Economics 302 (Sec. 001) Intermediate …mchinn/e302_lecture1_s11.pdf · Intermediate Macroeconomic Theory and PolicyTheory and Policy (Spring 2011) Instructor: Prof. Menzie Chinn

Economics 302 (Sec. 001)Intermediate Macroeconomic

Theory and PolicyTheory and Policy(Spring 2011)

Instructor: Prof. Menzie ChinnUW Madison

Administrative IssuesAdministrative Issues

• Course website: http://www.ssc.wisc.edu/~mchinn/web302_s11.html

• OH: MW 4-5, 7418 Soc Sci• Textbook: Blanchard, MacroeconomicsTextbook: Blanchard, Macroeconomics• Additional Readings: from WWW,

Econbrowser CBOEconbrowser, CBO• NYT, FT, WSJ, Economist

Administrative Issues• Grading: 20% PS 50% 2×MTs 30% Final• Grading: 20% PS, 50% 2×MTs, 30% Final• Dates:

- Class cancelled on 9/24- MT1 on Wed, 2/23,- MT2 on Wed, 4/4

Final on Mon 5/9 7:45AM- Final on Mon. 5/9, 7:45AM• Make-ups: None. Points are re-allocated if you

h l iti t N l t i thave a legitimate excuse. No late assignments accepted (must be handed in during lecture)

Context: GDP Growth

06

.08

.10

02

.04

.06

- 02

.00

.02

-.06

-.04

.02

-.082000 2002 2004 2006 2008 2010

(GDP05/GDP05(-1)) 4̂-1(GDP05WSJ_JAN11/GDP05WSJ_JAN11(-1)) 4̂-1

GDP (log levels)9 60

9.55

9.60

Potential GDP

In logs ofbillion Ch.05$

9

9.50(CBO, Aug. 2010)

WSJJan '11

9.40

9.45 Jan 11survey

9.35GDP(bn Ch.05$)

9.25

9.30

00 01 02 03 04 05 06 07 08 09 10 11

Source: BEA GDP 2010Q3 3rd release, CBO (Aug 2010), WSJ (Jan. 2011)

Employment140,000

138,000Nonfarm

136,000

Nonfarmpayrollemployment

134,000

132,000

130,000

Ex. temporary

128,00000 01 02 03 04 05 06 07 08 09 10

Census workers

Source: BLS, Employment Situation, Dec. 2010 release

Unemployment Rate11

10

8

9Unemploymentrate

WSJ

6

7

WSJJan '11

5

6

3

4

31980 1985 1990 1995 2000 2005 2010

Source: BLS, Employment Situation, Dec. 2010 release

Long Term UE, g ,Under-

employmentemployment

Source: Calculated Risk, 1/7/2011

Inflation.06

"Headline"

.04

.05Headline

CPI inflation(year-on-year)

WSJ

.02

.03

WSJ"headline"Jan '11

.00

.01 CoreCPI inflation(year-on-year)

-.02

-.01

-.0300 01 02 03 04 05 06 07 08 09 10 11

Source: BLS, CPI Dec.(CPIAUCSL/CPIAUCSL(-12))-1(CPILFESL/CPILFESL(-12))-1CPIINFL_WSJJAN11/100

Source: BLS, CPI Dec. release, WSJ (Jan. ’11)

Monetary Policy10

8

Ten year constantmaturity Treasurys

6

4

6Fed Funds

2

4

3 monthT-bills

0

2

090 92 94 96 98 00 02 04 06 08 10

Source: St. Louis Fed FRED II database

Fed interventions

http://www.clevelandfed.org/research/data/credit_easing/index.cfm

Consumption

9.2

9.3

11.0

11.1

9.0

9.1

10.8

10.9

8.8

8.9

10.6

10.7Log consumption(bn Ch.2005$)[left scale]

Log householdnet worth(bn Ch.2005$)[right scale]

8.6

8.7

10.4

10.5[ ]

8.4

8.5

10.2

10.3

90 92 94 96 98 00 02 04 06 08 10

Source: BEA, 2010Q3 3rd release; Fed Flow of Funds (12/13/2010 release)

90 92 94 96 98 00 02 04 06 08 10

House Prices

Source: Calculated Risk, 12/28/2010

Current Account, Net Debt02 20

00

.01

.02

10

.15

.20

02

-.01

.00

00

.05

.10

Current Account

04

-.03

-.02

10

-.05

.00Cu e t ccou tto GDP ratio[left axis]

- 06

-.05

-.04

- 20

-.15

-.10Net InternationalInvestment Positionto GDP ratio[right scale]

-.07

-.06

-.25

-.20

1970 1975 1980 1985 1990 1995 2000 2005 2010

[right scale]

CA/GDP NIIPEOP/(GDP*1000)

Net Exports and the Dollar

.3

.4

.02

.04

X/GDP(ex. oil)

.2 .00

( )[right scale]

.1 -.02

-.1

.0

-.06

-.04

Log realvalue of

X/GDP[right

-.2 -.081975 1980 1985 1990 1995 2000 2005 2010

value ofUSD

[rightscale]

Source: Federal Reserve Board, and BEA, 2010Q2 GDP 2nd release

1 0Long Term Log GDP

0.5

1.0

\

2001 recession ____

0.0 \1982

\1990-91recession

-1.0

-0.5

WWII

recession

-1.5 "Roaring'20's"

-2.5

-2.0 WWI \ \

1920-21 recession

__Great Depression

2.51910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Source: Historical Statistics, and BEA, 2010Q2 GDP 2nd release, rebased to 1980 = 0

2-1 Aggregate Output

•National income and product accounts are an accounting system used to measure aggregate economic activity.

