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1
Executive Master in
Management and Banking
João César das Neves1
Macroeconomics and Business
Macroeconomics and Business
João César das Neves
Winter 2012/13
Executive Master in
Management and Banking
João César das Neves2
Macroeconomics and Business
This Session
Economic policy: problems andissues• Questions of the national economy
• Types of economic policy• Aggregate problems• Reality and issues
Macroeconomics and BusinessSession 1
2
Executive Master in
Management and Banking
João César das Neves3
Macroeconomics and Business
João César das Neves• Mail: [email protected]• Home phone: 217214270• Mobile phone: non existent• Office: 5319, 3rd floor FCEE
Executive Master in
Management and Banking
João César das Neves4
Macroeconomics and Business
3
Executive Master in
Management and Banking
João César das Neves5
Macroeconomics and Business
Paul Krugman (1953-...) 2008 winner of the SverigesRiksbank Prize in Economic Sciences in Memory of Alfred Nobel
WND Books 2009
Los Libros del Lince, 2009
Executive Master in
Management and Banking
João César das Neves6
Macroeconomics and Business
-5
-4
-3
-2
-1
0
1
2
3
4
5
2004 2006 2008 2010 2012
GDP growth
Portugal
Euro zone
USA
Spain
2
4
6
8
10
12
14
16
18
20
22
2004 2006 2008 2010 2012
Unemployment rate
Portugal
Euro zone
USA
Spain
4
Executive Master in
Management and Banking
João César das Neves7
Macroeconomics and Business
Growth in 2009
-9
-7
-5
-3
-1
1
3
Slo
ven
ia
Fin
lan
d
Irela
nd
Ro
ma
nia
Hu
ng
ary
Jap
an
Ge
rma
ny
Italy
Bu
lga
ria
De
nm
ark
Sw
ed
en
Un
ited
Kin
gd
om
Slo
vakia
Cze
ch R
ep
ub
lic
EU
Eu
ro a
rea
Ne
the
rlan
ds
Sp
ain
Au
stria
Lu
xem
bo
urg
Be
lgiu
m
Po
rtug
al
US
A
Fra
nce
Gre
ece
Ma
lta
Cyp
rus
Po
lan
d
Esto
nia
Lith
ua
nia
La
tvia
14.1 15 18
Executive Master in
Management and Banking
João César das Neves8
Macroeconomics and Business
Unemployment in 2010
0
5
10
15
20
25
Ne
the
rlan
ds
Au
stria
Jap
an
Lu
xem
bo
urg
Cyp
rus
De
nm
ark
Slo
ven
ia
Ma
lta
Un
ited
Kin
gd
om
Ge
rma
ny
Bu
lga
ria
Cze
ch R
ep
ub
lic
Ro
ma
nia
Italy
Be
lgiu
m
Sw
ed
en
Po
lan
d
Fin
lan
d
US
A
EU
Po
rtug
al
Fra
nce
Eu
ro a
rea
Hu
ng
ary
Gre
ece
Irela
nd
Slo
vakia
Esto
nia
Lith
ua
nia
Sp
ain
La
tvia
5
Executive Master in
Management and Banking
João César das Neves9
Macroeconomics and Business
The «Great Recession»growth of world GDP (%)
-2
-1
0
1
2
3
4
5
6
7
8
1950 1960 1970 1980 1990 2000 2010
%
First oil shock
Second oil shock Gulf warFar-East crisis
September 11
2008 crisis
Executive Master in
Management and Banking
João César das Neves10
Macroeconomics and Business
Unemployment rate USA
0.00
5.00
10.00
15.00
20.00
25.00
1890 1910 1930 1950 1970 1990 2010
1893 panic
Great Depression
First oil shock
Volker recession
Great recession
6
Executive Master in
Management and Banking
João César das Neves11
Macroeconomics and Business
2009 2010IMF (WEO) forecasts
Executive Master in
Management and Banking
João César das Neves12
Macroeconomics and Business
2011 2012
IMF (WEO) forecasts
7
Executive Master in
Management and Banking
João César das Neves13
Macroeconomics and Business
2013
IMF (WEO) forecasts
Executive Master in
Management and Banking
João César das Neves14
Macroeconomics and Business
Portugal
IMF (WEO) forecasts
8
Executive Master in
Management and Banking
João César das Neves15
Macroeconomics and Business
Preliminary program
Executive Master Management and Banking
Macroeconomics and Business
1. Aggregate problems and approaches2. The Low Frequencies: Development3. The High Frequencies: Business Cycle4. Money and monetary problems5. Policy issues6. Open economy issues
Final (open book) test
Executive Master in
Management and Banking
João César das Neves16
Macroeconomics and Business
Two aspects of method1 – University method
9
Executive Master in
Management and Banking
João César das Neves17
Macroeconomics and Business
Two aspects of method2- TV cooking method
Executive Master in
Management and Banking
João César das Neves18
Macroeconomics and Business
Some Basic References
Williamson, Stephen (2010) Macroeconomics, Addison Wesley, Boston USA, 4th edition.
