I.
Macroeconomics and
Economic Policy
I.1 Macroeconomics
Scope of Interest, Essential
Data
I.1.1 Long-term economic growth
• Differences among countries/regions
• Factors of growth
• Growth of what? (see Lecture II)
– GDP vs. Wealth
– Real vs. nominal
Real GDP p.c., 1870 – 2009: USA, CND,
AUS, J
35,000
1990 International Geary – Khamis dollars
30,000
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 – 2009: USA, CND,
AUS, J
1990 International Geary – Khamis dollars, log scale
100,000
10,000
1,000
100
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
USA Canada Australia Japan
Real GDP p.c., 1870 – 2009: F, D, I,
UK
25,000
1990 International Geary – Khamis dollars
20,000
15,000
10,000
5,000
0
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
France Germany Italy UK
Real GDP p.c., 1870 – 2009: F, D, I,
UK
1990 International Geary – Khamis dollars, log scale
100,000
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., 1900 – 2009: ARG, S
1990 International Geary – Khamis dollars
30,000
25,000
20,000
15,000
10,000
5,000
0
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
Argentina Sweden
Real GDP p.c., 1900 – 2009: ARG, S
1990 International Geary – Khamis dollars, log scale
100,000
10,000
1,000
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
Argentina Sweden
GDP p.c. in 1900 and 2009 and average
growth rate
35,000
1990 International Geary-Khamis dollars 3.0%
30,000
2.5%
25,000
2.0%
20,000
1.5%
15,000
1.0%
10,000
0.5%
5,000
0 0.0%
1900 2009 AGR(%)
I.1.2 Economic cycle
• Short-term fluctuations of GDP growth
• Factors of the cycle
• Is the cycle inevitable?
• Boom vs. recessions, link to politics and
election cycle
• Economic crisis, depressions
• After last (2008-2009) depression: crisis of
macroeconomics both as theory and as
policy guidance
Real GDP, %yoy
8.0
6.0
4.0
2.0
0.0
-2.0
-4.0
-6.0
1980 1984 1988 1992 1996 2000 2004 2008 2012
EU USA
Inflation
• Different measures: CPI (prevailing), GDP
deflator and others (see different Lectures
later)
• What´s so wrong about inflation?
• The specter of hyperinflations (see Lecture V)
• Is low inflation always desirable (see
discussion on recent macroeconomic
problems)
• A crucial change in inflation since 1950s:
almost always positive (compared to previous
periods)
Inflation (CPI), %yoy
16
12
0
1980 1984 1988 1992 1996 2000 2004 2008 2012
-4
EU USA
Unemployment
• See your macroeconomic textbook (e.g.,
Dornbush, Fischer, Mankiw or Blanchard)
for definitions (and also see Lecture II)
• Unemployment and negative social
phenomenon
• Link between inflation and unemployment
– is there a negative correlation in the short-
term („trade-off“)?
– Almost no correlation over the long-term
Unemployment, %
12.0
10.0
8.0
6.0
4.0
2.0
0.0
1991 1995 1999 2003 2007 2011
Euro area UK USA
Inflation vs. unemployment, %
short-term
4.5 12.0
4.0
3.5 10.0
3.0
8.0
2.5
2.0
6.0
1.5
1.0
4.0
0.5
0.0 2.0
1991 1995 1999 2003 2007 2011
-0.5
-1.0 0.0
EMU Inf US Inf EMU Unemp (r.h.) US Unemp (r.h.)
