EWMBA 201B Macroeconomics

 

Spring 2004
Professor David Levine
levine@haas.berkeley.edu
Office: F671 Haas, phone 642-1697, fax 643-1420
Office hours: 7:30 to 8:15 p.m. on class days, or by appointment, or just stop by, call or email.

Web page http://faculty.haas.berkeley.edu/levine/macro/

Mikhail Edel edel@haas.berkeley.edu is the Graduate Student Instructor. Office hours after section or by appointment - please send email to schedule.

Basics | Section 1 | Section 2 | Section 3 | Section 4 | Section 5 | Section 6 | Section 7 | Section 8 | Section 9 | The Final Exam | News | General | Humor | Data Sources | Links


Basics

Class: Monday and Tuesday 6-7:30 & 8:15-9:30 p.m. in room C210.


Units: 2 units
Grading: 75% - Final, 25% - Class Participation

Class participation is required. Each class has a problem set.  Problem sets will not be graded, but from section 2 on you will record handing them in. Their presence will affect close grading decisions.

Final: Tuesday May 18 6-9:30 p.m. in C230 (note room change).  Feel free to bring a laptop computer.  If you use a computer, you should email me a copy of the exam.

 

Midterm: For the risk averse, an optional take-home midterm will be available April 19-23.  It will count as 20% of the grade, and lower the final's weight to 55%.

Course Abstract:  Macroeconomics concerns the environment of business including exchange rates, recessions, international trade deficits, inflation, unemployment, and government fiscal and monetary policy. This class focuses on understanding current events, with an emphasis on how those events influence politics and business. The class is based on lectures that rely on class participation and knowledge of current events.

Email: I will use the mailing lists Ewmba201b-1b@haas.berkeley.edu and Ewmba201b-2b@haas.berkeley.edu, so I hope you are on one of them.  Readings and messages will be emailed to you; you are expected to read your email several times a week.

Section is optional but highly recommended. Section will be held Saturday 10 a.m. to noon in a variety of rooms, as indicated each week.

Class reps: Mitch Varhula on Monday and Michael Ashton on Tuesday.


Reading List

The readings are found in Macroeconomics, by N. Gregory Mankiw (5th edition) and in daily readings of the Financial Times. You should have received your first copy by now.

All dates are approximate.

 

1. Introduction and Measurement: Monday and Tuesday March 15 and 16

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"The Science of Macroeconomics," Mankiw Chapter 1

"The Data of Macroeconomics," Mankiw Chapter 2

Homework #1. Please do before first class, but do not hand in:

  1. List three ways in which GDP over- or understates a nation's typical standard of living.
  2. List 2 reasons why the CPI might over- or understate the true inflation rate.
  3. What are 3 reasons why it matters if the CPI is accurate?
  4. The 2004 Economic Report of the President (the CEA is chaired by textbook author Greg Mankiw) notes that fast-food jobs might need to be reclassified. "When a fast-food restaurant sells a hamburger, for example, is it providing a 'service' or is it combining inputs to 'manufacture' a product?"  Why does anyone care how McJobs are classified?  (See http://www.cbsnews.com/stories/2004/02/20/politics/main601336.shtml.)
  5. Please look in the Financial Times and find a story that fits your name:

A) If your first name begins with A-D, find a story concerning why living standards and output per capita differ so much between countries. That is, a story on long-term determinants of output and living standards.

B) If your first name begins with E-K, find a story concerning persistently high or low unemployment and/or inflation.

C) If your first name begins with L-O, find a story concerning interest rates, money supply, and central bank policies.

D) If your first name begins with P-S, find a story concerning exchange rates and one or more of trade deficits, the current account, capital controls, or capital mobility.

E) If your first name begins with T-Z, find a story concerning government macroeconomic economic policy and/or corruption.

Optional Readings:

·        Economic Report of the President 2004 Chapter 3: The Year in Review. The Economic Report of the President is written every year by the Council of Economic Advisers and presents an excellent introduction to US macroeconomic conditions and policies. Chapter 3 is a good starting point summarizing the main macro issues.

·        Measuring the National Economy: A set of notes discussing in detail national income concepts such as value added, GDP, GNP and their measurement problems.