Kydland, F. and E., Prescott (1990) “Business Cycles: Real facts and a Monetary Myth”, Federal Reserve Bank of Minneapolis
http://minneapolisfed.org/research/qr/qr1421.pdf
Lucas Jr., Robert E. (1977) “Understanding Business Cycles,” in Lucas (1981) Studies in Business Cycles Theory, MIT Press p.215-39.
Neves, J.C. (2012) As 10 questões da crise, 3ª ed., Dom Quixote, Lisboa
Neves, J. (2006) ) Dois milhões de Anos de Economia, Universidade Católica Editora, Lisboa 3rd edition.
10
Executive Master in
Management and Banking
João César das Neves19
Macroeconomics and Business
Site of the coursewww.clsbe.lisboa.ucp.pt/docentes/url/jcn/MaBES
Executive Master in
Management and Banking
João César das Neves20
Macroeconomics and Business
Two guest stars
Alan Greenspan(New York, 1926-…)
Fed chairman 1987 – 2006
Edward Christian Prescott(Glenn Falls,1940-…)
Nobel prize winner 2004
11
Executive Master in
Management and Banking
João César das Neves21
Macroeconomics and Business
Kenneth S. Rogoff(Rochester, 1953-…) Harvard University
Carmen M. CastellanosReinhart (Havana, 1955-…)
Maryland University
Guest from the crisis
Raghuram G. Rajan(Bhopal, 1963- …)
University of Chicago
Executive Master in
Management and Banking
João César das Neves22
Macroeconomics and Business
One special guest star
Ben Bernanke(South Carolina, 1953-…)Fed chairman since 2006
12
Executive Master in
Management and Banking
João César das Neves23
Macroeconomics and Business
The rule of policy
«In reviewing a policy, I always asked myself the question, What are the costs to the economy if we are wrong? If there is no downside risk, you can try any policy you want. If the cost of failure is potentially very large, you should avoid the policy even if the probability of success is better than fifty-fifty, because you cannot accept the cost of failure»
Alan Greenspan (2007) The Age of Turbulence, Adventures in a new world, The Penguin Press, New York, p. 68.
Executive Master in
Management and Banking
João César das Neves24
Macroeconomics and Business
Three lessons
«There are at least three lessons here. First: Context matters. Take what you read in the paper with a many grains of historical salt. Second: Current data often provide poor guidance for effective policy making. To make forward-looking policies you have to understand the past. Finally: Establish good rules, change them infrequently and judiciously, and turn the people loose upon the economy. Booms will follow.»
(op. cit. p.3)
13
Executive Master in
Management and Banking
João César das Neves25
Macroeconomics and Business
1.Aggregate problems and approaches1.1. Types of aggregate problems
Neves, J. (2011) Introdução à Economia, Editorial Verbo, Lisboa 9th edition c. III B) 1
Executive Master in
Management and Banking
João César das Neves26
Macroeconomics and Business
Types of aggregate problems
• Economic development•Rise in welfare•Strong transformation of society
• Short-term fluctuations•Recessions and expansions•Unemployment• Inflation •Severe crises
14
Executive Master in
Management and Banking
João César das Neves27
Macroeconomics and Business
RC F AS
Br
Ba
Ec
Executive Master in
Management and Banking
João César das Neves28
Macroeconomics and Business
RC F AS
Br 2
Ba 4
Ec 2
15
Executive Master in
Management and Banking
João César das Neves29
Macroeconomics and Business
RC F AS
Br 2 8
Ba 4 2
Ec 2 8
Executive Master in
Management and Banking
João César das Neves30
Macroeconomics and Business
RC F AS
Br 2 8 6
Ba 4 2 12
Ec 2 8 0
16
Executive Master in
Management and Banking
João César das Neves31
Macroeconomics and Business
RC F AS
Br 2 8 6 16
Ba 4 2 12 18
Ec 2 8 0 10
Executive Master in
Management and Banking
João César das Neves32
Macroeconomics and Business
PBr=PBa=PEc=
RC F AS
Br 2 8 6 16
Ba 4 2 12 18
Ec 2 8 0 10
17
Executive Master in
Management and Banking
João César das Neves33
Macroeconomics and Business
PBr=1PBa=2PEc=3
RC F AS
Br 2 8 6 16
Ba 4 2 12 18
Ec 2 8 0 10
RC F AS
Br 2 8 6 16
Ba 8
Ec
Executive Master in
Management and Banking
João César das Neves34
Macroeconomics and Business
