Macro

1. Macro Measures and Policies

2. Here are the tools used to evaluate government performance in the popular discussion: • Gross National/Domestic Product (GNP/GDP) measures the total size of the market economy, defined either geographically (GDP) or by people (GNP). • GNP/GDP growth is often taken as a measure of economic performance. • Inflation (π) measures changes in price level • Consumer Price Index (CPI) measures the year‐to‐year change in the prices of commodities... • that is, the cost‐of‐living. • Productivity and productivity growth measure the amount of economic output we get per unit of inputs.

3. Here are the tools used to evaluate government performance in the popular discussion: • Unemployment Rate (UR) measures the population of people seeking work as a fraction of all those either working or seeking work. • Exchange rate measures the cost of foreign currency in terms of Canadian dollars. • Business pages often treat this as if it were a measure of economic and government performance. • Poverty measures assess the size of the population with ‘too little’ to get by. • Medical service waiting lists quantify the waiting times for various specific medical procedures. • Interest rates are the price of borrowing money. • Low interest rates are often seen as ‘good’.

4. The size of the market economy • Gross Domestic Product is the total marketed economic activity taking place within a geographic region, such as Canada. • Gross National Product is the total marketed economic activity done by a specific group of people, such as nationals of Canada. • Two equivalent definitions, suitable to different types of problems. • Sum of gross income from all sources in a region (or of a bunch of people). • Or, sum of private consumption + investment + government spending + the change in inventories + (exports ‐ imports). • The two definitions are equivalent because • all private consumption, firm investment and government spending eventually shows up as someone’s income; • increased inventories imply increased final sales later; • exports involve foreigners paying locals and imports involve locals paying out to foreigners.

5. These definitions add up payments for stuff. • Thus, stuff which is transacted without payment is not counted at all. • Most household work is not counted; • leisure is not counted; • much child care is not counted. • Anything which is valued but not paid for is left out of GDP, even though it is produced by people in the economy. • Some of it is imputed. • These definitions add up payments for stuff, and assume that those payments reflect their social value. • If the conditions for the First Fundamental Theorem hold, then they do in fact reflect their social value. • However, some things are transacted at prices different than their social value—these are things with externalities, public goods, regulated products, monopolistically supplied. • GDP (and GNP) is defined nominally. • If everybody’s income goes up by 10% and all prices go up by 10%, no improvement happens, so a sizeable increase in GDP may mean nothing much.

6. Employment and Unemployment • The population according to Statistics Canada is divided into 3 types: • Employed E (worked more than 1 hour this week); • Unemployed U (wants to work, but did not work 1 hour this week); • Employed + Unemployed = Labour Force L. • Out of Labour Force (does not want to work); • Unemployment rate UR = U/(E+U) = U/L.

7. Unemployment rate UR = U/(E+U) = U/L. • Information on the fractions of the population in each of these groups is collected every month by the Labour Force Survey. • Employed includes people who are working, but may be working more or less than they desire. • Unemployed includes only those who ‘want’ to work by the following criterion—they have looked for work during the past month. • Looking for work includes: • making a phone call; • applying for a job; • waiting for your union job to re‐appear; • reading the classifieds; • going to an employment center. • looking for work by these definitions is what you have to do to qualify for Employment Insurance benefits (with the exception of parental/maternal benefits). • Unemployed thus excludes those who have given up on looking (discouraged workers). • When the economy starts growing after a recovery, sometimes the unemployment rate rises, because the unemployed grow in number as people start actively looking for work again.

8. Prices, Price Indices and Inflation • To the extent that we care about consumption, we care not about how much we spend on goods and services, but rather about the quantity of goods and services that we get as a result of those expenditures. • If the prices of things change over time, then we want to adjust any measure based on spending or income for that price change. • Inflation is the change in the price of goods and services. If inflation is 2% between last year and this year, then it takes 2% more money this year to buy as much goods and services as we bought last year. • Consumer Price Index (CPI) is a measure of price level produced by Statistics Canada, and reported in the popular press. • Basic measurement strategy is this: • measure the total quantities of goods that people buy (e.g., food, clothing, shelter...), call these quantities a consumption basket. • Fix the basket quantities • Calculate a weighted average of the price increases using the fixed quantities as weights • Change in CPI is expressed as a percent increase, and is most reported measure of inflation.

9. Price indices such as the CPI can be used for lots of important things. • Can use them to adjust nominal GDP/GNP measures. Thus, if prices go up 2%, then we adjust nominal GDP 2% downwards to compare it with last year. • Bank of Canada targets CPI in setting its monetary policy. The current monetary regime targets inflation between 1 and 3 percent per year.

