Module: Macroeconomics

Transcription

International University
for Cooperative Education
Module: Macroeconomics
PD Dr. Hagen Bobzin
International University
for Cooperative Education
Niedersachsen
February 2014
Version: February 6, 2014
iUCE, February 2014
PD Dr. Hagen Bobzin, Macroeconomics
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Bibliography
Baumol, W. J., Blinder, A. S., Macroeconomics – Principles & Policy,
Mason, OH : South Western, 11. ed., 2009.
Davis, M. A., Macroeconomics for MBAs and Master of Finance,
Cambridge : Cambridge University, 2009.
Gwartney, J. D., Stroup, R. L., Sobel, R. S., MacPherson, D. A.,
Macroeconomics – Private and Public Choice, Mason, OH :
South-Western, 13. ed., 2008.
Hall, R. E., Lieberman, M., Macroeconomics – Principles & Applications,
Mason OH : South Western, 6. ed., 2008.
Mankiw, N. G., Macroeconomics, New York, NY : Worth, 7. ed., 2010.
le Mond diplomatique (ed.), Atlas der Globalisierung, taz-Verlag, 2006.
Sachs, J. D., Larrain, F., Macroeconomics in the Global Economy, New
York : Harvester Wheatsheaf, 1993.
Samuelson, P. A., Nordhaus, W. D., Economics, 19. ed., Boston :
McGraw-Hill, 2009.
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Abbreviations
BOP balance of payments
ECB European Central Bank
ECU European Currency Unit
EMS European Monetary System
EMU Economic and Monetary Union
ERM Exchange Rate Mechanism
ESA 95 European System of National and
Regional Accounts
ESCB European System of Central Banks
EU European Union
FDI Foreign Direct Investment
GATT General Agreement on Tariffs and
Trade
GATS General Agreement on Trade in
Services
GDP Gross Domestic Product
GNI Gross National Income
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HICP Harmonized Index of Consumer
Prices
ILO International Labour Organization
IMF International Monetary Fund
OECD Organisation for Economic
Co-operation and Development
PPP Purchasing Power Parity
ROW Rest of the World
SDR Special Drawing Right
TEU Treaty on the European Union
TFEU Treaty on the Functioning of the EU
TRIP Trade Related Aspects of Intellectual
Property Rights
WTO World Trade Organisation
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Symbols
B money base
C consumption
G government expenditure
i interest rate
I investment
K capital stock
L liquidity preference
M money stock
N labor
p commodity price
P price level
r rental rate of physical capital
S saving
T tax revenue
V velocity of money
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w wage rate
x quantity of a good
Y national income
π inflation rate
open economy
e exchange rate
Ex export value
Im import value
NK net capital imports
K Ex capital export
K Im capital import
TB trade balance
Z balance
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Table of Contents
1 Economic Matters in a Closed Economy
2 Basic Concepts in Macroeconomics
3 Macroeconomic Policy (Global Steering)
4 Prospects of Macroeconomics
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1.1 Preliminaries
1.2 Market Prices
1.3 Government Activities
1.4 National Accounting
1.5 Macroeconomic Goals
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1.1 Preliminaries
I microeconomics – macroeconomics
I households, firms, prices of factors of production and goods
(→ Module: Microeconomics)
I aggregates (e.g., consumption, investment, GDP, price level)
I closed – open economy
I internal equilibrium: full employment, price stability
I external equilibrium: adjusted balance of payments
(→ Module: International Economic Relations)
policy mix (Tinbergen’s rule, see p. 68)
I fiscal policy → full employment
I monetary policy → price stability
I economic growth
I currency policy → adjusted BOP
I value of money
I internal: price index/level (P, HICP), inflation
I external: exchange rate (price of a foreign currency), terms of
trade
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1.2 Market Prices
Overview:
I
I
I
I
Market demand
Market supply
Market equilibrium and price mechanism
Comparative statics
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1.2 Market Prices
Market Demand
I The law of demand states by plausibility that the demand x D for a
good declines if the corresponding price p increases.
I Aggregation denotes the summation of individual quantities
demanded to the market demand.
I The market (or aggregate) demand has similar properties as
individual demand and holds true the law of demand.
p
xD
x
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1.2 Market Prices
Market Supply
I The law of supply states by plausibility that the supply x S of a good
rises if the corresponding price p increases.
I Aggregation denotes the summation of individual quantities
supplied to the market supply.
I The market (aggregate) supply has similar properties as individual
supply and holds true the law of supply.
p
xS
x
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1.2 Market Prices
Market Equilibrium
A market equilibrium denotes a price at which demand and supply
match each other. Consequently, a market equilibrium has two
components: an equilibrium price p∗ and an equilibrium quantity x∗ .
In graphs, equilibria are determined by intersection points of demand
and supply curves.
p
xD
xS
p∗
x
x∗
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1.2 Market Prices
Price Mechanism
The price mechanism describes how markets may find an equilibrium
price when starting at a disequilibrium. The easiest way to think of
price mechanism is some sort of a trial and error process:
p
xD
xS
x S > x D denotes an excess supply, p ↓
p∗
x D > x S indicates an excess demand, p ↑
x∗
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x
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1.2 Market Prices
The same reasoning holds good for
I commodity or service markets (goods prices)
I labor or capital markets (wage rate, rental rate), see Sec. 2.3
I foreign exchange markets (exchange rate)
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1.2 Market Prices
Comparative statics
I variables internal to the market: price p and quantity x
→ movements along the curves
I external shocks, variations of parameters
→ shifts of demand or supply curves
comparison of equilibria
We learn: there are alternative equilibria.
