Macroeconomics Policies
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Macroeconomics Policies

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    Macroeconomics Policies Macroeconomics Policies Presentation Transcript

    • Basics of Macroeconomic Policies Sy Sarkarat, Ph. D. United States Fulbright Scholar for Azerbaijan State Economics University , Baku, Azerbaijan. Fall 2008 Copy Rights: This lecture was prepared to CRRC and it is designed for educational purpose not for profit.
    • Warming up
      • Q:Why did God create economists ?
      • A:In order to make weather forecasters look good.
      • Q. What does an economist do?
      • A. A lot in the short run, which amounts to nothing in the long run.
    • The Business Cycle Trough Peak Peak Peak Trough REAL GDP (units per time period) TIME Growth trend
    • Macro Equilibrium PRICE LEVEL (average price) REAL OUTPUT (quantity per year) D 1 S 1 Q E P E Aggregate demand Aggregate supply P 1 E
    • Macro Failures
      • There are two potential problems with macro equilibrium:
        • Undesirability - the price-output relationship at equilibrium may not satisfy our macroeconomic goals.
        • Instability – even if the designated macro equilibrium is optimal, it may be displaced by macro disturbances.
    • An Undesired Equilibrium PRICE LEVEL (average price) Q E P E Aggregate demand Aggregate supply E Equilibrium output Full-employment output Q F P* F
    • Stable or Unstable?
      • Prior to 1930s, macroeconomists thought there could never be a Great Depression
      • They believed that a market-driven economy was inherently stable and that government intervention was unnecessary.
      Adam Smith 1723 –1790
    • The Business Cycle in U.S. History Korean War World War II Vietnam War Great Depression Source: U.S. Bureau of the census, The Statistics of the U.S.A. Growth recession Long-term average growth (3%) Recession
    • Inflation and Unemployment: 1900-1940 Source: U.S. Bureau of the Census. 24 20 16 12 8 4 0 – 4 – 8 1900 1910 1920 1930 1940 Inflation Unemployment
    • Macro Disturbances AS 0 PRICE LEVEL (average price) REAL OUTPUT (quantity per year) ( b ) Demand shifts AD 0 AD 0 AS 0 PRICE LEVEL (average price) REAL OUTPUT (quantity per year) ( a ) Supply shifts F P* Q F AD 1 F P* Q F AS 1 G P 1 Q 1 P 2 Q 2 H
    • The Keynesian Revolution
      • British economist, John Maynard Keynes developed an alternate view of the macro economy.
      • Keynes asserted that a market-driven economy is inherently unstable.
      1885 -1942
    • Government Intervention
      • In Keynes’ view, the inherent instability of the marketplace required government intervention.
    • Fiscal Stimulus Package
      • 1960s, a tax cut in 1964 to stimulate economic growth and reduce unemployment
      • $168 billion fiscal stimulus package - the largest legislative initiative ever designed to ease an economic slowdown.
      • According to the Congressional Budget Office (CBO), the goal of a fiscal stimulus is to boost economic activity by increasing short-term aggregate demand.
    • The Multiplier
      • The cumulative decease in total spending is equal to the gap multiplied by the multiplier.
      • A recessionary gap of $100 billion per year would decrease total spending by $400 billion per year (If MPC = 0.75) .
    • The Multiplier Process 1. $100 billion in unsold goods appear 3. Income reduced by $100 billion 4. Consumption reduced by $75 billion 5. Sales fall $75 billion 6. Further cutbacks in employment or wages 7. Income reduced by $75 billion more 8. Consumption reduced by $56.25 billion more Factor markets Product markets Business firms Households 9. And so on 2. Cutbacks in employment or wages
    • Fiscal Policy
      • Fiscal policy is an integral part of modern economic policy.
      • Fiscal policy is the use of government taxes and spending to alter macroeconomic outcomes.
    • The Multiplier Cycles
    • The Multiplier
    • Monetary Theories
      • Money and credit affect the ability and willingness of people to buy goods and services.
      • If credit isn’t available or is too expensive, consumers curtail the credit purchases and businesses might curtail investment.
      Milton Friedman 1912 –2006)
    • Monetary Stimulus
      • The goal of monetary stimulus is to increase aggregate demand.
