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Macro CFA review

Macro CFA review. Outline . Measurement National income (GDP) and unemployment Business cycles Aggregate supply and demand model Money Money supply and demand Monetary and fiscal policy Activist versus non-activist policy. Gross Domestic Product.

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Macro CFA review

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  1. Macro CFA review

  2. Outline • Measurement • National income (GDP) and unemployment • Business cycles • Aggregate supply and demand model • Money • Money supply and demand • Monetary and fiscal policy • Activist versus non-activist policy

  3. Gross Domestic Product • Objective: Estimate the amount of economic activity • Approaches • measure output • measure expenditure • measure income • These all measure the SAME THING!

  4. Gross Domestic Product Gross Domestic Product (GDP) is the most common measure of economic activity GDP – The market value of all finalgoods and services produced in a year, within a country’s borders

  5. Expenditure GDP = C + I + G + NX C – Consumption expenditures I – Investment expenditures • machines, equipment, structures, software and inventory G – Government purchases of goods and services NX – net exports = Exports minus imports

  6. Income and output GDP = output of the economy • Output produced using land, labor and capital Payment to resources • Wages – payment to labor • Interest and profits – payment to capital (includes dividends) • Rent - payment to land GDP = wages + interest & profits + Rent

  7. Real and Nominal GDP • Nominal value – the value in current dollars • Expenditure method: GDP = C + I + G + NX • measured in current market prices • Real value – the value in constant dollars

  8. Inflation • Inflation – sustained rise in the average level of prices • Deflation – sustained decline in average level of prices • Price level – measured using a price index • Price index measures average, not relative prices

  9. Calculating the inflation rate Inflation rate is found by calculating the percent change in the price index Inflation rate 1977-1978 = Inflation rate 2007-2008 = Source: BLS, base year 1984-1982 average. End of period

  10. CPI inflation record, USA Source: Bureau of Labor Statistics

  11. Consequences Inflation • Inflation erodes the purchasing power of money • Results in loss of purchasing power of monetary and fixed income assets • Bank deposits, CDs, Bonds • Results in a decrease in debt burden as purchasing power of debts fall • Creates confusion about future prices

  12. The “inflation tax” • Inflation distributes income from those with fixed incomes to those with fixed costs. • Inflation acts as a tax on fixed income receipts • Tax on lenders/savers • The real value of fixed income falls as prices rise • The real value of fixed payments fall as prices rise

  13. Business Cycles

  14. Unemployed • To be considered unemployed, a person must • not have a job • be 16 years of age or older • be actively seeking employment, or awaiting recall • People not working and who are also not looking for work are notconsidered unemployed

  15. Unemployment rate The labor force = employed + unemployed persons • Interpret as the number of available workers The unemployment rate = unemployed divided by labor force

  16. Example, USA Source: Bureau of Labor Statistics Calculate the labor force Calculate the unemployment rate

  17. Types of Unemployment Frictional– Unemployment caused by short-term movement of workers and first time job seekers. Structural – Unemployment caused by technological or structural changes in the economy Cyclical – Unemployment caused by recession

  18. The natural rate of unemployment Natural Rate of Unemployment – • The unemployment rate with no cyclical unemployment • Frictionaland structuralunemployment are always present in the economy

  19. Unemployment rate

  20. Potential GDP When unemployment = natural rate • real GDP = potential • No cyclical unemployment

  21. Potential GDP

  22. Model of GDP determination GDP = output = expenditure • Output: Everything produced by land, labor and capital • Aggregate supply • Expenditure: C + I + G + NX • Aggregate demand

  23. Model of GDP determination GDP = output = expenditure • Output: Everything produced by land, labor and capital • Aggregate supply • Expenditure: C + I + G + NX • Aggregate demand

  24. Long-run Aggregate Supply • Long-run: real GDP is equal to potential GDP • Potential GDP is the most an economy can produce with resources and technology • Potential GDP is independent of price level

  25. Long-run Aggregate Supply Curve Price level LRAS Real GDP Yp The long-run Aggregate Supply curve is a vertical line at Potential GDP (Yp)

