World Economy Flashcards
Supply side of the economy
Labour and product markets make up the supply
side of the economy - What can be produced? How much labor is supplied?
Demand side of the economy - three key sources:
- firms,
- households,
- government,
- expenditure by customers abroad (on the home country’s exports)
Origin of GDP measurement
- 1937: Simon Kuznets, an economist at the National Bureau of Economic Research, presents the original formulation of gross domestic product in his report to the U.S. Congress, “National Income, 1929-35.”
- His idea is to capture all economic production by
individuals, companies, and the government in a single measure, which should rise in good times and fall in bad. GDP is born. - 1944: Bretton Woods conference - GDP becomes the standard tool for sizing up a country’s economy.
Microeconomics
- focus on the interactions of individual people given the rules that govern how they interact.
- To do this, we consider parts of the economy separately—the labour market, the markets for the goods and services that firms sell, and the credit market where borrowing and lending takes place.
Macroeconomics
- the study of the economy as a whole, and how the outcomes in one part of the economy affect, and are affected by, what happens in others.
- focus on totals and averages
Three ways of measuring value added:
GDP vs GNI
- Gross Domestic Product (GDP) denotes value of output of goods and services produced within a country
- Gross National Income (GNI) denotes value of output of goods and services produced by the nationals of a country (excluding foreign residents remittances but including remittances from nationals resident abroad).
GDP, GNI and the Current Account (CA) –> formula for CA + Private needs for funds + Public needs for funds = 0
Some peculiarities of GDP
Measuring value added: What are the three approaches?
Aggregate Production Function
- The “Cobb-Douglas” Production Function
- A model of production in the entire economy
- 𝑌 = 𝑇𝐹𝑃 × 𝐾^α × 𝐿^β
What are alpha and beta?
α + β determines the returns to scale
The Marginal Product of Capital
Solow model:
capital - STEADY STATE - meaning?
- investment = depreciation
- When this occurs, we say that we’re in a STEADY STATE, an equilibrium.
- At this point the capital stock is not changing and so neither is output
What is Productivity? Output per Input - Two notions of economic productivity:
TFP differentials as important as capital in differences in world income distribution?
Growth accounting - How do we Measure TFP?
- Theory says that MPK should be higher in poor countries and, assuming markets are efficient, capital should flow there.
- Reality (Caselli and Feyrer 2007): Rich countries: 8.4%, Poor countries: 6.9%
- Why? TFP is a critical component of the return to physical and human capital
- Capital is certainly part of the story but but not the only story
The key difference between the Solow model and endogenous growth models is that…
…the latter assume there is some mechanism which offsets the diminishing returns to capital
Potential mechanisms:
Research and development and knowledge spillovers
but also …
Investment in human capital
Schumpeter take on innovation - what drives it?
- entrepreneurs to innovate and destroy creatively
- Creative destruction: Innovation driven by the promise of excess profits, and new products and production methods making old products and firms obsolete
- Temporary monopoly profits (innovation rents) are possible as entrepreneurs capture markets.
- The size of the market important because it affects the scale of innovation rents that can be enjoyed.
- But also important that innovation cannot immediately be copied by an imitator: patents, trade secret …
- Institutions must be in place to ensure that the rents from innovation go to the entrepreneur and are not confiscated by the government or other powerful groups like organized crime.
- Impact of technology on jobs and wages depends on the:
- Technological change –> increase in productivity
- Automation –> Displacement effect
Usages of money
Why what is TFP explained? By what are the two explanations characterized?
How is Central banks’ money called?
- monetary base or high power money
- It is a liability in the CB’s balance sheet
- The base has two components, currency and reserves
Are reserves part of the money supply?
- Reserves do not circulate and so they are not part of the money supply
- Reserves are not used by the public but banks use them for interbank transactions and liquidity management
Balance sheet of a commercial bank
Money supply - types
Repurchase agreement
Treasury repo market
- The Treasury repo market is the main interface between the money market and the Fed
- The Fed is the lender offering a short-term loan of Reserve in returns for Treasury bills as collateral
- Counterparties of these loans are the primary dealers
- Primary dealers commit to bid for Treasury securities whenever Treasury wishes to borrow
How can central banks actually set interest rates?
