Scarica macroeconomics - corso erogato in inglese dalla professoressa C. Mussida a.a. '22 e più Appunti in PDF di Macroeconomia solo su Docsity! Macroeconomics Prof. Chiara Mussida o ・1・ What is the market? Is the place where the demand and the supplies interact, there are different market [market of labor, market of good and services …] In a graph with the prices on the x axe and the quantity on the y exe, the demand would have a negative slope. It’s called the law of demand. The supplies have a positive slope, there is a positive correlation between the prices and the quantities. In this case we call it the law of supplies. How are micro and macro linked together Covid-19 Each recessions have their own characteristics, it was: - An Exogenous (external) shock - A demand shock - A Supply shock: there weren’t any contribution from both sides, because of the shutdown, the infected people etc. - A global dimension shock ´ With over 150,000 deaths and 11,847,436 cases (as of February 10th, 2022), Italy ranks among the worst-hit countries by COVID-19. Real time statistics from worldometer. Global crisis: World Health Organization (WHO) statistics and responses. Provide daily initiative and information about the virus. Government innervation (exogenous) The Italian government was the first in Europe to declare, on March 9, an unprecedented national lockdown that paralyzed the country. The lockdown spread around the other countries. The first national lockdown. From March 25, productive activities were shut down, except for those deemed ‘essential’ for the functioning of the country’s economic system (supermarket, hospital, transportation within limitation). On May 4, lockdown rules started to be lifted, and, from June 15, almost all economic activities were finally allowed to re-open, albeit under strict safety protocols. After the partial re-open, things got worst again. the second partial lockdown, non-essential sectors/activities. The impressive resurgence of the contagion in the fall of 2020 forced the government and regional authorities to reintroduce restrictive measures targeted to economic activities to contain the second wave. The Covid-19 is recession in terms of health and the effects were also for economic and social. Negative GDP growth. The Macroeconomics looks at the economic as the overall, a study of economic at the aggregate level. The repercussions of this remarkable series of disruptive events on the Italian economy are enormous, and the government tried to attenuate these impacts by adopting several emergency measures and fiscal packages. To increase workers’ protection, the government issued an ad hoc Decree-Law on March 17 2021, which introduced 2 labor market policies: 1. a special COVID-19 short-time work retroactive compensation scheme. 2. a firing freeze that stopped firings extended several times. July 2021. For these reasons there were a reduction of the expected negative effects of covid- 19 on the labor market (unemployment/economy with the GDP). Effects of the crisis On the Economy & labor market. A rigorous evaluation of the crisis effects is challenging because COVID-19 was an ‘exogenous shock’ that virtually left no part of the world unaffected. In Italy, even more complicated for the existence of regional (and local) authorities. Given that the recession is still ongoing (fourth wave), it is important to try to investigate its effects (current and expected) as well as its duration. The questions of the economist Currently, there are some key challenges facing the (global) economy: How, where how long the economic effect of the crisis will last? The consequents due to covid has changed not only during the pandemic but also in a permanent way. Today the work organization has change with the introduction of the smart- working but only for some occupation. It was presented since 2017 as a flexible organization of working time, tasks … it is a structural change in the labor market. Before covid the presence of smart working was nearly 3%, after the pandemic it was up to 15%. We must remember that not all sectors of economic activity can use this, the consequences have/are affecting more some factors and some occupation. OECD (organization for economic cooperation and development): we can look at the countries with the most advanced economies, also report the definition of occupations based on the content of the jobs but especially in terms of skills: Blue collar-routine; the less educated with an occupation based on the same tasks/routine Blue collar-non routine; a law level of education but the task of their job changes, even though those tasks are not relevant and important. White collar-routine; the most educated but performing the same tasks (es. Accounted) White collar-Non routine White collar workers, more specifically the non-routine, are those more effected by the working from home, the smart working. Consumer behavior has also changed, more in general, there have been less consumer confidence and trust in terms of economy and institutions. A decrease of consumers, consequentially a decrease of investment, and an increase of savings. Different sources of the shock from Covid19 pandemic: Sick workers do not produce, and the GDP does not grow. Restrictive measures, such as firms’, industries’, universities and schools’ closures, quarantine, lock of tourism flows and, more in general, lockdown measures, importantly reduce the aggregate production. However, the technology helped to mitigate the negative effects (smart working, online teaching, cooperation on digital platforms, e-commerce, etc.). The spread of the supply shock was global, it was uncorrelated with the geographical distance. Indeed, the covid-19 started in China but the then it spread in the north of Italy. Notably, the geographical distance from the origin was not necessarily a determinant of the spread of the supply shock (the epicenter was Wuhan in China, but immediately after the shock reached the North of Italy) Air and sea routes might have played a role for the initial dissemination of the virus The demand-shock. The other side of the market, in this case we refer to a reduction of goods and service because of the shot down. The closure of the commercial activities and the restrictions to the individuals’ mobility significantly reduced the demand for goods and services. At least in person. Unemployment and reduced working hours reduced the available household income. Related to the unemployment, the reduction wasn’t so mild, but the issue was the working hours and then the reduction of income. It implies an increase of savings but most importantly of poverty. Poverty Two mechanism, the reduction of working hours and wages, the second point is the elimination of wages. Household income is inspected to be higher in respect to the labor income, it include the wage (labor income) and income form investment, in some respect capital income. Another source might be the rent. Poverty is a phenomenon, remarked by 2030 UN strategy; there are 17 sustainable development goals. The first one is to