Macroeconomics Economy and Policy Václav Šebek 2014 Václav Šebek (FSS MU) Introduction to Economics 1 / 26 1 Measuring Economy GDP Inflation Unemployment 2 Growth 3 Money and Inflation Václav Šebek (FSS MU) Introduction to Economics 2 / 26 Motivation Daily news headlines: ECB boss Mario Draghi said “We’ll do anything to save Eurozone” Germany reduced growth estimates and falling back into recession Central Banks throughout the world perform quantitative easing setting interest rates close to zero Europe faces deflation Economic growth in China considerably slower from 14% to 8.5% Macroeconomic issues often part of policy debates Macroeconomic situation influence politics considerably (eg labeling politicians successful or not) Macro-economists try to explain quite complicated system of all firms, people and events (the economy) Predictions are usually not much more successful than month weather predictions - there are simply too many factors Václav Šebek (FSS MU) Introduction to Economics 3 / 26 Measuring Economy Outline 1 Measuring Economy GDP Inflation Unemployment 2 Growth 3 Money and Inflation Václav Šebek (FSS MU) Introduction to Economics 4 / 26 Measuring Economy GDP GDP Definition Gross Domestic Product Sum of all final products and services made in economy during a period (year) - expressed in money Flow variable (sum per period) Two way of the count: Income Expenditure In the whole economy Income = Expenditure because each $ you spend is income for someone else Computed by national statistical offices four times a year Václav Šebek (FSS MU) Introduction to Economics 5 / 26 Measuring Economy GDP GDP Content What is included in GDP? Only the value of finished goods (byproducts don’t count) Only firstly sold and used goods (re-trade not included) Inventories What is not included in GDP Home works - family life (important: This could be a lot in countries with undeveloped services!) Illegal activities Václav Šebek (FSS MU) Introduction to Economics 6 / 26 Measuring Economy GDP Real x Nominal GDP GDP measured in money terms Nominal GDP = quantity of all production × current price of every product ⇒ change of either P or Q changes the product Real GDP = quantity of all production × constant set of prices ⇒ real GDP changes only with changes of Q, not P GDP Deflator = Nominal GDP Real GDP ≈ price level change Václav Šebek (FSS MU) Introduction to Economics 7 / 26 Measuring Economy GDP GDP Decomposition National income accounts identity: Y = C + I + G + NX Y - The product C - Consumption, goods and services bought by households I - Investment, goods bought for future use G - Government purchases NX - Net export or surplus with foreign countries (NX = IM − EX) Václav Šebek (FSS MU) Introduction to Economics 8 / 26 Measuring Economy GDP GDP’s Imprtance Good proxy variable to assess economic performance of a country Per capita x Total ⇔ Economic Power x Economic Level # Country GDP (mil $) GDP p/c ($) 1 USA 16,768,050 53,001 (#9) 2 China 9,469,124 6,959 (#82) 3 Japan 4,898,530 38,468 (#24) 4 Germany 3,635,959 44,999 (#18) 5 France 2,807,306 44,099 (#20) The more the better? Evident correlation between GDP and eg HDI (life expectancy, literacy etc.) Václav Šebek (FSS MU) Introduction to Economics 9 / 26 Measuring Economy Inflation Inflation Overall increase of price level Terms: Inflation - increase Deflation - decrease Disinflation - inflation slowdown Václav Šebek (FSS MU) Introduction to Economics 10 / 26 Measuring Economy Inflation Measuring Inflation GDP Deflator Consumer Price Index (CPI) Arbitrary chosen prices important in standard consumers basket Including: Food, Transportation, Schools, Culture, Gasoline, Electricity. . . CPI aggregates price changes of selected goods in time CPI and Deflator similar but different CPI watch fixed basket of goods with fixed weights CPI updated only once a decade because of consistency ⇒ is it still actual? Deflator does not include imported prices Václav Šebek (FSS MU) Introduction to Economics 11 / 26 Measuring Economy Unemployment Definition Adult population: Labor force: Employed Unemployed Others Unemployment: u = Unemployed Labor force Labor force participation rate: Labor force Adult population Frictional x structural x cyclic unemployment Václav Šebek (FSS MU) Introduction to Economics 12 / 26 Growth Outline 1 Measuring Economy GDP Inflation Unemployment 2 Growth 3 Money and Inflation