lOMoARcPSD|11468586 Cheat EC 140Final Sheet Factors GDP = fₜ(K,L,H) Variables DESIRED The Macro Model AE = C + I + G + X – IM (same as GDP expenditure side) Model desired aggregate expenditure AE with an Index %change final version v1.0 autonomous part A and induced part zY (z is the Kapital Price level is the average marginal propensity to spend). Expand AE = A + zY with =Y (national income) Variables ACTUAL price of everything. Power of money variables on back side to get: Firms contribute to GDP by value added. Does goes down as price level goes up. not account for illegal/black markets, leisure, Today dollars are nominal. Indexed “bads”. Adjusting for real GDP is better, to against a particular base year is real. account for inflation. Stuff with no clear market Real national income is quantity now @ AE tends to equilibrium when desired = actual, that is, value is counted at cost. base year prices. Measure price of the AE = Y. Otherwise, AE Actual < Desired AE Y= Income Side: Y = Net domestic income (NDI) + same stuff relative to some year as the inflationary or - inventories ↓ Depreciation + Indirect Taxes – Subsidies with CPI, which is calculated as an index. deflationary gaps - production ↑ NDI = Wages + Interest + Business profits For any index, deflator = nominal/real. push actual Actual > Desired A Expenditure Side: Y = Cₐonsume + Iₐnvestment Deflator is also a (price) index. Inflation production and - inventories ↑ inventory towards - production ↓ + Gₐvmt + EXₐports – IMₐports. is % change in deflator index. Or, desired amounts. Y Yₑ Investment = Net Invesment + Depreciation: not deflator = last year deflator × inflation Solve AE = Y for Y to get Yₑ = A/ (1–z). “investing” but inventory, plants, and equipment. Negative inflation is deflation. ΔYₑ/ΔΑ = 1/(1–z) is the simple multiplier, relating Count only gvmt spend on firms, not all spend. Decreasing inflation is disinflation. autonomous spending (vertical shift) to equilibium. eal interest = nominal – inflation. Business Cycle Regular short-run GDP RPeople S h if ts See variables + graphs on back page plan for normal, anticipated fluctuations. Measure actual vs potential GDP in fl ation. If price level goes up before B asic W ealth rises→consume more (a)→shift up (Y*) with full employment. Output gap = %diff = people plan, inflation is unanticipated, Interest rates up→less inventory (I₀)→shift down Recession is decreasing like being paid back in weaker dollars. Expectations up→consume more (a)→shift up output gap, recovery when Exchange rate is the price in Canadian Higher sales→higher desired stock (I₀)→shift up increasing. Depressions are long recessions. dollars to buy one of another currency. Government Spending up (G)→shift up Peak/trough when GDP hits local min/max. More valuable currency is appreciating, T₀ up→shift down, t up→flatter Output gaps put pressure on wages and working less valuable depreciating. Trade Foreign GDP up→X up→shift up hours. For example, COVID screwed GDP. Labour force is people who Labour Domestic price up→X down/m up→down and flatter Biggest recession ever with fastest recovery are 15+ and employed or unemployed CAD weaker→X up/m down→shift up and steeper (job searching). Unemployment rate is Modelling Change Express as Fiscal Policy Government can take your money, unemployed ÷ labour force. Potential or growth rates, normally percentages per year, spend your money, or give bonus money. Affects full employment still has some e.g. $2 after 50 yrs @ 5% is 2×(1.05)⁵⁰. The disposable income YD=Y–T. The budget balance is T–G, unemployed: frictional from turnover rule of 72 says it takes 72/x years for x% aka the primary budget surplus (or deficit). and structural from skill mismatch. growth to cause a double. Unlike monetary policy, fiscal policy lags. It takes time Growth is limited by resources: exhaustion of Seasonal from yearly patterns. Cyclical to get information and decide, but also to implement or from the business cycle. P roductivity is supply or degragation of the environment can execute the plans. This makes timing really hard. halt growth. Sustained economic growth must GDP per unit labour, with people (worse ) or hours worked (better ) . Savings The sum private + public where private is be tech change (by definition, this is janky). (= I₀ in Baby) and public is budget balance T–G. In models, change is either endogenous Aggregate Supply shows 1S–=bYis–Cmarginal propensity to save, opposite of MPC (explained by the model) or exogenous (not the quantity of aggregate output Y explained). E.g., in the neoclassical model created if it’s sold at price level P. Aggregate Demand is all equilibria points tech is exogenous but endogenous technology AS slopes up for