Lecture I

Macroeconomics in 20th
Century

Theory, data and economic policies

I.1 Macroeconomics
Theory and economic policies
• Economic theory with important practical
implications
• Theory: description of economic
performance, explains macroeconomic
aggregates:
– gross domestic product, consumption,
savings, investment, amount of money,
inflation, unemployment, budget deficit,
government debt, exchange rate, interest and
others
• Difficult link between macro- and
microeconomics
 Macroeconomic sectors (1)
• Households: all population, own and
provide factors of production (labour,
land, capital) to the firms, receive
payments (income) from them and
generate expenditures for goods and
services (for final consumption)
• Firms: “own” technology, employ
factors, produce goods and services for
final consumption (households,
government, export) or for intermediate
use (other firms, incl. foreign)
 Macroeconomic sectors (2)
• Government:
– Collects taxes
– Manages activities that society expects from it:
• spends on goods and services for public purpose
(e.g. defence), on employees in state administration,
even owns some firms (that produce goods and
services) – “produces” public services
• finances transfers and social benefits
• Financial sector: provides transmission services that
channel money from savers to borrowers (incl.
government)
• Foreign sector: purchases goods and services (exports),
sells goods and services (imports), generates flows of
capital out and into the domestic country (FDI in or out,
debt financing, equity capital)
 Models
• Model simplification: description of
relation between economic variables
– Verbal, mathematical, graphical
• Variables:
– Endogenous, explained by the model
– Exogenous, determined outside the model
(“given”)
• Equilibrium models
– Intuitive notion of equilibrium: state of rest
– General concept: Walrasian model of
general equilibrium
Time, static and dynamic models
• Static model
– Given the values of exogenous variable, the model
determines the values of endogenous variables, at
given moment of time
• Stocks and flows
– Given the change of exogenous variable(s), how the
endogenous variables adjust towards new
equilibrium values – comparative statics
– Time, allowed for adjustment: short-, medium- or
long-term model
• Dynamic (growth) model – follows the
trajectory of endogenous variables over time
– Initial conditions
– Assumption about the trajectory of exogenous
variables
 Economic policies
• Goals (targets): GDP growth, low
unemployment and inflation, balance
budget, stable exchange rate, “healthy”
balance of payments and others
• Tools: in model language, ability to
influence selected exogenous variables –
control variables
– Examples: money supply, controlled by central
bank, or governmental (budget) expenditure
• Transmission mechanism - impact on
endogenous variables/goals: model, its
solution, i.e. values of endogenous
variables
I.2 Long-term trends
 Real GDP p.c., 1870 – 2001: USA, CND,
AUS, J
30 000
1990 International Geary – Khamis dollars

25 000

20 000

15 000

10 000

5 000

0
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

USA Canada Australia Japan

Real GDP p.c., 1870 – 2001: USA, CND, AUS,
J
1990 International Geary – Khamis dollars
100 000 logarithmic scale

10 000

1 000
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

USA Canada Australia Japan

 Real GDP p.c., 1870 – 2001: F,D,I,UK
1990 International Geary – Khamis dollars
100 000 logarithmic scale

10 000

1 000
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

France Germany Italy UK

 Real GDP p.c., 1870 – 2001: A, B, NL, CH
1990 International Geary – Khamis dollars
100 000 logarithmic scale

10 000

1 000
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Austria Belgium Netherlands Switzerland

 Real GDP p.c., 1870 – 2001: DK, FIN, N,
S
100 000 1990 International Geary – Khamis dollars
logarithmic scale

10 000

1 000
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Denmark Finland Norway Sweden

 Real GDP p.c., 1870 – 2001: ARG, S
1990 International Geary – Khamis dollars
100 000 logarithmic scale

10 000

1 000
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Argentina Sweden
 Real GDP p.c., 1870 – 2001: ARG, S
1990 International Geary – Khamis dollars
25 000

20 000

15 000

10 000

5 000

0
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Argentina Sweden
GDP p.c. in 1900 and 2001 and average
growth rate
1990 International Geary-Khamis dollars
30 000 3,50

3,00
25 000

2,50
20 000

2,00
GK$

%
15 000
1,50

10 000
1,00

5 000
0,50

0 0,00

SA

a
ia

ly
y

K
um

d
k

ea
a

ce

a
Sw s

o
n

nd

tin
an

di
ar
ad

nd
an

pa

ic
es
Sw ede

U
Ita
tr

an

or
la

In

ex
gi

m
us

m
an

ad

en
nl

Ja

rla

er

K
Fr
el

en

M
er
Fi
A

gl

rg
he

itz

h
B

G
D

ut
an

A
et

So
B
N

1900 2001 AGR (%)