eradicating poverty. In Italy the poverty rate has increase, one issue was the in-work poverty. Is calculated the poverty rate: equivalized household income divided by the modified DECD scale. We take the size of household, and we give a weight, given to each household component. There’s poverty if the equivalized household income is lower than the 60% of the median of household income. Calculated at the national level. Psychological effects (wait-and-see attitude due to the uncertainty), disinformation, absence of trust and confidence in the institutions likely contribute to reduce the aggregate production. However, the possibility of home delivery, the e-commerce, and remote services to individuals and firms helped to mitigate these effects. The role of IT. The spread of the demand-shock: Internet and the interpersonal communication are the most important drivers of the spread of the economic contagion of the demand shock: from a local shock to a global (mass) shock. The media also played a role, to give information, awareness, prevention but also fake news. Closure and restrictions as well, reducing the demand. Keynesian effects (multiplier effects) likely enlarge and extend the reduction of the aggregate demand. Reduction of the Propensity to consume [C1] but an increase of the propensity to save, how is this related to the income reduction? Through C1 we have an effect on the disposable income [Yd] With the national lockdown there have been restriction, the most affected sectors are: ´ Manufacturing, very important for the Italian companies. ´ Immediate stop of the direct offer since the most affected countries are the Asian ones that produce and export manufacturing goods: stop of the international supply chains. ´ Stop of the production also in Western countries due to restrictive measures. Reduction of propensity to consume. ´ Drop of the aggregate demand for goods and delays in purchases and investments from consumers and firms (wait-and-see purchase delays). A drop of confidence due to the increase of uncertainty. ´ Services; negative effects also for services to the person (restaurant, retail, tourism and culture, sport). The consequences of the crisis on the international commerce. The demand for intermediate and exported goods (dramatically) reduced. The international service sectors mostly affected by the crisis are international tourism, travel agencies, transport companies. The global financial transitions and ICT services suffered a reduction as well. The duration of the covid-19 pandemic is still uncertain. The dimension and the persistence of the economic shock are still unknown. We can exclude a short and intense («v-shaped») scenario, as the pandemic started two years ago, but do not still know whether this will be long and slow («u-shaped»: a characteristic of the great depretion recession). There might be the possibility to have a «w-shaped» scenario, which means a sadden and important decrease is followed by a very fast recover. But then there’s a second shock, another important shock decrease of the GDP and an immediately increase. The «l-shaped» situation has an important decrease of the GDP and a very slow recover. We are looking at a graph with GDP on the Y axe and the time on the X axe. The uncertainty is one of the determinants of the duration of the phenomenon. IMMAGINE Real GDP growth projections 2022, World Economic Outlook Difference colors for different rages in terms of GDP: There’s a prevalence of green areas, including Italy, which means a positive growth of the GDP. Economic policy interventions: monetary policy. We already saw the first innervations up to the beginning of the pandemic, the lockdown and then relaxed restriction for commercial and activities. How might the ECB act? European center bank lead institution with the main focus to fix the exchange rate (price/value of a foreign currency, important because it gives information about the purchase power). Why encourage spending by giving money to households if the commercial activities remain closed? ECB interventions are usually associated with demand shock and not to supply shock. The current pandemic is associated with both demand and supply shock. Workers and firms reduced/lost their income after the lockdown, risk of poverty: risk of payment defaults and bankruptcy, due to the fact that the pandemic was an unexpected, immediate and exogenous shock, there were no insurance for pandemic: no ex-ante «precautionary saving» Other two options for the ECB: Helicopter money: it simply means “money to/for everybody” without any condition, like an helicopter. Lower interest rates? a lower interest rate, reducing the cost of money easing, is same terms, the indebtment and also reducing the risk of payment in default Moral hazard: in terms of monetary policies, to convince that is the right investment, we can’t obtain much. The reduction of rates might not be enough when firms need money/loan to pay mortgages, rents, wages, electricity, suppliers, and banks refuse to lend money (increase the cost of money) Fiscal policy in Italy: short-term measures: Government measures, the fiscal balance is the balance of the government which is the different between the expenditure and the taxation. We know that due to covid-19 the state became even more indebted IMMAGINE Before the pandemic, all countries apart from Germany had a budget deficit. After the arrival of Covid-19, the fiscal budget of Germany has become the worst scenario. Role of the EU: long-term measures financial (fiscal) ´ Next Generation EU Recovery Plan which includes the Recovery Fund, introduced in May 2020, last step of adoption in Dec 2020: the EC borrows money (€750 billions) on the financial market (long-term) thanks to its credibility (low indebtment costs). The fund will be shared among EU countries. Some are grants (subsidies, non-repayable contributions), some loans that will increase the debts of member states. abroad, we take this into account. We started to use the euro in 2002, we are free with other countries at least in Europe. Macroeconomics is also the study of the policy measures that the government uses to influence the overall economy. The policy maker looks at all the indicators (guideline) produced by the macroeconomic and offers policy suggestion. There are different types of policies: The economic cycle can be either negative or positive. ´ Fiscal police: the one that looks at the balance we saw previously, between government expenditure and taxation based on the current level. Expansive fiscal police: The government can decide to, whether Increasing expenditure and reduce taxation. Implies a Budget deficit. Restrictive fiscal police: The police reduce government expenditure and increase taxation ´ Monetary police: expansive monetary policy: system (ECB) increasing the available amount of money and this increase prices and inflation. Restrictive monetary policy: a redaction of money with the opposite consequences. ´ Labor market policy. We look at the unemployment, with the Filip curve we will see everything is