Adv. Macroeconomic Flashcards
BBNN: a model of disequilibrium. it summarizes the different conflicts that arise in an economy. in this model, we look at two control variables in the economy, domestic aggregate demand and competitiveness (the wage in dollars).
how the control variables are managed?
the aggregate demand is affected by monetary and fiscal policy.
the degree of competitiveness depends on the cost of the factors of the population. i.e. wage policy, nominal exchange rate.
BB: external equilibrium
the Balance of payments is the sources and uses funds statement of a country. it summarizes the transactions between a country and the rest of the world.
Sources of funds for a nation, i.e. exports or loans received and investments performed by foreigners in our country, are recorded as positive.
Used of funds, such as imports or investments in foreign countries, are recorded as negative.
When all the components of the balance of payments are included, it has to add to zero at all times.
there has been a long history regarding how to measure external sustainability/international trade imbalances (i.e. contains goods, services, payments).
Current accounts defined as total output minus the domestic aggregate demand (Y-C-G-I) incl. trade balance of goods/services/the income accounts. it’s a standard used to evaluate the sustainability of any given country. lately, there is an adjusted current accounts to track capital gains, hence including all dividends, interest rates, and transfers. denoted as CABB. when CA is in equilibrium, export equal imports. when CA is not in equilibrium, it’s either a situation of surplus or deficit.
there are 3 dimensions of external sustainability: trade balance, current account, and the balance of payments (narrowly defined).
Trade balance: export minus imports of goods and services. in BBNN, it’s denoted as TBBB.
Narrowly defined balance of payments: incl. the current accounts plus all the capital account excluding bank changes in reserves. it’s denoted as ΔR=0, meaning the change in reserve is what is zero, and not the full balance of payments.
when domestic aggregate demand increases while competitiveness remains the same (production capacity remains the same), the economy moves to a situation of deficit. Two reasons for this: 1) demand increase requited an increase in imports. 2) agents are consuming more domestically and less products are available to be exported.
when the competitiveness increases (production capacity increases) while the demand is the same, export tends to increase, import tends to decrease, eventually the surplus will be generated in the trade balance.
it has to be the case that if we move from the place where there was a deficit, to the place where there is a plus, there is a point at which the trade balance is zero. if we draw the straight-line from original dot to the new dot, we derive the combination of all aggregate demand and degrees of competitiveness at which the trade balance is in equilibrium. the line is upward sloping.
The diagnostic of any economy involves the assessment how far the economy is away from the equilibrium line.
US is becoming a world debtor from a world creditor. The first theory assumes that US has such a bright future that all consumers knew future income was going to be higher - so high that it justified running a deficit today. the second theory assume some sources of income were accounted in the current account for US. most explanation are based on unreported/unaccounted capital gains.
3rd theory explains that US has particular production and set of assets that allow it to earn additional income. i.e. American debts are better quality assets than Chinese debt. if the additional quality can earn a premium, it can finance US consumptions.
4th theory: US is not sustainable.
NN: internal eqilibrium . the internal market refers to how the economy uses the factors of production. often we talk about labor market.
Two situations of disequilibrium in labor market: unemployment and overheating. in situation of unemployment, real wages tend to decrease and overqualified people accept a compromised salary. at overheating, real wages tend to increase and the same workers are offered a higher wage. A situation of equilibrium is one in which salaries do not change. it has more to do with salaries and wages, than with bodies searching for a job.
The employment rate at which salaries are not changing is called the natural rate of unemployment. it’s possible that one country has different levels of unemployment that correspond to natural rate of unemployment at different points in time due to reasons such as new immigration policies, structural reforms, retirement ages changed. it’s also possible the rate is different across the regions of a country due to some restrictions or barriers between the regions.
the real wage is the wage adjusted by inflation. it’s related to the purchasing power of the workers. when it’s overheating, wages are going to increase faster than inflation to provide a higher real wage, a higher capacity to purchase. the opposite occurs under unemployment.
