Macroeconomics II - CERGE-EIhome.cerge-ei.cz/tlichard/teaching/macroII/L01handout.pdf · Ball, L....
Transcript of Macroeconomics II - CERGE-EIhome.cerge-ei.cz/tlichard/teaching/macroII/L01handout.pdf · Ball, L....
-
Info on the courseIntroduction
ConsumptionConclusion
Macroeconomics IILecture 1: Consumption
Tomáš Lichard
IES (Summer 2017/2018)
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Contacts
Instructor: Tomáš Lichard
Where to find me: Office 120, CERGE-EI building (Politickýchvězňů 7)When to find me (office hours): Tuesdays 9:30-11:30 or byappointmentHow to contact me: [email protected] website: home.cerge-ei.cz/tlichard/teaching/macroII
Tomáš Lichard Macroeconomics II
mailto:http://home.cerge-ei.cz/tlichard/teaching/macroII
-
Info on the courseIntroduction
ConsumptionConclusion
Literature
Primary textbook: N. Gregory Mankiw (2010):Macroeconomics 7e. Worth Publishers.
Other sources:
Ball, L. and N.G. Mankiw (2011): A New Approach toIntermediate Macroeconomics, Worth Publishers.Burda&Wyplosz (2012): Macroeconomics: A European Text6e.Additional reading may be assigned during the course
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Grading
The grading will be based on homeworks and a final exam:1 Two homeworks (30% of the grade)2 Final exam (70% of the grade)3 As an insurance, you can obtain bonus 10 points above the
maximum for activity (mainly at exercise sessions)
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Introduction
Last semester, you covered economy in the long run
What does it imply about output and prices?
This semester we will cover economy in the short run:
Recessions, depressions: what can we do about them, ifanything?
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Consumption & Investment
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
10
20
30
40
50
60
70
Sharesofgrossdomesticproduct:Personalconsumptionexpenditures
Sharesofgrossdomesticproduct:Grossprivatedomesticinvestment
Percent
ShadedareasindicateU.S.recessions Source:U.S.BureauofEconomicAnalysis myf.red/g/iGEU
2530
3540
4550
%
1995q1 2000q1 2005q1 2010q1 2015q1Quarter
Share of private consumptionShare of gross capital formation
Own work based on CSO data
Shares on GDP (Czech Republic)
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Consumption and investment
Consumption is the biggest part of GDPInvestment constitutes relatively lower share, but on the otherhand its much more volatile
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
-30
-20
-10
0
10
20
30
40
50
60
70
RealPersonalConsumptionExpenditures
RealGrossPrivateDomesticInvestment
Pe
rce
nt
Ch
an
ge
fro
mY
ea
rA
go
ShadedareasindicateU.S.recessions Source:U.S.BureauofEconomicAnalysis myf.red/g/iHbN
This means that these two variables are an important factorwhen trying to explain business cyclesTomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
Keynes’ Basic Arguments
His ideas (based upon introspection and casual observations)were centered around:
1 Marginal Propensity to Consume (MPC) – 0 < c < 12 Average Propensity to Consume (APC) – decreasing with
income3 Income as the primary determinant of consumption, interest
rate has little role
Based on this, we can express Keynes’ idea as:
C = C + cY
where:C > 0, 0 < c < 1
Note that APC = CY =CY + c
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
Empirical Support
On average, households with higher income really consumemore in absolute terms
They also save more, that would imply that really0 < MPC < 1.
Once controlled for income, interest rate does not have a(big) effect on consumption
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
But what do you make of this graph?
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
Failures
Based on the Keynes’ consumption function, householdsshould consume less and less of their income, meaning theywould save more and more, leading to problems withaggregate demand – it predicts secular stagnation
However, after the WWII income rose, but savings didn’t
Kuznets created a dataset containing aggregate data onincome and consumption from 1869 to 1940s -consumption-saving ratio was stable
⇒ There seem to be 2 relationships:1 In the short run, consumption function exhibits falling APC2 In the long run data showed stable APC
So we have to reconcile these two relationships
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
Intertemporal Budget Constraint
Let’s assume 2 periods:
S = Y1 − C1 (1)C2 = (1 + r)S + Y2 (2)
Combining these two equations we get:
C1 +C2
1 + r= Y1 +
Y21 + r
So in conclusion Fisher model shows that current consumptionis a function of (expected) lifelong income (cf Keynes’ view)
How does it look graphically?
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
Optimization problem
Consumer wants to maximize his or her “life-time” utility
max U(C1,C2)=u(C1)+βu(C2)
s.t.:
C1 +C2
1 + r= Y1 +
Y21 + r
How does it look graphically?
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
Comparative statics
What happens if the income increases?
What happens if the interest rate increases?
