MBMC CH 17 Macroeconomics: The Bird’s-Eye View of the Economy.

MB MC

CH 17 Macroeconomics:

The Bird’s-Eye View of the Economy

CH 17 Macroeconomics:

The Bird’s-Eye View of the Economy

Chapter 4: Macroeconomics:The Bird's-Eye View of the Economy Slide 2

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Copyright c 2004 by The McGraw-HillCompanies, Inc. All rights reserved.

Introduction

The Great Depression Important dates & stats:

October 24th, 1929 "Black Thursday," recorded sales of shares hits 12,895,000

October 29th, 1929 "Black Tuesday," recorded sales of shares hits 16,410,000.

December 1930, 1350 banks have suspended operations January 7th, 1931 report on unemployment shows that 4 to

5 million Americans are out of work. 2,293 banks suspended operations during 1931 1,493 banks suspended operations during 1932 4,000 banks suspended operations in 1933


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Introduction

The Great Depression Overall Impact In the U.S.:

Factories cut production 31% Number of people without jobs nearly tripled by 1933

when the unemployment rate hit 25% Stocks lost a third of their value in 3 weeks

In Germany: Nearly a third of all workers were without jobs Banking system collapsed


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Introduction

The Great DepressionWhat was the cause?

The Federal Reserve raising interest rates?The Stock market crash?“Hoarding” of money?A rigid money supply due to the gold standard?“Sticky” Prices & Wages ?Capitalism in general?Poor economic planning?


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Schools of Macroeconomic Thought

Discussion of the causes and “cures” of the GD provide a great example of 2 distinct schools of thought on how the economy works and how gov’t “should” be involved.

Indeed, we’ll see that the GD is the basis for the different points of view.


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We have two problems: first, to meet the immediate distress; second, to build up on a basis of permanent employment. As to "immediate relief," the first principle is that this nation...owes a positive duty that no citizen shall be permitted to starve....In addition to providing emergency relief, the Federal Government should and must provide temporary work wherever that is possible. You and I know that in the national forests, on flood prevention, and on the development of waterway projects....tens of thousands, and even hundreds of thousands of our unemployed citizens can be given at least temporary employment....

--Franklin D. Roosevelt, 1932


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The proposals of our opponents will endanger or destroy our system....I especially emphasize that promise to promote "employment for all surplus labor at all times." At first I could not believe that anyone would be so cruel as to hold out a hope so absolutely impossible of realization to these 10,000,000 who are unemployed....If it were possible to give this employment to 10,000,000 people by the government, it would cost upwards of $9,000,000,000 a year....It would pull down the employment of those who are still at work by the high taxes and the demoralization of credit upon which their employment is dependent....It would mean the growth of a fearful bureaucracy which, once established, could never be dislodged.

--Herbert Hoover, 1932


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Introduction

The Great DepressionThe (FDR/ “Keynesian”) response:

Macroeconomic policieso Government actions designed to affect the

performance of the economy as a whole» Monetary Policy & Fiscal Policy


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Macroeconomic Policy

Monetary PolicyDetermination of the nation’s money supplyControlled by the central bank or, in the

U.S., the Federal Reserve System (Fed)By changing the money supply,

government can affect the economy (output, employment, interest rates, inflation, stock prices, the value of the dollar).


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Monetary Policy

The Fed can increase money supply (buy bonds from the public, or decrease required reserves) to lower interest rates in an attempt to stimulate the economy during periods of downturn

= expansionary monetary policyThe Fed can decrease the money supply

(sell bonds, increase required reserves) to lower interest rates and slow the economy down.= contractionary monetary policy


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Fiscal PolicyDecisions that determine the government’s

budget, including the amount and composition of government expenditures and government revenues

TaxationGovernment spending



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Fiscal policy influences the balance between government spending and taxes:A deficit occurs when government

spending is greater than tax revenue.A surplus occurs when government

spending is less than tax revenue.The national debt is the summation of

previous year’s deficits



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Fiscal Policy

The government is our largest consumer and can spend money to stimulate the national economy (think FDR and the New Deal).

The government can also decrease taxes to put more money in the hands of individual consumers.

These are “expansionary fiscal policy”


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Macroeconomic Issues

“Economic growth” The “standard of living” Productivity The price level & inflation Recessions, expansions and business cycles Unemployment Measurement issues (aggregation and

indices)


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Macroeconomic Goals

There are some things that everyone can agree on…

Goals:

1. Rapid economic growth

2. “Full” employment

3. Stable prices


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How to achieve those goals?