BBNN labor market equilibrium:
with a constant domestic demand, decrease of competitiveness of firms leads to decreased production or bankruptcy –> reduction in hiring –> works tend to accept lower wages –> unemployment
BBNN labor market equilibrium:
with a constant competitiveness, increased domestic demand –> firms’ expansion of production –> want to hire more people –> higher salary for job seekers
In BBNN graph, we move from unemployment to overheating, we connect the original dot with the dot where the labor market is in equilibrium, we have a downward sloping straight line. above the line, there is overheating. below the line is unemployment. in short, decrease in aggregate demand need to be compensated by increase in the degree of competitiveness to keep demand and supply of labor equal.
The bigger the current account deficit it is, the farther the economy is from BB. the larger the unemployment rate is, the father the economy is from NN.
Competitiveness actually has at least two dimensions: productivity and the labor cost compared to the one in other countries. in BBNN model, vertical axis “Competitiveness” only indicates labor cost, excluding productivity.
wage in dollar is denoted as w/e, w is average wage in the economy in local currency, e is the nominal exchange rate measured as the quantity of local currency needed to buy foreign currency. in BBNN graph, since wage in dollar is inversely proportional to the competitiveness, the vertical axis is indicated as e/w.
the nominal exchange rate: the price at which two currencies are exchanged.
the real exchange rate: the relative price of the consumption baskets between two countries.
two rates are identical when all goods are traded and their prices satisfy the Law of One price. the relative price of the two consumption baskets is exactly the same as the nominal exchange rate.
in UK and US, the exchange rate is the numbers of foreign currencies that an EURO or US dollar can purchase. in rest of world, it’s the number of local currency that one foreign currency can buy.
the law of one price is an active wear is research in economics.
economic analysis date :www.tradingeconomics.com
a labor market in equilibrium does not necessarily mean the economy is booming or everybody has a job. being in the natural rate of unemployment just means wages and inflation are changing at the same rate.
Contingent unemployments is that workers have jobs but in the long run those jobs are not sustainable in the form that those wages are increasing at a slower rate than inflation, which defines a situation of unemployment.
when government have policy to increase aggregate demand, it will move the economy to the right in BBNN model. when it decrease the demand, it will move it to the left. when it moves to the left, the policy is called tightening policies. i.e. increase interest rate, increase central bank cash reserves to reduce cash in circulation in order to further reduce lending, increase tax,
Fiscal (taxes or expenditure) and monetary policy (interest rate, print money) move the economy right and left in BBNN model.
wage and exchange rate policy moves the economy up and down.
the multilateral currency is a weighted average of foreign currencies. there are several ways to do the weighting. i.e. b countries’ GDP, financial markets, the trades.
e in BBNN model is the mount of domestic currency required to purchase one unit of the multilateral currency. when a devaluation happens, e increases.
to increase competitiveness (e/w), two ways: decrease wage in local currency, or depreciate the exchange rate to increase e.
when an economy is in top quadrant –> policy: increase wage in local currency, or appreciate exchange rate to increase wage in foreign currency.
when economy is in bottom quadrant –> do opposite
a surplus means that the country is earning more than what it’s spending. when the society is accumulating savings, it will need to start consuming such saving. so when the economy is having a surplus, the demand will tend to increase.
A current account surpluses leads to an increase in demand (higher consumption) in the future.
Republican can argue that cutting taxes is more effective than increasing expenditures, while democrat will argue otherwise.
Countries remain in deficit situation for a long time and then only after a massive crisis the demand will go down. it will take a long time to reach equilibrium through automatic adjustment process, instead of active policy. Active policy plays a much bigger role, especially demand management policies in the adjustment process.
Social peace line is as the minimum standard of living acceptable by our citizens.
The difference of each country’s SP line can tell the trade off between wages and domestic demand (here demand includes social well fare coming from government expenditures, democracy, corruption, freedom of speech, civil right, public health care, etc. - quality of living)
Rudi Dornbusch called the equilibria position of full employment and current account in equilibrium “IMF equilibrium”. the position of unemployment and CA in equilibrium as “EU equilibrium” (salaries and standard of living are high) the position of deficit and full employment as “populism” (wages are high, but it is at expense of borrowing). none of these equilibria are sustainable in the long run.