Substitution vs. income effect
Income effect: movement to a higher indifference curveSubstitution effect: movement along the indifference curve
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
Liquidity constraint
However, in real world it is not that easy to borrow against apromise of higher future income (students are familiar withthis)
What happens if you are liquidity constrained?
In the most extreme scenario C1 = Y1
Two cases:1 Constraint is not binding2 Constraint is binding
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
LCH — Basic Idea
Modigliani, Ando & Brumberg: people like to smooth theirconsumption - they move income from periods when it is highto periods when it is low
If W is current wealth, and consumer lives for T additionalyears and works for R of them, then annual consumption is:
C = (W+RY )/T
This implies that the aggregate consumption function is:
C = αW + βY
APC then is: C/Y = α (W /Y ) + β
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
LCH
The above solves the conflict between long-run and short run:
in the short run the wealth is almost fixed, so APC isdecreasingin the long run the wealth changes with income, so APC isconstant
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
Empirically...
Elderly dissave much less than what would be predicted byLCH. Possible reasons:
1 Precautionary saving (but people can insure against manyrisks)
2 Bequests (altruism towards their children)
Kopczuk&Lupton (2007) estimated that approximately half ofthe positive net worth at time of death in their sample is dueto a bequest motive, rest is precautionary saving
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
PIH — Basic Idea
Developed by Milton Friedman, extension of the LCH
People experience random and temporary changes in theirincome from year to year
Y C = Y P + Y T
Change in income can be caused by changes in Y P or Y T
(Compare a farmer with a macroeconomics lecturer)
Consumption depends on permanent income, because peoplewill smooth consumption during transitory changes in income
⇒ C = αY P
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
PIH — Basic Idea
Friedman’s conclusion: Keynes’ function uses the wrongvariable:
APC =C
Y=αY P
Y
How does this explain our graph?
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
Random-Walk Hypothesis – Hall (1978)
If PIH holds and consumers have rational expectations, theconsumption should only change with unexpected shocks:
Ct+1 = Ct + εt+1
where εt+1 follows an iid process with zero mean independentof Ct – in that case the equation is an example of what instatistics is called a random walk
this implies that Et (Ct+1) = Et (Ct) + Et (εt+1) = Ct
In other terms, consumption should be a martingale process:Et (Ct+1 | Ct ,Ct−1...C0) = Et (Ct+1 | Ct) = Ct
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
One-dimensional random walk – example
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
Random-Walk Hypothesis – Hall (1978)
This gives us a testable hypothesis—Hall (1978) tested it:1 Past real disposable income (Yt) has no predictive power for
Ct+12 Indeces of stock prices have predictive power for Ct+1, which
violates pure PIH
Conclusion: evidence supports a modified version of PIH
However, since this study researchers have found more casesof deviation from PIH
1 consumers do not have rational expectations2 consumers are credit constrained
But some research shows (Havranek&Sokolova, 2016) that ifyou account for liquidity constraints, PIH is not a baddescription of reality
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
Time-inconsistent Plans
Behavioral economics: people are rational only boundedly;they may have what is called present bias
They may change plans as time passes (think of: “I will startgoing to gym/stop smoking/etc tomorrow”)
Example:1 Q1: Would you prefer $10 today or $20 in one week?2 Q2: Would you prefer $10 in 100 days or $20 in 107 days?
Rational model: pick the first or the second option in bothcases
However, a lot of subjects in experiments choose first optionin Q1 and second option in Q2 - this is often called hyperbolicdiscounting
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
Keynes’ Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
Hyperbolic discounting
0 10 20 30 40 500
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
Time
Insta
nta
neous u
tilit
y
βt
1/(1+β × t)
This can pose a problem for voluntary pension systems, saving,health care systems... (see Thaler&Sunstein (2008): Nudge.)
Tomáš Lichard Macroeconomics II
-
Info on the courseIntroduction
ConsumptionConclusion
What have we learnt?
Consumption is an important component of GDP, thereforethey are crucial for understanding business cycles
We took a look at how consumption is determined accordingto various hypotheses:
Keynes: depends on current income (constant MPC,decreasing APC)Intertemporal choice: consumers take into account their futureincomeLife-cycle hypothesis: consumers spend according to the stageof the life cycle they are inPermanent income hypothesis: consumer spend according totheir lifelong (permanent) income
Random-walk: if PIH is true, consumption should be arandom walk, which is partially observed
Tomáš Lichard Macroeconomics II
Info on the courseIntroductionConsumptionKeynes' Consumption FunctionBeginnings of Intertemporal Analysis - Fisher ModelLife-cycle Hypothesis (LCH)Permanent Income Hypothesis (PIH)Random-Walk HypothesisBehavioral Views
Conclusion