Transcript Government and Macroeconomics

Macro
Measures and Policies
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• Here are the tools used to evaluate government
performance in the popular discussion:
• Gross National/Domestic Product (GNP/GDP)
measures the total size of the market economy,
defined either geographically (GDP) or by people
(GNP).
• GNP/GDP growth is often taken as a measure of economic
performance.
• Inflation (π) measures changes in price level
• Consumer Price Index (CPI) measures the year‐to‐year
change in the prices of commodities...
• that is, the cost‐of‐living.
• Productivity and productivity growth measure the
amount of economic output we get per unit of inputs.
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• Here are the tools used to evaluate government
performance in the popular discussion:
• Unemployment Rate (UR) measures the population of
people seeking work as a fraction of all those either
working or seeking work.
• Exchange rate measures the cost of foreign currency
in terms of Canadian dollars.
• Business pages often treat this as if it were a measure of
economic and government performance.
• Poverty measures assess the size of the population
with ‘too little’ to get by.
• Medical service waiting lists quantify the waiting
times for various specific medical procedures.
• Interest rates are the price of borrowing money.
• Low interest rates are often seen as ‘good’.
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• The size of the market economy
• Gross Domestic Product is the total marketed economic activity
taking place within a geographic region, such as Canada.
• Gross National Product is the total marketed economic activity
done by a specific group of people, such as nationals of Canada.
• Two equivalent definitions, suitable to different types of problems.
• Sum of gross income from all sources in a region (or of a bunch of
people).
• Or, sum of private consumption + investment + government spending
+ the change in inventories + (exports ‐ imports).
• The two definitions are equivalent because
• all private consumption, firm investment and government spending
eventually shows up as someone’s income;
• increased inventories imply increased final sales later;
• exports involve foreigners paying locals and imports involve locals
paying out to foreigners.
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• These definitions add up payments for stuff.
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Thus, stuff which is transacted without payment is not counted at all.
Most household work is not counted;
leisure is not counted;
much child care is not counted.
Anything which is valued but not paid for is left out of GDP, even though it is
produced by people in the economy.
• Some of it is imputed.
• These definitions add up payments for stuff, and assume that those
payments reflect their social value.
• If the conditions for the First Fundamental Theorem hold, then they do in
fact reflect their social value.
• However, some things are transacted at prices different than their social
value—these are things with externalities, public goods, regulated
products, monopolistically supplied.
• GDP (and GNP) is defined nominally.
• If everybody’s income goes up by 10% and all prices go up by 10%, no
improvement happens, so a sizeable increase in GDP may mean nothing
much.
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• Employment and Unemployment
• The population according to Statistics Canada
is divided into 3 types:
• Employed E (worked more than 1 hour this week);
• Unemployed U (wants to work, but did not work 1
hour this week);
• Employed + Unemployed = Labour Force L.
• Out of Labour Force (does not want to work);
• Unemployment rate UR = U/(E+U) = U/L.
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• Unemployment rate UR = U/(E+U) = U/L.
• Information on the fractions of the population in each of these groups is
collected every month by the Labour Force Survey.
• Employed includes people who are working, but may be working more or less
than they desire.
• Unemployed includes only those who ‘want’ to work by the following
criterion—they have looked for work during the past month.
• Looking for work includes:
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making a phone call;
applying for a job;
waiting for your union job to re‐appear;
reading the classifieds;
going to an employment center.
• looking for work by these definitions is what you have to do to qualify for
Employment Insurance benefits (with the exception of parental/maternal
benefits).
• Unemployed thus excludes those who have given up on looking
(discouraged workers).
• When the economy starts growing after a recovery, sometimes the
unemployment rate rises, because the unemployed grow in number as
people start actively looking for work again.
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• Prices, Price Indices and Inflation
• To the extent that we care about consumption, we care not about how
much we spend on goods and services, but rather about the quantity of
goods and services that we get as a result of those expenditures.
• If the prices of things change over time, then we want to adjust any
measure based on spending or income for that price change.
• Inflation is the change in the price of goods and services. If inflation is 2%
between last year and this year, then it takes 2% more money this year to
buy as much goods and services as we bought last year.
• Consumer Price Index (CPI) is a measure of price level produced by
Statistics Canada, and reported in the popular press.
• Basic measurement strategy is this:
• measure the total quantities of goods that people buy (e.g., food, clothing,
shelter...), call these quantities a consumption basket.
• Fix the basket quantities
• Calculate a weighted average of the price increases using the fixed quantities
as weights
• Change in CPI is expressed as a percent increase, and is most reported
measure of inflation.
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• Price indices such as the CPI can be used for
lots of important things.
• Can use them to adjust nominal GDP/GNP
measures. Thus, if prices go up 2%, then we adjust
nominal GDP 2% downwards to compare it with
last year.
• Bank of Canada targets CPI in setting its monetary
policy. The current monetary regime targets
inflation between 1 and 3 percent per year.