GDP: Production and Income

The measure of aggregate output in the national income accounts is gross domesticnational income accounts is gross domestic product, or GDP.

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GDP P d ti d I


•There are three ways of defining GDP:


y g

1. GDP is the value of the final goods and services produced in the economy during a given periodthe economy during a given period.

A final good is a good that is destined for final consumption.

An intermediate good is a good used in theAn intermediate good is a good used in the production of another good.

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GDP P d ti d I


There are three ways of defining GDP:



2. GDP is the sum of value added in the economy during a given period.

V l dd d l th l f fi ’Value added equals the value of a firm’s production minus the value of the intermediate goods it uses in production.g p

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GDP P d ti d I





3. GDP is the sum of incomes in the economy during a given period.

Table 2-1 The Composition of GDP by Type of Income, 1960 and 2006

1960 2006Labor income 66% 64%Capital income 26% 29%Indirect taxes 8% 7%

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N i l d R l GDP

•Nominal GDP is the sum of the quantities of final goods

Nominal and Real GDP

Nominal GDP is the sum of the quantities of final goods produced multiplied by their current price.

•Nominal GDP increases over time because:•Nominal GDP increases over time because:

– The production of most goods increases over time.

– The prices of most goods also increase over time.

•Real GDP is constructed as the sum of the quantities of final goods multiplied by constant (rather than current) prices.

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N i l d R l GDP

YQuantity

f CPrice f

Nominal Real GDP


Year of Cars of cars GDP (in 2000 dollars)1999 10 $20,000 $200,000 $240,0002000 12 $24,000 $288,000 $288,000

To construct real GDP multiply the number of cars in each

2001 13 $26,000 $338,000 $312,000

To construct real GDP, multiply the number of cars in each year by a common price. Suppose we use the price of the car in 2000 as the common price. This approach gives us, in effect real GDP in chained (2000) dollarseffect, real GDP in chained (2000) dollars.

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N i l d R l GDPNominal and Real GDP

Fi 2 1

From 1960 to 2006 nominal

Nominal and Real U.S. GDP, Since 1960

Figure 2 - 1

From 1960 to 2006, nominal GDP increased by a factor of 25. Real GDP increased by a factor of about 4.5.

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N i l d R l GDP

The terms nominal GDP and real GDP each have many synonyms:


– Nominal GDP is also called dollar GDP or GDP in current dollars.

– Real GDP is also called GDP in terms of goods, GDP in constant dollars, GDP adjusted for inflation, or GDP in 2000 dollars.

– GDP will refer to real GDP, and Yt will denote real GDP in year t.

– Nominal GDP and variables measured in current dollars will be denoted by a dollar sign in front of them—for example, $Yt. for nominal GDP in year t.

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GDP L l V G th R t

•Real GDP per capita is the ratio of real GDP to the l i f h

GDP: Level Versus Growth Rate

population of the country.

•GDP growth equals: )( −YY

1

1)(

−

−

t

tt

YYY

Periods of positive GDP growth are called expansions.expansions.

Periods of negative GDP growth are called

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g grecessions.


GDP L l V G th R tGDP: Level Versus Growth Rate

Fi 2 2

Since 1960 the U S economy

Growth Rate of U.S. GDP Since 1960

Figure 2 - 2

Since 1960, the U.S. economy has gone through a series of expansions, interrupted by short recessions.

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2-2 The Other Major Macroeconomic Variables

Th U l t R t

•Because it is a measure of aggregate activity, GDP is

The Unemployment Rate

obviously the most important macroeconomic variable. But two other variables tell us about other important aspects of how an economic is performing:

– Unemployment

– Inflation

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Th U l t R t

•Employment is the number of people who have a job.


•Unemployment is the number of people who do not have a job but are looking for one.

•The labor force is the sum of employment and unemployment:p y

•L = N + U•Labor force = Employment + Unemployment•Labor force = Employment + Unemployment

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Th U l t R t

•The unemployment rate is the ratio of the number of people h l d h b f l i h l b


who are unemployed to the number of people in the labor force:

UL

u =

Unemployment rate =

In the United States, estimates based on the

Unemployment rate Unemployment/Labor force

7.0 4 6%u = =

In the United States, estimates based on the CPS show that:

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2006 4.6%144.4 7.0

u = =+


Th U l t R t

•The Current Population Survey (CPS) is used to compute the


unemployment rate.

•Only those looking for work are counted as unemployed. Those y g p ynot working and not looking for work are not in the labor force.

