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Intermediate Macroeconomics Guest Lecture 2

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Here's a lecture on effective demand.

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Intermediate Macroeconomics Guest Lecture 2

  1. 1. Structural Deficiencies in Effective Demand and their Implications for Ireland in 2009 EC4006 Intermediate Macroeconomics | Guest Lecture 2 Stephen Kinsella | stephen.kinsella@ul.ie | www.stephenkinsella.net
  2. 2. Really relevant question for Ireland Today: will wage reduction stimulate employment?
  3. 3. Keynes’ Causal Story in The General Theory wages -> prices -> interest rate -> Investment (Money Supply is fixed) Investment determines Consumption, Income (X), Output (Y) How? (1) X = C+I (The Material Balance Relationship) (2) Y = X (The Output/Income mapping) (3) C = f(Y) (The Consumption function)
  4. 4. Irish Unemployment Right Now
  5. 5. Where did this come from?
  6. 6. Rising Prices have eroded competitiveness Source: Central Bank of Ireland, Forfas NCC Report pg. 37.
  7. 7. Wait: what’s ‘competitiveness?’ Price of Irish stuff < Price of everyone else’s stuff -> Quantity Demanded for Irish stuff goes up, assuming they are of similar quality. From Friday: price of Irish Stuff = (Factor Cost + User Cost) Factor costs: Inputs to Process + Unit Labour + Unit Capital Costs. Idea: Drop Factor costs somehow, competition/survival instincts will drop prices quantity demanded of Irish stuff will rise.
  8. 8. “There’s a Problem With Irish Wages” Rates vs Levels, or: Forfas NCC report vs. the Unions
  9. 9. “Labour cost growth rates show the change in the cost of employing workers over time. Ireland’s growth rates have exceeded the EU- 15 average over both periods. The average rate of wage inflation in Ireland between 2004 and 2008 Q2 was 50 percent above the EU-15 average.” –––Forfas, (2008):58
  10. 10. US $ per Hour Worked $0 $5 $10 $15 $20 $25 $30 $35 $40 Poland Hungary Singapore New Zealand South Korea Spain Japan OECD US France Italy should we look at? What part of the chart Ireland EU-15 UK Luxembourg Source: US Bureau of Labour Statistics, September 2008 Finland 2006 Sweden Netherlands Germany 2000 Denmark
  11. 11. There is a problem with public sector wages (source: www.ronanlyons.com) 1200 900 600 300 Public Sector Finance Motor trades Wholesale Retail Hotels and restaurants Land transport Post, telecomms Other business Utilities Food, Beverages Textiles Paper, printing Chemicals Rubber, Plastics Other Minerals Metals Electrical, Optical Transport Equipment Mining 0 19 Q1 19 Q2 19 Q3 19 Q4 19 Q1 19 Q2 19 Q3 20 Q4 20 Q1 20 Q2 20 Q3 20 Q4 20 Q1 20 Q2 20 Q3 20 Q4 20 Q1 20 Q2 20 Q3 20 Q4 20 Q1 20 Q2 20 Q3 20 Q4 20 Q1 20 Q2 20 Q3 20 Q4 20 Q1 20 Q2 20 Q3 20 Q4 20 Q1 20 Q2 20 Q3 20 Q4 20 Q1 20 Q2 20 Q3 20 Q4 20 Q1 20 Q2 3 Q 98 98 98 98 99 99 99 99 00 00 00 00 01 01 01 01 02 02 02 02 03 03 03 03 04 04 04 04 05 05 05 05 06 06 06 06 07 07 07 07 08 08 08 19
  12. 12. Back to the macro Concentrate on changes in the real wage, w/p, or the profit share, π. Big question: how do changes in the real wage/profit share affect output? Let commodity production be determined by a markup rule, depending on labour, L and capital, K P = (1+∆)(wL+rK) Now ask: how high does w have to go to inhibit ∆?
  13. 13. Ratio Argument Ireland: wages are 8% of overall wage bills in high value added sectors like Bio/Pharma Drop w by 50%. What happens to total factor costs? Drop by 3-4%. So, will dropping wages w/p stimulate overall production in high value added export industries? NO.
  14. 14. What will? Changes in the other component of factor cost: rK. r is falling, thanks to property crash. K is not increasing though, because no one wants to invest. Cost of capital in Ireland has to change. How? Increased investment in production. This needs different expectations than we have now. Only Govt has ability to borrow & invest on that scale
  15. 15. What will? But, Govt is very poor at choosing good projects, and is really inefficient at producing them. Better to support local entrepreneurs in a light touch way, allow them to start businesses which will either fail or succeed according to the market. BUT, EU rules against state aid. Time to break the rules.
  16. 16. Back to IS-LM Mathematica Example
  17. 17. How does this help Ireland?
  18. 18. Liquidity Preference Idea: An investor will opt for liquidity (i.e. hold money) instead of a bond when they expect the interest rate on it to rise, causing a capital loss on the bond exceeding the running yield we might see.
  19. 19. Summary Whether wage reductions stimulate output depends on changes in effective demand and the ratio of levels of rK: wL. Changing wL dents domestic consumption and probably won’t increase competitiveness in short run. It’s clear we want to change effective demand to increase X/Y. What changes effective demand (again, determined by Factor Cost+User Cost) MEC (sort of) + Liq. Preferences + changes in User cost. Support people with no money but a good idea, you change User cost. ...and more ranting about this on Friday

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