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.
