Growth and logs

Savings
o
o
o
o

Bonds
o

F = Face Value, Pb = Price,

rate

N = Maturity,

o
o

Short-run: Unexpected increase in inflation => i => Pstock

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 => i => Pstock

DIV => Pstock

Net effect ambiguous but tends to be positive

Movement should be less than for bonds since bonds dont have div effect
Recessions

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]

Current Yield: ic =

o
o

Higher discount rate implies lower bond price

Required yields are higher during booms => bond prices fall during booms
Long term bonds have both interest-rate and inflation risk

Rate of Capital Gain: g =

Real interest is generally pinned down by economy

So e implies i and thus Pb

Unexpected boom that is associated with increase in inflation will decrease

Pb

Increase in output may also decrease inflation, in which case Pb

unclear
TIPS Treasury Inflation Protected Securities
PtTIPS =

CFt = Coupon Payment, i = discount

Pb,t =

Stocks
o

Price-earning ratio

Spvt = (GNP + TR + INT T) C

Private income Private consumption

Sgovt = (T TR INT) G = budget surplus
National Savings = S = GNP C G
Thus, S = I + (NX + NFP) = I + CA

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

CA = S I

; Fisher approximation: r = i

Expected discount rate = i + l

i = risk-free rate

l = equity risk premium

Gordons long-term growth model:

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

Pstock =

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

, where firm pays constant fraction k of earnings E

Production
o
Y = AF(K,N), where A = Total Factor Productivity, K = Capital, N = Labor hours
o
Cobb-Douglas: Y = AKaN1-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*AKa-1N1-a > 0 , positive with diminishing returns
o
MPN = (1-a)*AKaN-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
gY = gA + agK + (1 a)gN
o
gY/N = gA + a(gK gN)

gA = innovation, growth in human capital, etc.

gN = population growth

gK = saving by people
Saving, Investment, and Capital
o
Closed Economy: St = It
o
Capital Accumulation: Kt+1 = (1-d)Kt + It, where d = .10 for the US
o

, where k = capital-labor ratio

, provides a measure of real interest rate

Key differences to bonds:

Variable dividends rather than fixed coupons

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

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

o
Income Approach:

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
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)
Inflation
o

No set maturity

Pstock,t =

Long run: capital-labor ratio converges to k*

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

worker
o
Gross investment must replace worn-out capital (dK)
and expand with the population (nK)
o
k* =

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

Labor Demand - derived from profit maximization

o
P = price level of good, Y = real GDP
o
W = nominal wage, w = W/P = real wage
o
UC = nominal user cost of capital (rental price), uc = UC/P = real user cost
o
Firms maximize = P*Y (W*N + UC*K) subject to Y = AF(K, N)

N (w) =

, demand increases with A and K, decreases with w

u=

Intertemporal:

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

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

where c = a + y + yf/(1+r) cf/(1+r)

consumption growth =
if (1+r) > 1, then cf > c
smoothing: (1+r) = 1, c = cf
Increase in r has ambiguous effect on c and cf

income effect depends on if af is pos. or neg.

o
lender c and cf increase
o
borrower c and cf decrease

substitution effect price of future consumption is lower

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

Future: G + (1+r)B = Tf

consumer's: c +

Intertemporal: G +

c+

timing of taxes (T, Tf) is irrelevant

only present value of govt spending matters

Ricardian Equivalence financing with taxes vs. bonds

irrelevant

o
Marginal Propensity to Consume = c/y
Investment and Capital
o
Kt+1 = (1-d)Kt + It
o
Firm maximizes = P*AF(K,N) UC*K W*N

real terms: = AF(K,N) ucK wN

= MC

Personal Consumption Expenditure

o
Today: c + af = y + a
o
Next Period: cf = yf +

Labor Supply - derived from utility maximization

o
Substitution Effect - w encourages 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 - ucyclical
o
Steady State: fU = sE; f = fraction of people finding jobs, s = fraction of people losing
jobs

MPN = A

Desired capital stock: MPKf = Af

= ucf = MCf

use to find optimal investment

uc = (r + d)pk, pk = price of capital

Equilibrium in Goods Market
o
Y = Cd + Id + G, supply = demand
o
S = Y C G, so S = I

Spvt = Y T + INT C

Sgovt = (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
Af => S, I