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I constitutional state
I market economy, competition, price mechanism
I efficiency, performance justice, economic growth
I regulating and correcting state
I social market economy, market power, unaccepted market results
I equity, fairness, other forms of justice
I the state as agent in markets
I household (collective needs)
I firm (public sectors, market power, missing supply)
I public choice
I voting mechanisms (democracy)
I the way that governments make decisions
I market failure → government failure (see Sec. 4.2)
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Overview:
I
I
I
I
Flows of income
Closed economy without government activities
Closed economy with government activities
Open economy (outlook only)
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Flows of Income (General Principles)
I
I
I
I
two poles: housholds (consuming units) vs. firms (producing units)
factor markets and goods markets (exchange of services)
here: commodity flows
principle: For each pole inflow must be equal to outflow.
factor services (labor, capital)
households
firms
consumer goods and services
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Flows of Income (General Principles)
I Control the principle that inflow must be equal to outflow for
each pole by monetary terms.
I Drop commodity flows and use (reverse) monetary flows instead.
factor income Y
factor cost wN + r K
households
firms
consumption C
revenue C
I Y = factor income = national income
I C = consumption expenditure = value of sold products
I wN + r K = labor cost (wages) + capital cost
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National Accounting
double entry bookkeeping system (detailed rules in ESA95):
a first extremely simple example
debit
credit
production account:
Y=C
use of income account (households):
C = wN + r K
generation of income account (firms):
income account (private sector):
wN + r K = Y
C= Y
Caveat: Summarizing accounts induces a loss of information.
Cf. income account of the private sector: missing statement about
wN + r K (→ functional income distribution, Sec. 4.1)
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Flows of Income Including a Private Banking Sector
factor income Y
saving S
households
firms
consumption C
revenue C
nt I
investme
banks
I S = saving = anything of the income Y the household do not
consume (residual)
I S = future consumption
I I = investment (form the capital stock for future production)
I The banking sectors collects all recources not consumed, i.e. S,
and makes them available for investment I, see Sec. 2.1.
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National Accounting
double entry bookkeeping system
production account:
Y = GDP
goods and service account:
GDP = C + I
Y=C+I
use of income account (households):
C + S = wN + r K
generation of income account (firms):
income account (private sector):
wN + r K = Y
C + S= Y
finance account (banking sector):
I= S
The statement in the finance account is called ex post identity:
I=S
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Flows of Income with Government Activities
public expenditure G
government
tax revenue T
tax revenue T
factor income Y
saving S
households
firms
consumption C
revenue C
nt I
investme
banks
budget constraint of the state: G = T
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(See also Sec. 2.1.)
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National Accounting
Allowing for a government with regard to a closed economy:
production account:
Y = C + C St + I + I St
income account (priv’ sector):
C+S+T =Y
income account (publ’ sector):
C St + S St = T
income account (total):
C + C St + S + S St = Y
finance account (ex post identity):
I + I St = S + S St
by definition: government expenditure G = C St + I St
using the public sector income account: G = (T − S St ) + I St
substitution: I + (I St − S St ) = S ⇐⇒ I + (G − T ) = S
alternative ex post identity for a closed economy
I+G= S+T
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Flows of Income Regarding an Open Economy (Outlook)
government
tax revenue T
tax revenue T
factor income Y
consumption C
revenue C
nt I
investme
capital export KEx
banks
import Im
firms
export Ex
saving S
households
rest of the world
capital import K Im
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Expenditure Components of GDP
Source: Eurostat Pocketbooks, Key Figures on Europe, 2010, p. 24
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Overview:
I
I
I
I
I
Business cycle
Full employment vs. unemployment (→ internal equilibrium)
Price stability vs. inflation (→ internal equilibrium)
Economic growth
Ignored here:
Adjusted balance of payments (→ external equilibrium)
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Business Cycle
real GDP
A business cycle is identified as a
sequence of 4 phases:
1. Expansion or recovery (a
speedup in the pace of
economic activity)
2. Peak (the upper turning of a
business cycle)
3. Contraction (a slowdown in
the pace of economic activity)
4. Trough (the lower turning
point of a business cycle,
where a contraction turns into
an expansion)
trough peak
ti
te n
o
p business cycle
growth trend
time
expansion contraction
recovery prosperity
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Business Cycle
Further elements in the graph
I The business activity level is measured by real GDP.
I The output Y r (= real GDP) depends on employment N (→
labor market) and the capital stock K (→ investment):
Y r = f (N, K )
I The potential GDP denotes the output at the capacity limit
including full employment.
I The growth trend refers to economic growth in the long run.
I The business cycle is depicted twice without growth trend
(dashed red curve) and including the growth trend (red curve).
I On top of the business cycle there are seasonal ups and downs
not shown in the graph.
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P
cycle
without trend
A recession occurs if a contraction
is severe enough . . .
A deep trough is called a slump or
a depression.
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D
al G
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Business Cycle
Caveat: At one time, business cycles were thought to be extremely
regular, with predictable durations. But today business cycles are
widely known to be irregular – varying in frequency, magnitude and
duration.
Since WW II
I average duration of business cycles: three to five years
I average duration of an expansion: 44.8 months
I average duration of a recession: 11 months
Great Depression (1929–1933): 43 months from peak to trough
The Business Cycle Dating Committee of the Centre for Economic Policy
Research has identified the following recessions since 1970 for the euro
area: (peak/trough) (1974q3/1975q1) (1980q1/1982q3)
(1992q1/1993q3)
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Business Cycle
Inherent problems of business cycles
I unemployment and deflation especially in the trough
I inflation especially at the peak
I insufficient provision of the economy with goods below the
capacity limit
Some causes (arguments follow expectations, risks, (mis-)trust, and
sentiments)
I Planned activities (saving, investment) cannot be realized.
I Supply of money and demand for money do not match.
(e.g., credit crunch during the financial crisis)
I Sentiments can change expectations on the future.
In order to prevent problems of business cycles it would be useful to
predict corresponding phases.