interrelated. Examines the economy in the short- and long-run, the period of preference: • Short run : movements in the business cycle (economic cycle) • Long-run : economic growth (economic trend, the yellow line in the graph) Macroeconomics: goes beyond individual economic units, such as households and firms, or the determination of prices in a particular market, which are the subject matter of microeconomics → aggregates individual markets of goods, labor and assets → look at markets as a whole. Relevant concepts and issues are: AS Aggregate Supply: amount of output (good and services) the economy/market can produce given the resources and technology available. To formalize, it is the aggregate/total output or production. What is the available to everybody is the GDP, or in other words aggregate /total/output → Y. AD Aggregate Demand: total demand for goods to consume, for new investment, for goods purchased by government, and for net goods to be exported abroad) → AS = AD The aggregate supply must be equal to the Aggregate demand Y = C + I (investment) + G (public sector, associated to taxation) + (X – IM) For a close economy open economy The aggregate supply line has a positive slope, on the contrary, aggregated demand is negatively sloped. In the interaction between the two we have the equilibrium point with an associated price and a quantity. The study of macroeconomics is organized around three fundamental models that describe the world, each appropriate for a particular time frame: ü Very Long Run Model : it is linked with the domain of growth theory focuses on growth of the production capacity of the economy (potential output) to produce goods and services, needs to consider the available resources (for instance the employment). it looks at the potential output, can be either positive or negative. ü Long Run Model : a snapshot of the very long run model, in which capital [K ] and technology [A] are taken relatively fixed • Level of capital & technology determine level of potential output or productive capacity of the economy • Output is fixed (AS is a vertical line), in this case the prices is determined by changes in AD. The AD run the economy. ü Short Run Model : business cycle theories. • Fluctuations in demand (AD) determine how much of the productive capacity is used and the level of output and unemployment. It means that prices are fixed but the output is variable (AS is a horizontal line), and the output level is given by the Aggregate level of demand. The Phillips curve: IMMAGINE SLIDE Counts for Phillips who was an economist studying the relationship between changes in inflation and unemployment, in terms of market we are exanimating the labor and monetary market. The first assumption is that we are in the short run, AS curve is relatively flat and movements in AD drive changes in prices, output, and unemployment. Negative relation between change in inflation and unemployment rate, an inregulation. Each black points are each couple of change in inflection (change in prices) for a specific year and for a specific country. The blue line is the trend line which summarize the relation between change in inflation and change in unemployment. Prices tend to adjust slowly; the AD drives the economy in the meantime. The speed of price adjustment is illustrated by the Phillips curve, which relates change in inflation rate and unemployment rate (sacrifice ratio). The government need to implement policies to reduce inflation by increasing the unemployment; the so call sacrifice ratio. Growth and GDP “Gross development product” As all economic indicator, there are advantages and disadvantages by using the GDP. On average, Italy is on a low relatively growth of the GDP, 1-2%. Despite the continue studies on the disadvantages, The growth rate of the economy is still the rate at which GDP is increasing, most developed economies grow at a rate of a few percentage points per year. Growth in GDP is caused by: - Increases in available resources, the inputs (labor and capital); we can add the role of technology. - Increases in the efficiency or productivity of those resources, meaning exploiting available resources at the maximum level and at the minimum cost. For productivity we mean how much GDP is Generated by each unit of labor? GDPL It would be worth knowing what policies can raise a country’s average growth rate over long periods of time. How can this indicator act in order to increase the GDP? The policy maker can: Y = C + I + G + (X-IM) ü Increasing the government expenditure, adopting a fiscal policy, ↑ G ü increasing investment, a financing policy. ↑ I ü adopting a monetary policy means Increasing available supply money ↑ inflation, there would be a labor market policy increasing unemployment and our sacrifice ratio. ü Purchasing power, somehow related to monetary policy, and consumer confidence (economic sentiment). ü Increasing national production, otherwise we are not independent and tend to reduce GDP [X-IM] because we would have to import goods. Business cycle & the Output Gap The business cycle refers to the short-run model, having both recessions and booms (looking at the GDP indicator), on the contrary the trend line looks at the long-run. Business cycle: pattern of expansion (recovery) and contraction (recession) in economic activity around the path of trend growth. Trend path of GDP is the path GDP would take if factors of production were fully employed, what is call the potential output. The peak (not necessary above the trend line) meaning reaching the Maximum level, a recession reaching a trough and a consecutively recovery. Output gap : all the distances which shows the current position comparing to the trend line, is defined as the deviation of output from the trend (current/actual). It measures the magnitude of cyclical deviations of output from the potential level; we are exploiting all the available resources. Output gap = actual output – potential output IMMAGINE SLIDE Showing the Real potential GDP current to its trend, taking into account the inflation. We have a blue line representing the trend line and a red line representing the economic cycle. The grey vertical lines are representing the recessions, when it is under the real Gross Domestic Product is under the Real Potential Gross Domestic Product. Inflation and the business cycle Inflection; Change in prices meaning increasing level of prices: If the result is positive, we have inflection. where Y = output, N = labor, K = capital “Output is a function of labor and capital,” where the functional form can be defined in various ways For example: corn [Y] = f (land [K], labor[L/N], seed [K], machines [K]) ´ First pie chart: Composition of factors payments/expenditures/amount: we give a percentage to each of components. The most important payment goes to factors of production labor: composition of employees, taxes and other Most of the remainder goes to pay capital: depreciation, corporate profits, net interest, proprietors’ income, taxes and other. Only a small amount goes for other factors of production or true