0.0
2.0
4.0
6.0
8.0
10.0
12.0
1950
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
UnRate
1980
1982
1984
1986
CPI (rhs)
1988
US, long-term
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
Inflation vs. unemployment, %
2010
0.0
2.0
4.0
6.0
8.0
-2.0
10.0
12.0
14.0
16.0
Governments: Deficits and Debts
• Deficit: the difference between revenues
and expenditures of a particular
government
– Easy said, difficult to define and statistically
cover
– Net vs. Gross (interest payments)
• Debt: on most general level – a public
finance debt (total for the country) to both
private and public creditors
– Net or Gross again
• Definitions and some data – see Lecture II
Government Net Deficit, %GDP
10.0
5.0
0.0
-5.0
-10.0
-15.0
-20.0
-25.0
-30.0
-35.0
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011
D E IRL GRE USA
Government Net Debt, % GDP
120.0
100.0
80.0
60.0
40.0
20.0
0.0
1991 1995 1999 2003 2007 2011
D E GRE US
Current Account Deficit (CAD)
• Each country has (today immense)
economic (trade, financial, etc.)
relations with the rest of the world
• CAD: the difference between total
exports and total imports of goods and
services of a particular country
– For more details see Lecture II
Current Account Deficit, %GDP
10.0
5.0
0.0
-5.0
-10.0
-15.0
-20.0
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011
D GRE
I.2 Macroeconomics
Descriptive (Positive) Theory
Macroeconomics
• Describes the economy on the highest
level of aggregation
• Focus on macroeconomic aggregates,
namely GDP (GNP), consumption,
savings, investment, money, inflation,
unemployment, public finance deficit,
current account deficit, public debt,
exchange rate, interest rate and others
• Confines the analyses to following five
sectors
Sectors on macroeconomic level (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)
Sectors on macroeconomic level (2)
• Government (state):
– 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)
Theory and models
• Formalized relationship among
economic variables (linked to statistical
indicators)
– Forms: verbal, graphical, mathematical
• Building blocks:
– Markets and agents
– Focus of the model: endogenous variables
– External environment: exogenous
variables
Structure
• Structure of the model (based on theory):
system of equations (functional forms,
parameters)
• Solution of the system: equilibrium values
of endogenous variables
• Concept of equilibrium: in some
models/theories, equilibrium as a state of
the rest, on some markets supply does not
have to equal demand
• Disturbance to equilibrium: change in
exogenous variables, behavioural and
structural changes (change in parameters
or functional forms) or a random shock
Time, static and dynamic models
• Static model
– Equilibrium: given exogenous variables, the model
determines endogenous variables in a specific time
moment
– Comparative statics: given the change in exogenous
variable(s), the endogenous variables adjust between
two specific time moments, multipliers
– Time length between the two moments: short,
medium or long term adjustment
• Dynamic (growth) model – determines the development
of endogenous variables in time (growth trajectory)
– Initial conditions
– Assumptions about the time development of
exogenous variables
• Most of our course: static models and comparative
statics
I.3 Economic policies
Normative Theory
Towards “the norms” (1)
• Descriptive theory tells us what is,
normative theory tells us what ought to be
• No formalization of normative theories
here, but intuitively, what is “desired”?
– Stable improvement of society’s welfare
– Fair distribution of the welfare among the
members of the society
– In today’s globalized world, convergence of
standards of living in the different regions of
the world
– Respect to future generation
• Externalities (like environment)
• Avoid excessive today’s debts being repaid in the
future
• Policies, executed by state, as a tool to
achieve the norm (“a desired situation”)
Potential confusion I
• Differentiate: happiness, well-being,
welfare, living standard, economic level
• Macroeconomic policies, focused on
production of goods and services
(GDP)and employment, decisively affect
only last two terms
– They do significantly affect other three as
well, but more as necessary, but not
sufficient condition
– Many other factors do influence people’s
happiness and well-being
Role of the state
• Different role of the state
• In modern history – 3 approaches how
to meet the norms
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
Laissez faire capitalism
• Free market and political democracy
• Price as basic signal for production
decisions (what, how, for whom)
• Private ownership of means of production
• Small government and minimal
governmental policies/interventions
• Efficient allocation of the resource
assumed to be achieved via market
efficiency
Karl Marx
• 1818 - 1883
• Philosopher, sociologist,
historian, political
economist, political theorist,
revolutionary socialist
• Communist Manifesto (1848,
with Friedrich Engels)
• Das Kapital (volume I 1869,
volume II and III published
posthumously)
• Ideological founder of
Marxism
Central planning (socialism)
• Consumption decided and resources
allocated through the planning system,
not according price signals
• State ownership of productive means
• Equal distribution of the wealth
• Inconsistency with political democracy,
need for centralized political power
John Maynard Keynes
• 1883-1946
• Cambridge, UK
• Thinker – economics,
logic, probability
• Practitioner –
Treasury during WWI,
advisor to the War
Cabinet at WWII,
crucial role at the
birth of IMF/WB
Mixed capitalist economy.