Schools of thought

1. Conventional wisdom (“Classical Theory”) = leave the economy alone

2. J.M. Keynes = the economy needs guidance, hence government should intervene into markets through monetary and fiscal policy


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The Major Macroeconomic Issues

The “Standard of Living” The degree to which people have access to goods

and services that make their lives easier, healthier, safer, and more enjoyable

Output per person produced in a nation(note: this is not the same as output per worker)

What is not included in this definition?

(leisure time, good health, clean environment …)


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Standard of Living

Beginning of the 20th century:Typical work week = 60 hoursAnnual salary = $450 ($8,000 in today’s $)Average life expectancy = 47 years

End of the 20th century:Typical work week = 35 hoursAnnual salary = $35,000 + benefitsAverage life expectancy = 76 years


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Standard of Living

Why have we seen these changes in the standard of living over the past 100 years?Rapid economic growth! Productivity (output of goods and services)

has grown faster than the population.


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Economic GrowthA process of steady increases in the

quantity and quality of the goods and services the economy can produce.

How should we measure economic growth?

Real GDP


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Real Gross Domestic Product

Real GDP = the market value of final goods and services produced in a nation in a given year. “Market value” = price x quantity ($) Only include “final” goods and services because

we don’t want to “double-count”. “In a nation” = within the physical borders of the

country, regardless of who owns the company. Eg: value of Honda cars produced in Ohio counts in US

GDP Calendar year of when it was produced.


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The 3 Faces of GDP

Gross Domestic Product measures output of our nation, but also measures expenditure by households (consumption), businesses (investment), government (gov’t purchases) and the foreign sector (exports – imports).

Since every dollar spent is also a dollar earned, GDP also measures incomes of capital (payments to owners of capital) and labor (wages and salaries).

Note: capital income = 25%, labor income = 75%


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Nominal vs. Real GDP

Real GDP is a measure of output, expenditure or income expressed in values in a base year rather than in current prices. As such, real GDP measures actual physical volume of output.

Nominal GDP values GDP at current prices and as such measures the current dollar value of production.

Which is a better measure to use in gauging changes in output between years?


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Real GDP

Is Real GDP a good measure of economic well being? Good, but not great. Higher GDP generally means higher incomes, but

many factors that contribute to “well being” are not measured in GDP because they are not sold in markets.

Leisure time Environmental quality Income equality Underground economy

Each of these may have an inverse relationship with GDP


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GDP

Interesting question: How has the increase in women's participation in the labor force affected GDP? Women now producing output that is measured

and included in GDP Families now paying for goods and services that

were previously produced without being counted

• The increase in female labor force participation has overstated GDP growth.


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Percentages of American Men and Women over Age 16 Working Outside the Home, 1960 - 2001.

• Increase in female labor force participation increases the demand for housekeeping and child care.

• Unpaid household work is not counted in GDP.• Paid household work is counted in GDP.• The increase in female labor force participation has overstated GDP growth.


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GDP

Female labor force participation is now more than 50% higher than in the 60’s

Why has female participation in the labor force increased so much? Changes in social customs and normsThe principle of comparative advantage


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Output of the U.S.Economy, 1900-2001

In 2001 output of the U.S. economy was:•25 times the 1900 level•5 times the 1950 level


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Output per Person and per Worker in the U.S. Economy, 1900-2001

In 2001:•Output/person was 7 times the 1900 level•Output/worker was 5 times the 1900 level


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ProductivityIn 2001 the average U.S. worker could

produce five times more than in 1900.Average labor productivity:

workeremployed per output employed people of Number

output Total


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ProductivityU.S. trends in output per employed worker

1950 - 1973: increased 2.1%/yr1973 - 1995: increased less than 1%/yr1995 - present: increased nearly 2%/yr


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Productivity and Living Standards in China and the United States

2001 United States China

Output $10,200 billion $1,160 billion (U.S.)

Population 285 million 1,262 million

Employed 135 million 710 million

Output/person $35,790 $919

Average labor productivity $75,556 $1,634


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Recessions, Depressions & Expansions

The economy does not grow at a constant rate at all times. Rather, we experience ups and downs in output.

These cyclical ups and downs are called the “business cycle”

Recession = 2 consecutive quarters of declining aggregate output

Depression = a prolonged, deep recession (no common definition)


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Recessions: slowdowns in economic growth•1930s (depression); 1941-’45; 1973-’75; 1981-’82; 1990-’91;2001


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Recessions, Depressions & Expansions

Expansions are periods of rapid economic growth

The most notable recent period of expansion lasted nearly 11 years, from 1991 - 2001


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Expansions: periods of rapid economic growth•1945-’48; 1961-’69; 1975-’80; 1982-’90; 1991-2001


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Employment & Unemployment

The unemployment rate is the percentage of the labor force* that is unemployed.

