ECONOMIC MODELS AND THEIR USE IN ECONOMIC POLICY

INTERVENTIONS - DISEQUILIBRIA

Marketsindicator consequences

1.Product market prices inflation. deflation2.Labor market wages unemployment3.Capital market interests capacity utilization4.Foreign exchange exch. rate deficit. surplus.

ProblemsConflicting goals: Phillips curveIndirect effects:Lags: establishing the problem. decission making.

implementation

ECONOMIC MODEL

C=f(Y-T) C = a + b*(Y-T) consumption function

I=g(DY, R) I = c*DY + d*R investment function

G=T G = T government

Y=C+I+G Y=C+I+G identity GDP

Components:

variables: endogenous. exogenous

parameters: a>0. 0<b<1. c>0. d<0

equations: behavoiuristic. instituonal. tehnical. identities

Structural form:(1) Ct = a + b*(Yt-Tt)(2) It = c*(Yt-Yt-1) + d*Rt

(3) Gt = Tt

(4) Yt = Ct + It + Gt

Yt-1 predetermined endogenous variable. dynamic model

Reduced form:(4) Yt(1-b-c) = a + (1-b)*Tt + d*Rt – c*Y t-1

if defining A=1/(1-b-c) (a multiplier) we get

(4) Yt= a*A + (1-b)*A*Tt + d*A*Rt - c*A*Y t-1

(1) Ct = a + b*(a*A + (1-b)*A*Tt + d*A*Rt - c*A*Y t-1 -Tt)(2) It = c*(a*A + (1-b)*A*Tt + d*A*Rt - c*A*Y t-1 - Y t-1) + d*Rt

(3) Gt = Tt

ECONOMETRIC MODEL

Allocation – care for public goodsRedistribution – justice, progresivityStabilisation – macroeconimc stability

Market failuresmonopoliespublic goodsexternalitiesnon perfect marketsinformational problemsmacroeconomic disequlibria

Public provision. public financing and public regulation

PUBLIC SECTOR

Y = C + I + G

C = a + b(Y-T)

T =T0 + tY

*********

Y = a + b(Y - T0 - tY) + I + G

Y = a + bY - bT0 – btY + I + G

Y(1-b+bt) = a - bT0 + I + G

Y = 1/(1-b+bt)*a – b/(1-b+bt)*T0 + 1/(1-b+bt)*I + 1/(1-b+bt)*G

– b/(1-b+bt) tax multiplier – “supply side” economics

1/(1-b+bt) expenditures multiplier – “demand side” economics

DEMAND AND SUPPLY SIDE ECONOMICS

T – G = Bgp + Bgf + dH + dR + PP + dZ

T- G = Bgp + Bgf + dH

Problems:dH – inflation

Bgp – crowding out (physical. financial)

Bgf - foreign savings. monetization

dH – money printing

dH = ( p + r )/ v = p/v + r/v

dH = p/v (inflationary tax) + r/v (seignorage)

**************

Bgp – borrowing at home. Bgf - borrowing abroad. H – base money.

dR – reduction in foreign exchange reserves. PP – property sales. Z – late payments

p – inflation. r – growth. v – velocity of circulation

FINANCING OF BUDGET DEFICIT

dD = D(i-r) + PR – dH

solving by fiscal policy (1) dD = 0 0 = D*(i-r) + PR - PR = D*(i-r)

solving by inflation (2) dD = 0 0 = D*(i-r) – (p+r)/v

(p+r) = v*(D*(i-r)) p = v* D* (i-r) – r

D – public debt/GDP. PR – primary deficit/BDP . p – inflation. i – interest rate. r – growth. v – velocity of circulation

Example:v=10, D=0.8*GDP, i=0.05, r=0.02

-PR =0.8*(0.05-0.02) = 0.024 2.4% primary surplusp =10*0.8*(0.05-0.02)-0.02=0.22 22% inflation

RESOLVING PUBLIC DEBT