·        Economic Chart Dispenser (ECD)
This is a great resource for analyzing
U.S. macro data. You can use a simple form to choose hundreds of macro series, choose the sample period, chart the series and transform the charts in several useful formats (such as levels and rates of change). 

·        Oliver Richner pointed me to: Warren E. Buffett, “America's Growing Trade Deficit Is Selling the Nation Out From Under Us. Here's a Way to Fix the Problem—And We Need to Do It Now.” Fortune, Sunday, October 26, 2003 http://www.fhsu.edu/econ/rterry/Trade%20Deficit.pdf

Section: C230 Saturday-March 20th from 10:00AM-12:00PM

Clippings you sent

Saradhi pointed to an article on the importance of measuring the CPI:
http://www.thestreet.com/funds/jubak/10146428.html
This is an article about the suggestions Greenspan made to Social Security benefits to combat the problem of running out of money in the trust fund by 2075.  The article talks about "Chaining the Consumer Price Index" and says that it takes into account consumers spending less on items with increases in their price. I was wondering is this analogous to what we talked about in the class about buying oranges instead of bananas if the consumers are able to afford higher price items, but only with inverse logic. The article also talks about a study by BLS to find out if the true rate of inflation in healthcare is lower than the current measures because of the improved quality of living.   The article also talks about how BLS measures inflation in cost of housing not by how much the house price has gone up, but by how much the cost of renting a similar home has gone up which yields different results in CPI depending on whether rents and house prices move in unison or not.

For the CPI news release, see http://www.bls.gov/news.release/cpi.nr0.htm

FT Letters 3/18 are relevant to the class.  Richard Yamarone claims the
U.S. has massive undocumented employment, explaining why we have GDP growth and no recorded employment growth.


Ron P. found the following article interesting.  The author discusses the differences between the household and establishment employment reports that come from the BLS.  There is an interesting point at the end about the "wages report."  Apparently the street is going to be watching that very carefully as it could indicate inflationary pressures. The inflationary pressures could trigger the Fed to raise rates sooner rather later.
  http://www.businessweek.com/bwdaily/dnflash/apr2004/nf20040416_2609_db035.htm

Michael G. Rubiano directs us to an interesting op-ed in today's New York Times by Tim Kane questioning the appropriateness and the accuracy of the payroll survey statistics. 
http://www.nytimes.com/2004/04/07/opinion/07KANE.html?th

2. Economic Growth, March 22 and 23

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Mankiw tables (Table 7-1, p. 181; Figure 7-6 p. 191); case studies in Chapters 7 and 8 (190 on S & I around the world; 203 on population growth; 216 on worldwide growth slowdown; 218 on information technology) and the Appendix to chapter 8 “Accounting for the Sources of Economic Growth.”

 

Homework #2 due in class or in a before-class email:

  1. What are C, I, G, NX and Y for the U.S. in a recent year? What were they a generation ago? How does it matter if one looks at real vs. nominal GDP?
  2. Identify three factors that might make one nation richer or poorer than another or that might make GDP grow faster in one era than another.
  3. Identify some evidence that each of these factors either did or did not contribute to the slowdown in U.S. productivity growth since 1973.
  4. Do these factors help explain why economics growth has been more rapid in South Korea than in North Korea or why living standards are higher in California than in Baja California, but higher in Baja California than in Bangladesh?
  5. For each factor, identify a policy that might increase it in a cost-effective fashion.

·        Hint: Focus on policies that affect decisions at the margin, and do not merely reward people or companies for doing what they would do anyway.

Optional Readings:

·        Macroeconomics and Growth Project at the World Bank is a systematic source of information and data on growth and development issues.


Section in Room F320 Saturday-March 27th from 10:00AM-12:00PM

 

Clippings you sent

Tom Ngo points out: An interesting article about vitamin deficiencies in developing countries and how developed countries have been able to overcome these deficiencies with vitamin additives. May not be a strong factor for economic growth, but still quite interesting in regards to its impact on human capital (i.e. curb infant mortality, increase human life span, improve quality of life etc.)
http://story.news.yahoo.com/news?tmpl=story&cid=514&e=6&u=/ap/20040324/ap_on_he_me/fit_un_brain_food_2

 