profits. ´ Second pie chart: Components of demand C + I + G in the close economy, called domestic components. Immediately we can say that most important component is the consumption. Government expenditure and investment are equal. The foreign components are negligible; imports are higher than exports meaning we are not able to produce within the country borders, there’s a trade deficit. Components of demand Total demand for domestic output is made up of four components: 1. Consumption spending by households (C) 2. Investment spending by firms and households (I) 3. Government purchases of goods and services (G) 4. Foreign demand for our net exports (NX) The fundamental national income accounting identity is 1. Y = C + I + G + NX GDP∨Y=C+ I+G+(X−ℑ) 1) Consumption [C] C = C0 + C1 * Yd ✓ Yd = Y – T, the disposable/available income which goes to either consumption propensity to consume [C1] and to the propensity to save [1 - C1] ✓ C1 = Consumption propensity to consume, based on the consumer confidence ✓ 1 - C1 = Savings propensity to save ✓ C0 = Autonomous consumption component, it is the minimum consumption for survival when income is zero, so it’s not associated with the available income, reducing our savings. It is exogenous, external. Consumption spending is the primary component of demand. Consumption refers to the purchases of goods and services by the household sector (the Private sector). Includes spending on durable goods (ex. Cars), non-durable goods (ex. Food), and services (ex. medical services). When disposable income increases, consumption also increases but by a smaller amount. This means that when disposable income increases, people consume a smaller fraction of their income: the average propensity to consume decreases. Consumption as a share of GDP varies by country; depends on taste preference, income and also population composition. Consumption as a share of GDP C GDP Domestic Foreign components 2) Government [G] Government purchases of goods and services include national defense expenditures, costs of road paving by state and local governments, salaries of government employees. Government also makes transfer payments = payments made to people without their providing a current service in exchange, like social security benefits and unemployment benefits, disability, child allowance. Transfer payments are NOT counted as part of GDP because transfers are not part of current production (transfers plus purchases are government expenditure). Government purchases and transfer payments as a share of GDP; G GDP 3) Investment [I] Investments are additions to the physical stock of capital [K] (i.e., building machinery, construction of factories, additions to firms’ inventories). We can have short- or long-term investments. ´ Exogenous investments: the most common case by which investments are external ´ Isogenous investments; one component is external [io + i1] the other one associated to the income [*Y] One component is in the national income accounts, investment associated with business sector’s (in other companies) adding to the physical stock of capital, including inventories. Household’s building up of inventories is considered consumption, although new home constructions considered part of Investment, not Consumption. If we define investment as any current activity that increases the economy’s ability to produce output in the future (production capacity that must deal with potential output), we will include not only physical investment but also Human Capital Investment. We consider the human capital as an investment because of the increase in the ability to work, for being more efficient and increase our potential output. Net Investment = Capital Expenditure – Depreciation Net investment is the Gross Investment minus the depreciation on the existing capital. Net investment is the difference between the total amount of money a company spends on capital assets and the cost of depreciation of those assets. It indicates how much a company is spending to maintain and improve its operations. A positive value indicates that the business operations are leading to expansion. In contrast, a negative value indicates that the business operations are shrinking. The Gross Investment (included in the GDP measure) is the total amount spent on goods to produce goods and services, while net investment is the increase in productive stock. 4) Net exports [NX] subtracting domestic purchases of foreign goods (imports) from foreign purchases of domestic goods (exports) NX=export−imports We already said, there’s a trade balance: NX can be = > 0 (balance-of-trade surplus), < 0 (balance-of-trade deficit), or = 0 (balanced trade). Net exports as a share of GDP; NX GDP National income accounting GDP∨Y=C+ I+G+(X−ℑ) GDP is defined with income, out, production… Simple closed economy with no public sector, the most restricted Y= C + I Only two thing we can do with income, propensity to consume or to save Y = C + S Combining equation one and equation two (demand) C + I ≡ Y ≡ C + S (income) We rearrange this formula according to investment equals to savings with a simple economy I ≡ Y – C ≡S The case by which we introduce government expenditure [G] and the foreign sector [NX], the fundamental identity becomes Y = C + I + G + NX We denote all taxes by TA and transfer to the private sector by TR, the indicator for Yd (the disposable income) can be defined as Yd ≡ Y + TR – TA What consumers split between consumption and savings when there is a public sector is Yd ≡C + S shares of consumption and savings that are equal to the propensity to consume [C1] and the propensity to save [1-C1]. If we arrange this equation and we plug in equation for the output of productions, we obtain Yd – TR + TA ≡ C + I + G + NX If by substituting Yd in the last equation, we get C + S – TR + TA ≡ C + I + G + NX Rearranging S – I ≡ G + TR – TA + NX We obtain the Government budget [G + TR – TA], a deficit, and trade budget, a surplus [+NX]. S > I An excess of savings over investment in the private sector is equal to the government deficit + trade surplus. Any sector that spends more than it receives in income has to borrow to pay for the excess spending. Private sector can dispose of savings in three ways: 1. Make loans to the government 2. Private sector can lend to foreigners 3. Private sector can lend to firms who use the funds for I Measuring the GDP GDP is the value of final goods and services currently produced within a country over a period of time. Final goods and services NO DOUBLE COUNTING, we only look at the final result (e.g., no intermediate goods). Goods and services currently (in the time period being considered) produced and excludes transactions involving used goods. In the latest years, an important debate has come from National and International institution discussing measurement problems with the unemployment rate: Sometimes official unemployment numbers understate ‘real’ unemployment: there’s rigidity because if one of the two main criteria (1. Active search for a job; 2. Immediate availability) is not satisfied, individuals