ECO202 - Macroeconomic Theory and Policy

Macro is about long run growth and short run fluctuations. 1930's - Great Depression - "Birth" of Macro Macro Objectives Unemployment rate decreased as possible Inflation decreased and stable GDP stable and increased Sticking to the trend and full employment of resources major macro variables Aggregate output, income, expenditure Unemployment Inflation GDP Calculations 1. A. final goods approach Three Types of Goods Consumption goods Capital goods - Consume services of

Unemployment Rate P - Population Over Age 15 Not in Labour force L- Labor force U - Unemployed Not looking for work E- Employed To be employed - Don't have a job, looking for a job, and available to work. Out of Labour Force - Students, Elderly, Discouraged workers, Underemployment, Disguised unemployment Classical View if resources are fixed. Supply is perfectly inelastic. If but doesn't change. The only way to is During the great depression, i

If consumers become pessimistic so which causes output to . Transactions demand , so there is too much supply of money. Its may of bonds . People buy bonds so bond so . What happens to investment? It's ambiguous, because but as well. Expansionary Monetary Policy to point Compare points O and B. is equal. will be lower for because people became pessimistic between and Investment will be higher in because but is lower. is the same and is the same. is als

Real Money If you have $100, you must divide by GDP deflator to measure real money. If deflator is 2, real money is 50. Quantity Theory of Money Way back in history - Velocity of money - # of times that the total money should circulate to transact the total output. Example - Today - Compare - Not fixed, depend on Financial Market Changes Expansionary Monetary Policy buys bonds, of bonds , Return on bonds so If Transaction -

Central bank may target a given interest rate, say in by periodic announcements - so central bank has to offset any shock or change in the economy, by a proper monetary policy to keep rate at . Under interest rate targeting, monetary policy can be interpreted as changing the interest rate. As , , an . Therefore, monetary policy has to overly increase the policy, reduce by a lot. Fiscal Policy - expansionary fiscal policy is increased under fixed rate. (Because monetary policy is requir

We assume that we have 4 assets, foreign and domestic bonds, , and foreign and domestic money. To simplify - , because people don't usually hold foreign currency (only for illegal transactions and protection against domestic inflation.) How do we choose what to hold? Need to compare and , but you need to know the future exchange rate . You end up comparing and . Buy domestic Buy foreign We ignore risk and transaction cost. By arbitrage, in equilibrium both equal because PB so , t

(if if fixed) Suppose domestic interest rate increases: , appreciation - . so higher return, people tend to sell foreign and buy domestic. Capital inflow. Higher demand for domestic currency causes a price increase so . Suppose market expect nominal depreciation: UIP shifts (assume i is fixed) people tend to sell domestic bind and buy foreign. Capital outflow. Lower demand for domestic currency makes . IS/LM Curves in Open Economies IS - LM - UIP - RER - short run are fixe

capital flight, recession, high interest rates Financial or exchange crisis - usually Impact of an Expected Depreciation - creates capital outflow. Depreciation pressure. Central bank sells foreign assets. Money supply shrinks. People sell bonds to get transaction money. - loss of credibility. so demand and , improvement of trade balance in new equilibrium Balance of Payments Accounting Keep track of transactions with foreigners Current Account - Goods and services Financial Acco

Medium Run - is endogenous Can vary and are fixed Labour Market - To endogenite , the labour market should be modeled Boom - Wages go up, production cost rises, prices rise Recession - Wages fall, production cost falls, price tends to fall labour market and unemployment Unemployment rate is never zero Frictional Unemployment - Process of finding a job - matching Structural Unemployment - Due to real wage rigidity - minimum wage or sticky wage Minimum Wage Laws Has large impact on

Aggregate Supply Long Run Given Works at all runs All - points in labour market. and long(medium) run equilibrium - Start with . If (Boom), nominal wage, , . Production cost so . Therefore, is upward sloping. Given If is adjusted upward . At any level of is higher because workers ask for higher wages, expecting a higher price. Cost goes so to the point , meets . Aggregate Demand All runs. Solve as function of and plug into All possible points

Medium Run Equilibrium Demand Side Shocks - Impact of Expansionary Monetary Policy . The natural in partially offsets Point A - Short run equilibrium. adjusts up so shifts - point B is long run equilibrium. shifts back up to original point. Short run - Central bank buys bonds so so and rise. As income , and nominal wage, Production cost so . Real wage is fixed. Also Medium run - Expected price, , adjusts upward. Nominal wage, rises. Production cost so Its , makes re

Final Phillips Curve Regration - Expectations - Augmented Phillips Curve If the increase in price level is accelerating. If inflation is fixed Non-Accelerating Inflation Rate of Unemployment Canada - US - Based on old data Europe - Aggregate Demand If are kept fixed - So we can assume - If is fixed, growth rate of money supply sets inflation! Okun's Law The negative relationship between growth rate of real output and change in unemployment rate - For Canada - No

Inflation in Medium Run Central bank increases anticipated A - Short run equilibrium B - Long run equilibrium If people know to adjust expectations, no short run. Straight to point C and continue forever. If If everyone know, no confusion. So no short run. Central bank unanticipatedly cuts from to zero, at Exchange Rates in Medium Run Open economies in medium run - Flexible Regime Central bank unanticipatedly increases money growth - . Note the fast adjustment of financi

Technological progress is in form of a functional shift: 1. constant returns to scale 2. diminishing returns to each factor Given fixed other factor, the extra output due to one more unit of any input increases, decreasingly. If Constant Returns to Scale: If Lower case variables per capita Long Run: Saving - Investment (Suppose no government) 3. saving function Short Run Consumption Long Run Consumption Long Run

Suppose % % % solow model and saving rate Suppose earthquake ruins half the capital stock golden rule Is move investment always better? Is higher better? Only when maximize consumption convergence Absolute Convergence - Suppose all economies are similar, in all aspects, like technology, saving route, population growth rate, depreciation rate ... except the initial level of per worker capital But, the poorer economies grow faster than richer ones, so all of them converge to the s

Exogenous - In models like the Solow Model embedded model, the continuous growth of the economy, , is determined exogenously (outside the model) Endogenous - If the continuous growth of the economy is determined by the model AK Model - Production function is linear - diminishing return assumption is relaxed and the economy growth forever The growth rate of capital = growth rate of GOP = No steady state equilibrium expectations, real and nominal interest rate Nominal - Rate of retur

Consumption is very crucial for aggregate demand because The only objective of an economy is producing the maximum possible utility of consumption (welfare) Consumption is the biggest part of GDP so shocks to consumption affect GDP The size of MPC is very important for effectiveness of government final policies Consumption theories Keynes The absolute income hypothesis Modigliani The life cycle hypothesis Friedman The permanent income hypothesis The Absolute income hypothesis Income