Oliver Richner directs us: The Economist had an article ("More or less equal?" March 11th print edition) that mentions the global inequality is decreasing slightly on a population-weighted basis.  This is mostly thanks to China and India growing strongly in recent years while most other poor countries are not keeping up with richer nations.  On an equal-weighted basis the poor countries have fared much worse.  http://www.economist.com/displaystory.cfm?story_id=2498851

 

Relura Horton wrote:  I thought this article on China did a decent job of hitting on the over-heating issue. I especially like the mention of "dubious project" investment -- just adding fuel to the fire at this point. Wouldn't you think responsible investors would be aware of the bubble and would try to help create a slow-burn style growth as opposed to a firecracker explosion? I guess that's not how investment works, but the long term ramifications could be huge. The situation is obviously unsustainable, and the amount of paper being issued and foreign investment is just adding to the problem. Venture Capitalists Catch China Fever
http://businessweek.com/magazine/content/04_12/b3875052.htm


3. Unemployment and Inflation: March 29 and 30.

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"Unemployment," Mankiw Chapter 6.

Mankiw comments ignite firestorm on outsourcing http://abcnews.go.com/sections/GMA/WorldNewsTonight/outsourcing_firestorm_040213-1.html 

CEA backs off on optimistic job growth estimates http://www.epinet.org/issuebriefs/197/ib197_admretracts.pdf

Mankiw Chapter 4, “Money and Inflation,” sections 4-4 and 4-6 

 

Homework #3, due in class:

  1. What are two reasons why the reported unemployment rate might under- or overstate the true unemployment rate?
  2. What are two policies to reduce frictional unemployment?
  3. What are three costs of unemployment?
  4. Will offshore outsourcing raise long-term unemployment in the United States?  How will outsourcing jobs affect wages?

Note: This is a trick question.  Might real and nominal wages behave differently?

  1. What is the nominal interest rate in the United States today?  What is the real interest rate?

Note: This is a trick question.  State some assumptions and answer it anyway.

  1. How do the costs of inflation depend on whether it is anticipated, unanticipated, or variable?

Optional Readings:

·        The Bureau of Labor Statistics provides recent and historical data on labor productivity, labor force, unemployment, earnings, CPI, and PPI. This link is to their recent news releases.

·        America's Job Bank is the U.S. Department of Labor's attempt to improve job matching.

·        Nouriel Roubini has collected some recent clippings on outsourcing job offshore.

·        For the CPI news release, see http://www.bls.gov/news.release/cpi.nr0.htm

Section in Room C230 Saturday April 3rd from 10:00AM-12:00PM

 

4. Money, Interest and Income, No class Monday April 5.  Come Tuesday April 6 to the Andersen Auditorium (note room change) or to the make-up class Saturday April 10, 10-12:45, Room F320.

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Bullet points on Keynesian short-term model of recession

  • Assume a recession with fixed prices and wages.  Then expansionary fiscal policy (government spending increases, higher transfers, or lower taxes) works through a multiplier to increase a nation's aggregate demand and, thus, total output.
  • The multiplier is larger if the marginal propensity to consume is higher; more generally, if a $ of output induces more dollars of demand.
  • Okun's law tells us GDP rises about 2-3% for every 1 percentage point change in the unemployment rate.
  • As a corollary, if taxes rise and transfers (unemployment insurance, etc.) decline with income, the multiplier is smaller.  This effect is called an automatic stabilizer and implies a cyclical budget deficit.  Automatic stabilizers and, thus, cyclical budget deficits, are good.
  • Other good deficits lead to very rapid increases in GDP.  The familiar rule is to invest if the return > cost of funds.  More generally, deficits are not an increasing problem (they are sustainable) if the debt grows < GDP, so debt:GDP is stable or declining.  Exploding structural deficits are the bad type; as the U.S. is projected to have in future years.
  • Raising taxes or increasing the savings rate in a recession will not mostly increase national savings. Instead, the main effect is a deeper recession the paradox of thrift.

Read

"Introduction to Economic Fluctuations," Mankiw, Section 9-1.

"Aggregate Demand I," Mankiw Chapter 10

Homework #4:

 

I) Prepare Mankiw pp. 279-280 problems 1, 2, and 4a, b, and c for class.

II) Discuss how current fiscal policy in Japan, the EU and United States affect aggregate demand.