10. As a measure of the ‘cost‐of‐living’, CPI has many features that leave it wanting. • It is one measure for a whole population of people. But people may have their personal consumption basket very different from the one used for CPI. • People mitigate price increases by reducing consumption of the goods whose price goes up most, but CPI basket is fixed. In this case, CPI would overstate the change in the cost of living. • Since it takes last years’ quantity as fixed, it cannot accommodate new goods. If phones that take pictures enter the market, people are maybe better off because they can buy this new thing, but alas, it does not enter the CPI in any way, because phones that take pictures were not purchased last year. • Hyperinflation is a very high inflation rate • Generally the higher inflation the less predictable it is • Hyperinflation destroys confidence • Hyperinflation ruins incentives for long‐term investments

11. Sometimes governments use expenditure and revenue tools to affect the economy • For example, if the economy is in a recession, the government may want to help speed the recovery. • recession is defined as negative GDP growth for 2 consecutive quarters. • It may choose to spend more money while holding revenues constant. This implies increasing the deficit in the short term, and increasing the debt in the long term. • The increased expenditure will affect GDP: • GDP = C + I + G + NX where C is personal consumption, I is firm investment, G is government spending, and NX is exports less imports. • increased government spending pushes up G, which pushes up GDP. • it may also push down I. If firms are thinking about investing in capital, but government spending is used on capital, firms may be dissuaded. • it may also push down C. If people realise that they have greater • government debt obligations, they may try to save up for them. • typically, these counteracting effects will not completely undo the increase in G, so the net effect is still to push up GDP.

12. You can also think of this via the other definition of GDP, as the sum of everyone’s income from all sources. • Increase in government spending takes the form of: • increased government employment; • increased government transfers to people; • increased government spending on goods and services. • Here again, things are partially undone—increased government employment might result in decreased private employment (if government poaches private sector workers); increased transfers might result in decreased non‐transfer income (if transfer recipients decide to reduce their work hours because the government gave them more money).

13. Government spending (holding revenue constant) will also tend two rather negative effects • In the long‐term, the increased deficits increase debt. • In the short‐term, increased spending may push prices up. • The mechanism is this: governments are writing cheques to people, so people have more money to spend. But, if there are no more goods and services to buy, that larger amount of money will be spent on the same amount of stuff, pushing the price of the stuff upwards. • thus, government spending which creates more stuff will tend to be less inflationary, but government spending which does not create more stuff tends to be inflationary. • Thus, increased government expenditure (holding revenue constant) will typically result in the following in the short‐term: • Increased size of economy (increased GDP); • Increased employment (lower unemployment rate); • Possibly increased inflation; • And in the long‐term, increased debt.

14. Interest Rates • The interest rate is the amount that must be paid per unit of time (e.g., per year) in order to borrow/save money. • Typically, the rate paid to savers is less than the rate paid by borrowers. • This is because financial intermediation (read ‘banking’) uses real resources. • There are lots of different interest rates, beyond the distinction between borrowing and saving. • The Bank of Canada sets a particular rate: the overnight government bond rate. • This is the rate of interest (almost always presented in an annualised equivalent) to borrow one dollar overnight. • This is the Bank of Canada’s main policy instrument, and almost the only monetary policy instrument reported on in the business pages. • This rate is correlated with all other rates because a longer term rate is ‘like’ a sequence of promises on overnight rates. • However, it is not perfectly correlated with other rates.

15. Interest Rates, GDP/GNP growth rates, Unemployment rates and Inflation are connected. • The Bank of Canada uses its control of the overnight government bond rate to influence longer term rates. • Low rates are crucial for various kinds of investment. • People buy homes more readily when long rates are low. • Firms engage in investment when long rates are low. • These activities, and other investment‐related activities, fuel economy activity in both the short term and the long term. • In the short term, the input markets for these investments are spurred — e.g., homebuilders • In the long term, firm investments yield outputs. • So, low interest rates are seen by many to ‘cause’ increased GDP. • Macro‐economists don’t interpret this relationship as casually, because forward‐looking consumers and producers won’t get ‘fooled’ by such Central Bank activity. • The economy and employment can grow too fast. If people are all in a rush to buy goods and services, but the quantity of goods and services to buy has not really changed, then the price of those things rises—you get inflation.

16. Famous relationship between inflation and unemployment is Phillips curve • Downward sloping; greater inflation makes for lower unemployment • Holds in short run • In long run, appears to be vertical • Unemployment at “natural” rate • Determined by institutions • So short run gain from inflation disappears in long run • So the policies for lowering the natural rate of unemployment must be different from stabilization policies • Increase mobility • Increase information • Increase flexibility in general