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Economic Indicators
major attributes of economic indicators
I
I
I
Relation to the business cycle / economy
I Procyclic: moves in the same direction as the economy, e.g. GDP,
income tax revenue.
I Countercyclic: . . . opposite direction . . . , e.g. unemployment rate.
I Acyclic: has no relation to the economy (is generally of little use).
Timing
I Leading: change before the economy changes, e.g., stock markets
or business climate indicator. Leading economic indicators are the
most important type for investors as they help predict what the
economy will be like in the future.
I Lagged: . . . a few quarters after . . . , e.g. the unemployment rate.
I Coincident: moves at the same time the economy does, e.g. GDP.
Frequency of the data: In most countries GDP figures are released
quarterly while the unemployment rate is released monthly. Some
economic indicators, such as the Dow Jones Index, are available
immediately and change every minute.
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Unemployment
Definitions of the International Labor Organisation
Germany, 2013
I focus on economically active population only
population 81 m
(not children, retired persons, invalids or voluntary unemployed)
I employees = total number of insured persons covered by the
unemployment insurance schemes
I employed = self-employed + employees
42 m
I unemployed = all persons
2.8 m
I between 15 and 65 years of age
I without work, i.e. not in paid employment or self-employment,
I currently available for work
I seeking work
= number of recipients of insurance benefits
I labor force = employed + unemployed
I unemployment rate = ratio of unemployed to employed (ILO,
destatis) or ratio of unemployed to labor force (OECD)
6.5 %
More details follow in Sec. 2.3 (Labor Market).
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map of Germany
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Unemployment
Kinds of unemployment
I frictional: movement of people, e.g., between regions or jobs (it
takes time to find a new job)
I cyclical: the overall demand for labor is low due to a low level of
economic activity (business cycle or seasonal effects)
I structural: mismatch between supply of and demand for labor
I structural changes where some sectors grow while others decline
(one of the most important problems for new member states)
I In the EU high real wages, welfare benefits, subsidies, taxes, and so
on have created high levels of structural employment.
High or even full employment is probably the most important
economic and political goal. (target value: unemployment rate ≤ 5%)
Hidden unemployment is a problem in the political context.
NAIRU (Non-Accelerating Inflation Rate of Unemployment) refers to a
level of unempl’ below which inflation rises via increasing wage rates.
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Inflation
Inflation denotes a persistent increase in the general price level P of
commodities and services over some period of time.
I Inflation suggest an average increase in all prices of commodities
I
I
I
I
I
and services.
Inflation is an ongoing process not just a singular effect.
The inflation rate is measures on an annual basis (see below).
Inflation indicates that the value of money diminishes.
One needs more money to buy the same basket of goods.
The price level refers to a basket of goods consumed on average
by any household.
The ECB uses a basket of consumer goods consisting of 15.2%
food, 4.4% alcohol and tobacco, 7.1% clothing and footwear,
14.5% housing, 14.9% transport, 1.1% education etc.
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Inflation
I Y n = nominal GDP in prices of the current year (e.g., 2014)
Y n = p2014
x1 + p2014
x2
1
2
I Y r = real GDP measured in prices of a base year (e.g., 2000)
Y r = p2000
x1 + p2000
x2
1
2
I P = price level
P2014
x2
x1 + p2014
p2014
Yn
2
1
= r = 2000
Y
p1 x1 + p2000
x2
2
I Y n = PY r
P − Pt
I inflation rate π = t−1
(deflation if π < 0)
Pt−1
I The ECB refers to price stability if π ≤ 2%.
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Economic Growth
annual growth of business activity (most frequently used indicator:
GDP) in the long run (ignoring seasonal aspects or business cycle)
I quantities of factors of production
(labor, land incl. environment, capital)
I qualities of factors of production
(education, pollution of the environment, technical progress)
I organizational aspects
(constitutional state, administration, infrastructure)
measurement of growth:
I absolute growth Yt − Yt−1
I growth rate Yt − Yt−1
Yt−1
I GDP per head more relevant than GDP
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2.1 Commodity Market
2.2 Money Market
2.3 Labor Market
2.4 Total Equilibrium
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Commodity Market (Overview):
I
I
I
I
Consumption and saving
Investment and saving
(Demand sided) equilibria in the commodity market
Government sector
I Government expenditure
I Tax income (government finance)
I Budget deficit
I Effects of a fiscal expansion
Remark: Y = C + I + G refers to the demand side of an economy. The
supply side will be described by the labor market in Sec. 2.3.
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Consumption and Saving
I Income Y = resources households can consume C.
I Disposable income allows for taxes reducing the income (Y − T )
I Saving S = anything of the income Y the households do not
consume (residual, S = Y − C)
I Saving = future consumption
I Saving = resources needed for investment
(Today you can either consume a cow (slaughter) or spare it. If you
spare the cow it can be used for future consumption (→ saving) and
meanwhile for breeding (→ investment).)
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Consumption and Saving
Consumption C follows some simplified rules by plausibility:
I The higher the (disposable) income the more we spend on
consumption.
I An extra unit of income (e.g., 1 euro) leads to an extra amount of
consumption (e.g., 66 cent).
I There is a minimum amount Cmin the consumption does not fall
below (subsistence level)
C(Y )
Cmin
Y
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Investment and Saving
I
I
I
I
I
investment I – saving S (cf. ex post identity (I = S))
investment I – capital stock K, Kt+1 − Kt = Itn
depreciation D – consumed part of the capital stock
gross investment vs. net investment: I g = I n + D
by plausibility: investment I depends on the interest rate i.
i ↑ =⇒ I ↓
i
I
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Equilibria in the Commodity Market
I Any equilibrium requires Y = C + I (equilibrium condition).
I Suppose a given interest rate i, so that b
I = I(i) is determined.
