Economics 302 (Sec.

001) Intermediate Macroeconomic Theory and Policy

(1/23/12)

Instructor: Prof. Menzie Chinn UW Madison Spring 2012

Administrative Issues
Course website:
http://www.ssc.wisc.edu/~mchinn/web302_s12.html

OH: MW 4-5, 7418 Soc Sci Textbook: Blanchard, Macroeconomics Additional Readings: from WWW, Econbrowser CBO Econbrowser, NYT, FT, WSJ, Economist

Administrative Issues
Grading: 20% PS, PS 50% 2MTs, 2MTs 30% Final Dates: - MT1 on Wed, 2/22 - MT2 on Wed, , 4/11 - Final on Tue. 5/15, 7:25PM Make-ups: Make ups: None. Points are re re-allocated allocated if you have a legitimate excuse. No late assignments accepted (must ( t be b handed h d d in i during d i lecture) l t )

Context: GDP Growth

.100 .075 .050 .025 .000 -.025 -.050 -.075 -.100 00 01 02 03 04 05 06 07 08 09 10 11 12 WSJ f'casts Real GDP growth

(GDP05/GDP05(-1))^4-1 (G /G ( ))^ (GDP05WSJ_JAN12/GDP05WSJ_JAN12(-1))^4-1

GDP (levels)
16,000 Potential GDP (CBO, Aug.'11) 15,000

14,000 WSJ Jan. '12 GDP bn Ch.05$ Ch 05$ SAAR

13,000

12,000

11,000

10,000 , 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

GDP05 GDP05WSJ_JAN12 GDP05 POT CBOAUG11 GDP05_POT_CBOAUG11

Source: BEA GDP 2011Q3 3rd release, CBO (Aug 2011), WSJ (Jan. 2012)

GDP (log levels)

9.65 9.60 9.55 9.50 9.45 9.40 9.35 9.30 9 25 9.25 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 Log GDP bn Ch.05$ $ SAAR WSJ Jan. '12 Potential GDP (CBO, Aug.'11)

LOG(GDP05) LOG(GDP05WSJ JAN12) LOG(GDP05WSJ_JAN12) LOG(GDP05_POT_CBOAUG11)

Source: BEA GDP 2011Q3 3rd release, CBO (Aug 2011), WSJ (Jan. 2012)

Employment
140,000 Nonfarm payroll employment, l 000's, SA 138,000 ,

136,000

134,000 ex.-temp. Census workers

132,000

130,000

128,000 8,000 00 01 02 03 04 05 06 07 08 09 10 11 12

PAYEMS_DEC12-CENSUSTAKERS PAYEMS_DEC12

Source: BLS, Employment Situation, Dec. 2011 release

Unemployment Rate
11 10 9 8 7 6 5 4 3 1980 Unemployment rate, in %, SA

WSJ Jan. '12

1985

1990 UNRATE

1995

2000

2005

2010

2015

UNRATE_WSJ_JAN12

Source: BLS, Employment Situation, Dec. 2010 release

Unemployment Rate
20 Unemployment rates, in %, SA 16 Unemployed & underemployed

12 Official 8

Long-term (over 27 weeks)

0 1980

1985

1990

1995

2000

2005

2010

UNRATE U6RATE (UNEMP27OV/CLF16OV)*100

Source: BLS, Employment Situation, Dec. 2010 release

Inflation
.06 .05 .04 04 .03 .02 .01 .00 -.01 -.02 -.03 03 00 01 02 03 04 05 06 07 08 09 10 11 12 13 Inflation rate y/y, in %, SA Core CPI WSJ (Jan. '12) "Headline" CPI

(CPIAUCSL/CPIAUCSL(-12))-1 (CPILFESL/CPILFESL(-12))-1 ( ( )) CPIINFLYOY_WSJ_JAN12/100

Source: BLS, CPI Dec. 2011 release, WSJ (Jan. 12)