Welcome reception for new students, April 6 during break.

Optional Readings:

·        On the Simple Keynesian Model see http://ingrimayne.saintjoe.edu/econ/Keynes/SimpleModel.html .

·        On the paradox of thrift see http://ingrimayne.saintjoe.edu/econ/Keynes/Paradox.html

Make-up class Room F320 Saturday-April 10th from 10:00AM-12:45PM, section immediately to follow till 2:00 PM.

 

More from me: What is a sustainable deficit? 

        A deficit is "sustainable" if it keeps debt a stable share of GDP, when measured over the business cycle.  There are three deficits that are not a problem:
        a. Temporary blips that increase deficits during a recession (automatic stabilizers or active fiscal policy) are great; they help fight the recession. 
        b. Deficits to finance spending that lead to large increases in GDP, so debt:GDP declines are fine.  For example, a  well-designed immunization program, a badly needed road, or a well-targeted education or investment subsidy might meet this criterion. 
        c. Deficits that grow the debt more slowly than GDP are also ok, as the interest burden on future generations will be lower than on the current one.

        The debt:GDP ratio was rising in the
U.S. from the mid-1980s through early 1990s.  The ratio declined during the late 1990s, leading to a brief period with forecasts of the national debt declining to zero.  The end of the dot.com boom, tax cuts, and growth of military and security spending have shifted us to a large government deficit.  During the slow economy 2001-2003 this deficit is useful; the question is what to do when the debt:GDP ratio rises as it is on track to do after the recession.

Clippings you sent

Sandeep refers us to the BusinessWeek "Economic Outlook" by Laura D'Andrea Tyson
http://www.businessweek.com/@@fmnG5oYQHTAIOQ8A/magazine/content/04_13/b3876057
_mz007.htm   This article touches several issues discussed in the last lecture, particularly the implications of deficit financing through foreign borrowing.

 

Michael Rubiano sent a fine article on recent tax proposals: The first article is this week's Newsweek cover story by Allan Sloan, "Why Your Tax Cut Doesn't Add Up."  Mankiw is quoted several times in Sloan's article.  Of interest is the discussion regarding the reduction of income taxes enacted by Bush, but how very little has changed in salary taxes (a key difference that is often assumed to be one and the same).  Sloan also believes that a national consumption tax is inevitable, if we continue to pursue our current economic policies.
http://www.msnbc.msn.com/id/4660655/

The second article from USA Today, "GOP Budgets May Not Match Promises," talks about the discrepancies in the economic policies being espoused by Republicans, and that the proposed plans to reduce the deficit will actually make the deficit larger than if Congress and the White House simply did nothing.  "The Congressional Budget Office (CBO), the non-partisan agency that analyzes budgets for Congress, projected in January that the deficit over the next five years would total about $1.1 trillion. That assumes the economy improves and temporary tax cuts phase out on schedule. But GOP budget proposals, which call for extending the tax cuts and increasing some spending substantially, would generate a five-year deficit of as much as
$1.3 trillion or more. Those numbers all of which exclude spending for
Iraq almost certainly
understate the deficit gap. The White House didn't include spending for
Iraq in its 2005-09 budget, even though the United States is likely to spend billions more during that period to stabilize that nation, money that will almost certainly make the deficit even bigger. "

http://www.usatoday.com/news/washington/2004-04-06-gop-budget_x.htm

Songbin Wei liked this New York Times editorial. John Kerry advocated a balanced budget to recover the economy. Many of his economy advisers are from
Clinton's admin. Don't these folks know that the country is struggling for recovery and cyclical deficit is GOOD! ?  http://www.nytimes.com/2004/04/08/opinion/08THU3.html

 

LBellet@perriergroup.com attached below a copy and the link of a briefing paper on the Stability and Growth Pact in the EU written last February.  It did a good job explaining the rationale and shortcomings of the SGP. http://www.europarl.eu.int/comparl/econ/pdf/emu/speeches/20040216/bofinger.pdf



 

5. Monetary and Fiscal Policy, April 12 and 13.

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Bullet points on IS-LM

  • The IS curve shows when Y = C(Y-T) + I(r) + G. 
    • Changes in r move along the IS
    • Changes in autonomous C, I or G shift the curve.
  • The LM curve shows when the real money supply (M/P) equals the demand for liquidity L(Y, r).
    • Changes in Y move along the LM (that is, IS shifts)
    • Changes in autonomous the money supply, the price level, or the exogenous demand for liquidity shift the curve. 
  • Fiscal policy is a bit less effective in the IS-LM model as G up (IS shifts out) raises Y raises money demand.  The resulting higher interest rates crowd out some investment (movement along LM curve).
  • Crowding out is voluntary, as the Fed can accommodate the higher money demand with higher money supply (LM shifts out), keeping interest rates constant and having the full multiplier.