Since there are more complex forces in labor market than in finance market, it takes much longer for labor market to move to next stage in a cycle.
When Latin triangle expands, the political positions become more polarized than in the smaller triangle. to shift economy to another quadrant, it takes different political party vs current one.
“Inequality in the long run” by Thomas Piketty and Emmanuel Saez
The resulting “World Top Incomes Database” (WTID) is the most extensive data set available on the historical
evolution of income inequality. The series is constantly being extended and updated and is available online (http://topincomes.parisschoolofeconomics.eu/) as a research resource for further analysis.
Three Facts About Inequality in the Long Run
1. income inequality
whereas income inequality was larger in Europe than in the United States a century ago, it is currently much larger in the United States. This is true for every inequality metric. The simplest and most powerful measure, on which we focus in this article, is the share of total income going to the top decile.
Wealth inequality
the same “great inequality reversal” between Europe and the United States when we look at wealth inequality rather than income inequality.
Compared with income inequality, there are different dynamics for wealth inequality:
1. wealth concentration is always much higher than income concentration. The bottom half of the population hardly owns any wealth, but it does earn
appreciable income: On average, members of the bottom half of the population (wealth-wise) own less than one-tenth of the average wealth, while members of the bottom half of the population (income-wise) earn about half the average income.
In sum, the concentration of capital ownership is always extreme, so that the very notion of capital is fairly abstract for large segments—if not the majority—of the population. The inequality of labor income can be high, but it is usually much less extreme. It is also less controversial, partly because it is viewed as more merit-based. Whether this is justified is a highly complex and
debated issue to which we later return.
Looking back US history, wealth concentration has been
high throughout U.S. history with around 70% top decile wealth share. another 20-30% fraction correspond to the share owned by middle 40%.
pre-WWII, there was basically no wealth middle class and the top decile wealth share in EU was close to 90%, which fell dramatically after WWII to less than 60% (65% in UK and less in rest of EU). In other words, the wealth middle class now commands a larger share of total wealth in Europe than in the United States—although this share has been shrinking lately on both sides of the Atlantic.
Given that wealth inequality is lower in the United States today than in 1913 Europe, why is U.S. income inequality now as large as (or even slightly larger than) that in 1913 Europe? The reason is that modern U.S. inequality is based more on a very large rise of top
labor incomes than upon the extreme levels of wealth concentration that characterized the “patrimonial”
(wealth-based) societies of the past.
In 1913 Europe, top incomes were predominantly top capital incomes (rent, interest, and dividends) coming
from the very large concentration of capital ownership. Top U.S. incomes today are compose about equally of labor income and capital income. This generates approximately the same level of total income inequality, but it is not the same form of inequality.
In terms of wealth-to-income ratio, on the eve of WWI, net private wealth was about equal to 6-7 years of national income in EU and 2-3 years in 1950s and back to 5-6 years now. Similar pattern for Japan. While in US, the curve is flatter. through the whole century, US as generally 4-5 years with a slight U-shape curve.
The United States is the land of booming top labor incomes; Europe is the land of booming wealth (albeit with a lower wealth concentration than in the United States). These are two distinct phenomena, involving
different economic mechanisms and different parts of the developed world.
The fall of European wealth-income ratios following the 1914–1945 capital shocks can be well accounted for by three main factors: direct war-related physical destruction of domestic capital assets (real estate, factories, machinery, equipment); lack of investment (a large fraction of 1914–1945 private-saving flows was absorbed by the enormous public deficits induced by war financing; there was also massive dissaving in some cases, e.g., foreign assets were sold to purchase government bonds; the resulting public debt was eventually wiped away by inflation); and a fall in relative asset prices (real estate and stock market prices were both historically very low in the immediate postwar period, partly due to rent control, nationalization, capital controls, and various forms of financial repression policies).
nn
Intuitively, in a low-growth society (low population and productivity growth), the total stock of capital accumulated in the past can become very important. in such society with zero growth, at some point, the saving will stop work and the additional capital units become useless since capital/wealth-to-income ratio will become infinite.
why the United States accumulates structurally less capital relative to its annual income than Europe and Japan? Since U.S. population growth rates exceed 1% per year, thanks to large immigration flows, its growth rate is 2% while Eu and JP have close to zero population growth. this explain the low saving rate of US on aggregated level.