= an excess supply (surplus) of labor.

* A person must be > 16 years old, not working but available for work, and be actively seeking employment during the last month to be considered unemployed.


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The U.S. UnemploymentRate, 1900-2001

The unemployment rate:•% of the labor force that is out of workObservations:•Rises during recessions•Always greater than zero


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Increases In Unemployment During Recessions

Unemployment rate at beginning of recession (%)

4.8 (Nov. 1973) 9.0 (May 1975) + 4.2

6.3 (Jan. 1980) 10.8 (Nov./Dec. 1982) + 4.5

5.5 (July 1990) 7.8 (June 1992) + 2.3

Peak unemployment

rate (%)

Increase in unemployment

rate (%)


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Unemployment rates differ from country to country: For the past 20 years, more than 10% of the

European workforce has been unemployed. European unemployment is double the rate in the

U.S. During the 1950s & ‘60s, the European

unemployment rate was generally lower than in the U.S.


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Employment & Unemployment

Is all unemployment the result of macroeconomic changes?

Should we ever expect zero unemployment?

Why doesn’t the labor market clear (wages decrease) to eliminate the surplus?


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Unemployment

Is all unemployment the result of macroeconomic changes?

Some of it is, but not all… 3 types of unemployment:

FrictionalStructural Cyclical


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Unemployment

Frictional Unemployment is generally short term unemployment that results from the time it takes to properly match a new employee with a particular job.

From the worker’s perspective, this is unemployment that may be experienced as you “search” for a new job.

Is frictional unemployment bad? No. in fact it can be argued that this type of

unemployment is good and an essential part of a smoothly functioning economy.


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Unemployment

Structural Unemployment is long-term and chronic unemployment that exists even with the economy is producing at a normal rate.

A change in required skills, a lack of skills, language barriers, discrimination and structural features of the labor market (eg: min wages and labor unions) may result in this type of unemployment.

This type of unemployment may result from rapid technological change.


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Unemployment

Labor UnionsBenefits

Reduced worker exploitationSupport progressive labor legislationIncrease productivity (training, standards)Promote democracy in the workplace


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Unemployment

Labor UnionsCosts

Unions cause otherwise competitive labor markets to function inefficiently – disequilibrium and associated loss of surplus.

Unions may prevent companies from competing in the global economy.


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Unemployment

Cyclical Unemployment is the extra unemployment that occurs during periods of recession.

Typically short-lived and associated with downturns in productivity and output (GDP).


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Inflation & Deflation

Inflation is a sustained increase in the overall price level.

Deflation is a sustained decrease in the overall price level

OK, so what is the “price level”?


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The Price Level is the average level of dollar prices in the economy.

Consider prices in NYC in 1905: 1 pound of coffee = $0.15 Broadway show = $0.40 A new suit= $6.00 Annual tuition at a private college = $200

Are these price changes the result of Microeconomic (individual market) changes?

Partially, but micro changes likely only account for a very small fraction of the price changes


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Inflation and Deflation

Most measures of the price level are reported in the form of an INDEX – a series of numbers that each represent a specific period, and are only meaningful when compared to each other.

The most widely used index for the price level is the Consumer Price Index (CPI), which is tracked and reported by the Bureau of Labor Statistics (BLS)


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The CPI uses a “market basket” of goods and services typically bought during a base period (1993-1995).

This basket actually contains nearly 80,000 individual products, which are priced and re-priced at regular monthly intervals.

The price of these goods are expressed in terms of a percent of the base period’s price.


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CPI example: In April 2003 the CPI reached 183.8 This means that the cost of the total

market basket amounted to 183.8 percent of the base period cost.

Another way of looking at it is that a typical item costing $1.00 in the base period cost $1.84 in April 2003.


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Inflation & Deflation The base year used for the CPI really doesn’t

matter for estimating inflation:

Example: April 2003 CPI = 183.8 March 2002 CPI = 165.1

This means that prices in April 2003 were 183.8/165.1 = 1.113 times higher than they were a year earlier.

This means that prices increased by 11.3 percent over this time period.


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The U.S. Inflation Rate, 1900-2001

Inflation•The rate prices in general are increasing over time•Varies over time -- high in the ‘70s and low in the ‘90’s and today•Varies between countries -- in 2001 3% in U.S. & 400% in Ukraine


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National economies are becoming increasingly interdependent:In 1999 the U.S.:

Exported 10.8% of all goods and services produced.

Imported 13.3% of the goods and services used by Americans.


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The international flows create political and economic issues:The impact of trade on jobs

The steel and textile industriesTrade agreements (NAFTA)

Trade imbalancesWhen exports and imports differ significantlyTrade deficit: exports < importsTrade surplus: exports > imports


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Exports and Imports as a Share of U.S. Output, 1900-2001.