Monetary Policy
10 Ten year Treasurys 8 Fed funds 6

2 Interest rates, in % 0 90 92 94 96 98 00 02 TB3MS 04 06 GS10 08 10 Three month Treasurys y

FEDFUNDS

Source: St. Louis Fed FRED II database

Fed interventions
3500000 3000000 2500000 2000000 1500000 1000000 500000 0 LendingtoFinancial Institutions Long gTermTreasury y Purchases FedAgencyDebt Mortgage Backed SecuritiesPurch Liquidity Li idi to Key K Credit C di Markets

http://www.clevelandfed.org/research/data/credit_easing/index.cfm

Consumption
11.2 Logs, in b Ch 05$ bn.Ch.05$ 9.2 9.0 8.8 10.0 8.6 8.4 8.2 1980 Log consumption [left axis] 1985 1990 1995 9.6
www.econbrowser.com

Log household net worth [right axis]

10.8

10 4 10.4

2000

2005

2010

Source: BEA, 2011Q3 2nd release; Fed Flow of Funds

House Prices

Source: Calculated Risk, 12/27/2011

Net Exports and the Dollar

.3 .04 .2 2 .02 02

.1 ex -oil ex. oil .0

.00

-.02

-.1 1 Log real value of USD [l ft axis] [left i ] 1975 1980 1985 1990 1995

-.04 04

-.2

-.3

Net exports/ GDP 2000 2005 2010

-.06

-.08

Source: Federal Reserve Board, and BEA, 2011Q3 GDP 2nd release

Current Account, Net Debt

.02 02 .01 .00 00 -.01 -.02 02 -.03 -.04 04 -.05 - 06 -.06 -.07 1970 1975 1980 1985 1990 1995 2000 2005 Cu e t Account Current ccou t to GDP ratio [left axis] .20 20 .15 .10 10 .05 .00 00 -.05 Net International Investment Position to GDP ratio [right scale] -.10 10 -.15 - 20 -.20 -.25 2010

CA/GDP

NIIPEOP/(GDP*1000)

Oil Prices
5.0 Log price of oil ($/bbl, WTI) 4.5

4.0 Real 3.5

3.0 Nominal

2.5

2.0 90 92 94 96 98 00 02 04 06 08 10

LOG(OILPRICE) LOG(OILPRICE/(CPILFESL/221 3369)) LOG(OILPRICE/(CPILFESL/221.3369))

Source: St. Louis FRED II. Relative price is deflated by Core CPI, 2010=0

Long Term Log GDP

2001 recession -------9 Log GDP Ch.2000$ \ 1990-91 \ 1982 recession recession WWII 7 WWI \ 6 "Great Depression" 90 00 10 20 30 40 50 60 70 80 90 00 10 "Roaring '20's"

\ 1920-21 recession

__Great Depression

LOG(GDP00) LOG(GDP05/1 127106466361855) LOG(GDP05/1.127106466361855)

Source: Historical Statistics, and BEA, 2011Q3 GDP 2nd release, rebased to Ch.00$

2-1 Aggregate Output

National income and product accounts are an accounting system used to measure aggregate economic activity.

GDP: Production and Income The measure of aggregate output in the national income accounts is gross domestic product, or GDP.

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2-1 Aggregate Output

GDP P GDP: Production d ti and dI Income
There are three ways y of defining g GDP: 1. GDP is the value of the final goods and services produced in the economy during a given period period.

A final good is a good that is destined for final consumption. An intermediate good is a good used in the production of another good.

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2-1 Aggregate Output

GDP P GDP: Production d ti and dI Income There are three ways of defining GDP: 2. GDP is the sum of value added in the economy during a given period. V Value l added dd d equals l th the value l of f a fi firms production minus the value of the intermediate g goods it uses in p production.

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2-1 Aggregate Output

GDP P GDP: Production d ti and dI Income There are three ways of defining GDP: 3. GDP is the sum of incomes in the economy during a given period.
Table 2-1 The Composition of GDP by Type of Income, 1960 and 2006 1960 Labor income Capital income Indirect taxes 66% 26% 8% 2006 64% 29% 7%

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2-1 Aggregate Output

N i l and Nominal dR Real l GDP
Nominal Nominal GDP is the sum of the quantities of final goods produced multiplied by their current price. Nominal GDP increases over time because: The production of most goods increases over time. The prices of most goods also increase over time. Real GDP is constructed as the sum of the quantities of final goods multiplied by constant (rather than current) prices.

