Transcript of 1 Superstars of macroeconomics 1 Irving Fisher, Yale (1867-1947) James Tobin, Yale (1918-2002)...
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- 1 Superstars of macroeconomics 1 Irving Fisher, Yale
(1867-1947) James Tobin, Yale (1918-2002) Milton Friedman, Chicago
(1912-2006) Robert Mundell, Columbia (1932 - ) J. M. Keynes, Kings
College (1883-1946) Janet Yellen, the Fed (1946 - )
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- Debts and Deficits Last time: -Conceptual issues of debts and
deficits -Deficits and slower growth of potential Y in the closed
economy -Role of deficit spending in recessions, particularly in
the liquidity trap Today: -To raise or lower G in recessions,
Europe and US today? -The death spiral of debt and default 2
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- Two Views of the Great Unraveling (I): Soft Landing The two
faces of saving and the deficit dilemma
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- 4 What are the effects of deficit reduction on the economy? 1.
In short run: Higher savings is contractionary Mechanism: higher S,
lower AD, lower Y (straight Keynesian effect) 2. In long-run:
Higher savings leads to higher potential output Mechanism: higher
I, K, Y, w, etc. (neoclassical growth model) Dilemma of the
deficit: Should we raise G today or lower G?
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- Real output (Y) Inflation AD AS Impact of fiscal stimulus AS AD
?
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- The dilemma of the deficit To illustrate, I use a little
simulation model built from our five equation IS-MP model plus a
Solow growth model. Then compare (1) a large stimulus program to
reach full employment (2) a balanced budget program Use historical
data, calibrated model, and plausible projections of variables.
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- Stimulus v. balanced budget in 2012 -Balance budget in 4 years
(EU style austerity) -Stimulate to reach FE in 3 years (Krugman
style superstimulus) -Assume that 50% of public dissaving is offset
by private saving. 7
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- Actual deficits: trillion a year 8
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- The long-term debt Have higher debt-GDP ratio for long time
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- But the economy pays the price in high U -With fiscal
austerity, have long period of stagnation. 10
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- Lower potential with stimulus Slower growth in potential with
stimulus because the debt causes lower capital stock 11
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- Cumulative Difference in GDP Because of recession, balanced
budget doesnt make it up in a generation, even without discounting.
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- 13 Conclusions on Debt and Deficits Central long-run impact of
fiscal policy is on POTENTIAL output through impact on national
savings rate. But in deep recessions, particularly in liquidity
trap, need larger deficits to stimulate ACTUAL output reach full
employment. So policy needs differ in recession and full
employment.
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- Economics of External Debts
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- Debt and financial crises Political incentives for additional
borrowing could change quickly if financial markets began to
penalize the United States for failing to put its fiscal house in
order. If investors become less certain of full repayment or
believe that the country is pursuing an inflationary course that
would allow it to repay the debt with devalued dollars, they could
begin to charge a risk premium on U.S. Treasury securities. That
could happen suddenly in a confidence crisis and ensuing financial
shock. There is precedent for a financial disruption first
contributing to large, chronic deficits and then in some cases
contributing to the loss of investor confidence and even to a
default on a nations debt. [However,] the unique position of the
United Statesbecause of its economic dominance and the dominant
role of the dollar internationallymake it difficult to extrapolate
from the experience of other nations in estimating the risk or
timing of a financial crisis arising from failure to address the
projected U.S. fiscal imbalance. [National Academy of Sciences
panel, Choosing the Nations Fiscal Future, 2009] 15
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- American Econ Review, August 2011. Also see their book, This
Time is Different..
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- Misinterpretation by Deficit Commissioner When the markets lose
confidence in a country, they act swiftly and they act decisively.
Look at Greece, look at Portugal, look at Ireland, look at Spain.*
If they markets lose confidence in this country and we continue to
build up these enormous deficits and debt, they will act swiftly
and decisively. [Erskine Bowles, Chair, Presidents Commission] *
BTW: This is completely wrong analytically. 17
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- Defaults and restructuring are endemic Default: A sovereign
default is defined as the failure to meet a principal or interest
payment on the due date (or within the specified grace period).
These are often called restructuring or repudiation but have the
same effect. 18
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- Reinhard and Rogoff, From Financial Crash to Debt Crisis, AER,
2011
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- Fiscal deficits plus loss of confidence pushes over the tipping
point to where cannot refinance debts Country fiscal position
Rising risk premium and interest burden
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- REVIEW: Romer debt model Basic ideas: -This is the run on the
bank as applied to countries. -Basic idea is that have an
instability because of the impact of risk on country interest rates
(r d = r w + ). -Two equilibria: good (full employment) and bad
(default) Assumptions: -Government has debt of D and default
probability . -Governments have a random tax revenue, T, with cdf
F(T). -Interest: -When T < RD, the government defaults
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- REVIEW: Math of Romer model -Investor equilibrium: -Government
default occurs when T < RD, which has a cdf (cumulative
distribution function): -We have two equilibrium equations in R and
.
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- (prob. of default) Government and taxes 1 R (interest factor) 0
Investors REVIEW: Three equilibria
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- Simplified Romer model -Investor equilibrium that R = (1+r d )
determined by prob of default: -Assume for simplicity that taxes
(T) are known with certainty to be T*. So government default occurs
when T < RD : -We have two equilibrium equations in R and .
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- With adequate revenues, likely to have good equil. (prob. of
default) Government and taxes 1 R (interest factor) 0
Investors
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- (prob. of default) Government and taxes 1 R (interest factor) 0
Investors With low revenues, multiple equilibrium with bad
outcome
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- EZ interest rates
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- Examples of unstable equilibria
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- The unfortunate weak currencies in the EZ Spain and UK had
virtually same deficit and fiscal position in 2010. Interest rates
on sovereign debt
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- What can the EU do? 1.Fiscal austerity, but with great economic
cost. 2.Guarantee debts, but this involves north-south transfer.
3.ECB buy bad debt, but moral hazard and hidden transfers. 4.Break
up Eurozone, but this has untold economic perils. [See discussion
in earlier class.] 30
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- Does this apply to the US? Country type 1: What is the
historical frequency of foreign debt crises for countries with
either fixed exchange rates or debts denominated in external
currencies a la Greece, Italy, Spain, Argentina, etc.? Answer:
average of 14 every year for last two centuries. Country type 2:
What is the historical frequency of foreign debt crises for
countries with flexible exchange rates and debts denominated in
their own currency? E.g., US. Answer: I could not find one. Why?
Because country type 2 can print money ($). Problem is inflation or
hyperinflation, not debt crisis. 31
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- Final words You have heard of the hard sciences. But macro is a
very hard science. Why is it so challenging? Listen to the
conversation between Keynes and the revolutionary physicist, Max
Planck, that took place at high table in Kings College, Cambridge:
Professor Planck, of Berlin, the famous originator of the Quantum
Theory, once remarked to me that in early life he had thought of
studying economics, but had found it too difficult! Professor
Planck could easily master the whole corpus of mathematical
economics in a few days. But the amalgam of logic and intuition and
the wide knowledge of facts which is required for economic
interpretation in its highest form is overwhelmingly
difficult.