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Growth and logs

No set maturity

o

o

 

g(t) = slope of log(x(t)) vs. T

GDP Market value of all goods and services produced within a country

o

Value of all production or expenditures or income earned

o

Expenditure Approach: Y = C + I + G + NX

o

 

G does not include transfer payments or interest payments on govt debt

o

Income Approach:

 

o

 

Private disposable: Y + NFP + TR + INT T

Govt Income: T TR INT

Y

= Net Income + Stat. Discrepancy + Consumption of Fixed Capital + income to rest of world income from rest of world

o

 

o

GNP Production by residents at home or abroad

o

GNP = GDP + NFP

 
 

NFP = (Income paid to domestic production by rest of world) - (Income paid to foreign factors of production)

o

Inflation

 

, where P(t) is a price index [CPI, PCE deflator, GDP deflator]

 

o

o

; Fisher approximation: r = i – π

o

P stock , t =

=

Expected discount rate ρ = i + l

i = risk-free rate

l = equity risk premium

Gordon’s long-term growth model:

P stock =

, where g = constant growth rate of nominal dividends (< r)

Price-earning ratio

, where firm pays constant fraction k of earnings E

Short-run: Unexpected increase in inflation => i↑ => P stock

Long-run: Stocks provide a relatively good hedge against inflation

Dividends are a function of firms’ cash flows, which will eventually adjust to inflation

Unexpected increase in output

If π↑ => i↑ => P stock

DIV↑ => P stock

Net effect ambiguous but tends to be positive

Movement should be less than for bonds since bonds don’t have div effect

Recessions

Savings

o S pvt = (GNP + TR + INT T) C

Private income Private consumption

o S govt = (T TR INT) G = budget surplus

o National Savings = S = GNP C G

o Thus, S = I + (NX + NFP) = I + CA

CA = NX + NFP = Current Account Balance (NFP small relative to NX)

CA = S I

Bonds

o

F = Face Value, rate

P b = Price,

N = Maturity,

o

o

o Higher discount rate implies lower bond price

P b,t =

Current Yield: i c =

CF t = Coupon Payment,

i = discount

Required yields are higher during booms => bond prices fall during booms

o Long term bonds have both interest-rate and inflation risk

o Rate of Capital Gain: g =

o Real interest is generally pinned down by economy

So π e ↑ implies i↑ and thus P b

Unexpected boom that is associated with increase in inflation will decrease

P b

Increase in output may also decrease inflation, in which case P b unclear

o TIPS Treasury Inflation Protected Securities

Stocks

P t TIPS =

o Key differences to bonds:

, provides a measure of real interest rate

Variable dividends rather than fixed coupons

Stock prices decline shortly before the recession and start to rise towards the end of the recession [procyclical]

Bond prices increase during recession as interest rates fall [countercyclical]

Production

o

Y = AF(K,N), where A = Total Factor Productivity, K = Capital, N = Labor hours

o

Cobb-Douglas: Y = AK a N 1-a , where a = 0.3 for the US (capital share of income)

Constant returns to scale: AF(2K, 2N) = 2*AF(K, N) = 2Y

o

MPK = a*AK a-1 N 1-a > 0 , positive with diminishing returns

o

MPN = (1-a)*AK a N -a > 0 , positive with diminishing returns

= slope of production function on Output (Y) vs. Labor (N)

o

TFP is the main source of long-run growth

o

TFP and changes in labor input are the main sources of business cycle fluctuations

o

g Y = g A + ag K + (1 a)g N

o

g Y/N = g A + a(g K g N )

g A = innovation, growth in human capital, etc.

g N = population growth

g K = saving by people

Saving, Investment, and Capital

o

Closed Economy: S t = I t

 

o

Capital Accumulation: K t+1 = (1-d)K t + I t , where d = .10 for the US

 

o

, where k = capital-labor ratio

 

Long run: capital-labor ratio converges to k*

 
 

Steady state: (n+d)k* = sA(k*) 0.3 = sf(k*), worker

sf(k*) = saving per

 

o

Gross investment must replace worn-out capital (dK) and expand with the population (nK)

o

k* =

o

Capital Share of Income = r*K/Y = r*s/g

 

Labor Demand - derived from profit maximization

o Marginal Propensity to Consume = c/y

o

P = price level of good, Y = real GDP

Investment and Capital

o

W = nominal wage, w = W/P = real wage

o

K t+1 = (1-d)K t + I t

o

UC = nominal user cost of capital (rental price), uc = UC/P = real user cost

o

Firm maximizes Π = P*AF(K,N) UC*K W*N

o

Firms maximize Π = P*Y – (W*N + UC*K) subject to Y = AF(K, N)

real terms: π = AF(K,N) ucK wN

MPN = A

N d (w) =

=

= MC

, demand increases with A and K, decreases with w

Labor Supply - derived from utility maximization

o

Substitution Effect - wencourages work since the reward is higher

o

Income Effect - w, worker can afford more leisure and will supply less labor

o

Substitution dominates short run, Income effect dominates long run

o

Full employment output = potential output = Y* = AF(K, N*)

Unemployment

 

o

Frictional - search activity / matching time (difficult to reduce)

o

Structural - Long term non-cyclical unemployment

Wage rigidities; fundamental mismatch between workers and people

o

Cyclical - due to short-run disturbances in the economy

o

Natural Rate (

) = Frictional + Structural = u - u cyclical

o

Steady State: fU = sE; f = fraction of people finding jobs, s = fraction of people losing

jobs

u =

Personal Consumption Expenditure

o

Today: c + a f = y + a

o

Next Period: c f = y f +

o

Intertemporal:

o

max u(c) + βu(c f ); derive w.r.t. c f

u'(c) = β(1+r)u'(c f ), indifferent btwn present and future consumption

where c = a + y + y f /(1+r) c f /(1+r)

o

consumption growth =

if β(1+r) > 1, then c f > c

smoothing: β(1+r) = 1, c = c f

Increase in r has ambiguous effect on c and c f

income effect depends on if a f is pos. or neg.

o

lender c and c f increase

o

borrower c and c f decrease

substitution effect price of future consumption is lower

Government

o

Budget Current: G = T+B, B = bonds issued

Future: G + (1+r)B = T f

consumer's: c +

o

Intertemporal: G +

+

o

c +

timing of taxes (T, T f ) is irrelevant

only present value of govt spending matters

Ricardian Equivalence financing with taxes vs. bonds irrelevant

Desired capital stock: MPK f = A f

= uc f = MC f

use to find optimal investment

uc = (r + d)p k , p k = price of capital

Equilibrium in Goods Market

o

Y = C d + I d + G, supply = demand

o

S = Y C G, so S = I

S pvt = Y T + INT C

S govt = (T INT) - G

o

real interest rate r adjusts to clear market

r, S(substitution tends to dominate), I

o

A=> S, I no change

o

A f => S, I