I Two cases may happen
I Increase in inventories if total output Y exceeds desired
consumption C(Y ) and planned investment b
I.
consequence: Y ↓ and C(Y ) ↓
I Decrease in inventories if total output Y falls short of desired
consumption C(Y ) and planned investment b
I.
consequence: Y ↑ and C(Y ) ↑
An equilibrium in the commodity market appears if planned output
equals desired consumption and planned investment. Only if unplanned
changes in inventories disappear, there is no need to adjust Y, C or I.
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Equilibria in the Commodity Market
C+I
Y =C+I
increase in inventories
C(Y ) + b
I
C(Y )
decrease in inventories
45◦
Y2 → Y ∗ ← Y1
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Y
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IS-Curve
I
I
I
I
additional: planned investment I depends on the interest rate i.
start: Y = C(Y ) + I(i) or, alternatively, Y − C(Y ) = S(Y ) = I(i)
i ↑ =⇒ I ↓ =⇒ Y ↓
The IS-curve denotes all (Y, i) combinations that determine
equilibria in the commodity market.
i
Y
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Government Sector
I Government expenditure G = C St + ISt
I Balanced budget G = T or budget deficit 1 = G − T > 0
I expost identity I + (G − T ) = S. Not all of the private resources
S are available for private investments I having a budget deficit.
I Art. 115 Grundgesetz (German constitution):
The budget deficit 1 must not exceed public investment ISt , i.e.
1 ≤ I St .
Otherwise: 1 = G − T = C St + I St − T > ISt =⇒ C St > T
Golden rule of public finance: Cover ongoing expenditures by
ongoing revenues or: do not finance public consumption by credits!
I EU treaties, Protocol No 13, Art. 2 plus Art. 126 TFEU:
The budget deficit 1 must not exceed 3.0% of GDP (=Y).
EU: deficits by states
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Government Sector
Financing a budget deficit 1 = G − T > 0 by
(a) increasing the money stock ("print money")
→ forbidden, see Sec. 2.2.
(b) issuing bonds (credit of the private sector to the government)
(c) using foreign exchange reserves (requires an open economy)
Caveat: In a closed economony (c) is excluded by assumption and (a) is
excluded by law, so (b) remains. The government either finds a
creditor (banks, firms, households) or it goes bancrupt ("does not pay
for parts of G").
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Effects of a Fiscal Expansion
C+I+G
Y =C+I+G
C(Y − T ) + b
I+G
C(Y − T ) + b
I
45◦
Y∗ →
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Y ∗∗
Y
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Fiscal Expansion
I Choose some interest rate b
i and hold it constant.
I before: Y = C(Y ) + I(i) → IS-curve as before
I after: Y = C(Y − T ) + I(i) + G → new IS-curve (IS’)
i
b
i
IS → IS’
Y ∗ → Y ∗∗
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Y
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2.2 Money Market
Money Market (Overview):
I
I
I
I
I
Money supply
Money demand
Quantity theory of money
Equilibria in the money market
Effects of a monetary expansion
Remark: Money supply is controlled by the central bank. On monetary
policy see Sec. 3.2.
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2.2 Money Market
I Supply of money M (monetary aggregates)
I narrow money M1 = coins + paper money + checking deposits
I broad money M2 = M1 + saving accounts
Money supply M is different from monetary base B = coins + paper money +
reserves. The central bank controls directly B and indirectly M. More details
follow in Sec. 3.3.
I Demand for money L (= liquidity preference)
I transactions demand for money
I asset demand (financial economics)
I interest rate = price of money
I You must pay for the opportunity to borrow money.
I You receive money if you lend money to others.
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2.2 Money Market
Quantity Theory of Money
The monetarist approach
I Y n = P Y r = volume of transactions performed in the economy
I V = velocity of money (speed at which money circulates)
I M = money supply
Fisher’s identity (money as a medium of exchange)
M V = P Yr
quantity theory of money:
I assumptions: V = const., Y r = potential output (full employment)
I result: M ↑ =⇒ P ↑
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2.2 Money Market
Quantity Theory of Money
Inflation is always and anywhere a monetary phenomenon
Milton Friedman
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2.2 Money Market
Hyperinflation
Hyperinflation: Most economists agree that a situation where the
monthly inflation rate exceeds 50% can be described as hyperinflation.
1922
1985
1989
1990
1993
1993
Germany
Bolivia
Argentina
Peru
Brazil
Ukraine
5 000%
more than 10 000%
3 100%
7 500%
2 100%
5 000%
People lose their savings, which leads to a substantial loss in wealth for
broad segments of the population.
Over time money completely loses its role as a store of value, unit of
account and medium of exchange.
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2.2 Money Market
Asset Demand
I up until now: transactions demand for money (money as a
medium of exchange)
I now in addition: asset demand (money as a store of value)
Idea: You can hold two types of assets (→ portfolio)
I money in cash without interest payments
I interest bearing assets (e.g., bonds)
Plausibility: The higher the interest rate i
I the more you invest in bonds and
I the lower is your demand for cash L.
Remark: For a fixed transactions volume Y r the transactions demand
for money L = V1 Y r can only be reduced if V increases
(i ↑ =⇒ V ↑).
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2.2 Money Market
Equilibria in the Money Market
I
I
I
I
M = (nominal) supply of money
M/ P = real supply of money
L = transactions demand for money
i∗ = equilibrium interest rate
i
i∗
L
M/ P
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L
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2.2 Money Market
Equilibria in the Money Market
I
I
I
I
i∗ = const, Y ↑ (Y ∗ → Y ∗∗ ) =⇒ L ↑ (shift of L∗ → L∗∗ )
i ↑ (movement along L∗∗ )
new equilibrium at i∗∗
LM-curve: all (Y, i)-pairs corresponding to an equilibrium in the
money market.
i
i
i∗∗
i∗∗
i∗
i∗
L∗
M/ P
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LM-curve
L∗∗
L
Y∗
Y ∗∗
Y
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2.2 Money Market
Monetary Expansion
Increasing the stock of money M → M ′ shifts the LM-curve
i
i
i∗∗
i∗∗
i∗
i∗
L∗
M/ P M ′ / P
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LM-curve
LM-curve
L∗∗
L
Y∗
Y ∗∗
Y
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2.3 Labor Market
Labor Market (Overview):
I The labor market conforms the same rules as any other market:
I labor supply (workers)
I labor demand (firms)
I (real) wage rate (price of a labor unit)
I Unemployment (see Sec. 1.5 on the definition)
Remark: On fiscal policy as an instrument to reduce unemployment
see Sec. 3.2.
