N i k o l a o s L i o n i s

U n i v e r s i t y O f A t h e n s

( F e b r u a r y 2 0 1 7 )

1

Economic Policy

Government in the Marketplace 2

Public Policy

Competition (antitrust) policies

Regulation policies

Taxation and subsidizations

Trade regulations

Price and wage controls

Investment incentives

Employment incentives

Macroeconomic policies

etc.

Macroeconomic Policies Microeconomic policies

Fiscal

Monetary

Regulation

Competition

Industrial

Technological

Environmental

Public enterprises

etc

3

Government in the Marketplace

4

Macroeconomics

vs. Microeconomics

Macroeconomics Microeconomics

Behaviour of entire economies No matter how small

Assume most details Resource allocation & income

distribution is relatively unimportant

Aggregation

Combine many individual markets into one overall market

Macroeconomic variables: aggregate output, inflation, unemployment, …

Top-down approach to analyzing economy

Behaviour of individual units No matter how large

Focus on individual markets Allocate resources and distribute

income

Ignore macroeconomics issues

Bottoms-up approach to analyzing economy

5

Macroeconomics vs. Microeconomics

6

Microeconomics

Microeconomics 7

Behavior of economic agents. No matter how large (individuals, firms, governments).

Study agents’ decisions regarding the allocation of scarce resources (goods) and agents’ interactions in narrowly-defined markets.

Analyze market mechanisms (supply and demand) and determine market (partial) equilibrium. Conditions under which (free) markets lead to desirable allocations

and ...

... market failures, i.e. where markets fail to produce efficient results.

Areas of Microeconomic Research 8

Industrial organization/economics examines structure , behavior and equilibrium in imperfectly competitive markets.

Labor economics examines structure and equilibrium of the labor market (wages, employment, and labor market dynamics).

Financial economics examines risk and return of assets, structure of optimal portfolios, corporate financial behavior.

Public economics examines the design of government tax and expenditure policies and economic effects of these policies.

Political economy (new) examines the role of political institutions in determining policy outcomes.

Health economics examines the organization of health care systems and health insurance programs.

Urban economics examines the challenges faced by cities (air and water pollution, parking spaces, traffic congestion, poverty).

Law and economics examines law, legal regimes and institutions (design, enforcement, efficiencies).

etc

Supply & Demand in Microeconomics 9

Individual Demand It represents the quantity of a good that a single consumer would buy at a specific

price.

Market Demand It represents the total quantity demanded by all individuals (consumers) Sum of all individual demands.

Individual Supply It represents the quantity of a good that a single producer would produce at a

specific price.

Market Supply

It represents the total quantity supplied by all producers (firms) Sum of all individual supply schedules.

Market Equilibrium 10

0

Quantity

Pri

ce

D

D

Q0

S

S

P0

E

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Macroeconomics

Macroeconomics 12

Behavior of the economy as a whole. No matter how small (national, regional, and global economies).

Study aggregated indicators such as GDP, national income, unemployment, price indices, inflation, consumption, savings, investment, international trade and international finance and the interrelations among the different sectors of the economy.

Analyze how the whole economy functions. Deals with the performance, structure, behavior and decision-

making of an economy as a whole.

Supply & Demand in Macroeconomics 13

Aggregate demand (AD) curve Quantity of domestic product

demanded at each possible value of price level

Aggregate supply (AS) curve Quantity of domestic product

supplied at each possible value of price level

0

Quantity

Pri

ce

AD

AD

Q0

AS

AS

P0

E

Gross Domestic Product (GDP) 14

GDP measures the monetary value of final goods and services, i.e. those that are bought by the final user, produced in a country in a given period of time Add up money values All final goods & services

Produced - domestic economy Sold – organized markets

Nominal GDP

GDP in current monetary units (€) Value outputs at current prices

Real GDP

GDP in constant monetary units (€) Value outputs of different years at common prices

Components of GDP by Expenditure 15

GDP (Y) is the sum of consumption (C), investment (I), government spending (G) and net exports (X – M).

Y = C + I + G + (X − M)

C (consumption) consists of private expenditures in the economy (household final consumption expenditure).

I (investment) includes, for instance, business investment in equipment (not exchanges of existing assets) and spending by households (not government) on new houses. Note that I does not include purchases of financial products. Buying financial products is classed as 'saving‘.

G (government spending) is the sum of government expenditures on final goods and services. It includes salaries of public servants, purchases of weapons for the military and any investment expenditure by a government. It does not include any transfer payments, such as social security or unemployment benefits.

X (exports) represents gross exports. GDP captures the amount a country produces, including goods and services produced for other nations' consumption, therefore exports are added.