If the Fed disagrees with expansionary fiscal policy (IS curve shifts out), it can offset it with tight money (LM shifts inward to the left). The result is G up, higher r, and lower I(r).  More cheerfully, the Fed can offset contractionary fiscal policy to make sure a tax increase or cut in transfers or G does not cause a recession.

Read

Mankiw, chapter 11.

Homework #5:

  1. How do monetary and fiscal policy shift the IS and LM curves?
  2. Bring to class a recent newspaper article indicating a shift of the IS curve, the LM curve, or both.
  3. Given the upcoming election in the United States, what shifts in IS or LM would President Bush prefer for 2003 and 2004? What has happened?  Did this pattern appear in the 2000 election in the United States?  Pick another election that occurred recently elsewhere and discuss monetary and fiscal policy preceding the election.
  4. Mankiw p. 305 problems 1 and 3.

Optional Readings:

·        Purposes and Functions of the Federal Reserve System is an in-house publication on the goals and functions of Federal Reserve System.

·        The SF Federal Reserve Board's Introduction to U.S. Monetary Policy

·        Central Banking Resource Center has extensive set of links to central banks around the world and Web sites with central banking information.

·        Minutes of the Federal Open Market Committee are made available a few weeks after the next regularly scheduled meeting .

·        The Beige Book (formally, the "Summary of Commentary on Current Economic Conditions by Federal Reserve District") is a report published eight times a year in preparation of the FOMC meetings. Each Federal Reserve Bank gathers anecdotal information on current economic conditions through reports from Bank and Branch directors, interviews with key businessmen, economists, market experts, and other sources.

Section in Room C230 Saturday April 17th from 10:00AM-12:00PM

Your clippings

Damien asks:

1. Why has the Federal Reserve (and Mr Greenspan) become so famous in the last few years?  By famous I mean in the sense of popular media--has the role/impact of the Fed Reserve changed or become more significant in the particulars of the economy of the 90s? Or are people simply looking for the wizard behind the curtain? 


Around 1980 Paul Volcker became the most famous Fed chair up till then.  As you point out, Greenspan is now more famous.
a. Greenspan presided over an impressive period of
U.S. economic performance.  Most of the good performance was luck, but a substantial minority was due to decisions he made as central banker.
b. The press latches onto "winners" and they attribute more power to Greenspan than even he holds.
c. Success builds on itself.  After a while, people just believe he is wise beyond human limits.  Thus, they ask him about cutting Social Security versus raising taxes to restore long-term fiscal sustainability.


Relura thought this article did a nice job of discussing the EU stability pact, the EU requirements and fiscal reform. 
http://www.ekathimerini.com/4dcgi/news/economy_&xml/&aspKath/economy.asp?fdate=05/04/2004

Hari provides a link to a recent KQED Forum show on jobs: http://www.kqed.org/programs/program-archive.jsp?progID=RD19&ResultStart=1&ResultCount=10&type=radio

Saradhi writes: We were just talking about it in the last class. Not even four days do by and the Bundesbank chief is now out of office.  http://www.nytimes.com/2004/04/17/business/worldbusiness/17bund.html

Dave Graham sends "a good article on the potential impact of soaring budget deficits - interesting how these deficits can impact other nations as there is more competition for a limited amount of global capital.... 
http://story.news.yahoo.com/news?tmpl=story&u=/ap/20040414/ap_on_bi_ge/deficit_impacts

Matthew Kaminski provides an insight about the months leading up to the 2000 Election focus on the Fed's near-record levels of tinkering with the short-term interest rates to affect monetary supply. 
        The article gives insight into the 11 previous election cycles.  Additionally, the article offers 8 interest rate scenarios and their effect on the Federal funds rate (held, in this discussion, as the single most reliable indicator of Fed policy and results.)
http://www.fmcenter.org/pdf/rates&elections0500update.pdf


