Transcript How Does an Economy Work?

How Does an Economy Work?
The Macro-Economics of European Economies
MSc in Economic Policy Studies
John FitzGerald, January 2015
Course Outline
1. How does an economy work? JF 16-1-2015
2. The genesis of macroeconomics AM 23-1-2015
3. Modern macroeconomics AM 30-1-2015
4. Banks and financial markets AM 6-2-2015
5. The recent crisis AM 13-2-2015
6. The labour market JF 20-2-2015
7. Fiscal Policy and forecasting JF 6-3-2015
8. Trade JF 13-3-2015
9. The economics of global warming JF 20-3-2015
10. The future of the Irish economy AM and JF 27-3-2015
Outline of Lecture
• Theory
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Different “markets”
A model of the economy
Equilibrium and Disequilibrium
Market “Imperfections”, Expectations, Behaviour
• Applied - examples from 2000-15
• The EU and the US economies
• Disequilibria in EU economies
• How economies adjust
Different Markets
• Useful to consider the economy as a series of markets
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•
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The Goods (and Services) market
Money / Financial Markets
Labour Market
Housing Market
Government sector
• These markets are interlinked – a “model” of the economy
• For equilibrium in the economy the markets must be consistent
The Goods market - 1
• Demand for Goods (and Services)
• C+I+G : Closed economy
• C+I+G+X : Open economy
• C=Private Consumption; I= Investment; G= Government consumption; X=Exports
• Supply of Goods (and Services)
• Y : Closed economy
• Y+M : open Economy
• Y = Domestic Output; M=Imports
• Disequilibrium?
• Inflation, Current account of the balance of payments
• Imperfections?
The Goods market - 2
• Y=C+I+G (+X-M)
• Y= GDP, output = expenditure = income – demand for goods (and services)
• Y=Q
• Q= National output – supply of goods (and services)
• C=a + b(Y - T)
• T=Government revenue; a and b are coefficients, where b is 0<b<1
• Y=a + bY – bT + I + G + (X - M)
• Y(1-b)= a + I + (X - M) + G - bT
1
• 𝑌=
[𝑎 + 𝐼 + 𝑋 − 𝑀 + 𝐺 − 𝑏𝑇]
1−𝑏
• Assumes output will respond to an increase in demand
1
•
is the “multiplier”
1−𝑏
The Goods market - 3
• S=Y-C-T
• S= Savings
• Y=C+I+G+(X-M)
• Y-C-T=S=I+(X-M)+(G-T)
• S+(T-G)=I+(X-M)
• Total savings equals investment plus the current account surplus
• What happens if people want to save more?
The Goods market - 4
• Growth?
• Output is a function of inputs and productivity
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Inputs: labour, capital, materials
Investment increases capital and hence the productive potential of economy
Investment in human capital (education) increases productivity of labour
Investment in R&D may raise productivity of all factors
• Q= Y = a function of K,L,M, productivity
• The stock of capital labour and materials determines potential output
• However, how much will it be profitable to produce?
The Goods market - 5
• Profits=P*Q-W*L-Pk*K-Pm*M where firms maximise profits
• P= price of output; W= price of labour; L= employment; Pk = price of capital; K= capital stock;
M = materials; Pm= price of materials
• This means that output doesn’t automatically adjust to meet demand
• Open economy: is it profitable to produce in Ireland?
• If it is, how much labour, capital and materials will you need?
• Competitiveness matters
• In the long run it is through raising output that living standards rise.
• Raising demand on its own may not lead to increased output.
• e.g. Irish government policy in 1977-1979
• Imperfections?
Money / Financial markets
• Demand for Money
• Need money to buy and sell
• Affected by cost - credit
• Supply of Money
• Central Bank can create money
• Banks extend credit based on their stock of money
• Disequilibrium?
• e.g. inflows on financial account of the balance of payments
• Imperfections?
• e.g. Expectations – drive bubbles
The Labour market
• Labour Demand
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How profitable are firms – what happens to output
Cost in home country relative to foreign determines share of world output
Price of labour (labour costs), price of capital, price of materials
Openness of economy affects behaviour
• Labour Supply
• Demographics, Wage Rates, Costs of working, Value of leisure, Culture
• Openness of economy affects behaviour - migration
• Equilibrium – Disequilibrium
• Unemployment rate, rate of wage inflation
• Imperfections?
The Housing market
• Demand – factors driving demand
• Demographics – natural increase
• Income / wealth
• Cost – user cost, a function of interest rates, expected prices
• Supply – factors driving supply
• Profitability of building – price relative to costs
• Costs – labour, materials, land
• Disequilibrium
• How to measure it?