  26. Short-run Aggregate Supply • Short-run: • Prices of resources/input and costs of production are assumed to be fixed • Price of output may vary • As the price of output increases, the quantity of output supplied (real GDP) increases. • In the short-run, there is a positive relationship between price level and output (real GDP) supplied

  27. Short-run Aggregate Supply Curve Price level SAS LRAS Real GDP Yp There is a positive relationship between SAS and price level

  28. Aggregate Demand Aggregate expenditure: • Consumption (C) • Expectations, wealth • Investment (I) • Expectations, interest rate • Government Purchases (G) • Policy – can deficit if tax revenue not available • Net Exports (NX) • Exchange rate, relative prices, foreign income

  29. Aggregate Demand Price level AD Real GDP There is a negative/inverse relationship between price level and Aggregate demand

  30. Equilibrium Price level SAS LRAS AD = C + I + G + NX Real GDP Yp Long-run equilibrium, all curves meet at potential

  31. Recession SAS Price level AD Real GDP Y’ Yp During recession, real GDP may be less than potential

  32. Responses to recessions Activist/Keynesian response to recession • Use fiscal policy to increase AD • This is counter-cyclical policy • Increase government purchases (G) • Reduce taxes Increase consumption (C) Keynesians are all about Aggregate Demand!! • Multiplier effects: increase in G of $1 leads to greater increase in AD

  33. Response to recession SAS Price level AD’ AD Real GDP Y’ Yp Increase AD to fight recession

  34. Discretionary/automatic stabilizers Discretionary policy • Planned expenditures: American Recovery and Reinvestment act (ARRA) Automatic Stabilizers • Element of fiscal policy that changes automatically as income (real GDP) changes • Example: progressive taxes, unemployment benefits Result: Deficits higher during recessions

  35. Consequences of deficits Richardian equivalency theory Crowding out theory Supply-side economics

  36. Ricardian Equivalence theory • AD shift is the same if government borrows or increases taxes to finance spending • households see government borrow • expect an increase taxes in the future • save more (spend less) to pay future taxes • Result: expansion of AD depressed • David Ricardo (1772 – 1823)

  37. Richardian equivalence SAS Price level AD = AD’ Real GDP Y’ Yp No increase in AD as result of increase in G or reduction in taxes

  38. Crowding out theory • The government issues bonds to finance spending • Businesses also issue bonds to finance investment (I) • Government and businesses compete for the same funds • government borrowing “crowds out”, or reduces, private investment • Depresses increase in AD from government spending

  39. Crowding out SAS Price level AD’ AD ‘’ AD Real GDP Y’ Yp Increase in AD caused by increase in G offset by decrease in I

  40. Financing with Tax Revenue Eventually, government spending has to be financed with tax revenue Taxes reduce incentive to work • As tax rates increase, hours worked per person decreases • Leads to a decrease in potential GDP and decrease in LRAS

  41. Supply-side Economics • The study of the effect of taxation on aggregate supply is “supply-side economics” • Increase tax rates reduces in economic activity • less income available to tax • A decrease in tax rates increases economic activity • more income available to tax

  42. Taxes and hours worked 2004 Sources: Taxes: McDaniel 2007, Hours worked: GGDC and OECD

  43. Taxation on LRAS Price level LRAS’ LRAS Real GDP Yp’ Yp Increasing income tax rates leads to a decrease in potential GDP

  44. Activists and non-activist • Keynesian/New Keynesian • Intervene to increase AD – benefits outweigh cost • New Classical • Supply-side effects are powerful • Richardian equivalence means AD shift will be small

  45. Functions of Money Money must perform the following functions: • Medium of exchange • Satisfies double coincidence of wants • Unit of account • Goods are prices in money • Store of value • Maintains purchasing power • Standard of deferred payment • Debts denominated in money

  46. Types of Money • Commodity Money • money with intrinsic value • Example: gold coins • Fiduciary money or fiat currency • money backed by trust • U.S. dollar is a fiat currency

  47. Defining Money There are two official measures of the U.S. money supply M1 = Currency + checking deposits + travelers checks M2 = M1 + savings deposits + CD + retail Money market Money expands through the banking system

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