are classified by the one on the left. Alternative measures of unemployment, like workers marginally attached to the labor force, and workers who for economic reasons can only find part-time work. Unemployment correlated to the economic conditions of a country, it is correlated to the GDP We see different recession where the unemployment doesn’t react immediately, the reasons are because it is a lag indicator and because of the labor hoarding phenomenon; employers will wait and see. It is correlated to the importance, duration and nature of each recession and firing is a cost. There’s a lag. we more or less shortly. Interest rates [I] Interest rate = rate of payment on a loan or other investment, over and above the principal repayment, in terms of an annual percentage. Because when we pay interest rate we pay more. It is the opportunity cost of money; we can associate it to the investment because they might be exogenous or might be associated to the income. Cost of borrowing money or benefit of lending money. ü Nominal interest rate = return on an investment in current dollars ü Real interest rate = return on an investment, adjusted for inflation because we will have a referent year for its calculations. If R is the nominal rate, and r is the real rate, then we can define the nominal rate as: R = r + Exchange rate Each country has its own currency in which prices are quoted, comparing exchange rate with respect to the other one. Exchange rate is the price of a foreign currency. A reduction of complexity, in terms of exchange rate, has come with the introduction of the Euro in 2002 In the U.S. prices are quoted in U.S. dollars, while in Canada prices are quoted in Canadian dollars and most of Europe uses the euro. Ex. The British pound is worth U.S. $1.53 (Feb. 2013); for one pound we pay 1.53 dollars, UK is the stronger Two distinctions: ü Floating exchange rate price of a currency is determined by looking at the supply and demand, interactions in the monetary market. ü Fixed exchange rate price of a currency is fixed. If a decision needs to be taken about the typology of exchange rate, we are implementing a monetary policy. An example: for evaluating the wealth of a country we use the main indicator, the per capital GDP, to have a clear picture, but also population is relevant. How much was US real GDP growth in 2012? What about the growth rate of US population? Where we find data: GDP and its components: http://fred.stlouisfed.org Population data: www.census.gov Using this information, what can you infer about the evolution of US per capita GDP in 2012? Unemployment ・4・ Defined by the international labor organization which gives us the criteria, the unemployment rate that is the ratio between people in search for a job and an immediately available to work divided by the labor force . The search must be active, there’s a precise time. Italian national institute of statistics [ISTAT], there’s a service which is the labor force survey [LFS] that provide the main labor market indicators. Three main stocks: A. Unemployment [u.u.] B. Employment [e.e.] [u.u + e.e. = L.F.] C. Inactivity [n.n.], the residual components of the population, not in the labor force. Static framework only looks at the stock’s condition/status in the labor markets, comparing the status of stocks to the previous one survey, but what we obtain is the change which is not informative about the movements flows transitions among the stocks. Dynamic analysis is needed for a better understanding because we look at stocks and, also, to flows. 3 stocks & 6 flows (changes/movements between stocks): - A transaction/flows from employment to inactivity [n.e.] and on the contrary [e.n.] - A transaction/flows from unemployment to inactivity [u.n.] and on the contrary [n.u.] - A transaction/flows from employment to unemployment [e.u.] and on the contrary [u.e. turnover] Ø e.e. changes within the status job-to-job movements. Ø u.u. short and long-term unemployed, higher than 12 months. A related concept is the turnover; includes the flows between employment and unemployment. The measure is also associated with the employment turnover, an important phenomenon which is the job-to-job transaction [e.e.]. We can easily calculate the change in employment, unemployment and inactivity from one period to another one. E = Inflows (u.e. + n.e.) – outflows (e.u. + e.n.) U = inflows (n.u. + e.u.) – outflows (u.e. + u.n.) N = inflows (u.n. + e.n.) – outflows (n. u. + n.e.) In a static framework we have as a result a final value. In the Labor market we find interaction between labor demand (firms, employers) and labor supply (potential workers). Graph: We are in the labor market: on the vertical axe we have prices, in this case the wage, and on the horizontal axe we have the time (hours/e). The L D has a negative slope coming from the fact that there is the law of demand, so an increase of wages, that are needed to be paid, therefore a decrease in hours of working. The L S has a positive slope because of the law of supply, there’s a decrease in wages and therefore more opportunity for employers to increase the working hour. In the equilibrium point we have the equilibrium level of wage and employment [W*; E*], from the graphical representation point of view is the intersection of the labor demand line and labor supply line. [LD = LS] But the equilibrium It’s not stable: If the wages are below the equilibrium, we have an excess of labor demand from employers consequentially a decrease of working hour because workers are not available to work at such relatively low wage. An excess of demand in terms of employment; In each market, at the end, we go back to the equilibrium with a dynamic adjustment, increasing wages and absorbing excess demand. if the wages are higher with the respect of the equilibrium, there would be an excess of labor supplies meaning more and more workers available to work. In the long run, with a dynamic adjustment, we go back to the equilibrium by reducing wages absorbing the excess supplies; there will be unsatisfied supply, meaning the unemployment. With the statistics of the labor market, we can have a description of the economy. Unemployment (-U) and output (GDP) are tightly linked, but the link is not perfect because of the time lag. Unemployment is a lagging economic indicator because of the so-called labor hoarding. The practice in which a company does not lay off employees when they otherwise would (as during recession). Labor hoarding is a high risk as it reduces a company’s profitability during difficult time, but it guarantees employee talent will be available to that company (and, just as importantly, not to its competitors) when growth resumes. – The unemployment is an important indicator for the policy maker. – Rising GDP may be of little consolation to the unemployed and their families, The costs of unemployment are very large and not equally distributed – The costs of a recession implies that individuals, after a certain time, are fired. They are borne disproportionately by those individuals who lose their jobs – Youth and females, for instance, are among the groups most vulnerable to increased unemployment: an important phenomenon in Italy is the so call youth unemployment rate, a structural problem increasing a lot especially after the covid-19. If unemployment increase, as a consequence of the decrease of the GDP, on population we will see less consumption power as well as the propensity to save. Also, there will be a reduce in income because there won’t be any labor income. Another cost associated to the unemployment is the cost of firing people. [It has also social damages, it leads to depression, suicide etc.] Unemployment characteristics (associated to characteristics of the labor market): 2. Someone laid off may be recalled to her/his employer 3. An unemployed person may stop looking for a job, and thus leave the labor force. These are discouraged individuals. higher inflows from outflows, increase the unemployment; it rise when more people are entering the pool than leaving Lay off is typically the main cause of unemployment. However, during recession, job losses due, for instance, to firm closure, become an important cause of unemployment The aggregate/total unemployment rate (weighted average of the unemployment role of each population group capacity) tells us the share of the labor force that is unemployed. The aggregate number conceals wide variations across various segments of the population: - Youths have much higher unemployment rates than older workers - Female unemployment was especially higher than male unemployment through the 1980s and 1990s, now the gender gap is lower - Individuals residing in the less disadvantaged areas of the country The relationship between the aggregate unemployment rate, u, and that of groups is: u=w1∗u1+w2∗u2+..wn∗un, where wi are the fraction of the civilian labor force that falls within a specific group 4 types of unemployment Associated to the equilibrium, there is Frictional unemployment that is necessary for the correct functioning of the labor market, because time is needed to find a new job. It is the unemployment that exists when the economy is at full employment, results from the structure of the labor market including: the nature of jobs in the economy, social habits, labor market institutions. Frictional unemployment rate = natural rate of unemployment. It’s not a predictical and worrying phenomenon. 1) Seasonal unemployment is associated with a specific period of the year and sector of the economy activity (commerce). We can predict it but it’s not a worrying phenomenon. 2) Cyclical unemployment : comes during recession there is an increase of unemployment only due to the negative economy cycle (recession). We can’t predict it and it’s not a worrying phenomenon, there are different recession and It is unemployment in excess of frictional unemployment, occurs when output is below its full employment level (Y < Y*) Example of a policy intervention is the freezing of firing. 3) Structural unemployment : it is due to structural mismatch between labor demand and labor supply, individual characteristics require in the labor demand (trying, educational etc.). it is a worrying phenomenal that we can predict it. Long term interventions are needed. Labor market flows Dynamic labor market analysis: Labor market flows are movements or transitions among the main labor market states/stocks (conditions) or pool, that are employment, unemployment and inactivity. Labor market turnover, defined as flows into and out of unemployment and employment and between jobs (within employment, job-to-job/charming), is large Flows into employment or accessions include hires, while flows out of employment or separations include quits and layoffs/firing. Duration: It is important to distinguish the short-term and long-term unemployment. These two different durations define different characteristics, especially for policies: the more is long the worst would be. Another way of looking at flows into and out of unemployment is to consider the duration of spells of unemployment. A spell of unemployment is a period in which an individual remains continuously unemployed. The duration of unemployment is the average length of time a person remains unemployed: ü Short-term unemployment (STU): people moving quickly into and between jobs, duration < 12 months: ü Long-term unemployment (LTU): historically the duration of unemployment was high when unemployment rate was high. it occurs for duration > 12 months The Natural rate of unemployment Is the one needed for the correct functioning of the economy, the frictional unemployment. The duration of unemployment depends on cyclical factors and on the following structural characteristics of the labor market: • The organization of the labor market, including the presence or absence of employment agencies (for instance “Humana”, “Adecco”, “manpower”), youth employment services, etc. The aim of these agencies is to improve the match between labor demand e labor supply, for youth the problem is more difficult. • The demographic makeup of the labor force, characteristics of the labor market/economy. • The ability and desire of the unemployed to keep looking for a better job, an issue which depends in part on the availability of unemployment benefits (a possible policy for the short-term unemployment). This desire is negative associated to the discouragement effect. The determinants of the natural rate of unemployment [u*] can be thought of in terms of the duration and frequency of unemployment. It is Associated to [y*] where labor and capital are used at their maximum capacity. The frequency of unemployment is the average number of times per period that workers become unemployed. Two basic determinants of the frequency of unemployment: 1. Variability of the demand for labor across different firms in the economy (different business cycles). 2. The rate at which new workers enter the labor force, since new potential workers begin as unemployed workers: n.u. Because same workers go directly to employment. The determinants of duration and frequency of unemployment are the basic determinants of the natural rate of unemployment. Unemployment starts to increase by a lag, it is a lag indicator, and it remains high in the period immediately following the end of a recession. Time is needed for recovering from it. The first reason is mechanical: the end of a recession marks the bottom point – the trough – of the business cycle, and business activity is still at a low point. Unemployment and recessions since 1973: at the end of 1973-75; 1980; 1981-82 recessions unemployment was high but began to fall about the same time as the recessions ended. Following 2001 and 2008 recessions, instead, unemployment continued to increase: labor market conditions continued to worsen even though the recessions were over. This is the jobless recovery What will happen after the current pandemic in terms of unemployment? We still don’t know but we can see the V-shape of recession. On average the increase of the unemployment role was relatively mild. Increasing in