Transcript MACROECONOMIC OBJECTIVES

MACROECONOMIC OBJECTIVES
• Economic Growth
- Governments try to achieve high rates of growth which can be
sustained in the long run. Also it is important to achieve stable rates
that can be maintained and thus avoid both booms (when the rate is too
high) and recessions (when the rate is too low).
- Ireland performed exceptionally well from 1994 - 2007) in what is
referred to as the Celtic Tiger. However, due to an unsustainable
property bubble and the international credit crunch we then suffered a
severe recession. This problem of recession has affected many
developed economies in the most serious economic crisis since the
Great Depression
Wikipedia Reference
• Employment and Unemployment
- Governments aim to create new jobs (net) and keep unemployment as
low as possible. Unemployment was until mid 2007 in Ireland about
4.5% but is now rising sharply (14.3% at end of 2011).
Though the rate of unemployment has now stabilised this reflects the
fact that emigration (especially of young job seekers) has rapidly
increased from Ireland in past two years.
MACROECONOMIC OBJECTIVES (con)
• Inflation
- Again Governments try to keep the figure low so as to enhance
competitiveness. Inflation in Ireland was worryingly higher than our
EU neighbours in recent years (around 4% in 2007). However due to
recession the inflation rate then fell rapidly (- 4.5% in 2009 and
- 1.0% in 2010) before rising again in 2011 to 2.6%
• The Balance of Payments
- This relates to trade transactions with other countries. If we export
more in value terms of goods and services than we import, then we
obtain a balance of payments surplus.
- The Balance of Payments bears a close relationship to the exchange
rate. In general a favourable balance of payments tends to be
associated with a strong currency.
- Governments can pursue other intermediate objectives in pursuit of
the above primary goals. These could include control of interest rates,
taxation, money supply and government expenditure and other areas
such as industrial policy, public sector reform and industrial policy.
Economic growth (average % per annum),
Unemployment (average %), Inflation (average % per annum)
France Germany
Japan
UK
USA EU (12)a OECDb Brazil Malaysia Singapore China
Growth
1960–9
5.6
4.4
10.4
2.9
4.3
5.8
5.5
5.9
6.5
9.5
3.0
1970–9
4.1
3.1
5.4
2.4
3.3
3.8
3.7
8.5
7.7
9.2
7.4
1980–9
2.3
2.0
3.7
2.4
3.1
2.3
2.9
3.0
5.9
7.5
9.8
1990–9
1.9
2.3
1.5
2.1
3.1
2.2
2.5
1.6
7.2
7.6
10.0
2000–9
1.9
1.5
1.6
2.4
2.4
2.0
2.4
3.5
5.5
5.6
9.8
Unemployment
1960–9
1.5
0.9
1.3
2.2
4.1
2.5
2.5
n.a.
n.a.
n.a.
n.a.
1970–9
3.7
2.3
1.7
4.5
6.1
4.0
4.3
n.a.
n.a.
3.6
n.a.
1980–9
8.9
7.0
2.5
10.2
7.3
9.3
7.2
3.9
7.2
3.7
2.6
1990–9
11.1
8.1
3.1
8.1
5.8
10.5
7.0
6.9
3.3
2.8
2.8
2000–9
9.0
8.9
4.5
5.1
5.2
8.1
6.4
9.6
3.5
3.3
4.0
1960–9
3.8
3.2
5.5
3.8
2.4
3.7
3.1
46.1
0.8
1.2
n.a.
1970–9
8.9
5.0
9.1
12.6
7.1
9.5
9.2
30.6
5.5
5.9
n.a.
1980–9
7.4
2.9
2.5
7.4
5.6
6.5
8.9 354.5
3.7
2.8
7.5
1990–9
1.9
2.4
1.2
3.7
3.0
2.9
4.4 843.3
3.7
1.9
7.8
2000–9
2.0
1.9
0.0
2.7
2.8
2.3
2.5
2.6
1.6
2.6
Inflation
6.9
Growth rates in selected industrial economies
10
UK
USA
Annual growth rate (%)
8
EU12
Japan
6
4
2
0
-2
-4
-6
1970
1975
1980
1985
1990
1995
2000
2005
2010
Unemployment rates in selected industrial economies
Unemployment (% of workforce)
14
UK
EU12
USA
Japan
12
10
8
6
4
2
0
1970
1975
1980
1985
1990
1995
2000
2005
2010
Inflation rates in selected industrial economies
26
Inflation (% increase in retail prices)
24
22
UK
USA
20
EU-12
Japan
18
16
14
12
10
8
6
4
2
0
-2
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
Current account balance as percentage of GDP
5
Current account balance:% of GDP
4
3
2
UK
USA
Japan
1
0
-1
-2
-3
-4
-5
-6
-7
1970
1975
1980
1985
1990
Note: 2009 and 2010 based on forecasts
Source: based on data in Economic Outlook (OECD, various years)
1995
2000
2005
2010
THE CIRCULAR FLOW OF INCOME
• The Circular Flow of Income provides a simple model of the
economy made up of two groups that shows how firms
(producers) and households (consumers) are interconnected
• Each group plays two roles.
