MacroeconomicsLecture1:IntroductionReadingKeyResources:CourseTextbook:Blanchard,Olivier,AlessiaAmighiniandFrancescoGiavazzi(2010).Macroeconomics:AEuropeanPerspective.PearsonEducationCourseVirtualLearningEnvironment(VLE):www.vle.york.ac.ukLecturenotesandothercoursematerialwillbeuploadedhere.Macroeconomics:OverviewWhyStudyMacroeconomics?Perhapsself-evidentinthecurrenteconomicclimate.ThestudyofaggregatesGDPUnemploymentInflationDebtInterestratesCurrenciesThestudyoftheinteractionoftheseaggregates,andofthemarketsinwhichtheseaggregatesaredeterminedGeneralEquilibriumMacroeconomics:MethodologyThiscoursefocuseson‘mainstream’macroeconomicanalysisThisisasynthesisofKeynesianandneo-classicaleconomicsThemethodologyofthemainstreamistouseeconomicmodelsModelsaremathematicalabstractionsofrealityDigression:theuseofmathematicsineconomicsInthephysicalsciencesithasbeenlongrecognisedthattherearemeritstoaquantitativeapproach:“Ifyouknowathingonlyqualitatively,youknowitnomorethanvaguely.Ifyouknowitquantitatively–graspingsomenumericalmeasurethatdistinguishesitfromaninfinitenumberofotherpossibilities–youarebeginningtoknowitdeeply.Youcomprehendsomeofitsbeautyandyougainaccesstoitspowerandtheunderstandingitprovides.Beingafraidofquantificationistantamounttodisenfranchisingyourself,givingupononeofthemostpotentprospectsforunderstandingandchangingtheworld.”

CarlSaganDigression:theuseofmathematicsineconomicsThePhilosophyofScienceInthephysicalsciences,aconsensusofscientificmethodhaspainfullybeenestablished:Copernicus,BrunoetcThe‘AgeofEnlightenment’–especiallyassociatedwiththeemergenceofeconomicsasadiscipline(Smith,Milletc)Thatmethod(especiallyassociatedwithKarlPopper)is:hypothesisconstruction(theorizing–e.g.Newton)–leadingto:Empiricaltestingofhypotheses(e.g.ImplicationofNewton’stheorythatlightindependentofgravity)–leadingtoRejectionoftheories,andconstructionofnewbettertheories(Einstein’stheoryofrelativity)Returntostage1.Digression:theuseofmathematicsineconomicsPopperianfalsification,paradoxically,allowsaccumulationofknowledge.TheScientificapproachisfacilitatedthroughtheuseofmathematicsClarityofargumentResearcherscaninvokelawsofmathematicsinboththeorizing(e.g.tryreadingEinstein’stheoryofrelativity)andinempiricaltesting(e.g.Trialsofnewdrugsfollowverystrictstatisticalexamination)Sointhe‘NaturalSciences’thebattlehasbeen‘won’.NotePopperianfalsificationisnottheonlypossiblephilosophicalbasisforscience.Thereareother‘constructivist’alternatives-e.g.ThomasKuhn.Butthesealsoexpediateuseofmathematics.Digression:theuseofmathematicsineconomicsInthesocialsciences,thereisnosuchconsensusTheapproachtakenbyeconomicsistofollowthemethodologyemployedinnaturalsciences.Thischaracterisesthe‘mainstream’–atleastsinceaboutthe1960sOther‘socialsciences’havetodatebeenmorepredisposedtofollowdifferentmethodologiesPolitics,History:notethereareoftenoverlapswitheconomicsintermsofwhatisbeinganalysedNarrativeApproachesTextuallybasedanalysisDigression:theuseofmathematicsineconomicsConsequencesofdifferentmethodologicalapproachesinthesocialsciencesDisciplinesfinditdifficulttotalktoeachother...EspeciallyimportantforacademiceconomiststocommunicatebetterArguablythefollowingdifferenceinemphasisalsoarises:Narrativeapproachesemphasisethe‘special’.Eventsareuniqueinhistoryandresearchidentifiesanddescribesuniqueelementsofparticularevents.Theeconomicapproachemphasisesthe‘general’.Modelsaretypicallyaimedtobeuniversal.Thoughnotealsosome(better)economicapproachesemphasiseconditionality.Notealsosomenarrativeapproachesaregeneral(e.g.KarlMarx,orFrederikHayek).Digression:theuseofmathematicsineconomicsMoreimportantlytheapplicationofPopperianfalsification(orconstructivistphilosophyofscience)insocialsciencepresentsparticularproblems:Theoreticaldifficulties:we’redealingwithhighlyevolvedcomplexentities(i.e.Humanbeingsratherthanparticlesinavacuum).e.g.therationalexpectationsrevolution/Lucascritiqueetc.Empiricaldifficulties:identificationofcauseandeffectisdifficultbecause‘controlandtreatment’,i.e.laboratoryconditions,cannotinmostinstancesberecreated