M (imports) represents gross imports. Imports are subtracted since imported goods will be included in the terms G, I, or C, and must be deducted to avoid counting foreign supply as domestic.

Areas of Macroeconomic Research 16

Economic Growth

Understand the determinants of long-run increases in national income.

Business Cycle

Understand the causes and consequences of short-run fluctuations in national income

Economic Growth 17

0

Domestic Product

Pri

ce L

ev

el

D0

D0

Q0

S0

S0

D1

D1

Q1

E

S1

S1

C

Economic Recession 18

S

S

0

Domestic Product

Pri

ce L

ev

el

D0

D0

Q0

P0

D2

D2

P2

Q2

E

B

Recession Total output declines

(Production falls, People lose jobs)

Inward shift of AD curve

GDP in Greece 19

GDP in Eurozone 20

Business Cycles: Eurozone and Greece 21

Macroeconomic Policies 22

Stabilize the economy

Short run economic fluctuations (business cycle)

Long run economic growth

Fiscal policy

• Government revenue (taxation)

• Government expenditure

• ... Country’s debt

Monetary policy

• Money supply

• Interest rates (money demand)

• ... Exchange rates

23

Macroeconomic Stabilization

Macroeconomic Stabilization 24

Stabilization policy

Prevent or shorten recessions

Counteract inflation and stabilize prices

Economic Recession 25

S

S

0

Domestic Product

Pri

ce L

ev

el

D0

D0

Q0

P0

D2

D2

P2

Q2

E

B

Recession Total output declines

(Production falls, People lose jobs)

Inward shift of AD curve

Inflation 26

0

Domestic Product

Pri

ce L

ev

el

D0

D0

S

S

P0

D1

D1

P1

E

A Inflation

Sustained increase in price level Outward shift of AD curve

Stagflation 27

0 Domestic Product

Pri

ce L

ev

el

D

D

S0

S0

E

S1

S1

A

Stagflation

The effects of an adverse AS shift

Fight Unemployment 28

D1

D1

0 Real GDP

Pri

ce L

ev

el

D0

D0

S0

S0

E

A

Increase in output

Increase aggregate demand Government - Fiscal

policy Increase spending Cut taxes

Central Bank - Monetary policy Lower interest rates

Increase output Reduce

unemployment Raise prices

Fight Inflation 29

0

Real GDP

Pri

ce L

ev

el

D0

D0 S

S

D2

D2

E

B

Decrease in prices

Decrease aggregate demand Government - Fiscal

policy Cut spending Increase taxes

Central Bank - Monetary policy Increase interest rates

Decrease inflation (decrease prices)

Decrease output Increase

unemployment

Effects of Favorable Supply Shifts 30

0 Real GDP

Pri

ce L

ev

el

D0

D0

S0

S0

D1

D1

E

S1

S1

C

S2

S2

B

Growth enhancing structural reforms Micro policies

Increase output Reduce unemployment Price stability

31

Eurozone, Current Crisis and Stabilization

Maastricht Criteria 32

The Maastricht convergence criteria are the criteria for EU member states to enter the third stage of European Economic and Monetary Union (EMU) and adopt the euro as their currency. They impose control over inflation, public debt and the public deficit, exchange rate stability and the convergence of interest rates.

The purpose of setting the criteria is to maintain price stability within the Eurozone.

1. Inflation rates: No more than 1.5 percentage points higher than the average of the three best performing (lowest inflation) member states of the EU.

2. Government finance:

Annual government deficit: The ratio of the annual government deficit to GDP must not exceed 3% at the end of the preceding fiscal year.

Government debt: The ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year.

3. Exchange rate: Applicant countries should have joined the exchange-rate mechanism (ERM II) under the European Monetary System (EMS) for two consecutive years and should not have devalued its currency during the period.

4. Long-term interest rates: The nominal long-term interest rate must not be more than 2% higher than in the three lowest inflation member states.

Eurozone, ECB and Monetary Policy Inflexibility

33

Membership of the Eurozone establishes a single monetary policy for the respective states.

European Central Bank Fully independent Primary objective is to maintain price stability within the Eurozone (Treaty on the Functioning

of the European Union). The Governing Council defined price stability as inflation of under 2% over the medium term

(Harmonised Index of Consumer Prices for the euro area).

Member states can no longer use an isolated monetary policy to increase their

competitiveness (at the cost of other eurozone members) by Printing money and devalue, or Printing money to finance excessive government deficits or Pay interest on unsustainable high government debt levels.

If member states do not manage their economy in a way that they can show a fiscal

discipline (as they were obliged by the Maastricht treaty), they will sooner or later risk a sovereign debt crisis without the possibility to print money as an easy way out.