• Prevailing private ownership,
cohabitating with the state ownership
of certain assets
• Free market cohabitating with
governmental policies to cope with the
deficiencies of the free market
• Welfare state policies.
General role of the state (1)
• State executes different policies/interventions
that affect general welfare of the society
• Different groups (with different vested
interests) may have different thoughts about
the role of state here, examples:
– Efficient allocation of the resources ⇒ cultivating
the markets, regulatory and competition policies
– Provision of essential services (e.g. basic education,
defence)
– Attempting to achieve a fair distribution of wealth
across the society ⇒ welfare policies
– Ensuring society’s needs (police, defence, legal
system, coping with the externalities, etc.) ⇒ general
role of state, not a policy
General role of the state (2)
– Transfer payments, providing minimal living
standards (social policies, e.g. unemployment
benefits)
– Long-term social policies, e.g. securing the stable
health care and pension systems
– Regulation of natural monopolies
– External social costs (e.g. drugs) and benefits
(e.g. free vaccination) of the society
– Support to industry and commerce
Macroeconomic policies (1)
• Fundamental measure of the economy:
income(output), expressed as gross
domestic product (GDP, see next lecture)
• GDP development over time - GDP
growth:
– Over long period: long term growth
• In search policies the determine the long-term
differences in economic level among the countries
– Over shorter period: business cycle
• In search policies that help to overcome the
fluctuations of GDP
Macroeconomic policies (2)
• Other basic economic variables, closely
interlinked with/influencing both short- and long-
term GDP growth (all the concepts will be shortly
explained in Lecture II and III)
– (un)employment
– inflation
– Interest and exchange rate
– Components of aggregate demand: household
consumption, private investment, expenditure of the
state, exports, imports
– Factors, determining the aggregate supply: amount
of capital and labor available, general productivity of
country’s economy
– Public finance deficit
– Debt of public and private sector (and sum of both)
– Current account deficit and balance of payments
Macroeconomic policies (3), but …
• When translated into policies, this entails
– Fiscal policy
– Monetary policy
– Exchange rate policy
– International trade policy
• However, since WWII, many other policies emerged
– Supply-side policy
– Price and income policies
– Employment policy
– … and maybe some other policies (according the
ideology, political inclination and maybe populism of
policy-makers)
• in this course we almost exclusivelly cover only the
policies 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 unexpected outbreak of global
financial and economic crisis after 2007 a
failure of macroeconomics as a basis of
proper policy formation?
– Many people believe yes, your teacher not …
Literature to Lecture I
Prerequisite - microeconomics:
• Any text from VSE or IES FSV UK
• Varian, H.R.: Microeconomic Analysis. W.W.Norton&Company,
New York, 1984 (2nd and subsequent editions plus Czech
translation).
• Henderson, J.M., Quandt, R.E.: Microeconomic Theory. McGraw
Hill, 1958 (and subsequent editions).
Prerequisite - 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).
Data:
• Maddison, A.: The World Economy, A Millennial Perspective,
OECD, 2001.
• Main sources:
– IMF (World Economic Outlook (www.imf.org/external/data)
– Eurostat (http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/themes)
– Ameco, data base of the European Commission
(http://ec.europa.eu/economy_finance/db_indicators/ameco/index_en.htm)
– National Statistical Offices and Central Banks (ECB, FED, but also CNB)
– In the US, also US Burreau of Labor Statistics