PBr=1PBa=2PEc=3
RC F AS
Br 2 8 6 16
Ba 4 2 12 18
Ec 2 8 0 10
RC F AS
Br 2 8 6 16
Ba 8 4 24 36
Ec 6 24 0 30
18
Executive Master in
Management and Banking
João César das Neves35
Macroeconomics and Business
PBr=1PBa=2PEc=3
RC F AS
Br 2 8 6 16
Ba 4 2 12 18
Ec 2 8 0 10
RC F AS
Br 2 8 6 16
Ba 8 4 24 36
Ec 6 24 0 30
16 36 30 82
Executive Master in
Management and Banking
João César das Neves36
Macroeconomics and Business
Jean-Baptiste SAY
Lyon 1776 – Paris 18321803 - Traité de Économie Politique
19
Executive Master in
Management and Banking
João César das Neves37
Macroeconomics and Business
PBr=1PBa=2PEc=3
RC F AS JBS
Br 2 8 6 6 22
Ba 8 4 24 24 60
Ec 6 24 0 0 30
16 36 30 30 112S D
Br
Ba
Ec
Executive Master in
Management and Banking
João César das Neves38
Macroeconomics and Business
PBr=1PBa=2PEc=3
RC F AS JBS
Br 2 8 6 6 22
Ba 8 4 24 24 60
Ec 6 24 0 0 30
16 36 30 30 112S D
Br 16
Ba 36
Ec 60
20
Executive Master in
Management and Banking
João César das Neves39
Macroeconomics and Business
PBr=1PBa=2PEc=3
RC F AS JBS
Br 2 8 6 6 22
Ba 8 4 24 24 60
Ec 6 24 0 0 30
16 36 30 30 112S D
Br 16 22
Ba 36 60
Ec 60 30
Executive Master in
Management and Banking
João César das Neves40
Macroeconomics and Business
PBr=1PBa=2PEc=3
RC F AS JBS
Br 2 8 6 6 22
Ba 8 4 24 24 60
Ec 6 24 0 0 30
16 36 30 30 112S D ExS
Br 16 22
Ba 36 60
Ec 60 30
21
Executive Master in
Management and Banking
João César das Neves41
Macroeconomics and Business
PBr=1PBa=2PEc=3
RC F AS JBS
Br 2 8 6 6 22
Ba 8 4 24 24 60
Ec 6 24 0 0 30
16 36 30 30 112S D ExS
Br 16 22 -6
Ba 36 60 -24
Ec 60 30 30
Executive Master in
Management and Banking
João César das Neves42
Macroeconomics and Business
PBr=1PBa=2PEc=3
RC F AS JBS
Br 2 8 6 6 22
Ba 8 4 24 24 60
Ec 6 24 0 0 30
16 36 30 30 112S D ExS
Br 16 22 -6
Ba 36 60 -24
Ec 60 30 30
112 112 0
Say’s Law
22
Executive Master in
Management and Banking
João César das Neves43
Macroeconomics and Business
PBr=1PBa=2PEc=3
RC F AS
Br 2 8 6 16
Ba 8 4 24 36
Ec 6 24 0 30
16 36 30 82
PBr=0.5
PBa=1
PEc=1.5
Executive Master in
Management and Banking
João César das Neves44
Macroeconomics and Business
PBr=0.5PBa=1PEc=1.5
RC F AS
Br
Ba
Ec
RC F AS
Br 2 8 6 16
Ba 8 4 24 36
Ec 6 24 0 30
16 36 30 82
23
Executive Master in
Management and Banking
João César das Neves45
Macroeconomics and Business
PBr=0.5PBa=1PEc=1.5
RC F AS
Br -
Ba -
Ec -
RC F AS
Br 2 8 6 16
Ba 8 4 24 36
Ec 6 24 0 30
16 36 30 82
Executive Master in
Management and Banking
João César das Neves46
Macroeconomics and Business
PBr=0.5PBa=1PEc=1.5
RC F AS
Br - 4 3 7
Ba 4 - 12 16
Ec 3 12 - 15
7 16 15 38
RC F AS
Br 2 8 6 16
Ba 8 4 24 36
Ec 6 24 0 30
16 36 30 82
24
Executive Master in
Management and Banking
João César das Neves47
Macroeconomics and Business
PBr=0.5PBa=1PEc=1.5
RC F AS
Br - 4 3 7
Ba 4 - 12 16
Ec 3 12 - 15
7 16 15 38
RC= 7
F= 16
AS= 15
Executive Master in
Management and Banking
João César das Neves48
Macroeconomics and Business
PBr=0.5PBa=1PEc=1.5
RC F AS
Br - 4 3 7
Ba 4 - 12 16
Ec 3 12 - 15
7 16 15 38
+ 4 + 3 14
12
12
+ 4 + 12
10
28
0 + 3 + 12
7
16
15
RC= 7
F= 16
AS= 15
25
Executive Master in
Management and Banking
João César das Neves49
Macroeconomics and Business
RC F AS
Br - 4 3 7
Ba 4 - 12 16
Ec 3 12 - 15
7 16 15 38
RC F AS
Br - 4 1 5
Ba 1 - 10 11
Ec 3 12 - 15
4 16 11 31
RC: 3Ba = 3MAS: 4Br+2Ba=4M
S D ExS
Br 7 5 2
Ba 16 11 5
Ec 15 15 0
38 31 7
Executive Master in
Management and Banking
João César das Neves50
Macroeconomics and Business
Marie-Ésprit LÉON WALRAS
Evreux (França) 1834 - Clarens (Suíça) 19101874-77 - Élements d'Économie Politique Pure
[2ªed. 1889, 3ªed. 1896, 4ªed. 1900, 5ªed. 1926]
26
Executive Master in
Management and Banking
João César das Neves51
Macroeconomics and Business
RC F AS
Br - 4 1 5
Ba 1 - 10 11
Ec 3 12 - 15
4 16 11 31
S D ExS
Br 7 5 2
Ba 16 11 5
Ec 15 15 0
38 31 7
RC: 3Ba = 3MAS: 4Br+2Ba=4M
7M
Executive Master in
Management and Banking
João César das Neves52
Macroeconomics and Business
Walras’ Law
D
S
27
Executive Master in
Management and Banking
João César das Neves53
Macroeconomics and Business
Gross Domestic Product per capita Portugal 1833-2011
0
2000
4000
6000