• Rate of price increase?
• Imperfections?
Government Sector
• Revenue and Expenditure
• Revenue
• Economic costs of taxation
• Economic impact of taxation
• Other Revenue
• Expenditure
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•
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Government Consumption
Government Transfers
Subsidies
Investment
• Measure of imbalance – Deficit or Surplus
• Debt - sustainability
A model of the economy
• An equilibrium solution for economy requires equilibrium in all
markets
• Markets are interlinked.
• Linked by many variables:
• Interest rates, wage rates, prices, etc. etc.
• How will economy adjust to exogenous changes?
• e.g. changes in budget, changes in oil prices, changes in monetary policy
• How can governments influence growth?
• Importance of the supply side
Equilibrium, Disequilibrium
• May be out of long-term equilibrium. e.g.
• Running an increasing current account deficit – demand > output
• Inflation high and rising (prices and wages)
• Unemployment high
• Will economy return to equilibrium of its own accord?
• Possibility of multiple equilibria
• What is the role of government?
• Adjustment takes time
• Time to invest, to change output, to change expectations
• Never actually in equilibrium
Market Imperfections, Expectations, Behaviour
• Market imperfections e.g.:
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Monopolies / oligopolies: make more from lower output
Adjustment takes time e.g. investment
SME’s cannot finance themselves because of financial sector difficulties
Unions and employer cartels may affect wage bargaining
Restrictions on supply of building land may affect housing supply
Can Government improve the situation?
• Expectations e.g.
• People have economic “models” in their heads. These models may or may not be correct
• Consumption affected by lifetime income – what is lifetime income?
• Expect a rise in house prices – get on the property ladder!
• Behaviour
• In chemistry H2O always combine like that.
• No such certainties with human behaviour. History rarely repeats itself.
Applied
• Europe and the US 2007
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Goods market – Current account of the balance of payments and inflation
Money market – interest rates, nominal and real
Labour Market – unemployment and wage inflation
Housing Market – was there a housing market
• Europe and the US 2015
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•
•
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Goods market – Current account of the balance of payments and inflation
Money market – the “zero lower bound”
Labour market – out of equilibrium – will it return to full employment?
Housing market – EU economies and the US
The investment question
Current account of Balance of Payments - 1
1
0
-1
-2
-3
-4
-5
-6
80
82
84
86
88
90
92
94
96
98
00
BP_USA/GDPV_USA*100
BP_EU28/GDPV_EU28*100
02
04
06
08
Long-term real interest rates - 1
8
7
6
5
4
3
2
1
0
-1
80
82
84
86
88
90
92
94
96
98
00
02
04
ILN_USA-(PC_USA-PC_USA(-1))/PC_USA(-1)*100
ILN_EA12-(PC_EU27-PC_EU27(-1))/PC_EU27(-1)*100
06
08
Rate of inflation - 1
12
10
8
6
4
2
0
-2
1980
1985
1990
1995
2000
2005
(PC_USA-PC_USA(-1))/PC_USA(-1)*100
(PC_EU27-PC_EU27(-1))/PC_EU27(-1)*100
2010
House Price Inflation - 1
30
25
20
15
10
UK
5
USA
0
1980
-5
-10
-15
-20
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Government Borrowing - 1
1
0
-1
-2
-3
-4
-5
-6
-7
-8
80
82
84
86
88
90
92
94
96
98
00
GB_EU15/GDPV_EU15*100
GB_USA/GDPV_USA*100
02
04
06
08
Debt – GDP ratio - 1
75
70
65
60
55
50
45
40
80
82
84
86
88
90
92
94
96
98
00
GNT_USA/GDPV_USA*100
GNT_EU27/GDPV_EU27*100
02
04
06
08
Current account of Balance of Payments - 2
2
1
0
-1
-2
-3
-4
-5
-6
00
01
02
03
04
05
06
07
08
09
10
BP_USA/GDPV_USA*100
BP_EU27/GDPV_EU27*100
11
12
13
14
Long-term real interest rates - 2
4
3
2
1
0
-1
00
01
02
03
04
05
06
07
08
09
10
11
12
ILN_USA-(PC_USA-PC_USA(-1))/PC_USA(-1)*100
ILN_EA12-(PC_EU27-PC_EU27(-1))/PC_EU27(-1)*100
13
14
Rate of inflation - 2
6
5
4
3
2
1
0
2001
-1
2002
2003
2004
2005
pc inf_eu27
2006
2007
2008
2009
pc inf_usa
2010
2011
2012
2013
2014
Government Borrowing - 2
2
0
-2
-4
-6
-8
-10
-12
-14
00
01
02
03
04
05
06
07
08
09
10
GB_USA/GDPV_USA*100
GB_EU15/GDPV_EU15*100
11
12
13
14
Debt – GDP ratio - 2
110
100
90
80
70
60
50
00
01
02
03
04
05
06
07
08
09
10
GNT_USA/GDPV_USA*100
GNT_EU27/GDPV_EU27*100
11
12
13
14
Individual Countries in EU
• Look at 3 examples of problems and adjustment
• Latvia
• Spain
• UK
Latvia – current account of BOP
BP_LVA/GDPV_LVA*100
10
5
0
-5
-10
-15
-20
-25
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
Latvia – rate of inflation
• Consumer prices, nominal wages and house prices.