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Macro Issues in the News

Off shoring or OutsourcingUS corporations are sending jobs

overseas.Instead of hiring American workers at

home, corporations are hiring foreign workers to do the same jobs.

Examples: call center work (tech questions for computer or cell phone users), software development, software debugging.


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Off shoring or Outsourcing

Keep it simple: all that is happening is that US firms are purchasing labor from another country.So, Red Sox fans are outsourcing jobs to

the Dominican Republic! This is no different than any other form

of international trade, which is no different from any other form of trade.


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Off shoring or Outsourcing What are the causes of this

phenomenon and is it bad or good for the US? Causes:

Technology has made the world very smallThe principle of comparative advantage and

low hanging fruit – use the low opportunity cost resources first.

Countries like China and India have finally loosened their trade barriers and are pushing the exportation of goods, including labor.


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Is off shoring “bad”?Obviously if you lose your job it is bad for

you, but … Countries with the lowest barriers to

trade also have the highest rates of economic growth and vice versa.

We can use supply and demand to see that it can’t last forever…


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Importing goods from other nations results in higher demand for those goods. So, as we demand more and more foreign labor… Market wages in foreign countries must rise

(eg: real wages in southern China are 6 times higher than they were 20 years ago)

Eventually, wages will equilibrate between nations.


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Finally, no one ever says anything about Insourcing (foreign firms outsourcing to the US) which is also on the rise.

Trade creates wealth and makes everyone better off.

What type of unemployment is created by outsourcing?


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Social Security

Benefits are funded via a Social Security payroll tax. This tax is 6.2% of an employee's income paid directly by the employer, and 6.2% deducted from the employee's paycheck, yielding an effective rate of 12.4% of an employee's income.

Benefits from the program are paid out according to a detailed formula. The amount of benefits in retirement is typically based on the total accumulation of Social Security Income over a beneficiary's working career.


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Social Security is not a retirement fund. It is principally an age-based income subsidy which uses a special tax system to ear-mark funds to support it.

The Social Security “Crisis” Social security is “pay-as-you-go” system: SS

taxes on currently working individuals are collected and used to pay current recipients (there is no SS “trust fund”).


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Since its beginning, the revenues raised have exceeded the mandated benefit levels. The US government spends that extra money and issues Treasury bonds (IOUs) to the Social Security Trustees.

Example: At the end of 2003, the cumulative excess of Social Security taxes received over benefits paid out was more than $1.5 trillion.

In the past, SS recipients have done quite well, receiving more benefits than they paid in, because there were so many more workers than retired people.


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Now, the number of retirees is growing faster than the number of people entering the system and paying new taxes.

According to most projections, the Social Security trust fund will begin drawing on its Treasury Notes around 2018 or 2019, at which time the repayment of these notes will have to be financed from the general fund.


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SS

At some time thereafter, around 2042 (depending on who is doing the estimating) the Social Security Trust Fund will have exhausted the claim on general revenues that had been built up during the years of surplus.

This payout from general revenues will require tax increases, selling other government assets, or borrowing from the private sector. Some have argued that this potential future requires changes to the system. These people argue that Social Security is facing a "crisis" -- Bush described it as a "structural problem" and then said that Social Security "is on the road to bankruptcy"


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President Bush is now calling for “privatization” of SS system. In other words, he is proposing cutting SS benefits (to make up the shortfall), but allowing individuals to make-up some of that lost benefit by seeking higher returns in the stock market.

Hello? What’s going to happen when they flop?


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Controversy: the projections of payouts vs. revenues are based upon estimates of economic growth.

Demographic projections are also estimates. For example, people are living longer – does this mean longer payout or are they working (and therefore paying into SS) longer too?


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The other side of the story The problem really isn’t that big. A recent

CBO report finds that extending the life of the SS into the 22nd century, with no change in benefits, would require additional revenues equal to only 0.54 percent of GDP, which is less than 3 percent of federal spending – much less than we're currently spending in Iraq.

Given that, it is easy to come up with fiscal packages (taxes) that would secure the retirement program, with no major changes, for generations to come.


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Some estimate that restoring one quarter of the recent tax cuts on the richest 1% of Americans would provide indefinite solvency for the system without cutting benefits at all.

Other solutions: Remove the cap on SS taxable income (which

essentially makes the SS tax regressive in nature) Increase the age of retirement Balance the budget?

MBMC CH 17 Macroeconomics: The Bird’s-Eye View of the Economy.

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Transcript of MBMC CH 17 Macroeconomics: The Bird’s-Eye View of the Economy.