Transcript of 1 st Lecture: Macroeconomics, Theory and Policy Nikolina Kosteletou 1 The Current State of...
- Slide 1
- 1 st Lecture: Macroeconomics, Theory and Policy Nikolina
Kosteletou 1 The Current State of Macroeconomics National and
Kapodistrian University of Athens Department of Economics Master
Program in Applied Economics UADPhilEcon
- Slide 2
- Macroeconomics: evolution and current state 2 What is it about?
How it has evolved since beginning of previous century Is it
useful? Policy measures Two poles of interest: Theory policies
- Slide 3
- Macro: What is it about? 3 P. Krugman 2009: the study of
big-picture issues, like recession, inflation, unemployment R.
Cabarello 2010: the goal of macro is to explain and model the
aggregate outcomes that arise from the decisions made by multiple
and heterogeneous economic agents interacting through complex
relationships and markets.
- Slide 4
- Macro: What is it about? 4 -examines the economy as a whole and
answers questions such as 'What causes the economy to grow over
time?', 'What causes short-run fluctuations in the economy?' 'What
influences the values various economic indicators and how do those
indicators affect economic performance?economic indicators
- Slide 5
- Branch of economics concerned with 5 Fluctuations Stabilization
policies Determinants of inflation Determinants of employment and
unemployment Interest rates Exchange rates Effect of government
policies( fiscal, monetary, exchange rate policies) Determinants of
growth Performance of trade with other countries (i.e. the balance
of payments)
- Slide 6
- Why do we study macroeconomics? is it useful? 6 Public:
economics-macroeconomics Lively topic of debate-theoretical
interest Revolutions-counter revolutions Role of government recent
recession and crisis
- Slide 7
- Macroeconomics developed as a separate branch 7 20 th century:
great depression, wars, reconstruction, growth, business cycles,
stabilization policies, current economic crisis. 19 th cent.:
Monetary economics (quantity theory of money, prices) Classical
dichotomy between real and nominal variables Gold standard Origin:
The Wealth of Nations. Adam Smith, 1776.
- Slide 8
- Before the crisis of 1930s 8 Emphasis on the markets and its
inherent forces for equilibrium Business cycles theories
Description of cycles (phases) No sign of policies Austrian school
(A. Pigou, D. Robertson): monetary policy ineffective, public works
desirable. Crisis of 1929 (Great depression): what to do about
severe slump, role of the government.
- Slide 9
- The Keynesian revolution 9 Keynes challenged the notion that
the free market economies can function without a minder Market
mechanism is not enough for an economy to get out of depression
Role of government 1936: General Theory of Employment, Interest and
Money unemployment Slow adjustment of wages, Role of spending on
public works Role of budget deficit in reviving the economy
Effective demand Role of monetary policy (money is not
neutral)
- Slide 10
- The Keynesian revolution 10 Main elements: Supply demand Prices
- quantities All markets do not clear Labor market: equilibrium
with unemployment Rigidities: wage rigidity Government should
intervene
- Slide 11
- The Keynesian revolution 11 Development of analytical framework
Economic policy Role of government in implementing fiscal and
monetary policy National accounts (components of national
expenditure) Development of econometric models for the study of
policy influence on income, consumption, investment. Prediction-
Disputes about microfoundations of macroeconomics Keynesian
economics as a special case of general equilibrium analysis
- Slide 12
- Classical economics 12 before Keynes: classical economics
developed during a period in which capitalism was emerging from
feudalism and in which the industrial revolution was leading to
vast changes in society. Adam Smith, Jean-Baptiste Say, David
Ricardo, Thomas Malthus, John Stuart Mill. Adam SmithJean-Baptiste
SayDavid RicardoThomas MalthusJohn Stuart Mill Keynes: General
Theory (previous orthodoxy)
- Slide 13
- Classical economics: main elements 13 General equilibrium All
markets clear Efficient allocation of resources free markets can
regulate themselves No role for government intervention Quantity
theory of money: money is a veil Dichotomy: real and nominal values
Say's Law: supply creates its own demand that is, aggregate
production will generate an income enough to purchase all the
output produced.
- Slide 14
- Neoclassical synthesis 14 Synthesis of Keyness ideas with
neoclassical models. Neo-Keynesians. Keynesian theory as a special
case. John Hicks (IS/LM), Paul Samuelson. Neoclassical model,
correct in the long run. Keynesian model, correct in the short run.