•People without jobs who give up looking for work are known asPeople without jobs who give up looking for work are known as discouraged workers.

•Participation rate labor forceParticipation rate=

labor forcepopulation of working age

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Th U l t R tThe Unemployment Rate

Figure 2 - 3

Since 1960, the U.S. unemployment rate has

U.S. Unemployment Rate Since 1960

unemployment rate has fluctuated between 3% and 10%, going down during expansions and going up during recessionsduring recessions.

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Th U l t R tThe Unemployment RateWhy Do Economists Care About Unemployment?

•Economists care about unemployment for two reasons:

– Because of its direct effects on the welfare of the unemployed.

– Because it provides a signal that the economy may not beBecause it provides a signal that the economy may not be using some of its resources efficiently.

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Th I fl ti R t

Inflation is a sustained rise in the general level

The Inflation Rate

of prices—the price level.

The inflation rate is the rate at which the priceThe inflation rate is the rate at which the price level increases.

Symmetrically deflation is a sustained declineSymmetrically, deflation is a sustained decline in the price level. It corresponds to a negative inflation rate.

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Th I fl ti R tThe Inflation RateThe GDP Deflator

The GDP deflator in year t, Pt, is defined as the ratio of nominal GDP to real GDP in year t:

$t

Nominal GDPReal GDP

t

t

YP

Y= =

The GDP deflator is what is called an

tReal GDP

tY

The GDP deflator is what is called an index number—set equal to 100 in the base year.

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Th I fl ti R tThe Inflation RateThe GDP Deflator

The rate of change in the GDP deflator equals the rate of inflation:

( )P PP

t t

t

− −

−

1

1

Nominal GDP is equal to the GDP deflator multiplied by real GDP:

$Y PYt t t=

deflator multiplied by real GDP:

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Th I fl ti R tThe Inflation RateThe Consumer Price Index

•The GDP deflator measures the average price of output, while the consumer price index, or CPI, measures the average price of consumption, or equivalently, the costaverage price of consumption, or equivalently, the cost of living.

•The CPI gives the cost in dollars of a specific list of g pgoods and services over time, which attempts to represent the consumption basket of a typical urban consumer.

36 of 31



The set of goods produced in the economy is not the same as the set of goods purchased by

f tconsumers, for two reasons:

Some of the goods are sold to firms, to theSome of the goods are sold to firms, to the government, or to foreigners.

S f th d t d dSome of the goods are not produced domestically but are imported from abroad.

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U.S. Inflation Rate, Using the CPI and the GDP Deflator

Figure 2 - 4

The inflation rates, computed using either the CPI or the GDP deflator are largely

Deflator Since 1960

GDP deflator, are largely similar.

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Figure 2-4 yields two conclusions:

The CPI and the GDP deflator move together most of the time. In most years, the two inflation rates differ by less than 1%.inflation rates differ by less than 1%.

There are clear exceptions, however. In 1979 d 1980 th i i th CPI1979 and 1980, the increase in the CPI was significantly larger than the increase in the GDP deflator.

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Th I fl ti R tWhy Do Economists Care About Inflation?

The Inflation Rate

Economists care about inflation for two reasons:

During periods of inflation, not all prices and wages rise proportionately, inflation affects income distrib tionaffects income distribution.

Inflation leads to other distortions.

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2-3 The Short Run, the Medium Run, and the Long Run

The level of aggregate output in an economy is determined by:determined by:

demand in the short run, say, a few years,

the level of technology, the capital stock, and the labor force in the medium run, say, a decade or so,

factors such as education researchfactors such as education, research, saving, and the quality of government in the long run, say, a half century or more.

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2-4 A Tour of the Book

The Organization of the

Figure 2 - 5

The Organization of the Book

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2-4 A Tour of the Book

The book is organized into three parts:The book is organized into three parts:

A core which has three parts – the short run, th di d th lthe medium run, and the long run.

Three extensions which explore the role of expectations, closed economies, and expansion and recessions.

A deeper look at the role of microeconomic policy.

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Key Termsnational income and product accountsaggregate outputgross domestic product, (GDP)gross national product, (GNP)

unemploymentlabor forceunemployment rateCurrent Population Survey (CPS)g p , ( )

intermediate goodfinal goodvalue addednominal GDP

p y ( )not in the labor forcediscouraged workersparticipation rateunderground economynominal GDP

real GDPreal GDP in chained (2000) dollarsdollar GDP, GDP in current dollarsGDP in terms of goods GDP in constant

underground economyinflationprice levelinflation ratedeflationGDP in terms of goods, GDP in constant

dollars, GDP adjusted for inflation, GDP in 2000 dollars real GDP per capitaGDP growth

deflationGDP deflatorindex numbercost of livingconsumer price index (CPI)GDP growth

expansionsrecessionshedonic pricing

l

consumer price index (CPI)short runmedium runlong run

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employment base year

Documents

Economics 302 (Sec. 001) Intermediate …mchinn/e302_lecture1_s11.pdf · Intermediate Macroeconomic Theory and PolicyTheory and Policy (Spring 2011) Instructor: Prof. Menzie Chinn