unemployment: increase the firing and the labor hoarding. The equation for the natural rate of unemployment is similar to equation for the overall rate of unemployment: u* = w1 u1 * + w2 u2 * + …. + wn un * The equation says that the natural rate is the weighted average of the natural rates of unemployment of the subgroups in the labor force. Several adjustments are needed to account for: Ø Changing composition of the labor force, including increasing share of youth Ø Changes in the fundamental determinants of the natural rate, including unemployment benefits The natural rate is the full-employment-unemployment rate. It varies over time, and it is a benchmark: 1. If actual unemployment rate is above natural rate, u > u* and Y < Y*: we need to decrease the unemployment, increase the employment and out to reach the equal level of full employment level of output Y*: we expect an increase in unemployment, so output reduce and approach the full level. Cost of inflation Perfectly anticipated inflation: Suppose an economy has been experiencing inflation of 5% and the anticipated rate of inflation is also 5%, then all contracts will build in the expected 5% inflation. In these terms we see: – Nominal interest rates account for the inflation; R = r + π – Long term labor contracts account for the inflation, because of indexation – Tax brackets are typically adjusted to account for the inflation. Inflation has no real costs, except for two qualifications: – The costs of holding currency rise along with the rate of inflation, and the demand for currency decreases. – Menu costs of inflation; arise from the fact that with inflation, as opposite to price stability, people have to devote real resources to marking up prices and changing pay/telephone and vending machines as well as cash registers. We can say that this concept has the mean to rearrange everything, coming from the example of the menu of a restaurant. Imperfectly anticipated inflation: full adjustment to inflation does not describe economies in the real world imperfectly anticipated Most contracts are written in nominal terms – If inflation is unexpectedly high, debtors repay loans in cheaper dollars – If inflation in unexpectedly low, debtors repay loans in more valuable dollars (take a loss) – The possibility of unexpected inflation introduces an element of risk, which might prevent some from making some exchanges they otherwise would undertake – Unanticipated inflation redistributes wealth and income, the two-example mentioned before were bond debtors and retired people. Redistribution effect operates with respect to all assets fixed in nominal terms Money, bonds, savings accounts, insurance contracts, some pensions, effected by the level of inflation Realized real interest rates are lower than nominal interest rates if inflation. Nominal interest rate R = r (real interest rate) + π (inflation) If there is inflation, real interest rate is equal to r = R - π Inflation and indexation Indexation implies the adjusting of inflation; when we compare, for instance, wages and income they are indicators that must been adapted to inflation (considering purchasing power, cost of living etc.), because, otherwise, we only obtain a partial view. In countries where inflation rates are high and uncertain (inflation is unanticipated), long-term borrowing using nominal debt becomes impossible because there’s too much uncertainty: lenders are simply too uncertain about the real value of the repayments they will receive. In such countries governments issue indexed debt: it considers the price level and the possible changes because it was a bond indexed to the price level when either the interest rate or the principle or both are adjusted for inflation. The advantage of the country is the reduction of the risk. The holder of the indexed bond will typically receive interest equal to the stated real rate plus the actual inflation rate, reducing the risk; the increase of uncertainty Is due to the indexation obtaining at least the real value + the current inflation rate. Some formal labor contracts include cost of living adjustment (COLA) provisions. Link increases in money wages to increases in the price level. Suppose real material prices increase, and firms pass these cost increases on as higher prices of final goods • Consumer prices will increase • Under a system of wage indexation, a system in which wage are adjusted for inflation, wages will also rise. This phenomenon is called wage pressure, leading to further price, materials-cost and wage increases. Indexation in this example feeds an inflation spiral Need to differentiate between supply and demand shocks to understand the consequences of wage indexation: - In the case of a demand shock, it also defined as “pure” inflation disturbance and firms can afford to pay the same real wages and will not be affected in real terms by indexation; it means an increase In prices, the shift of the demand will be on the left (and no change In the supply). - In the case of a supply shock, real wages must fall, and full indexation prevents this from happening; wage indexation greatly complicates the adjustment of an economy to a supply shock. Wage indexation complicates the adjustment of an economy to supply shocks. Many have argued that the government should adopt indexation on a broad scale, including bonds and the tax system because: ─ Inflation would be easier to live with ─ Costs of unanticipated inflation would disappear Governments have been reluctant to index for three reasons: 1. Indexing makes it harder for the economy to adjust to shocks whenever changes in relative prices are needed 2. Indexing adds another layer of calculation to most contracts 3. Indexation will weaken the political will to fight inflation, lead to higher inflation, and perhaps make the economy worse off (GDP growth); with indexation we reduce somehow the power of policy maker, an example of policy reducing inflation would be the monetary one. Another intervention could be the sacrifice ratio. Aggregate supply and demand ・6・ One level of output and one level of price which ensure the equilibrium. Output and prices are determined by aggregate supply and aggregate demand. AS curve describes the price adjustment mechanism of the economy. AD (from different components) change output in the short run and change prices in the long run. The AS/AD model is the basic macroeconomic tool for studying output fluctuations and the determination of the price level and the inflation rate, how the economy work. It can be used to explain how the economy deviates from a path of smooth growth over time, to explore the consequences of government policies intended to reduce unemployment and output fluctuations, and maintain stable prices ´ Aggregate supply curve describes, for each given price level, the quantity of output firms is willing to supply. Upward sloping since firms are willing to supply more output at higher prices ´ Aggregate demand curve shows the combinations of the price level and the level of output at which the goods and money markets are simultaneously