50
40
30
20
10
0
2000
2002
2004
2006
2008
2010
2012
-10
-20
-30
-40
-50
cons price inf_lva
wage inf_lva
house price inf_lva
2014
Latvia – real interest rate
ILN_LVA-(PC_LVA-PC_LVA(-1))/PC_LVA(-1)*100
30
20
10
0
-10
-20
-30
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
Latvia – Investment share of GDP
• Housing, building and construction and total
40
35
30
25
20
15
10
5
0
00
01
02
03
04
05
06
07
08
09
10
ITOTV_LVA/GDPV_LVA*100
IHV_LVA/GDPV_LVA*100
IBCV_LVA/GDPV_LVA*100
11
12
13
14
Latvia – exports share of GDP
Exports scaled by GDP
70
60
50
40
30
20
10
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
Exports scaled by GDP
2009
2010
2011
2012
2013
2014
Relative wage rates
• Wage rates in a common currency to base 2000=100:
• Latvia, Spain, Germany, Ireland, UK, Portugal, EU28
430
380
330
w_gbr
w_prt
280
w_eu28
w_irl
230
w_deu
w_esp
180
w_lva
130
80
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Latvia – unemployment rate
Unemployment Rate
25
20
15
10
5
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
Series2
2009
2010
2011
2012
2013
2014
Latvia – government borrowing as % of GDP
GB_LVA/GDPV_LVA*100
0
-1
-2
-3
-4
-5
-6
-7
-8
-9
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
Latvia – Debt as % of GDP
50
45
40
35
30
25
20
15
10
5
0
2000
2002
2004
2006
2008
Debt share of GDP
2010
2012
2014
Latvia – Conclusions?
Spain – current account of BOP
BP_ESP/GDPV_ESP*100
2
0
-2
-4
-6
-8
-10
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
Spain – rate of inflation
• Consumer prices, nominal wages and house prices.
20
15
10
5
0
2000
2002
2004
2006
2008
2010
2012
-5
-10
-15
-20
cons price inf_esp
wage inf_esp
house p inf_esp
2014
Spain – real interest rate
ILN_ESP-(PC_ESP-PC_ESP(-1))/PC_ESP(-1)*100
9
8
7
6
5
4
3
2
1
0
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
Spain – Investment share of GDP
• Housing,35building and construction and total
30
25
20
15
10
5
0
00
01
02
03
04
05
06
07
08
09
10
ITOTV_ESP/GDPV_ESP*100
IHV_ESP/GDPV_ESP*100
IBCV_ESP/GDPV_ESP*100
11
12
13
14
Spain – exports share of GDP
Exports scaled by GDP
35
30
25
20
15
10
5
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
Exports scaled by GDP
2009
2010
2011
2012
2013
2014
Relative wage rates
• Wage rates in a common currency to base 2000=100:
• Latvia, Spain, Germany, Ireland, UK, Portugal, EU28
170
160
150
w_gbr
140
w_prt
130
w_eu28
120
w_irl
110
w_deu
w_esp
100
90
80
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Spain – unemployment rate
Unemployment Rate
30
25
20
15
10
5
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
Unemployment rate
2009
2010
2011
2012
2013
2014
Spain – government borrowing as % of GDP
GB_ESP/GDPV_ESP*100
4
2
0
-2
-4
-6
-8
-10
-12
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
Spain – Debt as % of GDP
GNT_ESP/GDPV_ESP*100
100
90
80
70
60
50
40
30
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
Spain – Conclusions?