Dynamics from the short to long run not well worked out. Economic
policy effective in the short run-ineffective in the long run.
- Slide 15
- Neoclassical model 15 aim: explanation of how scarce resources
are allocated among alternative ends. 3 basic assumptions: Rational
preferences Individuals maximize utility Firms maximize profits
Full information
- Slide 16
- Neoclassical model 16 Description: General equilibrium (all
markets clear) Equilibrium prices and quantities determined within
markets. Economic units: firm - household (consumer) Firm: produces
goods It buys productive resources from households and sells goods
aim of the firm: max of profit given prices Perfect
competition
- Slide 17
- Neoclassical model 17 Household: possesses productive resources
Buys goods from the firms Sells inputs to the firms Aim: max
utility given prices Perfect competition also in the market of
productive resources
- Slide 18
- Neoclassical model 18
- Slide 19
- Decades: -50s, 60s 19 Refinement of Keynesian models Critique
on microfoundations new theories about special topics Consumption:
Modigliani, Friedman, Dusenberry Liquidity preference: (Tobin,
Baumol) 3 waves of critique: monetarism, rational expectations,
real business cycles
- Slide 20
- Common points of critique on Keynesian economics 20 Skepticism
about the benefits of active stabilization policy Self correcting
mechanisms of the economy Question about the effect of public
policy Fiscal policy inflation Stagflation (-70s) Prices: question
with assumption of their stability (effect of demand on
prices)
- Slide 21
- Common points of critique on Keynesian economics 21 New
phenomena and evolution in economic and social life: Demographic
composition of workforce New labor saving technologies Changes in
consumer preferences Liberalization of international trade Increase
in the price of oil
- Slide 22
- Keynesian model insufficient 22 New ideas and theories: Natural
rate of unemployment: rate above which labor market tightens. Any
attempt of the authorities to lower unemployment creates inflation.
Expectations (endogenous) Supply side comes to the center of
discussions- supply costs
- Slide 23
- monetarism 23 Milton Friedman, Karl Brunner, Allan
Meltzer(-60s). Basic points of critique on Keynesian economics:
Downgraded role of monetary policy and excessive emphasis on fiscal
policy. Monetarists place emphasis on long run results Basic
hypothesis: In the long run money is neutral. An increase in Ms
increase in P
- Slide 24
- monetarism 24 Increase in prices is caused by increased
spending that derives from increased circulation of money: Changes
in the quantity of money affects spending money matters in the
short run. in the short run monetary policy can be effective
(Keynesian view) Emphasis on the final long run effect
- Slide 25
- monetarism 25 Monetarists: do not deny real effects of monetary
policy during the transitional period (from the short run to the
long run). stress the eventual inflationary consequence of
successive monetary expansions. emphasize the inability of fiscal
policy to stimulate economy for a long period of time. sustained
stimulus to aggregate demand inflation.
- Slide 26
- monetarism 26 Skepticism about fine tuning of demand management
policies. Fine tuning: small adjustments to certain policy
variables in order to improve a nations economy. Emphasis on low
inflation over the long run. Proper policy: Determination of the
inflation target and then determination of money growth. Policies:
popular in the -70s. F.E.D., E.C.B.
- Slide 27
- Monetarism and expectations 27 Keynes: expectations important,
but exogenous. Monetarists: expectations are endogenous and depend
on past experience. Adaptive expectations If expectations about
inflation change, then the Phillips curve shifts. Phillips curve
can be vertical and consistent with the natural rate of
unemployment. Neutrality of money is verified.
- Slide 28
- Contribution of monetarists to theory and policy 28
Manipulation of M1, M2 or M3 by central banks. Monetary targeting
as an approach to monetary policy. Monetary policy through pegging
of C.B. basic interest rate. Understanding that increased spending
is related to inflation. IS-LM framework: monetary and fiscal
policy determine demand, output and unemployment.
Expectations.
- Slide 29
- Monetarists methodology 29 Statistical methods. Models of one
equation to describe the economy. Methodology of monetarists did
not last. on the contrary Keynesian models encompassed monetarist
ideas about the role of monetary policy.