David Tjen "came across this article that discusses the anticipation of the Fed increasing interest rates.  Apparently, it seems that everyone knows its coming, but they don't know when.  It appears that Greenspan will need to walk a very thin line this week in his reports.  I would think that for the president's re-election chances, Greeenspan will try and keep interest rates as low as possible for as long as possible.  Do you think it's possible that Greenspan has enough influence over the Fed to keep interest rates low through the election cycle in order to aid the President, even if it is against
America's best interest to do so? 
http://story.news.yahoo.com/news?tmpl=story&cid=580&e=2&u=/nm/20040419/bs_nm/economy_fed_greenspan_dc

I do not usually recommend articles in the FT, as you are all reading it every day.  The editorial by Francis Bator, 4/6/04, p. 13, covers a lot of what we are discussing this week.

 
Damien recommends:  The Sunday business section of the SF Chronicle includes an interview with Robert Parry, Chairman of the Fed Reserve Board of SF.  Its a discussion on a little bit of everything, including job growth, productivity, inflation, FDI, outsourcing, monetary policy, global development, along with discussions of particular industries and markets.  The way I looked at the article was as a challenge:  its the kind of article we should able to understand as a result of this course. 


jkay points us to an inflation article:
http://www.forbes.com/markets/newswire/2004/04/12/rtr1329330.html


6. Introduction to the Open Economy: April 19 and 20

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Bullet points on Open Economy Macro

The nominal exchange rate is determined by

  • Relative inflation rates (also called the hypothesis of Purchasing Power Parity) especially in the long run.
  • Investment high relative to national savings implies a trade deficit.  That trade deficit is brought about by a strong currency especially in the medium run and in small open economies.
  • Relative interest rates as financial investors buy a currency to buy bonds and enjoy its high relative return especially in the short run.
  • Speculation, leading real exchange rates to vary 2:1 over time for no obvious reason.


Fixed exchange rates and flexible rates both have strengths and weaknesses. 

  • Fixed rates
    • reduce uncertainty and transaction costs,
      • until they crash. 
    • Also, fixed rates differing from market rates can lead to a black market and corruption.
  • Flexible rates
    • let markets decide;
    • unfortunately, flexible rates vary too much,leading to high risk.


A strong currency and a weak currency both have winners and losers. Strengthening Euro implies

  • Europeans richer consumers, tourists to the U.S., those owning Euro-denominated assets or income flows (bonds, etc.)
  • lower EU inflation,
  • but lower EU net exporters.


In an open economy, some policies work better and others worse, depending on the exchange rate regime.

  • Fixed exchange rates
    • Fiscal policy now works better as monetary policy always accommodates.
    • Monetary policy is ineffective as the central bank does nothing but fix the exchange rate.
  • Flexible exchange rates
    • Fiscal policy works worse as the resulting stronger currency leads to "open economy crowding out" of NX.
    • Monetary policy works great as expansionary M policy lowers r to spur I and also weakens the currency to spur NX.

 

A voluntary take-home midterm will be distributed this week (4/19-23). Email me if you would like to take it and I will email back an exam. You have 80 minutes to complete the exam from the start time you designate. The grade distribution of midterm exams will equal that of final exams, so it will not influence by much your expected grade (although it may reduce the uncertainty). 

Required reading:

"The Open Economy" (a chapter that assumes output = NAIRU level of output at all times) and "The Open Economy in the Short Run," Mankiw Chapters 5 & 12.

"Introduction to the Open Economy" and “A Morality Play of International Trade”

Catered dinners during break.

Homework #6:                           

  1. Explain the claim: "Countries that run persistent trade deficits are also net borrowers."
  2. Why is monetary policy less effective with fixed exchange rates than with flexible?
  3. Why is fiscal policy less effective with flexible exchange rates than with fixed?
  4. Mankiw p. 339-40 problems 1 and 2.