UK – current account of BOP
BP_GBR/GDPV_GBR*100
-1.2
-1.6
-2.0
-2.4
-2.8
-3.2
-3.6
-4.0
-4.4
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
-10
wage_inf
housep_inf
-5
cons_inf
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
UK – rate of inflation
• Consumer prices, nominal wages and house prices.
30
25
20
15
10
5
0
UK – real interest rate
ILN_GBR-(PC_GBR-PC_GBR(-1))/PC_GBR(-1)*100
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
UK – Investment share of GDP
• Housing, building
and construction and total
20
16
12
8
4
0
00
01
02
03
04
05
06
07
08
09
10
ITOTV_GBR/GDPV_GBR*100
IHV_GBR/GDPV_GBR*100
IBCV_GBR/GDPV_GBR*100
11
12
13
14
UK – exports share of GDP
Exports scaled by GDP
35
30
25
20
15
10
5
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
Exports scaled by GDP
2009
2010
2011
2012
2013
2014
Relative wage rates
• Wage rates in a common currency to base 2000=100:
• Latvia, Spain, Germany, Ireland, UK, Portugal, EU28
170
160
150
140
w_gbr
w_prt
130
w_eu28
120
w_irl
110
w_deu
w_esp
100
90
80
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
UK – unemployment rate
Unemployment Rate
9
8
7
6
5
4
3
2
1
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
Unemployment rate
2009
2010
2011
2012
2013
2014
UK – government borrowing as % of GDP
GB_GBR/GDPV_GBR*100
2
0
-2
-4
-6
-8
-10
-12
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
UK – Debt as % of GDP
GNT_GBR/GDPV_GBR*100
90
80
70
60
50
40
30
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
UK – Conclusions?
AMECO Database
• Many annual variables for EU economies, US, Japan etc.
• Don’t assume that the data are always right!
• Where available, runs from 1960. Includes EU forecasts to 2016
• Be careful that 2014 onwards are EU forecasts!
• Three approaches to accessing it:
1.
Online: http://ec.europa.eu/economy_finance/ameco/user/serie/SelectSerie.cfm
2.
Excel File: AMECONov14.xlsx plus list_of_variables.pdf
3.
Excel File: AMECOTCD.xlsx – a limited number of variables, 1 variable per sheet
• House prices from BIS datatbase:
• Online: http://www.bis.org/statistics/pp_detailed.htm#selected
Future Presentations
1. The origins and resolution of the current crisis in Estonia, Bulgaria,
Greece and Spain (20th February)
• What were the origins? How is it resolving? Look at disequilibria in markets
2. The origins and resolution of the current crisis in Latvia, Portugal,
Spain and Italy (20th February)
• What were the origins? How is it resolving? Look at disequilibria in markets
3. The crisis in Scandinavia (Finland, Sweden, Denmark) 1988-1995
(6th March)
• What were the origins? How was it resolved? Look at disequilibria in markets
Reading for this lecture
• Basic text:
• “Macroeconomics a European Perspective”, Blanchard, Amighini and Giavazzi.
Probably more theory than you need, but provides the basics
• Chapters 3-6
• The rest of the reading discusses real economic situations.
• The objective is to evaluate whether economies are out of equilibrium and if so why?
How are they adjusting or how have they adjusted? What are the problems?
• FitzGerald, J., 2013 “Financial crisis, economic adjustment and a return to growth in the EU”, Revue de l’OFCE - Debates and
policies, No.127 pp. 277-302 http://www.ofce.sciences-po.fr/pdf/revue/127/revue-127.pdf
Look at one or two of these publications for the EU and its component economies
• IMF World Economic Outlook, October 2014. http://www.imf.org/external/pubs/ft/weo/2014/02/pdf/text.pdf
• OECD Economic Outlook, November 2014, http://www.oecd.org/eco/outlook/General-assessment-of-the-macroeconomicsituation.pdf
• National Institute Economic Review, November 2014, http://ner.sagepub.com/content/230/1.toc
• European Commission: European Economic Forecast, Winter 2014
http://ec.europa.eu/economy_finance/publications/european_economy/2014/pdf/ee2_en.pdf
Reading for this lecture
• Possible additional reading for projects
• OECD country surveys http://www.oecd.org/eco/surveys/
• Zsolt Darvas, A TALE OF THREE COUNTRIES: RECOVERY AFTER BANKING CRISES, Bruegel Policy Contribution ISSUE 2011/19, DECEMBER
2011
• http://ec.europa.eu/economy_finance/publications/publication13551_en.pdf and
http://ec.europa.eu/economy_finance/publications/publication692_en.pdf compares Finland and Sweden in the 1990 crisis