 Factors of long-term growth
• Before 1850 – comparatively low economic growth
• Essential change: industrial revolution
• Welfare growth in different parts of the world -
examples
– USA, UK: 2nd half of 19th century
– Western Europe: 1950-1970
– BRICs: 2000 - 2007
• Growth factors:
– capital ← investment
– labor ← demographic growth
– Productivity ← technological progress
Welfare and population growth
schematically, cca 1960-2000

G
HDP
p.c.

OECD

developing
countries

population
growth
Remark on inflation: USA, 1900-
1998
Source: Blanchard
 Growth and inflation in 20th
century
• Growth: since 1870 a substantial increase,
especially since 1950
• Price levels: until the outbreak of WWI, the
price level stable and average inflation close
to zero; between WWI and WWII much lower
stability, but average still zero
• After WWII: permanent growth of price level
• Hypothesis: strong long-term growth must
be accompanied by always positive
inflation?
I.3 Short term fluctuations
 GDP growth EU15, 1956-
2003
8

EU growth EU averages US averages

6

% 2

-2

-4
60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06
time
 %
10
12

0
2
4
6
8
65

67

69

71

73 EU

75
USA

77

79

81

83

85

87

time
89

91

93

95

97

99

01

03

05
Unemployment EU15 a USA

07
 Growth and public deficit, USA
1951-2003

2.0 10
1.0 General G. Balance - %GDP Growth in %
8
0.0
6
-1.0
-2.0 4
%

%
-3.0 2
-4.0
0
-5.0
-6.0 -2
-7.0 -4
55 57 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07
time
 Growth and current account
deficit - “Asian tigers”
10.0
8.0
6.0
4.0
2.0
%
0.0
-2.0
-4.0 GDP growth Current Account Deficit

-6.0
-8.0
89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
time
Growth, inflation, CAD - Czech
Republic
10.0 60.0

GDP Growth (% ) Current Account Deficit (% of GDP) Inflation (% )

5.0 50.0

0.0 40.0

% -5.0 30.0 %

-10.0 20.0

-15.0 10.0

-20.0 0.0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
time
I.4 Theory and policies
 Macroeconomic policies
• To create appropriate conditions for
sustainable economic growth and the
improvement of the well-being of the
population in the long run.
• To understand, preview and soften the
fluctuations around the trend (to soften
the business cycle) in the short- and
medium run.
• Basis: market economy, the government
intervenes to remedy market deficiencies
• The crucial question: how much
governmental intervention is needed to
achieve the goals above?
 Some examples (1)
Best illustrated by following examples:
• Was the growth difference between 0-1800 and
1801-2000 result of some organized
„governmental“ activities?
– The power of markets?
– Adam Smith, invisible hand
• Was the Great Depression a result of the
market failure?
– Many believe yes (but not all).
• Was an extraordinary growth after WWII a
result of a careful economic policy of the
governments?
– Many macroeconomists 40 years ago convinced that
yes (but in reality, it was not)
 Some examples (2)
• Was the state intervention responsible for
the high US inflation in 60‘s, EU high
unemployment till today or Japanese
problems in the 90‘s?
– Very probably yes.
• Was the lack of market coordination,
wrong policies and insufficient regulation
of banking and financial sector behind
today’s sharp fall of output?
– Still remains to be seen, but already today,
many believe yes.
Adam Smith
• 1723 – 1790
• Political economist and
philosopher
• 1751 – professor of
logic at Glasgow
University
• 1759 – Theory of Moral
Sentiments
• 1776 - An Inquiry in the
Nature and Causes of
the Wealth of Nations -
invisible hand
 No clear answer
• The existence of the state is a
fact, the degree of state
intervention into economic
affairs is matter of discussion
• The dividing line among the
economists and the politicians
as well.
• Markets have power and do not
fail, only people do fail.
 Literature to Lecture I
Macroeconomics:
• Any text from VSE or IES FSV UK.
• Mankiw, G.N.: Macroeconomics,
Worth Publishers, New York, 1992
(and subsequent editions).
• Blanchard, O.: Macroeconomics,
Prentice Hall, 1997 (and subsequent
editions).
Long-term data:
• Maddison, A.: The World Economy, A
Millennial Perspective, OECD, 2001.