- Slide 30
- Rational expectations and the New Classical economics 30
Counterrevolution or revolution. -70s (2 nd wave of critique for
the Keynesian approach) Representatives: Robert Lucas, Thomas
Sargent, Neil Wallace. Economists put forward looking behavior in
the linear IS/LM model. Basic assumption: equilibrium (all
expectations are fulfilled). Rational expectations: there is
perfect information. consumers and policy makers (economic agents)
have in mind the same model about the functioning of the
economy.
- Slide 31
- Rational expectations and the New Classical economics 31
Equilibrium: a state in which no one has any reason to act
differently, given a correct understanding of the environment in
which they act, as determined by the collective actions of others
(expectations are fulfilled) Rational expectations: John Muth
(1961) Price of agricultural products. Prices of financial
markets.
- Slide 32
- Consequences of rational expectations 32 The government cannot
affect economic activity, with fiscal or monetary policy.
Microfoundations are important. Individuals maximize utility, firms
maximize profits. Intertemporal models of general equilibrium. All
markets clear instantaneously. Efficiency: perfect information,
zero transaction costs, no frictions. If economic agents don't have
perfect information expectations are not rational and policy can be
effective.
- Slide 33
- 33 Economic policy can affect the real economy only if
expectations are not rational. In practice: economic policy
influences expectations economic behavior is changed instantly.
There is no trade off between inflation and unemployment.(Phillips
curve is vertical) Central Banks: target on inflation
- Slide 34
- New Classical Economic Theory 34 Theory of rational
expectations has limits: it cannot: explain fluctuations of
economic activity. explain economic crisis. suggest policies to
stimulate the economy. Efficiency assumption doesn't hold in
practice, especially in financial markets
- Slide 35
- Real Business Cycles 35 New classical economics -80s. F.
Kydland, E. Prescott, C. Plosser. Households maximize utility Firms
maximize profits The cycle is caused by a technological shock
Economic activity adjusts to external shocks (such as new
technology, increase in the price of oil) Monetary issues do not
matter. Classical dichotomy exists. Analysis is true for the long
as well as the short run.
- Slide 36
- The empirical side of business cycles 36 Special emphasis on
quantitative analysis. Extensive use of statistical data. Methods
of prediction have improved. Emphasis on statistical
characteristics of aggregate economic variables. Supply side
matters for the economic activity.
- Slide 37
- Contribution of business cycles 37 Markets are characterized by
imperfections. Emphasis on the study of the supply side. Supply
side is added to a theoretical model. Alternative policy measures
for the reduction of unemployment. Potential output: output that is
produced when markets function perfectly.
- Slide 38
- New Keynesian Theories 38 In the meantime: Keynes core ideas
matched with various strands of neoclassical economics gave rise to
new Keynesian theories. assumptions about rational expectations
have become part of Keynesian models. Rigidities + rational
expectations: new Keynesian models. Rigidities: price and wage
stickiness There is a role for the government and the Central Bank
to control the economy.
- Slide 39
- New Keynesian Theories 39 -90s Return to the IS/LM and the
Phillips curve New version of the Phillips curve: Triangle Model
Stagflation: NAIRU theory. Non Accelerating Inflation Rate of
Unemployment: it refers to a level of unemployment below which
inflation rises. Stagflation Natural rate of unemployment Cost of
getting unemployment too low: accelerating inflation.
- Slide 40
- New synthesis 40 New Keynesian approach with real business
cycles. Microfoundations are important. Price and wage rigidities
are important. They cause deviations of actual production from its
potential magnitude. There is scope for government intervention.
Emphasis for the proper functioning of efficient markets.
- Slide 41
- DSGE models 41 State of the art policy model is a New Keynesian
DSGE model with sticky prices and a Taylor type rule for interest
rates. Wage and price rigidities are reconsidered and incorporated
in real business cycle models. Monetary policy can be effective and
may cause output and employment fluctuations. D: dynamic. These
models predict transition paths for the economy when it is
disturbed away from steady state. S: stochastic. Random shocks to
parameters are included. GE: General equilibrium
- Slide 42
- Post-Keynesians 42 Demand matters in the long run as well as in
the short run. There is no automatic tendency towards full
employment. Rigidity of sticky prices or wages is not the basic
cause of the market failure to provide full employment. IS/LM is
rejected. Emphasis on monetary policy: CB can choose either the
quantity of money or the interest rate to influence demand.