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2.3 Labor Market
Labor Market Equilibrium
Labor market equilibrium
I
I
I
I
Everybody seeking work finds a job (full employment b
N ).
N (number of employed persons)
Equilibrium at w
b (wage rate), b
max
N
= maximum number of persons that can work in principle.
Voluntary unemployment (N max − N S ): people not willing to
work at the given wage rate; inactive on the labor market.
w
ND
NS
w
b
N max N
b
N
iUCE, February 2014
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2.3 Labor Market
Minimum Wage Rate
The effect of a minimum wage rate (wmin > w∗ ) on a perfect labor
market is unemployment.
Different statement for an imperfect market.
w
ND
NS
NS > ND
wmin
N max − N S
w
b
N max N
b
N
I N ∗: realized employment (N ∗ ≤ b
N)
S
D
I N − N : (involuntary) unemployment
I N max − N S : voluntary unemployment
N∗
iUCE, February 2014
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2.3 Labor Market
Minimum Wage Rate
Minimum wage rates follow from
I collective agreements between labor unions and employer groups,
I governmental orders.
I Administrative orders of employment protection can have the
same effect.
iUCE, February 2014
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2.3 Labor Market
Supply Side of the Economy
Supply side of the economy:
I The total output Y of an economy depends on the realized
employment N and the capital stock K: Y = f (N, K )
Output Y increases with realized employment N.
I All we produce is offered at the markets: Y S = f (N, K )
I Potential output b
Y S refers to production at the capacity limit
including full employment: b
Y S = f (b
N, K )
Two reasons for unemployment:
(a) minimum wage rates (see above)
(b) lack of demand (Y D < b
Y S ), then potential output b
Y S will be
reduced and N falls below full employment b
N (see below).
iUCE, February 2014
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Overview:
I IS-LM approach
I total equilibrium including the labor market
I outlook: dynamic aspects (growing capital stocks)
iUCE, February 2014
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A total equilibrium of the economy requires simultaneous equilibria on
the commodity market (IS) and the money market (LM).
i
LM
i∗
IS
YD
Y
Y D = C + I + G refers to the demand side of an economy.
iUCE, February 2014
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I The equilibrium (Y D , i∗ ) above refers to the of an economy.
I The labor market equilibrium ( b
N, w
b) represents the supply side;
all workers produce a total output b
Y S that is to be sold.
b
Y S = potential output at full employment
I Problem: For a lack of demand Y D < b
Y S , produced output will
be reduced to Y D = Y S which results in unemployment.
Graphical presentation on the next page.
iUCE, February 2014
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i
LM
i∗
IS
YD
b
YS
Y
The following section deals with the question as to how this problem
can be solved.
iUCE, February 2014
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3.1 Theory of Economic Policy
3.2 Keynesian Approach
3.3 Instruments of Macroeconomic Policy
iUCE, February 2014
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Overview:
I Jan Tinbergen
I Policy assignment
I Stability and Growth Pact (EU)
iUCE, February 2014
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Tinbergen
Probably most important rationale of the theory of economic policy.
Jan Tinbergen
Regarding an interdependent economic system, each economic objective
requires at least one independent instrument.
→ Use instruments adequately to causes of problems.
iUCE, February 2014
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Policy Assignment
In our closed economy the internal equilibrium is based on two goals:
I full employment
I price stability
Two independent instruments are available:
I fiscal policy (public expenditure G) by the government
I monetary policy (money stock M) by the central bank
Policy assignment:
I fiscal policy (G) → full employment
I monetary policy (M) → price stability
Caveat: The two goals are interrelated, so both instruments must be
coordinated in order not to contradict each other.
iUCE, February 2014
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Stability and Growth Pact (EU)
The policy assignment in the European Union (EU) has a special
problem of coordination.
I The monetary policy for those Member States adopting the euro
is performed by the European Central Bank (ECB).
I Fiscal policies are executed by national governments.
Eurozone
The Stability and Growth Pact is an attempt to coordinate national fiscal
policies in order not to jeopardize the European monetary policy.
iUCE, February 2014
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Further goals:
I economic growth
I adjusted balance of payments (external equilibrium)
Economic growth is pursued by
I competition policy (passive role of a constitutional state)
I industrial policy, business cycle policy (active role of the
government, much mor attractive for politicians)
Pursuing an adjusted balance of payments in an open economy depends
on the system of exchange rates (flexible or fixed exchange rates)
iUCE, February 2014
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Overview:
I Lack of aggregate demand
I Fiscal policy
I Monetary policy
I Involuntary unemployment
I Sticky wage rates
I Stability Act (Germany)
iUCE, February 2014
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Fiscal Policy (Fiscal Expansion)
I
I
I
I
Start at (Y1D , i1 ) with Y1D < b
Y S (unemployment)
Fiscal expansion G ↑ =⇒ right shift of the IS-curve
New IS-LM equilibrium (Y2D , i2 ) with i ↑ and Y ↑
Unemployment reduced (Y ↑), but not eliminated (Y2D < b
Y S)
i
LM
i2
i1
IS
Y1D Y2D b
YS
iUCE, February 2014
IS’
Y
74/116
Fiscal Policy
Fiscal policy might be used as follows (idea):
I Rule of thumb: The higher the national output Y S the more
workers are needed.