different price levels. Price– models argue tech is affected by the macro from increasing As the domestic price K eynesian model (so it’s explained). unit (marginal) level goes up, exports range Growth outside of the neoclassical model (i.e. costs. There’s a go down and imports go up, Price+ exogenous tech) is also called the Solow flat “Keynesian” making the AE curve shift residual (or total factor productivity). range somewhere Y* Y down and be flatter. left of Y* and Y The AD curve is all the Growth Models The neoclassical AS steep right of Y*. equilibrium points growth model has diminishing marginal The Philips for all price levels. returns to either Kapital, Human capital, or curve shows Y The curve’s sensitivity to Y* Labour, and constant returns to scale if both sticky wages: shocks depends on the go up proportionally. In the long run, the only wages rise quickly in inflationary gaps simple multiplier since AD change is tech which means LRAS is a and fall slowly in recessions, since AS AD is just a bunch of Yₑ points. constant vertical line. Y can’t shift as fast to fix them. Modern models say tech is endogenous like, The true multiplier (change in Yₑ given ΔA) real Living learning by doing or innovation/competition, is smaller than simple (horizontal shift) shift standards which lead to increasing marginal returns. This “ simple” whenever AS slopes up. increase faster shift is the only way we can get sustained growth, The paradox of thrift is that if everyone than scale like the industrial revolution (see graph →) saves, b goes down and everyone gets Neoclassical model adjustment process in poorer (Yₑ down) response to an output gap always forces 1800 Time Automatic Stabilizers are parts supply to Y* in the long run ↓ S upply/Demand of tax-and-transfer systems that reduces the Short run assumes Factor prices shift AS to Long run has factor prices D+→P+Y+ read as AD up causes multiplier making AD more stable (smaller constant factor prices close output gaps, fully adjusted, tech (Y*) is price up and GDP up changes in real GDP due to shock). and tech technology still const changing S+ → P− Y + S− → P+ Y − Unlike discretionary (purposeful) fiscal policy D+ → P + Y + D− → P − Y − S+ D+ → P? Y+ S− D−→ P? Y− adjusting G₀ or T₀, automatic stabilizers are S > D → P− Y ? D > S → P+ Y ? induced (automatically shift). Examples Use to table to lookup cause from include employment insurance, progressive result or vice versa taxes, and the welfare system. Y* Y Y* Y AE Price Level LRAS Price Level Price Level Price Level GDP per capita Nominal Wage Change Price Level GDP Ⓒ James/Mahbod/Imaad/Ainsley 2021. Don’t upload me to Coursehero :( Y* Y Support us and see list of previous versions’ errors at ko-fi.com/jahyong Downloaded by Ben Holt (bthomasholt@gmail.com) lOMoARcPSD|11468586 Money is a medium of exchange AD/AS Curves Positive AD shock (from Y*) AE Curve in place of bartering stuff (which needs a →inflationary gap Net tax rate goes up AE coincidence of wants). This makes it a →supply increases → t up → z down useful store of value to keep the power to →new Yₑ with price level up → graph flatter buy stuff unless there’s hyperinflation Causes similar to EC120 demand → Yₑ down (inflation over 50% per month). Value A • anything that shifts A E up Other causes Y measurement allows for it to be a unit of Y* • population up • MPC goes down account to balance. Y • Imports up Negative AS shock (from Y*) Yₑ’ Yₑ Coinage suffers from debasing (making →recessionary gap Foreign income up lower quality coins) causing people to AE →gov spending can close gap →X₀ up→NX up hoard the better ones (Gresham’s law). →new Yₑ with price level up →A up→shift up Paper money are promises to pay holder Causes similar to EC120 supply →Yₑ up by X₀ × 1/(1–z) of paper the money. Can lead to runs on Y Other causes A Y * • technology le v el down the bank when everyone asks for money • Wealth goes up Both can cause • people/capital down at once and there isn’t enough money. stag fl ation (price le v el • factor prices up Y • Future expectations up Fiat money is not convertable into gold Yₑ Yₑ’ • Interest rate down and unemployment up ) (e . g . oil , wages , commodities ) or anything at all. Instead “pay to bearer AE Relative foreign on demand”, fiat bills say “this is legal prices down/appreciate tender”. Almost all money now is fiat. Bank of Canada is Canada’s central bank and →X₀ down→shift down has 4 main functions: (1) Banker to the chartered Deposit money is made-up money in →also IM up A banks that people “have”. Banks promise (commercial) banks. They keep deposits with the BoC, →graph flatter called reserves. (2) Banker to the federal gov, who keeps more money than exists (fractional →Yₑ goes down some deposits. (3) Regulator of the money supply by Y reserves). Deposits are demand or Yₑ’ Yₑ N shifts up/down with A buying and selling gvmt bonds. (4) Regulator of financial notice depending if you can withdraw but has opposite flat/steep AE whenever. Term deposits collect interest institutions alongside OSFI (Office of the Superintendent Relative domestic and no withdrawal until term is finished. of Financial Institutions). Bank of Canada Balance Sheet prices down/depreciate Assets Liabilities Near money is stuff with value easily Reserves →X₀ up→shift up • Federal bonds • Currency A converted (liquidated) into money, like are a commercial bank’s • Provincial bonds • Gov Deposits →also IM down term deposits. Money substitutes are • Commercial Bank cash and deposits at BoC. →graph steeper Y Deposits used in exchange but are not stores of Yₑ Yₑ’ →Yₑ goes up Commercial banks in Canada value, like credit card debt. have a fractional banking system, so they reserve only some deposits. Reserves÷deposits is the reserve ratio, and banks have a target reserve ratio (v). When above, lend excess reserves to collect interest. Money Creation in banking happens from: (1) immigrants bringing Example If a commercial bank with target ratio 10% gets a new deposit of $250. Target reserves are cash to Canada (2) finding money under 10%×$1250 = $125, so excess reserves are $300 + $50 – $125 = $225 (BoC deposits are part of reserves) beds and (3) when the BoC increases Assets Liabilities Assets Liabilities Assets Liabilities money supply. When money is “created” (i.e. deposited in a commercial bank), it Cash +250 50 Deposits +250 1000 Cash −225 300 Deposits 1250 Cash 75 Deposits 1250 moves through the balance sheets → BoC Deposits 50 Kapital 100 BoC Deposits 50 Kapital 100 BoC Deposits 50 Kapital 100 Loans 900 Loans+225 900 Loans 1125 The total deposit money created is (deposit)÷(target reserve ratio) So the bank loans out $225 so cash decreases and loans increase. Lending to a second-hand bank Fiat money is created by the central bank increases their cash, so they lend, repeating the cycle to make $250/10% = $2500 of new deposit money. (the BoC) through purchase of securities. Commercial Bank Balance Sheet Money is “destroyed” in the opposite A central bank digital currency would still have banks Assets Liabilities process to creation. acting as lenders and borrowers but commercial banks will • Reserves (including • Demand/Notice deposits no longer be providers of medium of exchange. Price Level Price Level Graph Shifts Invert causes/effects to get the other directions X Money Markets Apply S/D logic to the interest rate (price) and quantity of money. Increase in Y or P shifts MD up. MS is vertical because it’s not affected by interest rate deposits at the BoC) • Gov securities • Loans (incl. mortgages) • Canadian securities • Foreign currency • Term deposits • Gov deposits • Foreign liabilities • Shareholder equity E Trends Actual GDP stays around potential. Labor force grows, so (un)employment rises. Unemployment rate has no long term trend (except for the massive COVID drop, of course) Price Level Price Level i Actual COVID EffectX DJ’s COVID Obsession AE < Y but production ] Inventory down (decrease in I₀Ù didn’t rise, so GDP fell. ] Quantitative easing: BoC buys federal bonds at all The MD curve i₀ Oil price drop maturities to fund CERB (MS shift upÙ comes from (see below) so AD down ] BoC lower interest rate (decrease in iÙ three reasons: i₁ To fix, gov did CERB ] BoC buys provincial bonds for first time (MS shift upÙ transactions (transfer/negative tax) M S₀ M S₁ ] G o v ernment increased budget defecit (increase in D Ù demand (spending), so T₀ fell and AD up precautionary demand (rainy-day fund ] Commercial banks increased deposits at BoÝ Wage subsidy (CEWS) ] E xports/imports dropped (NX relati v ely unaffected Ù / keeping money in your pockets), and lowers factor price, ] MPC fell (lot more savings) Y Y* speculative demand (investing / shifts AS right diversification strategy). The Potential COVID EffectX Canadian oil prices opportunity cost of money is the real ] Possible high inflation post-pandemic as reserves fall: Fall in I₀ so AD interest rate on bonds. of banking system get loaned ou8 down (because oil ] Possible long term decline in potential G D P (Y *) as Assume money neutrality in the long industry worth less) people were unemployed (get rusty) and missed out run: % change in MS → same % AS curve shifts right on schooling leading to less productivity/human change in P. Money neutrality is highly (lower factor price) capitaE debated: hysterisis effects (reasons Y* Y ] Population decrease as immigration dippe 4 why it shouldn’t be) change Y* and ] Stimulus packages could cause inflation make AS and AD move different amounts when AS returns to a new Y*: (1) investment can lead to growth in Y* (2) reduction in human capital during recessions decreases Y* (people get rusty when unemployed) Downloaded by Ben Holt (bthomasholt@gmail.com) lOMoARcPSD|11468586 Monetary Policy Boomer Time 1983–1987 1987–1990 1991–2000 2001–2007 2007–2010 COVID lol is BoC’s decisions around the money supply and the Recession: Recovery: Increased MS Started inflation 9/11 happens lol recession Buy bonds to interest rate. The BoC does not target the targeting at 5% happens anyways fund CERB etc Stagflation high Try increasing caused high Reduce interest rate eventually 2% money supply directly because money supply inflation and to prevent recession Set 2% target now Reduced This was bad to avoid high inflationary gap because so CAD appreciates interest rate (1) Cannot control deposits Friedman inflation Also bad (2) Uncertainty around position/slope of MD. Bank of Canada Timeline Instead the BoC targets the interest rate because onetar Transmission echanism in closed economy starts with (1) MD curve position/slope doesn’t matter interest down → cheaper borrowing → more investment → AE up → AD right → Y up (2) Easier to communicate to the public (3) They control a particular interest rate That particular interest rate is the overnight interest rate i₀ which is bank-bank (market-determined but BoC punches the market in the face eight times a year at FADs). The bank i₁ MD ID rate is BoC charges to banks (0.25p.p. higher), deposit rate Y Y Yₑ Yₑ’ M S ₀ M S ₁ I ₀ I ₁ Y* is BoC pays to banks (0.25p.p. lower). In open economy, lower interest → less attractive for foreigners → currency supply lef t Once the BoC targets the interest rate, the associated → depreciate → N up, which ust exaggerates the existing effect on AD / Y / price level excess supply/demand is closed through open market A stepper MD curve or flatter I curve → greater effect on Y from increased MS operations with commercial banks: selling/buying bonds from them. This makes MS endogenous. Since changes in Expansionary Increase in GDP investment take time, monetary policy lags. policy shifts moves down M i s Fi cal Policy is government decisions around expenditures and taxation. Two sources of money: net taxes (T) and borrowing, and they also have two expenditure accounts: spending on goods and services (G), and debt-service payments (iD). When governments spend more than they get, they run a budget deficit (ΔD). This must be financed with new borrowing (ΔD), so we have ΔD = (G – T) + iD When ΔD positive, the existing stock of debt increases and when ΔD negative, it decreases. The deficit ithout debt is called the primary budget defecit = G – T. Debt as a nominal value is meaningless, so we measure a country ’s indebtedness with the debt to GDP ratio (d). The change in the debt-to-GDP ratio is Δd x + (r–g)×d where x is the deficit-to-GDP ratio, r is the interest rate, and g is the gro th rate of GDP = j w The structural budget (aka CAB/cyclically ad usted budget) deficit is the deficit that would exist if real GDP was e ual to potential. The government uses it to determine its stance on fiscal policy since must comprare between cabinets in charge during booms and busts. If actual deficit > structural deficit, in a recessionary gap. If actual < structural, inflationary. q w with a current account deficit (Canada should not borrow from the rest of the world) Regulation of the housing market in Canada has included lower down-payments and longer amortizations but never negative real interest rates. NS left Crowdin t happens when governments run big deficits → lower i → lower I which increase their stock of debt. This causes cro ding out / decreases in investment and net exports. NS₁ More spending → decrease in public saving → NS shifts left → higher interest rate → investment crowded out. NS₀ I Higher interest rate also attracts foreign capital → increase currency ₁ ₀ demand → appreciate currency → net exports crowded out. Q Q C The current account splits into the trade account and the capital-service account. q exports TA investment income SA transfers from foreigners SA receipts from asset sales KA C C imports TA investment expenses SA transfers to foreigners SA payments for buying assets KA official financing KA C C =$ If unbalanced, there’s a statistical discrepancy (CA + KA + SD 0), usually negative because people tend to underreport foreign assets. Exports/Imports are split up into merchandise and services. Merchandise includes goods like lumber, oil, minerals. Services include things like tourism. Like many other ‘developed’ countries, Canada has been a large international