8000
10000
12000
14000
16000
18000
1833 1883 1933 1983
€, p
.20
10
Executive Master in
Management and Banking
João César das Neves54
Macroeconomics and Business
GDP per capita1800-2012
0
5000
10000
15000
20000
25000
30000
35000
1800 1850 1900 1950 2000
USA
Portugal
Brazil
Spain
Angola
28
Executive Master in
Management and Banking
João César das Neves55
Macroeconomics and Business
Business Cycles (real GDP growth)1833-2011
-30
-20
-10
0
10
20
30
40
1833 1853 1873 1893 1913 1933 1953 1973 1993
%
Executive Master in
Management and Banking
João César das Neves56
Macroeconomics and Business
Business Cycles(av. 3-years GDP gr.) 1953-2012
-2
-1
0
1
2
3
4
5
6
1953 1963 1973 1983 1993 2003
Port
Spain
EUA
Brazil
29
Executive Master in
Management and Banking
João César das Neves57
Macroeconomics and Business
Business Cycles (av. 3-years GDP gr.) 1953-2012
-9
-7
-5
-3
-1
1
3
5
7
9
1953 1963 1973 1983 1993 2003
Port
Spain
EUA
Brazil
Angola
Executive Master in
Management and Banking
João César das Neves58
Macroeconomics and Business
Inflation rate Portugal, 1833-2011
-30
-20
-10
0
10
20
30
40
50
60
70
1833 1853 1873 1893 1913 1933 1953 1973 1993
%
30
Executive Master in
Management and Banking
João César das Neves59
Macroeconomics and Business
Inflation rate 1960-2012
0
5
10
15
20
25
30
1960 1970 1980 1990 2000 2010
Portugal
Spain
US
EU-12
Executive Master in
Management and Banking
João César das Neves60
Macroeconomics and Business
Inflation rate 1960-2012
-20
0
20
40
60
80
100
1960 1970 1980 1990 2000 2010
Portugal
Spain
US
EU-12
Brazil
Angola
31
Executive Master in
Management and Banking
João César das Neves61
Macroeconomics and Business
Inflation rate 1960-2012
-800
200
1200
2200
3200
4200
5200
1960 1970 1980 1990 2000
Brazil
Angola
Executive Master in
Management and Banking
João César das Neves62
Macroeconomics and Business
Unemployment rate Portugal, 1952-2013
0
2
4
6
8
10
12
14
16
18
1952 1962 1972 1982 1992 2002 2012
MF
OCDE
UE
UCP
IMF
32
Executive Master in
Management and Banking
João César das Neves63
Macroeconomics and Business
Unemployment rate1960-2012
0
2
4
6
8
10
12
14
16
18
20
1960 1970 1980 1990 2000 2010
Spain
Port
EU-12
US
Brazil
Executive Master in
Management and Banking
João César das Neves64
Macroeconomics and Business
This Session
Economic policy: problems andissues• The macroeconomic approach
• The problems identified• The models to assess them
Macroeconomics and BusinessSession 2
33
Executive Master in
Management and Banking
João César das Neves65
Macroeconomics and Business
1.Aggregate problems and approaches1.2. Structures of aggregate problems
Williamson, Stephen (2010) Macroeconomics, Addison Wesley, Boston USA, 4th edition, c.1
Lucas, R.(1988) «What do economists do?» The 411th convocation address at the University of Chicago (December 9, 1988)
Executive Master in
Management and Banking
João César das Neves66
Macroeconomics and Business
Problems of the aggregate economy
1. Spectral band• Low frequency problems - long-term
growth• High frequency problems - business cycle
2. Types of value• Real issues• Nominal issues
3. Economic sectors• Private agents• Policy interventions
34
Executive Master in
Management and Banking
João César das Neves67
Macroeconomics and Business
Portugal: GDP (log) and HPtrend
9
9.5
10
10.5
11
11.5
12
1953 1963 1973 1983 1993 2003
Executive Master in
Management and Banking
João César das Neves68
Macroeconomics and Business
Portugal: GDPcycle
-0.1
-0.08
-0.06
-0.04
-0.02
0
0.02
0.04
0.06
0.08
0.1
1953 1963 1973 1983 1993 2003
35
Executive Master in
Management and Banking
João César das Neves69
Macroeconomics and Business
Relative importance of growth and cycles
Lucas calculationsLets suppose consumption evolves with a growth
component and cycle component, with the rule:
where m is the long term rate of growth and s is the volatility of the cycle component (which has average 1)
In the USA output trend, m = 3% and s = 1,3%.Lucas asks what is the increase in consumption today
that would compensate for a variation of long term growth rate and for a elimination of fluctuations.