        • Aggregate Demand – The total quantity of output demanded at alternative price levels in a given time period, ceteris paribus.
    • Investment
      • Lowering interest rates lowers the cost of borrowing which encourages investment.
      • Increased investment injects new spending into the circular flow.
      • The multiplier effect result in an even larger increase in aggregate demand.
    • Monetary Tools
      • The Federal Reserve controls the money supply using the following three policy instruments:
        • Reserve requirements
        • Discount rates
        • Open-market operations
    • Monetary Policy - Last Two Recessions
      • 1991 and 2001, the Fed lowered rates, and the impact was evident about nine months after the rate cuts started. 
      • In 1990, the Fed started cutting rates on July 13. The rate cuts were slow and small, but ten months later real GDP rose at a 2.6% annual rate starting in the second quarter of 1991.
      • In 2001, the Fed started cutting rates Jan. 3. Nine months later, real GDP rose at a 1.6% annual rate in the fourth quarter, and was followed by a 2.7% growth rate in the first quarter of 2002.
    • List of the rate cuts and a rebound in GDP growth: from the start of the rate cut cycle to a rebound
      • 1991: Six rate cuts totaling 200 basis points - to 6.0% in GDP in nine months
      • 2001: Eight rate cuts totaling 350 basis points -to 3.0% in GDP in nine months
      • 2007-08: Five rate cuts totaling 225 basis points - to 3.0% in GDP in five months
    • Limits on Monetary Restraint
      • Two factors make it harder for the Fed to restrain aggregate demand:
        • Expectations.
        • Global money.
    • Constraints on Monetary Stimulus Inelastic demand Investment demand Rate Of Investment 7 6 0 Interest Rate Inelastic investment demand can also impede monetary policy A liquidity trap can stop interest rates from falling The liquidity trap Interest Rate E 1 E 2 g 1 g 2 Quantity Of Money Demand for money
    • Shifts of Aggregate Supply AS 2 E 2 Rightward AS shifts reduce unemployment and inflation AS 1 E 1 Output (real GDP per period) 0 Price Level (average price per unit of output) AD
    • Instability
      • The aggregate supply curve shifts to the left when there is an increase in production costs.
      • The aggregate demand curve shifts when volatility in currencies cause significant changes in import and export prices.
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    • Aggregate Supply
      • The macro economy experienced stagflation in the 1970s.
      • Stagflation is the simultaneous occurrence of substantial unemployment and inflation.
    • Supply-Side Theories
      • Decreases in aggregate supply cause inflation and higher unemployment.
      • Increases in aggregate supply move us closer to both our price stability and full employment goals.
    • Supply-Side Theories AD 0 AS 0 REAL OUTPUT (quantity per year) PRICE LEVEL (average price) Q 3 P 3 Q F E 0 P 0 AS 1 E 3
    • Supply-Side Policy
      • Supply-side policy seeks to shift aggregate supply curve.
      • Supply-side policy is the use of tax incentives, (de)regulation, and other mechanisms to increase the ability and willingness to produce goods and services.
      Jean-Baptiste Say 1767-1832
    • Changes in Marginal Tax Rates Since 1915
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    • Consumer Confidence
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    • Financial Crisis
      • Financial Crisis : banking crisis, exchange rate crisis, or a combination of the two
        • Banking crisis : banking system’s becoming unable to perform its normal lending functions
          • Disintermediation : banks becoming unable to serve as intermediaries between savers and investors
          • Exchange rate crisis : sudden and unexpected collapse in the value of a nation’s currency
    • Domestic Issues in Crisis Avoidance
      • Problem in financial sector regulation
        • Moral hazard : incentive to act in a manner that creates personal benefits at the expense of the common good: e.g., banks have an incentive to make riskier investments when they know they will be bailed out
        • Moral hazard problems are exacerbated by governments’ providing incentives or threatening banks to make bad loans for political ends
          • In East Asian crisis, such loans gave rise to the term crony capitalism
    • New Deal - Shock Treatment Jumpstart the Economy
      • Fiscal stimulus policies — public works projects, tax rebates.
      • Policies that put money directly into the hands of those who were most likely to spend it are what pulled us out of the Great Depression.
      • Example : $300 billion fiscal stimulus.
    • Example
      • A $300 billion fiscal stimulus will lead to a $1 trillion economic impact.