Macroeconomics precourse – Part 1 Academic Year 2013-2014

1. Macroeconomicsprecourse – Part 1 AcademicYear 2013-2014 CoursePresentation This course aims to prepare students for the Macroeconomics course of the MSc in BA. It provides the essential background in macroeconomics PAOLO PAESANI Office: Room B6, 3RD floor, Building B Telephone: 06-72595701 E-mail: paolo.paesani@uniroma2.it Office hours: to be agreed

2. Macro • MACROECONOMICS • Macroeconomicsis a branchofeconomictheorythatstudies the functioningof the economic system of a nationas a whole and itsconnectionswithothereconomicsystems. • Economic system = Households + Non financialCompanies + Financial Intermediaries + Government (including the centralbank) • Orthodoxapproach: Microeconomics (studyof single elements) as the basisofmacroeconomics (studyof the whole) • Heterdoxapproach: I’lltellyouaboutitnexttime !

3. Macro • SOCIO-ECONOMIC CONTEXT • Well-definedpropertyrightsoveravailableresources; • Freedomto put availableresourcesto the best (mostprofitable) useasjudgedby the owner (resourceallocation); • Propertyrightsprotection; • Freedomto transfer propertyrights in a regulated and organised way (Voluntaryexchange); • Price-basedresourceallocation; • Capitalist economy; • Open economy; • Governmentas a relevantmacroeconomicactor • Money as medium ofexchange, meansofpayment, unitof account and storeofvalue.

4. Macro THE ECONOMIC SYSTEM Mankiw (2010)

5. Macro GOVERNMENT AS A PART OF THE ECONOMIC SYSTEM Governmentas a part of the economic system • Purchasesgoods and servicesfrom the private sector (linkagewith the market forgoods and services); • Hiresworkers and rents capital goodsfrom the private sectorwhichituses in combinationwith intermediate goods and servicesto produce public goods (linkagewith the market forfactorsof production); • Taxeshouselds and firms (directtaxation, indirecttaxation, excises and fees) (TAX) • Transfersmoneytohouselds and firms (pensions, unemploymentbenefits, subsidies) GOVERNMENT Mankiw (2011)

6. Macro FINANCIAL SYSTEM AS A PART OF THE ECONOMIC SYSTEM Financial system (institutions and marketsrelatedto the circulationofmoney and credit) : • Centralbank; • Monetaryfinancialinstitutions (normalbanks); • Non monetaryfinancialintermediaries (investment and pensionfunds, insurancecompanies, rating agencies, investementbanks ….) • Money markets (Short-termfinancialassets) • Financial markets (bonds, shares, derivatives, forex, commodities) GOVERNMENT

7. Macro THE GLOBAL ECONOMIC SYSTEM Everyeconomic system islinkedto the othersthrough multiple channels: • International tradeofgoods and services (Exports and Imports); • International mobilityoffactorsof production (migration, foreigndirectinvestment); • Private internationalfinancialflows (portfolio investment, forextransactions) • Public internationalfinancialflows (management ofofficialforexreserves, interntionalaid, internationaltransfers) GOVERNMENT

8. Macro GROSS DOMESTIC PRODUCT GrossDomesticProduct (GDP, Y) is the nominalvalueofall the finalgoods and servicesproducedwithin a countryover a givenperiodoftimeevaluated at market prices. nominalvalue = measured in termsofmoney Finalgoods and services = goos and servicesproducedover a givenperiodoftime and NOT USED to produce othergoods and servicesduring the sameperiodoftime. Produced = Trading ofsecondhandgoodsisnot part of GDP Within a country = National dimension Givenperiodoftime = UsuallyOneyear (flow variable) Market prices = Onlyfinalgoods and servicesregularlybought and sold in a market contributeto GDP.

9. Macro GROSS DOMESTIC PRODUCT Wheat RawBread Primarysector AGRICULTURE Secondarysector INDUSTRY Tertiarysector SERVICES 100 EUR 50 EUR 150 EUR Packagedbread Total valueofgoods and services = 300 EUR Valueof intermediate goods and services = 150 EUR GDP = 150 EUR Gross National Income = 50 + (100-50) + (150 – 100) = 150 EUR Consumers

10. Macro GROSS NATIONAL PRODUCT Gross National Product (GNP) is the nominal market valueofall the finalgoods and servicesproducedwithin a country or a abroadover a givenperiodoftimebynationalfactorsof production. GNP = GDP + NFI NFI = NET FOREIGN INCOMES = (Incomeofdomesticlabour and capital employedabroad) – (Incomeofforeignlabour and capital employed in the country) Nationality + Residence matter

11. Macro NATIONAL INCOME Gross National Income (GNI) isequaltoGross National IncomeminusIndirectTaxation (ex. VAT) GNI = GNP - VAT Hint: Whenyoubuyanything (eg. a book) , 20% of the price youpayis VAT and istrasferredto the State, the restcompensatesfactorsof production employedto produce it.