21.
2(1 ). 0,1,2,...,s
t tc m e z t−
= + =
Executive Master in
Management and Banking
João César das Neves70
Macroeconomics and Business
Variation in long term growth
m Compensation
1% 45%
2% 20%
3% 0
4% - 17%
5% - 31%
6% - 42%
Lucas Jr., Robert E. (1987) Models of Business Cycles, Basil Blackwell, chapter III
Interpretation
• The consumers would require an increase of 20% to be compensated
from a reduction of growth rate from 3% to 2%
• They would accept a reduction of 42% of current consumption if growth rate increased to 6%.
36
Executive Master in
Management and Banking
João César das Neves71
Macroeconomics and Business
Variation in volatility
CRA\s 1,3% 3,9% 12%
1 0,008% 0,072% 0,65%
5 0,042% 0,38% 3,4%
10 0,084% 0,76% 6,8%
20 0,17% 1,5% 13,6%
Lucas Jr., Robert E. (1987) op. cit.
Interpretation• If the volatility of American GDP (1,3%) was eliminated, consumers would gain the
equivalent of much less than 0,2% of consumption
(depending of their relative risk aversion, CRA)
• If volatility was 10 times larger, the benefit of its
elimination would still be much smaller than anything related to
growth
Executive Master in
Management and Banking
João César das Neves72
Macroeconomics and Business
Economic structure of the issues
Changes of Output per Worker
Secular growth Business cycle
Due to changes in capital 1/3 0
Due to changes in labour 0 2/3
Due to changes in productivity 2/3 1/3
Source: Cooley, Thomas (ed) (1995) Frontiers of Business Cycle Research, Princeton University Press, p.11
37
Executive Master in
Management and Banking
João César das Neves73
Macroeconomics and Business
“Understanding Business Cycles”
“One exhibits understanding of business cycles by constructing a model in the most literal sense: a fully articulated artificial economy which behaves through time so as to imitate closely the time series behaviour of actual economics”
Lucas, R. (1977) "Understanding Business Cycles"
Executive Master in
Management and Banking
João César das Neves74
Macroeconomics and Business
Model 1 - Five Monkeys and a banana
• How will five monkeys that have not been fed for a day react to one banana being thrown into their cage?• Let us take our banana, cut it into five pieces,
give each to of the five monkeys one piece, and impose on them the rule they may interact only by exchanging banana pieces for minutes of backscratching, at some fixed rate (I confess to having no idea how this imposition might be effected in practice).
• We can predict the outcome of this interaction (equilibrium price and quantities exchanged), at least given sufficient computational ability.
in Lucas, R. (1980) “Methods and Problems in Business Cycle Theory”
38
Executive Master in
Management and Banking
João César das Neves75
Macroeconomics and Business
Model 2 – Recession in a park
• The location I have in mind is an old-fashioned amusement park (...) At the gate, visitors use U.S. dollars to purchase tickets and than enter the park and spend the tickets.• “GNP” in the park (total tickets spent) and employment
(the number of man hours worked) will fluctuate from one day to the next due to fluctuations in demand.
• Then, with no advance warning to anyone inside the park, and no communication to them as to what is going on, the cashiers are instructed for this one day to give 8 tickets per dollar instead of 10. What will happen?
• What I have done, in short, is to engineer a depression in the park.
Lucas, R.(1988) «What do economists do?» The 411th convocation address at the University of Chicago (December 9, 1988)
Executive Master in
Management and Banking
João César das Neves76
Macroeconomics and Business
Models and the crisis
«One thing we are not going to have, now or ever, is a set of models that forecasts sudden falls in the value of financial assets, like the declines that followed the failure of Lehman Brothers in September [2008]. This is nothing new. It has been known for more than 40 years and is one of the main implications of Eugene Fama’s “efficient-market hypothesis” (EMH), which states that the price of a financial asset reflects all relevant, generally available information. If an economist had a formula that could reliably forecast crises a week in advance, say, then that formula would become part of generally available information and prices would fall a week earlier.»