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2-1 Aggregate Output

N i l and Nominal dR Real l GDP
Y Year 1999 2000 2001 Quantity of f Cars C 10 12 13 Price of f cars $20,000 $24,000 $26,000 Nominal GDP $200,000 $288,000 $338,000 Real GDP (in 2000 dollars) $240,000 $288,000 $312,000

To construct real GDP GDP, multiply the number of cars in each year by a common price. Suppose we use the price of the car in 2000 as the common price. This approach gives us, in effect real GDP in chained (2000) dollars. effect, dollars

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2-1 Aggregate Output

N i l and Nominal dR Real l GDP
Fi Figure 2-1 Nominal and Real U.S. GDP, Since 1960 From 1960 to 2006 2006, nominal GDP increased by a factor of 25. Real GDP increased by a factor of about 4.5.

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2-1 Aggregate Output

N i l and Nominal dR Real l GDP
The terms nominal GDP and real GDP each have many synonyms: Nominal GDP is also called dollar GDP or GDP in current dollars. Real GDP is also called GDP in terms of goods, GDP in constant dollars, GDP adjusted for inflation, or GDP in 2000 dollars. GDP will refer to real GDP, and Yt will denote real GDP in year t. Nominal GDP and variables measured in current dollars will be denoted by a dollar sign in front of themfor example, $Yt. for nominal GDP in year t.

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2-1 Aggregate Output

GDP L GDP: Level lV Versus G Growth th R Rate t
Real GDP per capita is the ratio of real GDP to the population l i of f the h country. GDP growth equals:

(Yt Yt 1 ) Yt 1

Periods of positive GDP growth are called expansions. Periods of negative g GDP g growth are called recessions.
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2-1 Aggregate Output

GDP L GDP: Level lV Versus G Growth th R Rate t
Fi Figure 2-2 Growth Rate of U.S. GDP Since 1960 Since 1960, 1960 the U.S. U S economy has gone through a series of expansions, interrupted by short recessions.

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2-2 The Other Major Macroeconomic Variables

Th Unemployment The U l tR Rate t
Because it is a measure of aggregate activity, GDP is obviously the most important macroeconomic variable. But two other variables tell us about other important aspects of how an economic is performing: Unemployment Inflation

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2-2 The Other Major Macroeconomic Variables

Th Unemployment The U l tR Rate t
Employment is the number of people who have a job. Unemployment is the number of people who do not have a job but are looking for one. The labor force is the sum of employment and unemployment: p y L = N + U Labor force = Employment + Unemployment

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2-2 The Other Major Macroeconomic Variables

Th Unemployment The U l tR Rate t
The unemployment rate is the ratio of the number of people who h are unemployed l d to the h number b of f people l in i the h labor l b force:

U u= L
Unemployment rate = Unemployment/Labor force In the United States, estimates based on the CPS show that:

u2006
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7.0 = = 4.6% 4 6% 144.4 + 7.0

2-2 The Other Major Macroeconomic Variables

Th Unemployment The U l tR Rate t
The Current Population Survey (CPS) is used to compute the unemployment rate. y those looking g for work are counted as unemployed. p y Those Only not working and not looking for work are not in the labor force. People without jobs who give up looking for work are known as People discouraged workers. Participation Participation rate

labor force = population of working age

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2-2 The Other Major Macroeconomic Variables

Th Unemployment The U l tR Rate t
Figure 2 - 3 U.S. Unemployment Rate Since 1960 Since 1960, the U.S. unemployment rate has fluctuated between 3% and 10%, going down during expansions and going up during recessions. recessions

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2-2 The Other Major Macroeconomic Variables

Th Unemployment The U l tR Rate t
Why Do Economists Care About Unemployment?
Economists care about unemployment for two reasons: Because of its direct effects on the welfare of the unemployed. Because it provides a signal that the economy may not be using some of its resources efficiently.