Eurozone and Ongoing Fiscal Compliance 34

Under the convergence criteria, member states must have their economies in order.

Stability and Growth Pact (1997) required ongoing fiscal compliance. Inflation below 1.5 %. Budget deficits below 3% of GDP. Debt-to-GDP ratio of less than 60%.

To meet these criteria, many countries had to adopt strict budgetary

reforms.

In practice, these standards were not consistently applied. weak due diligence in assessing the suitability for entry into the euro. equally weak application of the few rules that were supposed to police its operation. … paving the way for future problems.

“French” Philosophy “German” Philosophy

Discretion Active management

o Breaking rules if additional flexibility helps

Current crisis management

o Commit future to fix current crisis o No default (low interest rate) o No exit (no currency attacks)

But…. Time inconsistency problem

o What is optimal ex ante is not optimal ex post o eg. government’s temptation to default or monetize debt

Exposure in much more severe future crisis

Solidarity Fiscal union

o Fiscal transfers as an insurance /convergence mechanism o … but without fiscal control to Brussels???

Moral hazard problem

o Permanent fiscal transfers

Rules Autonomous rule-based framework – no ad

hocery o Rules guide market expectations o Commitment to rules yields long-term benefits

Future crisis prevention

o Safety valves for current crisis o (Some) debt restructuring

But … Unforeseen contingencies

Liability

No bailout clause/rule o Maastricht: Monetary bailout through monetization of

debt and fiscal bailout were made illegal.

Incentive for fiscal authority to behave

prudently o No bailout clause as a market discipline.

35

Eurozone and Stabilization Policies

“French” View “German” View

Output gap/Convergence theory Countries with lower GDP were catching up with the core

eurozone countries in which GDP was higher

Liquidity Current crisis’ funding shortages is a pure liquidity

problem.

A country’s finances are liquid if it can obtain enough funds to serve all its current funding obligations. o Financial frictions might prevent a country from

obtaining necessary funds. o A country can suffer from liquidity problems even

when it is solvent.

An illiquidity problem can easily morph into an insolvency problem.

Country’s illiquidity can be solved if central bank can print money.

Unsustainable credit boom GDP growth was simply driven by cheap credit and the

growth path was unsustainable

Solvency

Current crisis’ funding shortages is a sign of insolvency due to earlier fiscal or banking sector excesses.

A country is insolvent if providing an extra euro of

(bailout) funds yields less than the euro put in. o When tax revenues fall short of expenditures, the

extra euro will be partially used up for paying off existing creditors.

Liquidity won’t solve the underlying structural

problems.

Insolvency can be solved through structural reforms and an early debt restructuring. o Without debt default, only tax increases,

expenditure cuts or growth enhancing structural reforms can make the country solvent again.

36

Eurozone and Stabilization Policies

“French” Policy “German” Policy

Output gap and liquidity crisis

Keynesian Stimulus

(Demand side)

Increase government spending financed by government borrowing Government expenditure is more effective than tax cuts

But …

If supply does not react demand shock will simply translate into inflation

Fiscal stimulus might spill over to other countries than help the country itself (eg. imports)

Reforms in boom

Eurobonds with joint liability (solidarity)

Unsustainable credit boom and insolvency

Austerity/Reform (Supply side)

Fiscal rules to limit public debt level No extra government expenditure

Balance budget

Debt brake

Reforms in crisis Correct structural problems in public and private sector

But …

Disruptive in the short run and only boost the economy in the long run

Political economy problem (myopic politicians)

European Safe Bonds (ESBies) to avoid any joint liability

37

Eurozone and Stabilization Policies

Keynesian Stimulus: Demand Side Economics 38

D1

D1

0 Real GDP

Pri

ce L

ev

el

D0

D0

S0

S0

E

A

Increase in output

Increase AD Government - Fiscal

policy Increase spending Cut taxes

Central Bank - Monetary policy Lower interest

rates Print money

Increase output Reduce

unemployment Raise prices

Austerity and Reform: Supply Side Economics

39

0 Real GDP

Pri

ce L

ev

el

D0

D0

S0

S0

D1

D1

E

S1

S1

C

S2

S2

B

Growth enhancing structural reforms Micro policies

Increase output Reduce unemployment Price stability

40

Useful Data

Interest Rates on 10-year Government Bonds

41

Greek Current Account Balance (% GDP) 42

Greek Corporate and Household Deposits

Political Risks Business Confidence in Greece and Eurozone

44

Source: Berenberg

Nominal GDP, Real GDP, Real GDP Per Capita in the U.S.

45

The Growth Rate of U.S. Real GDP 46

Δείκτης ρύθμισης αγοράς και σχέση με την παραγωγικότητα

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