- Set reserves quantity to achieve rate = stable reserves, volatile interest rate
- Set rate directly = volatile reserves, stable interest rate
Interbank (interest) rate corridor
Scarce reserves regime
Reserve balances held by banks are relatively low, and banks actively trade reserves in the money market to meet their reserve requirements.
3 interest rates: MLF (Marginal Lending Facility), MRO (Main Refinancing Operations), DF (Deposit Facility)
Characteristics of the corridor system
Provision of just enough central bank reserves to meet banks’ aggregate liquidity needs stemming from net autonomous factors and minimum reserve requirements
(autonomous factors: items that do not reflect monetary policy operations or reserve holdings. They are called autonomous because they are not under the control of the CB. They are: 1. net government deposits; 2. banknotes in circulation; 3. net foreign assets)
2 approaches to QE
Demand, interest rate and inflation THE MACROECONOMIC VIEW - Phillips curve, Taylor rule
Aggregate demand formula
Taylor Rule - formula
Transmission mechanism of changes in interest rate
Since 2008 all major CB’s have implemented unusual policies …
Multiple channels of QE
- Signalling channel
- Inflation channel
- Portfolio balance / safety channe
Okun’s law and output gap:
Recession vs crisis
Aggregate demand equation
Examples of aggregate demand shocks
Domestic Demand equation (more complex)
Phillips curve
Demand: output gap and interest rate
- σ: This symbol typically represents the sensitivity of the output gap to the real interest rate. It is a
positive parameter that indicates how changes in the real interest rate affect aggregate demand. - i: This is the nominal interest rate.
- Eπ: This represents the expected inflation rate.
interest rate setting
- i: This is the nominal interest rate set by the central bank.
- i∗ : This is the neutral interest rate, which is the theoretical level of the interest rate that neither stimulates nor restrains economic growth when the economy is operating at potential (neither overheating nor underperforming).
- 𝛼: This is a coefficient that measures the responsiveness of the interest rate to changes in the output gap
- β: This is a coefficient that measures the responsiveness of the interest rate to deviations of inflation (𝜋) from the target inflation (𝜋∗)
- 𝜋 − 𝜋∗ : This represents the deviation of actual inflation from the target inflation.
What is the velocity of money?
Aggregate Supply x Aggregate Demand - chart
The monetarist view - price-level vs money supply
- V=PY/M
- MV=PY
Money super-neutrality
What are the problems with the monetarist view?
Discretionary and non discretionary fiscal policy
- Automatic Stabilisers As economy expands and contracts so does the tax revenue. Also more modest effect on expenditure – unemployment benefits rise in downturn. Therefore deficit becomes larger in recession and falls in a boom
A structural budget deficit is…
excess of public spending over revenues which would persist if the economy were to grow steadily at its highest sustainable employment rate, i.e. at the same rate as potential output.
Why might fiscal multiplier not work?
- In recessions the crowding out is small and the multiplier large
- Also consumers may not be able to save today in anticipation of higher taxes tomorrow because they might be credit constrained. This is particularly true in recessions
r and r* - what does policy have to do if there are too much savings and not enough demand to keep the economy at full employment?
What risk to B and R carry?
What is the difference between fiscal and monetary dominance?
What are the two main elements in a (sovereign) debt restructuring:
What triggers a debt restructuring?
Higher debt (and crucially deficits) leads to higher interest rates (real and risk premia) and so it lowers investment - ?
- However, if, after a financial crisis, the private sector is deleveraging with a period of low real interest rates then this offsets.
- Therefore the argument holds only if risk premia increase substantially
Higher debt requires higher future taxes/lower expenditure and so lower future growth - ?
Important channel but this doesn’t argue in favour of tighter current policy – debt must be used to push tax increases across longer period of time and therefore may reduce adverse effects. Growth even worse if don’t use debt
Higher debt raises fears of higher future inflation and tighter monetary policy - ?
Only works for unanticipated inflation
High debt signals greater future uncertainty/less ability to run countercyclical fiscal policy - ?
Should expect greater business cycle volatility although automatic stabilisers still work and have been main policy tool used
What is the right level of government debt?