Potential output b
Y S corresponds to full employment (Y S ≤ b
Y S ).
Problem if b
Y S > Y S = Y D = C + I + G (lack of demand).
I Aggregate demand of the private sector C + I too small.
Hence, labor demand is small and this leads to unemployment.
I Supplement private demand with public demand G = C St + ISt
(Y D = Y S ) ↑
and
Y S converges to b
YS
Additional output generates additional jobs and reduces
unemployment.
iUCE, February 2014
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Fiscal Policy
Caveat:
I Public demand is to be financed by private resources.
An income tax T has similar effects as a tax on labor.
I Withdrawing resources from the private sector reduces private
demand. This leads to a loss of jobs.
I Possibly, jobs are merely shifted from the private to the public
sector (crowding out effect).
iUCE, February 2014
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Monetary Policy (Monetary Expansion)
I
I
I
I
Start at (Y1D , i1 ) with Y1D < b
Y S (unemployment)
Monetary expansion M S ↑ =⇒ right shift of the LM-curve
New IS-LM equilibrium (Y2D , i2 ) with i ↓ and Y ↑
Unemployment reduced (Y ↑), but not eliminated (Y2D < b
Y S)
i
LM
LM’
i1
i2
IS
Y1D Y2D b
YS
iUCE, February 2014
Y
77/116
Benefit cost analysis of a monetary expansion
I Benefit: M S ↑ =⇒ Y ↑ (closer to full employment)
I Cost: M S ↑ =⇒ P ↑ (inflation)
Statement of a former German chancelor (head of government):
"I prefer 5% of inflation to 5% of unemployment."
iUCE, February 2014
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Overview:
I Instruments of fiscal policy
I Instruments of monetary policy
iUCE, February 2014
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Instruments of Fiscal Policy
The major objective of fiscal policy is to reduce unemployment.
Instruments of fiscal policy
I increasing private demand C + I
I stimulation of C by reducing income or consumption taxes
I promotion of I by reducing investment cost (e.g., public credits at
low interest rates, other investment incentives)
I increasing public demand G = C St + ISt
I public investment programs
I funds to accommodate the business cycle (incl. ERP fund)
→ Accumulate surplus funds for problems in the future.
I finance G by credits with the hope of a higher tax income in the
future (deficit spending)
Legal basis in Germany: Act on the Promotion of Economic Stability
and Growth (1967)
iUCE, February 2014
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Instruments of Monetary Policy
The major objective of monetary policy is to promote price stability.
Instruments of monetary policy (eurozone, ECB, ESCB-Statute)
I open market operations, discount window, foreign exchange
operations
I minimum reserves,
I overnight interest facilities
(Secondary) Targets
I steering of money supply M
I steering of liquidity of the private banking sector
I steering of interest rate i
Results: (indirect) effects on real terms (Y, C, I) only in the short run;
in the long run monetary policy affects almost only P.
The Fed (USA) puts more emphasis on indirect effects than the ECB (EU).
iUCE, February 2014
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Basic ideas how instruments work:
(1) Open market operations, discount window, foreign-exchange
operations
→ monetary base
(2) Minimum reserves
→ money creation by private banks
(3) Standing facilities
→ steering of interest rates
iUCE, February 2014
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operations
Idea: The central bank controls the volume of bank reserves by
buying and selling financial assets.
I main refinancing operations
(maturity: 1 week)
I longer-term refinancing operations
(maturity: 1 month)
I fine-tuning operations
(maturity not standardized)
The ECB is «in principle» not allowed to buy government bonds.
iUCE, February 2014
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operations
Idea: The central bank lends money to the private sector (usually
private banks only) at an interest rate called discount rate.
iUCE, February 2014
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(1) Open market operations, discount window, foreign exchange
operations
Idea: The central bank buys or sells assets dominated in foreign
currencies. Example: The ECB buys US dollars.
iUCE, February 2014
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operations
Idea: Retard the process of money creation by loans of the private
money creation
banking sector.
iUCE, February 2014
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operations
ECB data
Purpose to provide and absorb overnight liquidity, bound overnight
market interest rates
I marginal lending facility to obtain overnight liquidity (marginal
lending rate)
→ ceiling for the overnight market interest rate
I deposit facility to make overnight deposits (deposit rate)
→ floor for the overnight market interest rate
iUCE, February 2014
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4.1 Social Policy
4.2 Government Finance (+ Public Choice)
iUCE, February 2014
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4.1 Social Policy
Overview:
I Poverty
I Welfare state and social insurance
I Redistribution of income (functional income distribution)
iUCE, February 2014
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4.1 Social Policy
Poverty (The World Bank)
I Poverty is a state of people not having enough (recources or
money) today in some dimension of well-being.
I Absolute poverty refers to the deprivation of basic human needs
(food, water, sanitation, clothing, shelter, health care and
education).
Food-energy intake method: poverty line = consumption
expenditures at local prices just sufficient to meet some food
energy requirement (e.g., $ 1 a day =
ˆ 1500 calories per day).
I Relative poverty refers to economic inequality in the society in
which people live (e.g., less than 50 percent of a country’s mean
income or consumption).
Global absurdity: a cow in the developed world receives subsidies that amount
to almost twice the annual income of an average Third World farmer.
iUCE, February 2014
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4.1 Social Policy
Welfare State and Social Insurance
The welfare state is a concept of a mixed economy arising in Europe in
the late 19th century.
I Idea:
I Markets direct the detailed activities of daily economic life
(→ individual economic plans).
I Governments regulate social conditions and provide pensions,
health care, and other aspects of a social safety net.
I (One) Instrument: social insurance (see next page)
I Example: Germany is referred to as a «social» market economy.
iUCE, February 2014
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4.1 Social Policy
Welfare State and Social Insurance
Social insurance is a mandatory insurance provided by the state in
order to improve social welfare.