in equilibrium. Downward sloping since higher prices reduce the value of the money supply, which reduces the demand for output Intersection of AS and AD curves determines the equilibrium level of output and price level. Is the equilibrium e stable condition? No, because it might have shift in either aggregate supply or aggregate demand. It is commonly known as a “shock” for both demand and supply (a shift). For instance, we mentioned recessions (covid-19, both demand and supply shock) which implies a change in equilibrium level of prices and output. the sign, positive or negative, is given by the nature of the shift. ü Increase in aggregate demand ; the consequence graphically is a shift to the right of AD. Increase in prices and of output. ü Decrease in aggregate demand ; the consequence is a shift to the left of the AD, a reduction in prices and output. There’s a reverse relation between P and Y which suggest the negative slope of the AD function. Aggregate demand policy and the Keynesian supply curve GRAPH Aggregate demand policy and classical supply curve GRAPH In the long run, if firms hire more workers what happened in terms of wages? Must charge higher Prices, also because the cost of production will increase. We would see a reduction in real money stock, remembering the relation between M P There will be a shift to the right of AD (the same we saw before). The increase of AD when MP real money available is consistent with a full- employment level of output. Supply side economics GRAPH Focuses on the aggregate supply (AS curve) as the driver in the economy. They say that supply side policies are those encouraging growth in the potential output, our Y*; only supply side polices can permanently increase the output, per se. We would see a shift to right of the supply vertical curve regardless of prices (long run). GRAPH Removing taxes and unnecessary bureaucracy and regulation; the idea is that cutting taxes will increase AS enough that tax collection will increase, rather than fall. Encouraging technological progress. We must take in consideration the Demand side polices, which are more effective in the short run rather than the supply side polices. The increase in output due to the cut in taxation is lower than the tax cut itself, in the long run we move to a new equilibrium point. GDP will increase but by a small amount compared to the tax collection itself. Recession and Depression ・7・ The Crise of macroeconomic instability started in 1929 Great Depression Period between 1980s and 2007 was a time of macroeconomic stability Great Moderation Period between of 2007 and 2009 brought an end to the great Moderation Great Recession Covid-19 pandemic, since 2020, is still ongoing. Each recession has its own characteristics, each one teaches us something new; as bad as the great recession was, it would have been much worse if it wasn’t for the macroeconomic lessons learned from the Great Depression. Great events disrupt both the economy and the study of economics. The study of macroeconomics in particular grows out of economic experiences, especially traumatic ones • In the Great Depression 25% of the labor force was unemployed. • Macroeconomic fluctuations so mild between 1980 and early 21st century was dubbed the Great Moderation. • Great Recession of 2007-2009 dashed hopes of taming the business cycle. • During the 20th century many countries experienced very high and accelerating inflation, a high increase in price and a reduction in GDP, the phenomenon was a stagflation. • Over the later part of the 20th century the budget balance in the U.S. swung from deficit to surplus, and then back to deficit (instability in the US). The Great Moderation During the period considered in the graph, a wide fluctuation in business cycle during early decades of post-war period. The changes weren’t much, that’s why we call it “great moderation”. Dampened out between 1980-2007 Great Moderation The Inflation also brought under control during Great Moderation, Financial crisis demonstrated macroeconomic policy might be better, but shocks are still with us; it cannot prevent shocks. The Great Recession The Great Recession was bad, but not a revisit of the Great Depression (1929). At the peak, close to 1 in 6 were unemployed or underemployed during the Great Recession. Long-term unemployment of Great Recession was especially hard on households, which continued several years after the official end of the recession; it was a U-shaped recession, very slow recover. Covid-19 Exogenous shock of both demand and supply due to the rapid and immediate diffusion of the coronavirus. No dramatic increase of unemployment due to the measures introduced by government to reduce the effect of the pandemic: Shutdown of nonessential economic activities; Short-time work programs (CIG); the suspension of the layoffs has limited the short-term effects of COVID-19 on the labor market Facts on the great recession The Great Depression (GD) shaped many institutions in the economy, including the Federal Reserve and modern macroeconomics. The best-known event of the GD is the stock market crash: between Sep-1929 and Jun-1932 the market fell by 85 percent. Between 1931 and 1935 investment collapsed, and the CPI index fell nearly 25 percent. In 1937-38 there was a major recession within the depression: unemployment rate pushed up to nearly 20 percent and interest rates were close to 0. ü What was monetary policy during this period? Money stock fell rapidly due to bank failures, increased currency-deposit ratio, and the failure of the Fed to take adequate expansionary measures ü What was fiscal policy during this period? Fiscal policy makers tried balancing the budget through increased taxes contractionary policies at an inopportune time ü What macroeconomic theories can explain the GD? Classical economics of the time had no well-developed theory that could explain the persistent and excessive unemployment or any policy recommendations to solve the problem. The GD and the inadequacy of prevailing economic theories in the 1930s was the setting for John Maynard Keynes and his famous work The General Theory of Employment, Interest, and Money. His theory explained: 1) What had happened. 2) What could have been done to prevent the Great Depression. 3) What could be done to prevent future depressions. Essence of the Keynesian explanation of the Great Depression is contained in the simple aggregate demand model. Growth in the 1920s based on: • Mass production of the automobile • Mass production of the radio • Housing boom Collapse in the 1930s resulted from: • Drying up of investment opportunities • Reduction in consumption expenditures • Poor fiscal policy The Great Depression showed that the private economy was inherently unstable, and the Active stabilization policy needed to maintain a strong economy. The Keynesian model offered: • An explanation for what had happened • Suggestions for policy measures that could have prevented the Great Depression • Suggestions for policy measures to prevent future depressions The Monetarist Challenge