Digression:theuseofmathematicsineconomics

“AnIndianborneconomistonceexplainedhispersonaltheoryofreincarnationtohisgraduateeconomicsclass,”PaulKrugmanwritesintheopeningparagraphofhisPrefacetoPeddlingProsperity.“‘Ifyouareagoodeconomist,avirtuouseconomist,’hesaid,‘youarerebornasaphysicist.Butifyouareanevil,wickedeconomist,youarerebornasasociologist.”Krugmanthencontinues,“Asociologistmightsaythatthisquoteshowswhatiswrongwitheconomists:theywantasubjectthatisfundamentallyabouthumanbeingstohavethemathematicalcertaintyofthehardsciences....Butgoodeconomistsknowthatthespeakerwastalkingaboutsomethingelseentirely:thesheerdifficultyofthesubject.Economicsisharderthanphysics;luckilyitisnotquiteashardassociology.”(1994:xi)Digression:theuseofmathematicsineconomicsWhyisEconomicsharderthanPhysics?

1.Wearegrapplingwithcomplexentities(humanbeings)afortiorimacroeconomics...Yesitisdifficult.Butdoesthisfactmeanweshouldrejectmathematicalformulationofeconomicissues?Digression:theuseofmathematicsineconomics2.Difficulttoconstructvalidtestsoftheories.e.g.What’stheeffectofafiscalstimulus?Keynesiantheorypredictsexpansion,Classicaltheorypredictsnoeffect.Theproblemoftheabsenceofcounter-factual.Notwocountriesthesame,notworecessionsexactlythesame–socomparisonisdifficult.Nonethelessthereisawealthofstatisticalevidenceandexperience.Shouldthisbeignored?Shouldthisnotbequantified?Digression:theuseofmathematicsineconomicsLastword:/dani_rodriks_weblog/2007/09/why-we-use-math.html“Weusemathsnotbecausewearesmart,butbecausewearenotsmartenough”DaniRodrikSeealsoessaybyPaulKrugman/krugman/www/dishpan.htmlBacktothecourse...WewillbeexaminingmathematicalmodelsofthemacroeconomythisweekIS/LMClosedeconomyOpeneconomyAS/ADKeynesiantheoriesClassicaltheoriesModelsofeconomicgrowthBacktothecourse...Youshouldapproachallofthesemodelsfromascientificperspective.i.e.trytosuppressanypreconceptions/ideologyyoumighthave...expecttochangeyourmindThetheoriesyouwillseedonotrepresentuniversaltruththoughtheyshouldatleastbeinternallyconsistentNotealsothat(empiricalorapriori)rejectionofoneelementofamodeldoesnotconstituterejectionofallofthemodel.Issues(perennial)VolatilityoftheMacroeconomyThegreatmoderation(c.1980-2008)Thegreatrecession(2008-nearfuture?)Thegreatstagnation(2008-distantfuture?)PersistenceofmacroeconomicvariablesInternationaldifferencesinmacroeconomicperformanceIssues(specific,contemporaneous)CurrentrecessionCreditcrunchSovereignandbank-sectordebtMacroeconomicpolicyMonetarypolicyFiscalpolicyRestructuringoffinancialsectorInternationallinkagesGlobalisationFinancialcontagionMacroeconomicvariablesGrossDomesticProduct–thevalueofoutputproducedinaneconomyinayear.InNominalterms,conceptuallyatleastonewayofcalculatingthisistosimplyaggregatealltransactions(notepracticaldifficultiesofdoingthis),i.e. foranNgoodeconomy(expenditureapproach)GDPNotecomparingovertimewouldnotbeagoodindicatoroftherealvolumeofoutputproducedgivennon-zeroinflation.Nbwhyareweinterestedintherealvolumeofoutput?DeterminesrealaggregateconsumptionStandardoflivingmeasureGDPInordertosimplifynotation:

P=thepricelevel Y=realGDPNotethatneitherthepricelevelnorrealGDPareeasilyobservedUKNominalGDP1957-2011GDPandthe‘Pricelevel’RealGDPestimatedfromtotalnominalGDP(moreorlessobservable)andanappropriatelyestimatedpriceindexP.MeasuresofP:TheGDPdeflatorTheConsumerPriceIndexTheRetailPriceIndexTheProducerPriceIndexetcUKPriceindexPricesandinflationTherateofincreaseofthePriceindexistheinflationrateUKInflationUKCPIinflation2-2TheOtherMajorMacroeconomicVariablesTheInflationRateTheinflationrates,computedusingeithertheCPIortheGDPdeflator,arelargelysimilar.U.S.InflationRate,UsingtheCPIandtheGDPDeflator

Since1960Figure2-4TheConsumerPriceIndexGDPThengiven‘PY’

and‘P’,realGDPisconstructed:RealGDPisameasureofthevolumeofoutputNotemeasurementdifficulties–especiallychangingqualityofgoods:putersUKRealandNominalGDPUKrealGDPUKrealGDP1957-2011StylizedfactsAveragegrowthrateof0.75%Suggestionofrecentdecrease?VolatilityaroundthataverageGreatervolatilityinearlyyears‘Greatmoderation’Impressiverecentrecession...UKrealGDP1957-2011Similar(thoughnotidenticalofcourse)patternsemergeinothercountries...Somesmalldifferencesinpost-wartrendgrowthSomedifferencesinoverallvolatilityHeterogeneityinthecurrentrecessionHistoricheterogeneityintimingofpreviouscyclesBusinesscycleconvergenceinrecentdecadesGlobalisation?GermanyrealgrowthGreecerealgrowth:noteaxisscaleIrelandrealgrowthItalyrealgrowthSpanishrealgrowthrealGDPBecausethere(tosomeextent)appearstobeaconstant(ish)growthrateinthelongrunitisconvenienttotransformtherealGDPdataintologarithmsThis(approximately)linearizesthedataTakinglogarithmsdoesnotaddorsubtractanythingfromtheunderlyingdata LogrealGDP(UKdata)SeparatingtrendandcycleSeparatingtrendandcycleNotethatthetrendhastobeestimated.Therearevariousalternativemethodsofdoingthis,thoughnoconsensusonthe‘best’way.(thepreviousslideusedtheHodrick-Prescottfilter)ThekeypointisthatthedriversofthetrendandcyclicalmovementsaretypicallymodeledtobedifferentSeparatingtrendandcycleBlancharddistinguishesbetweentheShortrun“afewyears”:focusesonwhyactualGDPmightbedifferentfromtrendGDP(or‘potentialoutput’)DemandshocksSupplyshocksMediumrun“adecadeorso”:focusesonthereturnofGDPtothetrendIssuesofstabilityandforceofequilibratingfactorsinmarketsLongrun“halfacenturyormore”:focusesonthedeterminantsofthetrendFactorsofproductionFactorproductivity(institutions,technology)LongruntrendgrowthintheUK1957-2011Rapidgrowthinthe1960sAverageannualgrowthofrealGDPof3%1957-1969Slowdowninthe1970sAverageannualgrowthofrealGDPof1.7%1969-19821982-1997:2.67%1997-2007:2.94%2008-2011:-0.98%LongruntrendgrowthintheUK1957-2011Drivers:Post-warconvergence(recalltheSolowmodel)Slow-downoftechnologicalprogresscombinedwithresourcescarcityinthe1970sITrevolutionc.1990-presentInstitutions1-1(Blanchard):TheUnitedStatesTable1-1Growth,Unemployment,andInflationintheUnitedStatesSince19701970–2006(average)1996–2006(average)200620072008Outputgrowthrate3.1%3.4%3.3%2.1%2.5%Unemploymentrate6.25.0Inflationrate4.02.0Outputgrowthrate:annualrateofgrowthofoutput(GDP).Unemploymentrate:averageovertheyear.Inflationrate:annualrateofchangeofthepricelevel(GDPdeflator).Theperiod1996-2006wasoneofthebestdecadesinrecentmemory:Theaveragerateofgrowthwas3.4%peryear.Theaverageunemploymentratewas5.0%.