I insurance: covers risks of accidential damages
I mandatory: all individuals have the right and the obligation to
participate (no selection)
I social welfare: individual prosperity and social peace depend on
each other (cf., e.g., high unemployment rates)
I examples: unemployment, health, or pension insurance
I realization differs between countries
Problem with business cycles: During a boom the revenues from an unemployment
insurance are high but unemployment is low. In a recession unemployment
benefits are paid out at low levels of revenues.
iUCE, February 2014
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4.1 Social Policy
Functional Income Distribution
Functional income distribution describes the partitioning of GDP into
factor incomes.
I national accounting: Y = wN + r K
I labor share wN/Y
I capital share r K/Y
Problem addressed by Karl Marx: What party – workers or capital
owners – has more power to take influence on the distribution of
income (→ collective bargaining on wage rates).
Indirect problem: such a «distribution battle» may lead to a decrease in
GDP (→ minimum wage rates, strikes organized by labor unions).
iUCE, February 2014
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Overview:
I Sources of revenue
I Classification of taxes
I Public firms
I Privatization
I Selected classes of expenditure
I Social policy
I Education and health policy
I Regional and urban development
I Government failure
I Equity versus efficiency
I Public sector efficiency
I Reallocation of ressources
iUCE, February 2014
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Sources of Revenue
Classification of taxes by OECD
OECD figures
1. taxes on income, profits and capital gains, Germany: solidarity duty
(individuals, corporate)
(→ income of households and firms, flows)
2. social security contributions
3. taxes on property (immovable property, net wealth, estate,
inheritance, financial transaction, etc.)
(→ wealth of households and firms, stocks)
4. taxes on goods and services
(→ business activities)
I taxes on production, sales, rendering services (value added tax)
I taxes on specific goods and services (excises, customs, etc.)
I taxes on use of goods or on permission to perform activities
Classification by ESA95: (1) taxes on production and imports, (2) taxes on
income, wealth, . . . , (3) capital taxes, (4) social contributions
iUCE, February 2014
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Sources of Revenue (Public Firms)
Public firms (→ social ownership) are based on two aspects:
I the private sector is not willing or not able to provide certain
commodities or services at an adequate level (e.g., television).
I the provision of such goods entails risks of market power which is
expected to be abused (e.g., local electricity or water services).
Publicly owned firms may solve these problems. They sell their services
at low profits (revenue ≈ cost), profits accrue to society, or these firms
are subsidized by the government (i.e. by consumers or tax-payers).
In essence, public firms finance their activities by corresponding revenues.
iUCE, February 2014
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Sources of Revenue (Privatization)
Reasons for privatization of public firms
I The conditions for a public firm are no longer valid so that private
solutions are preferred (cf. telecommunications services).
I Public firms tend to be inefficient due to missing competition (e.g.,
former Deutsche Telekom, Deutsche Bahn, Deutsche Post).
I The government needs exceptional revenues to finance public
debt (e.g., Greece sells harbors and airports).
iUCE, February 2014
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Selected Classes of Expenditure (Overview)
Source: Eurostat yearbook 2010, p. 116
iUCE, February 2014
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Selected Classes of Expenditure
Social Policy
iUCE, February 2014
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Education and health policy
I Expression of a provisional state (→ one aspect of a welfare state)
I The government finds individuals not to assess the advantages of
education or health risks properly.
I Basic decisions and responsibilities are shifted from
«incompetent» individuals to the government.
I Government expenditure is necessary to meet these
responsibilities (→ financed by tax revenues).
Problem: where are the limits? Range from elementary schools to private and
public universities.
iUCE, February 2014
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Regional and urban development
I Problem: regions and towns differ in their economic vitality.
I Passive strategy («workers to the joby»): markets direct
resources into prosperous regions or urban areas (→ rural
exodus). Areas lagging behind suffer from unemployment and
unemployed are expected to move towards prosperous places
(→ problem of migration from periphery to agglomeration areas)
I Active strategy («jobs to the workers»): a reallocation of
recources shall help poor regions to catch up with properous
Example: EU
areas (e.g., infrastructure investments).
iUCE, February 2014
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Government Failure
Equity versus efficiency
I «Perfect» markets yield outcomes where resources are used
efficiently (→ efficiency).
I Market failure refers to market imperfections that hamper
efficiency.
I Not all market results – although efficient – are accepted by
societies, e.g., unequal personal income distribution (→ equity).
I If governments intervene in order to regulate or to correct market
results, they run at the risk to fail also (→ government failure).
Example: If a government redistributes personal income under reasons
of equity it destroys the incentives to participate in competition. The
effect might then be a shrinking GDP.
iUCE, February 2014
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Government Failure
Public sector efficiency
If the public sector
I substitutes (water provision, railway services)
I complements (institutional, material, personal infrastructure), or
I competes with (television, universities, transport modes)
the private sector, the question arises as to what solution provides
preferable outcomes.
Empirical findings: publicly provided solutions tend to be more
inefficient than private solutions especially over a longer period of time.
Reasons:
I lack of private property / lack of responsibility for resources
I missing competition / missing incentives to find better solutions
I investments do not follow rentability criteria
iUCE, February 2014
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Government Failure
Reallocation of resources
I Factor allocations primarily result from factor markets. Factor
prices direct resources to purposes where they are needed most
urgently.
I Regional reallocation of resources is a development strategy by
the state helping poor regions to catch up with more prosperous
areas (see above).
Problem: a reallocation requires to withdraw resources from
prosperous areas (→ slow down) and to distribute them among
regions with a less effective usage of resources (→ speed up).
