GLOBAL&MACROECONOMIC ENVIRONMENT

ROLSTONFERNANDES ROLSTON FERNANDES

INFLATION
Inflation Rate: Rate of change in Consumer InflationRate:RateofchangeinConsumer PriceIndexovergivenperiodofTime I=CurrentCPI LastPeriodCPI I = Current CPI Last Period CPI LastPeriodCPI

UNEMPLOYMENT
Frictional: Economic changes prevent Frictional:Economicchangesprevent matchingqualifiedworkerswithjobopenings Structural: Unemployed workers do not have Structural:Unemployedworkersdonothave theskillstomatchnewlycreatedjobs C li l R Cyclical:Recessionphaseofbusinesscycle, i h fb i l economyproducingatlessthancapacity

LABOURDEMAND&SUPPLY LABOUR DEMAND & SUPPLY

Afirmsdemandforlabourisincreasedby 1. Increaseinpriceofthefirmsoutput 2. Increaseinpriceofaproductiveinputthatisa substituteforlabour substitute for labour 3. Decreaseinpriceofaproductiveinputthatisa complementtolabour Thesupplyoflabourisinfluencedby 1. Substitutioneffect:Increaseinwageratecauses workerstosubstitutelabourhoursforleisurehours workers to substitute labour hours for leisure hours 2. IncomeEffect:Increaseinincomeincreasesworkers demandforleisure

MONETARY&FISCALPOLICIES

MONEY,THEPRICELEVELAND INFLATION
ThegoalsoftheCentralBankare 1. Keepinflationlow 2. Promoteeconomicgrowthandfullemployment 3. Smoothbusinesscycles 3 Smooth business cycles CentralBanktargetstheOvernightRates BalanceSheetoftheCentralBank 1. Assets:GovernmentSecurities,GoldandForeign Deposits,andloanstoBanks 2. Liabilities:ReserveNotes/Currency,Reserveson y Deposits

CENTRALBANKPOLICYTOOLS CENTRAL BANK POLICY TOOLS

1. 2. 1. 2. 1. 2. 3. OpenMarketOperations:MostOftenused RBIbuysgovernmentsecuritiesforCash ReservesIncrease Money SupplyIncreases SellingSecuritiesdecreasestheMoneySupply RequiredReserveRatio:SeldomChanged Required Reserve Ratio: Seldom Changed Reducingrequiredreservepercentageincreasesexcessreservesand increasesthemoneysupply Increasingrequiredreserveratiodecreasesthemoneysupply DiscountRate: ItistheinterestratememberbankspaytheRBIforborrowedassets Byraisingthediscountrates,Feddiscouragesbanksfromborrowing reserves,thusencouragingthemtoreducetheirlending(reduced reserves thus encouraging them to reduce their lending (reduced moneysupply) Decreasingthediscountratetendstoincreasethemoneysupply

DEMANDFORANDSUPPLYOFMONEY DEMAND FOR AND SUPPLY OF MONEY

Thedemandformoneyislargelydeterminedis e de a d o o ey s a ge y dete ed s largelydeterminedbyinterestrates y p Interestthatcouldbeearnedonmoneydeposited insavingsaccountormoneymarketfundisthe opportunitycostofholdingmoney Thesupplyofmoneyisdeterminedbythecentral bankandisindependentoftheinterestrate (perfectlyinelastic) (perfectly inelastic)
IR

MoneySupply

DemandforMoney

RealMoney

DEMANDFORMONEY DEMAND FOR MONEY

Nominal Demand for Money increases with NominalDemandforMoneyincreaseswith pricelevel The demand for real money increases with Thedemandforrealmoneyincreaseswith RealGDP Fi FinancialInnovationhasdecreasedthe i lI i h d d h demandformoneyonbalance

EFFECTSOFMONEYONREALGDP EFFECTS OF MONEY ON REAL GDP

MoneySupplyIncrease o ey Supp y c ease NominalandRealInterestRatesdecrease Businessesinvestmore,householdsincrease Businesses invest more, households increase purchasesofdurablegoods Foreignersinvestless,exchangeratefalls,imports g , g , p down,exportsup,netexportsincrease Aggregatedemand,RealGDP,andPriceLevel increaseintheShortRun Inlongrun,fullemploymentGDP

QUANTITYTHEORYOFMONEY QUANTITY THEORY OF MONEY

Equation of Exchange: MV = PY EquationofExchange:MV=PY
MoneySupply Velocity=Price RealOutput Sincevelocityandrealoutputarerelativelyconstant: Increasesinthemoneysupplyleadtoproportionalincreasesin thepricelevel

INFLATIONANDPRICELEVEL INFLATION AND PRICE LEVEL

Price Level: The price level measures the price PriceLevel:Thepricelevelmeasurestheprice levelinaneconomyatapointintime Inflation: It is a persistent increase in the price Inflation:Itisapersistentincreaseintheprice level.Therearetwotypes 1. DemandPullInflation(ADUp) 1 D d P ll I fl i (AD U ) 2. CostPushInflation(SRASDown)

COSTSOFANTICIPATEDINFLATION COSTS OF ANTICIPATED INFLATION

HighInflation,evenwhenwellanticipated, imposescostsonaneconomy.Itcan: 1. Divertresourcestodealwithinflation 2. Decreasevalueofcurrencyasstoreofvalue 3. Distortinvestmentreturns(becauseoftaxeffects),reducing capitalinvestmentandpotentialGDP NominalRate=RealRate+ExpectedInflation HigherInflation HigherExpectedInflation HigherNominalRates FasterMoneySupplyGrowth HigherInflation HigherNominalRates Withhigherexpectedinflation: 1. Expectednominalreturnsonbusinessinvestmentwillbehigher (increaseddemandforfinancialcapital) 2. Saversrequiregreaterreturnonsavings(decreasedsupplyof financialcapital)

PHILIPSCURVE PHILIPS CURVE

When actual inflation > expected inflation: Whenactualinflation>expectedinflation: Wagedemandslagactualinflation,realwage falls,unemploymentfalls,outputincreases falls unemployment falls output increases Wh Whenactualinflation<expectedinflation: l i fl i d i fl i Wagedemandsexceedactualinflation,real wagerises,unemploymentincreases,output falls

BUSINESSCYCLETHEORY BUSINESS CYCLE THEORY

Potential GDP (LAS) grows at a steady rate PotentialGDP(LAS)growsatasteadyrate whileaggregatedemand(AD)growth fluctuates WhenADgrowsfasterthanLAS:Cyclical Expansion,RealGDPabovepotentialReal GDP,UnemploymentFalls,InflationaryGap WhenADgrowsmoreslowlythanLAS:Cyclical contraction,RealGDPlessthanpotentialGDP, UnemploymentRises,RecessionaryGap

WHYDOESADFLUCTUATE? WHY DOES AD FLUCTUATE?

Keynesian View: Fluctuations in business KeynesianView:Fluctuationsinbusiness confidence(AnimalSpirits) Monetarist View: Fluctuations in investment MonetaristView:Fluctuationsininvestment andconsumption,causedby(inappropriate) fluctuationsmoneysupplygrowth NewClassicalCycleTheory:Onlyunexpected fluctuationsinADcausescycles NewKeynesianCycleTheory:Bothexpected andunexpectedchangesinADcausecycles

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