- The firms are the producers of the goods and services in the
economy. However they equally are the employers of all the
factors of production (such as labour).
- The households are the consumers of the goods and services.
Equally they are the suppliers of the factors of production.
- The households receive income (for supply of the factors of
production to the firms). In turn they generate expenditure (in
payment for goods and services purchased).
- Thus there is continual flow of income and expenditure in the
economy. The firms keep paying out income; in turn they
receive back expenditure (when the goods produced are
purchased).
THE CIRCULAR FLOW OF INCOME (con)
• An economy is in equilibrium when
Income = Expenditure (or Aggregate Demand)
• If you think about it, you will see that this is quite logical.
Imagine during the year that all the firms in the economy pay
out €100 bl. income to households. Now if all this money is
disposed of as expenditure then the firms will receive back €100
bl. and be in the position to pay out exactly the same amount in
income the following year.
Therefore when Income = Expenditure, the overall level of
economic activity remains unchanged.
The circular flow of income
Firms
Factor
payments
Consumption of
domestically
produced goods
and services (Cd)
Households
WITHDRAWALS AND INJECTIONS
However in practice there can be withdrawals from and injections into the
income-expenditure flow
• The main withdrawals (W) are
- Savings (S). A person can opt to save some money (e.g. in a bank)
rather than spend it.
- Taxation (T). The government can legally take money off citizens thus
reducing their capacity to spend.
- Imports (M). When we buy imports e.g. a Japanese car the money
goes abroad (out of the domestic economy).
•
Likewise there are 3 corresponding injections (J)
- Investment (I). People can borrow money from banks (e.g. for a new
house) thus increasing spending power .
- Government Expenditure (G). Money that is raised in tax revenue is
largely on health, education, social welfare etc.
- Exports (X). When we export goods e.g. food, additional money comes
into economy.
WITHDRAWALS AND INJECTIONS (con)
So therefore when we allow for all these withdrawals and injections,
equilibrium in economy entails that
W=J
i.e. S + T + M = I + G + X
- Imagine a bath that is full of water with the stopper out at the bottom
and the tap running.
- Now if the amount going out through the bottom (withdrawals) is
exactly matched by the amount coming in through the taps (injections),
then the bath will remain full with the level of water unchanged.
- Likewise with the economy! When withdrawals (money going out) are
exactly matched by money coming in (injections), then it remains in
equilibrium (i.e. with level of activity unchanged).
- However if W > J then the level of economic activity will fall causing
recession.
- If J > W then the level of activity will rise in money terms causing
inflation. It is important to realise that too much money coming into
economy will lead to a rise in the general price level. Ultimately this
could lead to income falling (as competitiveness with other countries
could be eroded).
The circular flow of goods and incomes
Goods and services
£
Consumer
expenditure
Wages, rent
dividends, etc.
£
Services of factors of production (labour, etc)
The circular flow of income
INJECTIONS
Export
expenditure (X)
Investment (I)
Factor
payments
Consumption of
domestically
produced goods
and services (Cd)
Government
expenditure (G)
BANKS, etc
Net
saving (S)
GOV.
ABROAD
Import
Net
expenditure (M)
taxes (T)
WITHDRAWALS
fig
Cd, W, J
Deriving equilibrium national income
Equilibrium national income is
where Y = E (and W = J).