Václav Šebek (FSS MU) Introduction to Economics 13 / 26 Growth Motivation If GDP really correlates with well-being then its growth its quite important Economy’s ability to grow is one of its main atributes Sustain relative wealth of rich countries Improve relative and absolute wealth of poor ones Convergence theory: The poorer you are, the quicker you grow (does it hold?) Václav Šebek (FSS MU) Introduction to Economics 14 / 26 Growth Motivation See separate file. Václav Šebek (FSS MU) Introduction to Economics 15 / 26 Growth Determinants GDP growth is primarily affected by productivity Since GDP is sum of all production, producing more with the same population brings higher product (GDP) Productivity: product per one worker-hour It is not so simple. . . Václav Šebek (FSS MU) Introduction to Economics 16 / 26 Growth Productivity Any change in productivity is conditioned by: Physical capital - tools, machinery etc. Human capital - knowledge, skills, experiences etc. Natural resources - climate for agriculture, oil. . . Technological knowledge - inventions, computers, management. . . Production function of an economy is thus expressed: Y = A.F(L, K, H, N) Václav Šebek (FSS MU) Introduction to Economics 17 / 26 Growth Pro-growth Public Policy What policies are considered to be good for growth? 1 Encouraging saving and investment 2 Foreign investment 3 Education 4 Property rights and political stability 5 Free trade 6 Control of population growth (poorer countries) 7 Research and Development Václav Šebek (FSS MU) Introduction to Economics 18 / 26 Growth Catch-up Diminishing returns theory: The larger the capital stock of a country, the smaller impact of investments on growth Example: 1960-1991 Country Invesment (% of GDP) Growth South Korea 23 % 7 % USA 21 % 2 % This imply a chance for poor countries ⇒theory of convergence Doesn’t always work however Václav Šebek (FSS MU) Introduction to Economics 19 / 26 Money and Inflation Outline 1 Measuring Economy GDP Inflation Unemployment 2 Growth 3 Money and Inflation Václav Šebek (FSS MU) Introduction to Economics 20 / 26 Money and Inflation Money An asset used to buy goods, does not equal to wealth Three basic functions: Medium of exange (making trade easier, avoiding barter) Unit of account Store of value Money is the most liquid asset Václav Šebek (FSS MU) Introduction to Economics 21 / 26 Money and Inflation Money Commodity x fiat money Today’s money consists of: M1 - cash, deposits on demand M2 - M1 + long-term deposits, assets in mutual funds etc. M1:M2 ≈ 1:4 Václav Šebek (FSS MU) Introduction to Economics 22 / 26 Money and Inflation Bank Sector Two-tier banking system Central Bank (ECB system, Czech National Bank, Federal Reserve System. . . ) Usually government-independent Regulates circulating money Its objective is either particular level of inflation or unemployment or both Tools: interest rates, open-market operations, reserves requirements Commercial Banks (all others: Sberbank, Sparkasse, Société Générale. . . ) Lend money and accept deposits Václav Šebek (FSS MU) Introduction to Economics 23 / 26 Money and Inflation Money Multiplier How money are created? Assume 10% reserves requirement 1st Bank Assets Liabilities Reserves $ 10.00 Deposits $ 100.00 Loans 90.00 2nd Bank Assets Liabilities Reserves $ 9.00 Deposits $ 90.00 Loans 81.00 3rd Bank. . . Václav Šebek (FSS MU) Introduction to Economics 24 / 26 Money and Inflation Money Multiplier Original deposit $ 100.00 induces additional $ 90.00, 81.00, 72.90. . . = $ 1,000.00 original deposit + ∑(1 − reserves) × (additional deposit) 100 + 0.9×100 + 0.9 × 90 + 0.9 × 81. . . = 1000 = 10 × 100 Multiplier in this example is 10 = 1 reserve requirement CB does not control money directly, but through commercial banks via money multiplier CB especially does not control household’s behavior, how much HH deposit bankers willingness to lend Václav Šebek (FSS MU) Introduction to Economics 25 / 26 Money and Inflation Quantitative Money Theory M × V = P × Y M - money, V - velocity of money, P - price level, Y - real product or in marginal values: m.v = π.g m - money growth, v - velocity change, π - inflation, g - (economic) growth Explains inflation and deflation eg: Long lasting slight deflation between 1870-1914 Hyperinflations (eg Germany 1923, Zimbabwe) Recent fear of deflation in the West Václav Šebek (FSS MU) Introduction to Economics 26 / 26