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2-2 The Other Major Macroeconomic Variables

Th Inflation The I fl ti Rate R t Inflation is a sustained rise in the general level of pricesthe price level. The inflation rate is the rate at which the price level increases. Symmetrically, deflation is a sustained decline Symmetrically in the price level. It corresponds to a negative inflation rate.

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2-2 The Other Major Macroeconomic Variables

Th Inflation The I fl ti Rate R t
The GDP Deflator

The GDP deflator in year t, Pt, is defined as the ratio of nominal GDP to real GDP in year t: Nominal GDP $Y P= = Real GDP Y
t t t t t

The GDP deflator is what is called an index numberset equal to 100 in the base year.
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2-2 The Other Major Macroeconomic Variables

Th Inflation The I fl ti Rate R t
The GDP Deflator

The rate of change in the GDP deflator equals the rate of inflation:

( Pt Pt 1 ) Pt 1

Nominal GDP is equal to the GDP deflator multiplied by real GDP:

$Yt = Pt Yt
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2-2 The Other Major Macroeconomic Variables

Th Inflation The I fl ti Rate R t
The Consumer Price Index
The GDP deflator measures the average price of output, while the consumer price index, or CPI, measures the average price of consumption, or equivalently, the cost of living. The CPI g gives the cost in dollars of a specific p list of goods and services over time, which attempts to represent the consumption basket of a typical urban consumer.

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2-2 The Other Major Macroeconomic Variables

Th Inflation The I fl ti Rate R t
The Consumer Price Index

The set of goods produced in the economy is not the same as the set of goods purchased by consumers, for f two t reasons: Some of the goods are sold to firms, to the government, or to foreigners. S Some of f the th goods d are not t produced d d domestically but are imported from abroad.

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2-2 The Other Major Macroeconomic Variables

Th Inflation The I fl ti Rate R t
The Consumer Price Index
Figure 2 - 4 U.S. Inflation Rate, Using the CPI and the GDP Deflator Since 1960 The inflation rates, computed using either the CPI or the GDP deflator, deflator are largely similar.

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2-2 The Other Major Macroeconomic Variables

Th Inflation The I fl ti Rate R t
The Consumer Price Index

Figure 2-4 yields two conclusions: The CPI and the GDP deflator move together most of the time. In most years, the two inflation rates differ by less than 1%. There are clear exceptions, however. In 1979 and d 1980, 1980 the th increase i in i the th CPI was significantly larger than the increase in the GDP deflator.
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2-2 The Other Major Macroeconomic Variables

Th Inflation The I fl ti Rate R t
Why Do Economists Care About Inflation?

Economists care about inflation for two reasons: During periods of inflation, not all prices and wages rise proportionately, inflation affects income distribution. distrib tion Inflation leads to other distortions.

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2-3 The Short Run, the Medium Run, and the Long Run
The level of aggregate output in an economy is determined by: demand in the short run, say, a few years, the level of technology, the capital stock, and the labor force in the medium run, say, a decade or so, factors such as education, education research, research saving, and the quality of government in the long run, say, a half century or more.
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2-4 A Tour of the Book

Figure 2 - 5 The Organization of the Book

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2-4 A Tour of the Book

The book is organized into three parts: A core which has three parts the short run, th medium the di run, and d th the l long run. Three extensions which explore the role of expectations, closed economies, and expansion and recessions. A deeper look at the role of microeconomic policy.
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Key Terms
national income and product accounts aggregate output gross domestic product, (GDP) gross national product, g p , (GNP) ( ) intermediate good final good value added nominal GDP real GDP real GDP in chained (2000) dollars dollar GDP, GDP in current dollars GDP in terms of goods, goods GDP in constant dollars, GDP adjusted for inflation, GDP in 2000 dollars real GDP per capita GDP growth expansions recessions hedonic pricing employment l unemployment labor force unemployment rate Current Population p Survey y( (CPS) ) not in the labor force discouraged workers participation rate underground economy inflation price level inflation rate deflation GDP deflator index number cost of living consumer price index (CPI) short run medium run long run base year

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