , , , , , , Table 12.4: Macro data for LRAS 2001 LRAS 2002 LRAS 2003 Figure 12.4 illustrates the shifts in AS 2002 the aggregate demand and supply 3.0 AS 2001 curves. This helps us understand AS 2003 what occurred. We begin by considering the aggregate supply curves. In 1995, a long run equilibrium existed because the actual inflation rate equaled the expected inflation rate; both equaled percent. Since the aggregate supply (AS) curve intersects the long run aggregate supply (LRAS) curve AD 2001 at the expected inflation rate, the two aggregate supply curves intersect at 1.0 AD 2002 AD Long run aggregate 12,500 13, supply (LRAS) curve: The rise in productivity in 2002 Figure 12.4: Early Bush years: and 2003 increased potential GDP (see table 12.4). This shifted the long run aggregate supply (LRAS) curve right in both years as shown in figure Aggregate supply (AS) curve: The aggregate supply (AS) curve intersects the long run aggregate supply (LRAS) curve at the expected inflation rate. o : Since the expected inflation rate remained at 2.3 percent, the AS and o LRAS intersect at 2.3 as illustrated in figure : The expected inflation rate decreased from 2.3 percent to 1.5; hence, the aggregate supply (AS) curve now intersects the long run aggregate supply (LRAS) curve at 1.5 as illustrated in figure Table 12.5 summaries the shifts of the aggregate supply curves: LRAS curve AS curve LRAS curve AS curve Productivity growth rate the same Productivity growth rate decreased LRAS shifts right AS shifts down LRAS shifts right AS shifts down Table 12.5: aggregate supply (AS) curve

4 4 Next, we turn to the aggregate demand (AD) curve: : Government purchases increased. This expansionary fiscal policy shifted the aggregate demand (AD) curve right : Government purchases increased modestly. Also, Congress passed and the President signed the Jobs and Growth Tax Relief Reconciliation Act of 2003 which reduced taxes. These two expansionary fiscal policies shifted the aggregate demand (AD) curve right again. Table 12.6 summarizes the shifts of the aggregate demand (AD) curve: Fiscal policy Fiscal policy AD curve shifts right AD curve shifts right Table 12.6: Aggregate demand (AD) curve Late 2000 s Table 12.7 reports the data for the late 2000 s. Once again, we apply the adaptive expectations principle to complete the expected inflation rate column. Unemp Real Actual Infl Expected Infl Govt Productivity Year Rate (%) GDP Rate (%) Rate (%) Purch Growth (%) , , , , , , Table 12.7: Macro data for Aggregate Supply (AS) Curve The expected inflation rate fell from 3.1 to 2.7 to 2.0 percent. Since the aggregate supply (AS) curve intersects the long run aggregate supply (LRAS) curve at the expected inflation rate, the aggregate supply (AS) curve shifts down as seen in figure Table 12.8 provides a summary: Aggregate Demand (AD) Curve A Puzzle Based on figure 12.5, the aggregate demand (AD) curve had to shift left because the aggregate demand (AD) curve is downward sloping. But government purchases increased, albeit modestly, consequently the aggregate demand (AD) curve should have shifted right as described in table This is a puzzle isn t it. As we shall now see, business and consumer confidence solves the puzzle rate falls rate falls AS shifts down AS shifts down Table 12.8: Aggregate supply (AS) curve Fiscal Policy Fiscal Policy AD shifts right AD shifts right Table 12.9: Aggregate demand (AD) curve puzzle

5 5 Figure 12.5 illustrates the shifts in the aggregate demand (AD) and aggregate supply (AS) curves that help us understand the data: 3.0 AS AS AS AD AD ,400 14,500 14,600 Figure 12.5: Late Bush years: AD ,700 14,800 14,900 15,000 Consumer and Business Confidence Consumer and business declined dramatically shown in figure 12.6: University of Michigan Index of Consumer OECD Manufacturing Confidence Indicators Sentiment for U.S Figure 12.6: Consumer sentiment and business confidence: Jan 2006-Jan 2009 Claim: Changes in consumer and/or business confidence shift the aggregate demand (AD) curve. Increases in confidence shift the aggregate demand (AD) curve right Decreases in confidence shift the aggregate demand (AD) curve left.

6 6 Figure 12.7 illustrates the effect of a decline in consumer and/or business confidence: FP Question: What would the real interest rate AD Question: How many final goods and (r) equal, if the actual inflation rate () were services would be purchased if the actual inflation percent, given that the Fed does not rate () were percent, given that all other change its inflation policy? factors relevant to demand remained the same? FP At a given inflation rate () Consumer and/or business confidence decline Households and/or firms purchase less r (%) Fewer goods and services purchased Figure 12.7: Decline in Consumer Confidence AD AD Aggregate demand (AD) curve shifts left Question: Why did consumer and business confidence decline? We will now argue that the home mortgage crisis plays a key role. But first we must learn a little about how home mortgages work. Home Mortgages We shall study three types of mortgages which are used today: Fixed rate Variable (adjusted) rate Graduated (escalating) payment These mortgages differ in how they are repaid. Fixed Rate Mortgage We begin with fixed rate mortgages because they are the most straightforward. In this case, the repayment structure is simple. The lender must repay the bank a fixed amount every month for a specified period in the future. If the mortgage is a 20-year mortgage the fixed payment must be made for 20 years, if the mortgage is a 30-year mortgage the payment must be made for 30 years, etc. Question: How are mortgage payments determined for a fixed rate mortgage? To address this question, suppose that you receive a $200, year home mortgage from a bank at the present time. Today, the interest rate on such a loan is about 4 percent. For purposes of illustration, however, we shall use an interest rate of 10 percent to simplify the arithmetic. Also, to make the calculations more manageable assume that mortgage payments are made on an annual rather than monthly basis. Claim: With a 10 percent nominal interest rate, your annual payment on a 20-year, $200,000 mortgage would be $23,492.

7 7 Why isn t the annual payment $23,491 or $23,493? Why precisely $23,492? To explain this first note how mortgage interest is calculated. Interest is calculated on the unpaid balance: This Year s Previous Year s Interest on This Unpaid = Unpaid + Previous Year s Year s Balance Balance Unpaid Balance Payment Interest Rate Previous Year s Unpaid Balance This year when the loan is first issued, the unpaid balance equals the full amount of the loan, $200,000. As time progresses the unpaid balance falls and hence the interest also declines as reported in table 12.10: Payment Unpaid Balance Interest This year (Year 0) 200,000 20,000 Next year (Year 1) 23, , ,000 23,492 = 196,508 19,651 Year 2 23, , ,651 23,492 = 192,667 19,267 Year 3 23, , ,267 23,492 = 188,442 18, Year 10 23, ,348 14, Year 19 23,492 21,356 2,136 Year 20 23,492 21, ,136 23,492= 0 Table 12.10: Fixed rate mortgage calculations The mortgage payment is determined so when the final payment is made, the unpaid balance equals precisely 0. In our example, an annual payment of $23,492 results in an unpaid balance of precisely 0 after 20 years. Any payment greater than or less than $23,492 would not result in an unpaid balance of 0.