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• As a measure of the ‘cost‐of‐living’, CPI has many features
that leave it wanting.
• It is one measure for a whole population of people. But people
may have their personal consumption basket very different from
the one used for CPI.
• People mitigate price increases by reducing consumption of the
goods whose price goes up most, but CPI basket is fixed. In this
case, CPI would overstate the change in the cost of living.
• Since it takes last years’ quantity as fixed, it cannot
accommodate new goods. If phones that take pictures enter the
market, people are maybe better off because they can buy this
new thing, but alas, it does not enter the CPI in any way,
because phones that take pictures were not purchased last year.
• Hyperinflation is a very high inflation rate
• Generally the higher inflation the less predictable it is
• Hyperinflation destroys confidence
• Hyperinflation ruins incentives for long‐term investments
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• Sometimes governments use expenditure and revenue tools to affect the
economy
• For example, if the economy is in a recession, the government may want
to help speed the recovery.
• recession is defined as negative GDP growth for 2 consecutive quarters.
• It may choose to spend more money while holding revenues constant. This
implies increasing the deficit in the short term, and increasing the debt in
the long term.
• The increased expenditure will affect GDP:
• GDP = C + I + G + NX where C is personal consumption, I is firm investment, G
is government spending, and NX is exports less imports.
• increased government spending pushes up G, which pushes up GDP.
• it may also push down I. If firms are thinking about investing in capital, but
government spending is used on capital, firms may be dissuaded.
• it may also push down C. If people realise that they have greater
• government debt obligations, they may try to save up for them.
• typically, these counteracting effects will not completely undo the increase in
G, so the net effect is still to push up GDP.
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• You can also think of this via the other definition
of GDP, as the sum of everyone’s income from all
sources.
• Increase in government spending takes the form of:
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increased government employment;
increased government transfers to people;
increased government spending on goods and services.
Here again, things are partially undone—increased
government employment might result in decreased private
employment (if government poaches private sector
workers); increased transfers might result in decreased
non‐transfer income (if transfer recipients decide to reduce
their work hours because the government gave them more
money).
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• Government spending (holding revenue constant) will also tend two
rather negative effects
• In the long‐term, the increased deficits increase debt.
• In the short‐term, increased spending may push prices up.
• The mechanism is this: governments are writing cheques to people,
so people have more money to spend. But, if there are no more
goods and services to buy, that larger amount of money will be
spent on the same amount of stuff, pushing the price of the stuff
upwards.
• thus, government spending which creates more stuff will tend to be
less inflationary, but government spending which does not create
more stuff tends to be inflationary.
• Thus, increased government expenditure (holding revenue
constant) will typically result in the following in the short‐term:
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Increased size of economy (increased GDP);
Increased employment (lower unemployment rate);
Possibly increased inflation;
And in the long‐term, increased debt.
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• Interest Rates
• The interest rate is the amount that must be paid per unit of time
(e.g., per year) in order to borrow/save money.
• Typically, the rate paid to savers is less than the rate paid by
borrowers.
• This is because financial intermediation (read ‘banking’) uses real
resources.
• There are lots of different interest rates, beyond the distinction
between borrowing and saving.
• The Bank of Canada sets a particular rate: the overnight
government bond rate.
• This is the rate of interest (almost always presented in an annualised
equivalent) to borrow one dollar overnight.
• This is the Bank of Canada’s main policy instrument, and almost the
only monetary policy instrument reported on in the business pages.
• This rate is correlated with all other rates because a longer term rate is
‘like’ a sequence of promises on overnight rates.
• However, it is not perfectly correlated with other rates.
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• Interest Rates, GDP/GNP growth rates, Unemployment rates and Inflation
are connected.
• The Bank of Canada uses its control of the overnight government bond
rate to influence longer term rates.
• Low rates are crucial for various kinds of investment.
• People buy homes more readily when long rates are low.
• Firms engage in investment when long rates are low.
• These activities, and other investment‐related activities, fuel economy
activity in both the short term and the long term.
• In the short term, the input markets for these investments are spurred — e.g.,
homebuilders
• In the long term, firm investments yield outputs.
• So, low interest rates are seen by many to ‘cause’ increased GDP.
• Macro‐economists don’t interpret this relationship as casually, because
forward‐looking consumers and producers won’t get ‘fooled’ by such Central
Bank activity.
• The economy and employment can grow too fast. If people are all in a rush
to buy goods and services, but the quantity of goods and services to buy
has not really changed, then the price of those things rises—you get
inflation.
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• Famous relationship between inflation and
unemployment is Phillips curve
• Downward sloping; greater inflation makes for lower
unemployment
• Holds in short run
• In long run, appears to be vertical
• Unemployment at “natural” rate
• Determined by institutions
• So short run gain from inflation disappears in long run
• So the policies for lowering the natural rate of
unemployment must be different from stabilization
policies
• Increase mobility
• Increase information
• Increase flexibility in general
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