In particular, it is critical to realize that r – g (r is rate of return of capital and g is growth rate) was very large during most of human history (Fig. 4). Growth was very low until the industrial revolution. This large gap between r and g explains why wealth concentration was so large until World War I and why wealth concentration was smaller in the United States, where population growth was faster.
nn
To the extent that population growth (and possibly productivity growth) will slow down in the 21st century, and that after-tax rates of return to capital will rise (due to rising international tax competition to attract capital, and maybe also to changing technology), it is likely
that r – g will increase again in the 21st century, which could lead to a structural rise in wealth concentration.
nn
We stress, however, that our ability to properly measure and monitor the dynamics of the global distribution of wealth is far from being satisfactory. National statistical institutes as well as international organizations are facing major difficulties in tracking down cross-border wealth, and magazines are ill-equipped to produce rigorous statistics. Despite some recent progress in this area (28), our ability to measure global wealth is also severely limited by the rise of tax havens (29).
nn
What are the main forces that determine the level of labor income inequality in the long-run? The most widely used economic model is based on the idea of a race between education and technology (30). That is, the expansion of education leads to a rise in the supply of skills, while technological change leads to a rise in the demand for skills. Depending on which process occurs faster, the inequality of labor income will either fall or rise.
Inequality does not follow a deterministic process. Which factor dominates depends on the institutions and policies
that societies choose to adopt.
Class on April 3rd 2020
US tax on super rich class changed from 92% to 60% then to Reagen's 35%. US and Sweden tax illusion is high. but tax evasion is low.
US government’s argument about inequality is that with government’s interventions (i.e. food stamps) which are usually not reflected in taxed income format, the consumption inequality is much less than it’s shown in form of income inequality.
compared with other economies, US has more economic mobility, but along the time, the US line becomes more steeper which means the economic mobility is more challenging for younger generations. US becomes more hostile for poor people.
in UK, the private education is no better than public education. this means the kids can generally enjoy equally good quality education than in US.
globalization has had negative impact on income inequality in US since it shifted a lot of low-skilled job from US to overseas, but it had good impact on China and Brazil.
Why income inequality bothers us?
- wealth creators (i.e. rich entrepreneurs, facebook, Apple, Uber, Google)
- wealth diverters (i.e. corrupt politician)
we often make judgements by categorizing people pr companies into these two buckets and we move them around between these two buckets when things changed. i.e. google was wealth creator at the beginning and then wealth diverter originated from privacy intrusion case.
US are conditioned by political system to be polarized.
capital accumulation is a slow process is to consider the
following elementary arithmetic: With a saving rate of 10% per year, it takes 50 years to accumulate the equivalent of 5 years of income.
During the 20th century, growth rates were exceptionally high (in particular due to very high population growth, which even today represents about half of global gross domestic product growth), and rates of return were severely reduced by capital shocks (destructions) and the rise of taxation. Simple simulations show that this effect is quantitatively sufficiently important to explain why wealth concentration did not return to pre-WWI levels in the postwar period.
nn
This model seems to capture relatively well some of the evolutions that we are currently observing at the global level. For instance, if we use the global billionaires rankings published by Forbes magazine since 1987, we find that the very top fractiles of the global wealth distribution have been rising on average at about 6 to 7% per year in real terms over the 1987–2013 period, i.e., more than three times as fast as average global wealth (about 2% per year over the same period) (24).
nn
the long-run dynamics of income inequality is the most difficult part because income inequality combines forces arising from the inequality of capital ownership
and capital income (which, as we have just seen, are relatively complex) and forces related to the inequality of labor income (which involve a different set of economic and social processes).
nn
Attention to income inequality creates sense for social mobility.
hh