It is hard to prove that this strategy has positive effects in total. The
European development program seems to lack almost any
advantageous effects.
iUCE, February 2014
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5 Appendix
Table of Contents
1.1 Preliminaries
1.2 Market Prices
2.2 Money Market
2.3 Labor Market
iUCE, February 2014
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5 Appendix
Table of Contents
4.1 Social Policy
iUCE, February 2014
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5 Appendix
Index
aggregation
demand . . . . . . . . . . . . . . . . . . . . . . . . . . 9
supply . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
asset demand . . . . . . . . . . . . . . . . . . . . . . . . 54
benefit cost analysis . . . . . . . . . . . . . . . . . . 78
budget
deficit . . . . . . . . . . . . . . . . . . . . . . 45, 114
business cycle . . . . . . . . . . . . . . . . . . . . . . . .27
circular flow of income . . . . . . . . . . . . 22, 24
COFOG . . . . . . . . . . . . . . . . . . . . . . . . . 25, 98
depression . . . . . . . . . . . . . . . . . . . . . . . . . . 27
equilibrium
external macroeconomic . . . . . . . . . . . 7
internal macroeconomic . . . . . . . . . . . 7
eurozone . . . . . . . . . . . . . . . . . . . . . . . . . . 110
ex post identity . . . . . . . . . . . . . . . . . . . . . . 21
fiscal policy . . . . . . . . . . . . . . . . . . . . . . . . . . 74
instruments . . . . . . . . . . . . . . . . . . . . . . 80
GDP
potential . . . . . . . . . . . . . . . . . . . . . . . . 27
government failure . . . . . . . . . . . . . . . . . . 102
hyperinflation . . . . . . . . . . . . . . . . . . . . . . . . 53
income distribution, functional . . . . . . . . .93
inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
law of demand . . . . . . . . . . . . . . . . . . . . . . . . 9
law of supply . . . . . . . . . . . . . . . . . . . . . . . . 10
iUCE, February 2014
market
demand . . . . . . . . . . . . . . . . . . . . . . . . . . 9
equilibrium . . . . . . . . . . . . . . . . . . . . . . 11
failure . . . . . . . . . . . . . . . . . . . . . . . . . . 102
supply . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
monetary base . . . . . . . . . . . . . . . . . . . . . . . 50
monetary policy . . . . . . . . . . . . . . . . . . . . . . 77
instruments . . . . . . . . . . . . . . . . . . . . . . 81
money
demand . . . . . . . . . . . . . . . . . . . . . . . . . 50
supply . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
policy
assignment . . . . . . . . . . . . . . . . . . . . . . 70
fiscal . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
monetary . . . . . . . . . . . . . . . . . . . . . . . . 77
poverty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
price level . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
price mechanism . . . . . . . . . . . . . . . . . . . . . 12
quantity theory of money . . . . . . . . . . . . . 51
recession . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
social insurance . . . . . . . . . . . . . . . . . . . . . . 92
Stability and Growth Pact . . . . . . . . . . . . . 71
tax
classification . . . . . . . . . . . . . . . . . . . . . 95
structure . . . . . . . . . . . . . . . . . . . . . . . 113
Tinbergen’s rule . . . . . . . . . . . . . . . . . . . 7, 69
unemployment . . . . . . . . . . . . . . . . . . . . . . 33
welfare state. . . . . . . . . . . . . . . . . . . . . . . . .91
107/116
5 Appendix
Regional Unemployment in Germany (Oct. 2013)
Regional unemployment
in the Federal States and
Districts of Germany
(Oct. 2013)
Germany 6.5 %
Western G. 5.8 %
Eastern G. 9.5 %
Federal Agency for Labor
Unemployment rates in
percentages of the total civil
labor force
go back
iUCE, February 2014
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5 Appendix
Regional Unemployment in the EU (2007)
Regional unemployment
in the European Union
and Turkey
focus on Eastern
enlargement and
periphery
Unemployment rates in
percentages of the total civil
labor force
go back
iUCE, February 2014
109/116
110/116
5 Appendix
Eurozone (2014)
EU: 28 Member States
Eurozone (18 members)
1.1.2014: + Latvia
internally fixed rates
(single currency)
Rest of the European
Union
States adopting the euro
unilaterally
go back
iUCE, February 2014
5 Appendix
Money Creation Process
Minimum (required) reserves (money creation process)
round
1B 1CU
1D 1R 1Loan
0.
1.
2.
3.
..
.
I
I
I
I
1M1
= 0.21M1
= 0.81M1
= µ1D
= 1D − 1R
= 1CU + 1D
–
–
20.0
14.4
10.4
..
.
–
80.0
57.6
41.4
..
.
–
8.0
5.8
4.1
..
.
100.0
72.0
51.8
37.3
..
.
–
100.0
72.0
51.8
..
.
–
–
68.0
71.4
274.7
285.7
27.5
28.6
347.1
357.1
343.5
357.1
100.0
–
–
–
accumulated
at 10. round
after ∞ rounds
go back
monetary base (high powered money) B = CU + R
money supply M1 = CU + D
R = µD, reserve ratio µ = 10%
Consequence: µ ↑ =⇒ R ↑ =⇒ Loan ↓ =⇒ M1 ↓
iUCE, February 2014
111/116
5 Appendix
ECB Interest Rates
go back
iUCE, February 2014
112/116
5 Appendix
Sources of Revenue (Tax Structure)
Source: OECD in Figures 2008, pp. 56–57
iUCE, February 2014
go back
113/116
5 Appendix
General Government Deficit
Source of data: Eurostat (code: tsieb080)
iUCE, February 2014
go back
114/116
5 Appendix
General Government Debt
Source of data: Eurostat (code: tsieb090)
iUCE, February 2014
go back
115/116
5 Appendix
Regional Reallocation of Recources
Example: The EU supports
regions lagging in their
development (75% of the
EU-average income per
head) with resources from
the European Fund of
Regional Development.
2007–2013: EUR 347 billion
≈ one third of the EU’s
budget
go back
iUCE, February 2014
116/116

Module: Macroeconomics

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