Lucas, Robert E. (2009) “In defence of the dismal science”, in The Economist, August 6th, 2009
39
Executive Master in
Management and Banking
João César das Neves77
Macroeconomics and Business
1.Aggregate problems and approaches1.3. Walrasian Equilibrium Models
Williamson, Stephen (2010) Macroeconomics, Addison Wesley, Boston USA, 4th edition, c. 2 and 4
Executive Master in
Management and Banking
João César das Neves78
Macroeconomics and Business
Marie-Ésprit LÉON WALRAS
Evreux (França) 1834 - Clarens (Suíça) 1910
1874-77 - Élements d'Économie Politique Pure[2ªed. 1889, 3ªed. 1896, 4ªed. 1900, 5ªed. 1926]
40
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Macroeconomics and Business
Economic circuit
Families Firms
GOODS Market
RESOURCESMarketResources
GoodsExpenditure
Income
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Macroeconomics and Business
BEHAVIOUR OF FAMILIES
Max U(Goods, Leisure)
BUDGET CONSTRAINT OF THE FAMILIES (F)sources: wages + interests + transfers (Pub., For.) -
taxes =
usages: consumption + investment + bond purchases(net) + increase in money holdings (net)
w/p.L + ρ.K + r.(B+B*)/p + (TrF + Tr*F) - TF = C + IF+ (∆B+∆B*)/p + (∆M+∆M*)/p
Families
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BEHAVIOUR OF FIRMS
Max Profits
BUDGET CONSTRAINT OF THE FIRMS (E)sources: production =usages: wages + interests + profits of the firms
Y = w/p.L + (1+r).K - (1-δ).K + profits- Including the transfers in the firm’s profits
profits + TrE + Tr*E = TE + IE
Y - TrE - Tr*E = (w/p.L + (r+δ).K) + TE + IE
Note: ρ = r+δ
Firms
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Families (F) Firms (E)
GOODS Market
RESOURCES MarketResources
GoodsExpenditure
Income
Public St (G)
Foreign St*
Economic circuit
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BUDGET CONSTRAINT OF THE PUBLICSECTOR (G)
(National Budget)sources: taxes + loans issued + new money
issues
usages: current consumption+ transfers + debtinterests + public investiment
T + ∆B/p + ∆M/p = G + Tr + r.B/p + IG
Budget constraint: Public sector
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Portugal, public balance/GDP 1947-2011
-14.0
-12.0
-10.0
-8.0
-6.0
-4.0
-2.0
0.0
2.0
4.0
1945 1955 1965 1975 1985 1995 2005
43
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Public Balance/GDP 1995-2012
-12
-10
-8
-6
-4
-2
01995 2000 2005 2010
%
Tot.Balance
exc.temp.meas.
adj.cic+med.
Pact
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Public balance/GDP 1970-2012
-20
-15
-10
-5
0
5
1970 1980 1990 2000 2010
Spain
Portugal
US
EU-15
Brazil
Angola
44
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BUDGET CONSTRAINT OF THE FOREIGNSECTOR (X)
(BALANCE OF PAYMENTS)sources: Exports - Imports + Inflows of transfers
and factor income (net)
usages: Inflow of assets (net) – ForeignInvestiment + Inflows of reserves of foreigncurrency
Ex - Im + Tr* + r.B*/p = ∆B*/p - IX + ∆M*/p
Budget constraint : Foreign sector
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Current Balance (BC + BK)
-15
-10
-5
0
5
10
1970 1980 1990 2000 2010
%
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Current Account(%GDP)
-15
-12
-9
-6
-3
0
3
6
1960 1970 1980 1990 2000 2010Spain
Portugal
Brazil
US
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Macroeconomics and Business
Current Account(%GDP)
-15
-12
-9
-6
-3
0
3
6
9
12
15
1960 1970 1980 1990 2000 2010
Spain
Portugal
Angola
Brazil
US
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FAMILIES w/p.L + (r+δ).K + r.(B+B*)/p + (TrF + Tr*F ) - TF - C
= SF = IF + (∆B+∆B*)/p + (∆M+∆M*)/pFIRMS ( as Y = F(K,L) )Y + TrE + Tr*E - (w/p.L + (r+δ).K) - TE = IE =
Retained earnings = SE
PUBLIC SECTOR[ T- G - Tr - r.B/p] = - Budget Deficit = SG = IG - ∆B/p
- ∆M/pFOREIGN SECTOR [Im - Ex - Tr* - r.B*/p] = CA Deficit = SX = IX - ∆B*/p
- ∆M*/p
Walras’ law 1/4
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Adding all constraints
IF + (∆B+∆B*)/p + (∆M+∆M*)/p + IE + IG - ∆B/p -∆M/p + IX - ∆B*/p - ∆M*/p =
= [w/p.L + (r+δ).K + r.(B+B*)/p + (TrF + Tr*F ) - TF - C] + [Y + TrE + Tr*E - (w/p.L + (r+δ).K) - TE] + [ T- G - Tr - r.B/p] + [Im - Ex - Tr* - r.B*/p]
(A)
Walras’ law 2/4
47
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From equation (A) we may obtain:A) Savings = Investment
Cancelling ∆B, ∆B*,∆M,∆M* and using the definition of S:IF + IE + IG + IX = SF + SE + SG + SX � I = S
where I = ∆K + δK <=> Kt+1 = I + (1-δ) K B) Product = Expenditure
Cancelling similar terms:I = - C + Y - G + Im - Ex �Y = C + G + I + Ex –Im
C) Product = Income
Directly form the firms constraintY = w.L + (r+ δ)K + Lu
Walras’ law 3/4
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D) Walras’ Law