Y = Cd + W
E = Cd + J
C
z
d
W
x
O
Ye
J
Y
THE MULTIPLER
•
This is another concept introduced by Keynes the fundamental idea of which is
very simple
•
Basically when money is spent in the economy there are substantial ripple
effects
- So for example if I build a garage costing €10,000 the builders will
initially receive the money
- however a large fraction will subsequently be spent - assuming constant
consumption ratio of .8 - of €8,000 on buying new materials
- the suppliers will in turn spend .8 of the €8,000 i.e. €6,400 - with other
retailers who in turn will pass on .8 of what they receive
•
So ultimately a far greater amount of income is created in the
economy (€50,000) than initially paid out (i.e. €10,000) with the multiplier in
this case = 5
•
However it can work in both directions thus accentuating a recession when
income is falling
E, W, J
The multiplier: (c) a shift in the
expenditure curve
Y
Multiplier = DY / D J
= c - a / b- a
E2
E1
c
DY
b
DJ
a
O
Ye1
Ye2
Y
The multiplier: (a) a shift in injections
W, J
Multiplier = ΔY / Δ J
= ΔY / ΔW
=c–a/b–c
= 1/mpw
W
b
J2
J1
O
ΔJ
ΔW
a
Ye1
ΔY
J2
c
J1
Ye2
Y
MULTIPLER FORMULAE
• APC = Average Propensity to Consume: so for example if a person on
average consumes €80 out of an income of €100, APC = .8
• APS = Average Propensity to Save: so if person saves €20 out of
income of €100, APS = .2
• MPC = Marginal Propensity to Consume: thus is a person spends €12
out of additional €20 received in income APS = .6
• MPS = Marginal Propensity to Save: MPS = .4
• Formula for multiplier in a closed economy
k = 1/(1 – MPC) = 1/MPS
Thus if MPC = .6 and MPS = .4, k = 1/(1 - .6) = 1/.4 = 2.5
• Formula for multiplier in an open economy (with Gov. intervention)
k = 1/MPW = 1/{1 – (MPS + MPT + MPM)
So if MPS = .2, MPT = .3, MPW = .3, k = 1/{1 – (.2 + .3 +.3)
= 1/.8 = 1.25
MULTIPLER AND ACCELERATOR
• The accelerator relates to a relationship between investment and
growth whereby it is postulated that the level of investment is directly
related to changes in the rate of growth in the economy
This would mean that when there is a downturn in growth in the
economy this will lead to a drop in investment compounding the
downturn
Likewise when growth rates improve (as in a boom) the levels of
investment themselves increase thus “accelerating” the rate of growth
• Multiplier and accelerator effects tend to work together: initially an
increase in expenditure (say consumer) will lead to an increase in the
growth rate which in turn will lead to an accelerator effect (via
investment) further increasing growth
However these combined effects can operate in both a positive and
negative fashion
So booms and slumps tend to be compounded through multiplier
accelerator effects
MEASUREMENT OF NATIONAL INCOME
•
National Income represents the value in money terms of what is
produced in an economy on an annual basis. When divided by
population to obtain income per capita it provides the conventional
measurement of the standard of living. Economic growth then
represents the real change in National Income from year to year.
There are three ways of measuring National Income
1. Income Approach
This is the attempt to measure the total amount paid out in income
during the year. There are problems with this approach.
For example farming income is difficult to measure accurately. Also
activity in the underground economy will not be assessed.
2. Expenditure Approach
This is the measurement of the total amount spent in an economy
during the year. Again there can be problems. Capital expenditure in
the private sector is hard to assess. Also smuggling activity (between
countries) would distort figures.
3. Output Approach
This is the measurement of the value added at each stage of production
which is measured accurately would also provide a valid measurement
of economic activity. However the main difficulty here is the problem of
double counting. See http://www.cso.ie/statistics/nationalingp.htm
NATIONAL INCOME CONCEPTS
There are different National Income concepts
•
•
•
•
•
•
•
•
•
•
The one that is officially used in Europe is GDP (Gross Domestic
Product) at market prices.
However this is not very valid for Ireland as it does not take account of
outflows of money that have been generated in the country (especially
the profits of multinational companies).
So a more accurate figure for Ireland is GNP (Gross National Product)
at market prices.
Net measurements can also be taken (i.e. that do not include
depreciation).
Also measurements can be at market prices (as for expenditure) or
factor cost (for income).
An alternative measurement of human welfare is provided through the
United Nations Human Development Index (HDI).
This includes three components
1. Life Expectancy at birth
2. Education based on literacy levels and years of schooling
3. GDP per capita.
COMPARISONS OF NATIONAL INCOME
•
Many problems can arise both in measuring national income an making
comparisons between countries
- quality of information can vary from country to country
- differences as between income and wealth measurements
- in poorer nations money may not be widely used therefore much activity may
be unmeasured
- exchange rates can distort comparisons (e.g. falling dollar vis a
vis the euro
- distribution of income can vary widely
- climatic differences can be important and lifestyles may significantly
differ between countries
- cost of living variations can be significant
- diseconomies of growth can lead to national income rising due to the very
problems caused by its rise in the first place (e.g. the need to build new
roads because of traffic congestion)
- many feel that income measurements as a standard of welfare are too
restrictive and that factors like education and life expectancy should be
also taken into account