debtor for most of its existence. Alternatively calculate CA by national savings net of investment, i.e. CA (GNP − T − C) + (T − G) − I where gross national product is the GDP + net investment income. = Y Y₀ Y₁ Y Y₀ Problems with Debt and Policy Having a large stock of debt is bad, so people complain about tHe FuTuRe GeNeRaTiOnS. Deficits are ok if spent on I₀ instead of C because that increases Y* which makes it easier to pay back Exchange Rate Markets Q are like any other competitive market. P and act like normal S/D curve except price is the exchange rate from to Y (units of needed to buy a unit of Y) and the uantity is the uantity of Y in that market. q q $X-$Y Exchange Rate s Balance of Payment is how we record all the transactions between Canada and the rest of the world. It is fixed by design. The current account deals in goods and services, while the capital account measures asset-related transactions. When money is spent elsewhere, something of e ual value is given, so A + KA = $0. Credits Debits deficit curve Some politicians insist on a balanced budget. There are three ways to do this and they all suck. (1) annually balanced budget removes automatic stabilizers and prevents the right policy being used in output gaps. (2) cyclically balanced budget is hard because nobody agrees where Y* is. (3) prudent debt-to-GDP ratio also forces low spending, stopping inflationary policy. Interest Rate w curve When goverments have continued budget defecits, and they cannot increase in taxes, BoC has to monetize the debt: buying bonds and paying down debt directly. This can cause inflation. For fiscal policy, high debt-to-GDP → hard to find lenders → expansionary fiscal policy is ineffective → stuck in recession. T in deficits are bad: a government budget deficit (the government should not borrow) g Ou Primary Deficit j Primary Deficit X w Price Level y AE M $X $ $ $X $ æ $ Demand for Y shifts right when Increase in demand for Y’s good Inflation in country Supply of Y shifts right when Increase in demand for ’s good D Y Inflation in country Y Y $ å å $ åå Q$ S Y $ Market does not always make currencies e q X X æ ì ì ually valued, so alternatively measure by making the price of goods (e.g. Big Macs) e ual. This is the purchasing po er parity price in price in Y. q = $X ÷ $ Some countries like to fix their exchange rate, to decrease the risk to importers and exporters e.g. China, which enjoys being an exporting nation, has a fixed exchange rate to keep the yuan from appreciating. They do this by increasing their foreign exchange reserves, artificially increasing the supply of yuans to the market w Downloaded by Ben Holt (bthomasholt@gmail.com) lOMoARcPSD|11468586 CPI and Inflation Calculations+Examples 2018 Good A Given base Good B year is 2018 Good C (CPI = 100), 2019 find inflation Good A between 2018 Good B and 2019. Good C Total Expenditure (2018): GDP Deflator PPP Given Big Mac costs 390¥ in Japan and 22.40元 in China, the Real GDP 2019 (using 2018 prices): Bond Market Equilbrium Given a interest rate below equilbrium, there will be an excess demand for money, leading to a sale of bonds, a decrease in the price of bonds and an increase in the interest rate back to equilbrium. An interest above equilibrium would have opposite effects. Price Quant Calculate $1.10 90 the GDP deflator of this economy $1.90 215 in 2019 if the base year is 2018 $4.80 90 GDP 2018: $2.00 $2.20 $9.50 130 210 88 Nominal GDP 2019: Total Expenditure (2019, with 2018 quant): Calculate CPI for 2019: z = b(1 – t) – m C = a + b(YD) YD = Y – T T = T0 + tY NX = X – IM IM = mY G = G₀ X = X₀ I = I₀ Exchange Rate CAD to USD rate went from 1.13 to 1.21. CAD depreciated as more CAD to buy 1 USD CAD to USD rate went from 1.27 to 1.13. CAD appreciated as less CAD to buy 1 USD A | all autonomous expenditures z | marginal propensity to spend b | marginal propensity to consume m | marginal propensity to import C | desired consumption a | autonomous consumption YD | disposable income Y | national income T | net tax revenues T₀ | autonomous tax revenues net of transfers t | net tax rate of all taxes net of subsidies NX | desired net exports X | desired exports IM | desired imports m | marginal propensity to import For simplicity, all autonomous with no induced G/G₀ | desired government expenditure X/X₀ | desired exports I/I₀ | desired investment Variable Reference Table AE = A + zY yen-yuan PPP exchange rate is 390/22.40 = 17.41¥/元. But if the actual exchange rate is 16.11¥/元, so the yuan costs less than it should (undervalued) and the yen is overvalued. The percent undervaluation (with respect to the actual exchange rate) is (16.11¥ − 17.41¥) / 16.11¥ = −8.1% Downloaded by Ben Holt (bthomasholt@gmail.com)