Defining D = C + G + I + Ex - Im and noting that families demand (D) and State and Foreign sectors supply (S) bonds and money
Y + ∆BS/p+∆B*S/p + ∆MS/p+∆M*S/p = D + ∆BD/p + ∆B*D/p + ∆MD/p + ∆MD*/p
Total supply = Total demand[Y - D] + [∆BS/p -∆BD/p] + [∆B*S/p -∆B*D/p] + [∆MS/p
-∆MD/p] + [∆M*S/p - ∆MD*/p] = 0If all markets but one are in equilibrium, the last is
also in equilibrium
Walras’ law 4/4
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Portugal, savings by sector (%)
-10
0
10
20
30
40
50
1953 1963 1973 1983 1993 2003
Families
FirmsFor.
Pub.
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Portugal, lending/borrowing requirements by sector (%)
-15
-10
-5
0
5
10
15
1999.75 2001.75 2003.75 2005.75 2007.75 2009.75 2011.75
Firms
Banks
Public S.
Families
Foreign S.
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Keynes (1936 p.25-26) criticized what he called «Say’s law»: «supply creates its own demand», from which he deduced that «there are no obstacles to full employment».
In his book, Keynes manipulated the theories of his predecessors, who never defended the positions he attributed to them. The meaning of this «law» is, thus, much debated among specialists.
One simple interpretation of Say’s Law consists in the application of Walras’ Law to the case of barter. In this case total demand of goods equals total supply of goods and the there can never be
global underemployment.
Jean Baptiste Say
(1776-1832)
Say’s Law and Walras’ law
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Economic decisions
• Global movements of the economy will be understood as the aggregation of individual decisions by families and firms, in response to economic shocks and policies.
• The model, unlike its predecessors of the 1950s and 1960s, will have «microeconomic foundations», thus avoiding the schizophrenia caused by the division between Microeconomics and Macroeconomics.
50
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Families• Intra-temporal decisions:
• Choice between labour and consumption• Change in income - income effect• Change in wage rate - income and substitution effects
• Inter-temporal decisions• Choice between consuming today or tomorrow
• Change in wealth - wealth effect• Change in interest rate - wealth and inter-temporal
effects
Firms• Intra-temporal decisions:
• Production choice• Technological shock
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Families: intratemporal decision
C = w/p.(H - D) + (r+δ).K - T
C Consumption
H D Leisure
w/p.H + (r+δ).K - T
Max U(C, D)
MRSC,D = U’C/U’D= p/w
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Solution of utility maximization
Max U(C, D)
s.t. C = w/p.(H - D) + (r+δ).K - T
L = U(C,D) + λ.[C - w/p.(H - D) - (r+δ).K + T]
Rest one hour = U’D
Work that hour and get w/p units of consumption, with utility w/p U’C
U’D = w/p U’C � U’C /U’D = p/w
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Families: Income effectchange in (r+δ).K
H D
w/p.H + (r+δ).K - T
Income effect: Being richer, increases consumption and
leisure, reducing labour
C
52
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Families: Income and substitution effects – change in w
C
H Leisure D
w/p.H + (r+δ).K - T
Substitution effect:Labour being better rewarded,
consumption is cheaper. This reduces leisure and increases consumption
Income effect:Being richer
increases leisure and consumption
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1650
1700
1750
1800
1850
1900
1950
2000
2050
200 220 240 260 280 300 320
Ave
rage
hou
rs w
orke
d pe
r pe
rson
Real Wage (index 1953=100)
Hours worked vs Real wagePortugal
Source: OECD
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Families: intertemporal decision
• Another decision has to do with the passage of time. Every year, the consumer faces the restriction
(where Ydi= w/p.Li + ρ.Ki - T)Ydt + (1+r).B0/p = Ct + Bt/p
Ydt+1 + (1+r).Bt/p = Ct+1 + Bt+1/p Solving the system by eliminating B1:
1 1 10
/p/p.(1 )
1 1 1t t t
t t
Yd B CB r Yd C
r r r+ + ++ + + − = +
+ + +
W
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Families: intertemporal decision
Ct+1 Future Consumption
W Ct Present Consumption
W.(1+r)
1
1t
t
CW C
r+= +
+
IMRS = UCt+1/UC = 1/(1+r)
54
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Solution of utility maximization
Max U(Ct+1, Ct)
s.t. W = Ct + Ct+1/(1+r)
L = U(Ct+1, Ct) + λ.[W - Ct - Ct+1/(1+r)]
Consume one unit = U’Ct
Save that unit, get the interest (1+r) and consume it next year, with utility (1+r) U’C+1
U’Ct = (1+r) U’Ct+1
� U’Ct+1 /U’Ct = 1/(1+r)
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Fisher separability theorem 1/2
W Ct Present Consumption
W.(1+r)
consumption
production
savings
(1+r). savings
Ct+1 Future Consumption
