UBC Faculty Research and Publications

Macroeconomics on One Page 2011

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Macroeconomics on One Page Macroeconomics seeks to explain & predict the be- haviour of the economy “as a whole.” Managers need macro knowledge to interpret news & form reasoned views of the likely impact of policy changes. 1 Four macro “markets” Focus on five key variables (& their “relatives”): GDP, unemployment, interest rates, inflation rates, & exchange rates. Many macro variables have “real” versions that adjust raw (“nominal”) data to take into account price variation. While interdependent, each variable can be thought of as determined within a particular market. All goods & services markets: GDP (Y ), GNI, net vs gross, price level (CPI & GDP deflator: P ), inflation (pi = ∆P/P ).1 Potential GDP (Ȳ ), real GDP (Q = Y/P ). GDP measured by summing final expenditure categories, industry value-addeds, or factor incomes (wL+ rK). Labour markets: employment rate (L/N), job gains/losses (∆L), unemployment rate (u = U/L), vacancies (V ), hours, wages (w, real: w/P ). Under -employment: involuntary part- time. Unemployment causes: job search (ex- tended by high U benefits), mis-match, mini- mum wages, sticky wages, seasonal & cyclical demand changes. u cannot fall below the natu- ral rate, u (NAIRU), w/o accelerating inflation. Financial markets: interest rates, nominal, r, & real, r − pi. Normal yield curve: higher r for longer term bonds. Central banks lower r via bank rate cuts and buying bonds (to increase reserves). Credit crunches =⇒ TED spread ↑. Currency markets: exchange rates, nominal, e, & real, e[PH/PF ] = relative price of domestic goods.2 Real depreciation increases X, lowers M . Purchasing power parity for Y comparisons and e predictions. Fixed vs. floating e. 1∆P means the year-on-year change in the price level. Di- vide by inital price level to make it a rate of change. 2PH & PF are price levels in home (H) & foreign (F) cur- rency units (CU), e in FCU/HCU. 2 Macro relationships Composition of nominal GDP Y = C + I +G+ (X −M) C = personal consumption of durable & non-durable goods + services I = private investment in structures (inc. residen- tial) & equipment + change in inventories G = gov’t consumption (GC) +investment (GI) X −M = exports minus imports (trade balance) Aggregate Production Function Q = Af(K,L) Real GDP↑ ⇐= tech. progress (A ↑), capital ac- cumulation (K ↑), labour supply growth (L ↑). Money supply & inflation Money base, B, is currency + reserves, money sup- ply M is currency + deposits. Money multiplier, due to reserve ratios, = ∆M/∆B > 1. “Quantity Theory of Money”: Holding V and Q constant in MV = PQ implies inflation (pi = (Pt+1− Pt)/Pt) = money supply growth: (Mt+1 −Mt)/Mt. Recessions Reductions in GDP, accompanied by extended pe- riods of high u, low V/L, declining L, pi, followed by recoveries (Y → Ȳ ). Accumulation of Capital & Debt Kt+1 = (1− δ)Kt + It +GIt Debtt+1 = (1 + r)Debtt + PBDt Primary budget deficit = (GCt +G I t + St)− Tt Structural budget deficit = PBD(Ȳt) +rDebtt. Trade deficit = M −X → increase in foreign claims 3 Macro Controversies Keynesians attribute recessions (Y ↓) to insufficient demand and advocate raising C and I by r ↓ and T ↓. Spending multiplier: G ↑=⇒ ∆Y > ∆G. Chicago school argues budget deficits reduce C (savings to pay future taxes) I (public borrowing “crowds out” private borrowing), leaving ∆Y ≈ 0. Supply-siders advocate reduced marginal tax rates (MTR) to increase I & L, =⇒ Y ↑. Laffer-curve claim: MTR ↓ =⇒ T ↑.


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