12. Macro OTHER MEASURES OF INCOME Mankiw (2011)

13. Macro GDP PER CAPITA Dividing GDP by the country’s population (POP) weobtain GDP per-capita. GDP per capita can betakenas a roughmeasureof the economic welfare of a country’s residents. GDP per capita = GDP / POP GDP per capita isanaveragethattellsusnothingaboutdistribution. Economists and statisticianshavedevelopedspecificindicatorsforthat (e.g. Lorenz Curve, Ginicoefficient, …)

14. Macro GDP PER CAPITA Source: BNP_perhoofd_2012_%281%29.PNG

15. Macro GDP = AGGREGATE DEMAND Y = C + I + G + X – M Mankiw (2011)

16. Macro AGGREGATE DEMAND: CONSUMPTION Aggregate consumptiondepends on: Currentdisposableincome (Ydisp = Y – TAX + TRA) dC/dYdisp > 0 ExpecteddisposableincomedC/dYexp> 0 Inflation (?), Real interest rate < 0 (?) Wealth = Financial assets + Realassets > 0 Incomedistribution , Consumer credit …. Ydisp – C(t) = S(t) = Private Savings

17. Macro AGGREGATE DEMAND: PRIVATE INVESTMENT Aggregate investmentdepends on: Expectedprofits + attitudetowardsrisk Expected aggregate demand Inflation (?), Real interest rate < 0 Credit + financialfactors K(t+1) – K(t) = I(t) – dK(t) = Net investement K(t) = Aggregate Stock of capital , 0< d <1 depreciation rate

18. Macro AGGREGATE DEMAND: GOVERNMENT PURCHASES Governmentpurchasesdepend on: Sizeof the public sector Fiscal policy decisions G(t) + TRA(t) – TAX(t) = Government budget deficit GBD = change in public debt + monetaryfinancingof BD

19. Macro AGGREGATE DEMAND: NEXT EXPORTS Net Exportsdepend on: Nominalexchange rate E (amountofforeigncurrency per unitofdomesticcurrency) dNX / dE < 0 Domestic price level P dNX / dP < 0 Foreign price levelP*dNX / dP* > 0 Domestic GDP Y dNX / dY < 0 Foreign GDP Y*dNX / dY* > 0 Barrierstointernationaltrade Quality, National specificities … NX (t) + NFI(t) + NFTRA(t) + FDI(t) + PRMK(t) + dRES (t) + EO(t) = 0 Balanceofpayments

20. Macro DECOMPOSING GDP Y = PQ where Y = Nominal GDP, P = GDP deflator, Q = real GDP Mankiw (2011)

21. Macro • INFLATION • Inflation rate = Rateofchangeof the GDP deflatorovertime • Π = [P(t) – P(t-1)] / P(t-1) • Π > 0 = Moderate Inflation • Π = 0 (approx.) = Stableprices • Π < 0 = Deflation • Π >> 0 = High Inflation • Π >>>>>> … 0 = Hyper-inflation

22. Macro • INFLATION AND THE PURCHASING POWER OF MONEY • 1/P can betakenasanindicatorof the purchasingpowerofmoney (amountofgoodswhich can bepurchasedspending 1 euro) • M/P = Real Money balances • W/P = Realwage • Inflationerodes the purchasingpowerofmoney. As suchcreditors and people on fixedincomefearitwhiledebtors and people on floatingincome do not (iftheirincomemove at the placeofinflation). • Interesting link on the effectsofinflation: • http://203.200.22.249:8080/jspui/bitstream/123456789/2209/1/A_tract_on_monetary_reform.pdf

23. Macro MEASURING INFLATION Mankiw (2011)

24. Macro • GROWTH • Inflation rate = Rateofchangeof the real GDP overtime • Γ = [Q(t) – Q(t-1)] / Q(t-1) • Π > 0 = Growth • Π = 0 (approx.) = Stagnation • Π < 0 = Recession • Growththeoryisoneof the mainbranchesofmacroeconomics

25. Macro REAL GDP AND GROWTH Mankiw (2011)

26. Macro REAL GDP AND GROWTH Mankiw (2011)

27. Macro • REFERENCE • Mankiw, G.N. (2010) BriefPrinciplesofMacroeconomics, 6° ed.,