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W Ct Present Consumption
W.(1+r)
consumption
production
debt
(1+r). debt
Ct+1 Future Consumption
Fisher separability theorem 2/2
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Families: Wealth effect –change in W
W Ct Present Consumption
W.(1+r)
Wealth effect: An increase in disposable
income in any period is spread throughout the
timeline
Ct+1 Future Consumption
56
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Families: Wealth and substitution effects – change in r
W Ct Present Consumption
W.(1+r)
Substitution effect:the increase in the interest rate will increase savings and future consumption, by
reducing present consumption
Wealth effect:Being richer increases all
consumptions
Ct+1 Future Consumption
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Economic Agents: Families
DECISIONS OF THE FAMILIES
- Labour Supply:• intratemporal substitution effect wt ⇒ Lt
• intertemporal substitution effect wt+1 ⇒Lt
- Consumption Decision:• Intertemporal income effect
Ydt ⇒ Ct , Ct+1 , Ct+2 ...• Intertemporal substitution effect
r (Ydt ) ⇒ Ct , Ct+i
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Firms: intratemporal decision
Y Output
L* Labor L
profits = Y – w/p.L - (r+ δ).K
Y = F(K,L)
MPL
w/p
L* L
F’L= w/p
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Firms: Technological improvementY
Labor L
MPL
w/p
L* L
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DECISIONS OF THE FIRMS
Demand for Labour w = p.PML
Demand for Capital ρ = p.PMK
cost of the rent of capital ρ = r+δ
Economic Agents: Firms
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The theorem of «Invisible Hand»1- Pareto’s optimum
«An optimum is defined as an attainable state such that, within the limitations imposed by the consumption sets, the production sets, and the total resources of the economy, one cannot satisfy better the preferences of any consumer without satisfying less well those of
another»G. Debreu (1959) Theory of Value – An axiomatic Analysis of
Economic Equilibrium, cap.6, p.90
59
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VILFREDO PARETOParis 1848 – Geneve 1923
1906 - Manuel d’Économie Politique
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«It is shown, under certain weak assumptions, that, if an attainable state of an economy is an equilibrium relative to a price system, that state is an optimum (...) A converse assertion is proved under somewhat different assumptions: if an attainable state of an economy is an optimum, there is a price system relative to which that state is an equilibrium. To sum up briefly, an attainable state is an optimum if and only if there is a price system to which all the agents are adapted in the way described above. These two essential theorems of the theory of value thus explain the role of prices in an economy»
G. Debreu op. cit., cap.6, p.90
The theorem of «Invisible Hand»2- Fundamental theorems of welfare
60
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1952 – Arrow,K and G. Debreu 'Existence of an equilibrium for a competitive economy‘, Econometrica, vol. XXII, 265-90
1959 – Debreu, G. Theory of Value, New York: Wiley.
The theorem of «Invisible Hand»
KENNETH J. ARROW
New York 1921- ...
GERARD DEBREU
Calais (França) 1921- 2004
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General equilibrium
Output
Y
Labor L
C
D
Families
FirmsY
L
F’L= w/p
U’C/U’D= p/w
MRS = w/p = MRT
61
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The crucial element
«How much has America’s political system –its protection of individual rights, especially property rights, and its relative low degree of regulation and low incidence of corruption– contributed to the gap between standards of living of U.S. residents and those of developing countries? I suspect a great deal.»
Alan Greenspan (2007) op. cit. p. 388.
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Not a little delicate machine
«The sky is not falling. No need to panic and start playing around with all sorts of policy responses. Despite the impression created by some economic pundits, the U.S. economy is not a delicate little machine that needs to be fine-tuned with exact precision by benevolent policymakers to keep from breaking down. Rather, it is large and complex, with millions of people making billions of decisions every day to improve their lives, the lives of their families and the health of their businesses.
On the one hand, it’s difficult to screw up all these well-intentioned people by crafting bad policy, but, on the other hand, it is of course entirely possible to do so. And once things are broken, they are much harder to fix. (…). This economy is fundamentally sound.»
(op. cit. p.1)