Answers to Homework 6

Section in Wells Fargo Room  Saturday-April 24th from 10:00AM-12:00PM

 

Your clippings

Todd Kelly found the following article on free-trade Democrats in Foreign Policy.  "Even though the piece has a politically motivated slant to it, it sounds genuinely thought out and worthy of consideration.  Yet the cynic in me wonders if this is pie in the sky - is there someone that could educate and gain the trust of the public to pull this off?"  http://www.foreignpolicy.com/story/cms.php?story_id=2505

There is another interesting Globilization Index article that ranks countries by their level of globalization        http://www.foreignpolicy.com/story/cms.php?story_id=2493


7. More Open Economy Macro: April 26 and 27

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Required reading:

            Homework #7:

1.      “Free trade makes the United States richer.” Discuss.

2.      “Financial liberalization leads to financial crises.”  Discuss.

3.      As noted above, CEA chair Greg Mankiw said outsourcing jobs overseas is “something that we should realize is probably a plus for the economy in the long run.”  Explain his reasoning.  Provide two arguments against his reasoning applying to current outsourcing.

Bullet Points

 

Trade and Outsourcing

1. Free trade and outsourcing are almost always good for consumers. 

2. Free trade is almost always bad for some producers and workers. In general they lose less than consumers gain.
        * This effect is important in elections in part because producers and some unionized workers have more political clout than the generic consumer.
        * This harm is worse in the short run, particularly during a recession, as unemployed workers do not rapidly get new jobs.

3. In some complex models, free trade and outsourcing can move monopoly rents, high-paying jobs, or technologically dynamic sectors overseas.  World GDP still rises with trade, but some nations can still be net losers.

Financial Crises

Essentially all market economies have financial crises with a large-scale collapse in asset values and massive reductions in the availability of credit.  These crashes depend on feedback cycles where lower asset prices cause more selling of assets.  Each crisis is different, but they all combine some form of positive feedback.

A typical cycle:

  • Financial investors lose a bit of confidence.
  • Risk premium rises and interest rates rise.
  • Low confidence + rising interest rates reduce the value of stocks and other assets.
  • Lower asset prices reduce the value of collateral.
  • Lower collateral makes banks unwilling to lend and raises default rates.
    • Weak accounting systems implies that banks cannot tell who has valuable collateral.
  • Defaults lead to low confidence => back to the top.

More dynamics: Exchange rate collapse

  • Loss of confidence implies weak currency. 
    • With a fixed exchange rate, interest rates have to ZOOM. 
    • Eventual devaluation.
  • Weak currency makes it harder to repay dollar-denominated loans.

More dynamics: Debt deflation

  • Lower asset values and company bankruptcies imply banks own more assets.
  • Banks sell the assets, putting downward pressure on asset prices.

More dynamics: Banking crisis

  • Lower asset values and company bankruptcies imply banks own more assets of low value.
  • Bank's bankruptcies further reduce credit to companies that otherwise might survive.
  • Lower credit availability leads to more bankruptcies of companies and lower asset values.

More dynamics: Political risk

  • Financial disruption lowers confidence in political system
    • Suharto in Indonesia
    • Chiapas uprising + assassination in Mexico
  • Fear of political change leads rich folk to move some of their wealth overseas.
  • Capital outflow further weakened the currency.

Fixed versus Flexible rates

Fixed rates

  • Certainty
    • But only for a period, and then often a crisis
  • Lower transaction costs
    • But black market if capital constraints
  • Effective fiscal policy
    • But forego monetary policy
  • Constraints monetary policy so effective nominal anchor
    • BUT US monetary policy is often inappropriate.

Flexible rates

  • Fewer crises
    • But enormous swings in market rates, some unrelated to fundamentals.
  • Effective monetary policy
    • Fiscal policy has open economy crowding out

Monetary union

  • Credible fix of the exchange rate so fewer crises.
  • Higher trade
  • BUT no flexibility of Monetary policy
    • EU has a problem of low fiscal stabilization or employment flows.
  • EU is a political as much as economic creature.

 

Optional Readings:

·        For a favorable view of free trade, see the articles at The Heritage Foundation Publications Library on Trade and Foreign Aid.

·        For a more critical view of globalization, see the ILO report A Fair Globalization: Creating Opportunities for All, 2004.

 

Your Clippings

Adam sent "a good summary of devaluation (causes and effects)"
http://www.newyorkfed.org/aboutthefed/fedpoint/fed38.html
 
Tejas found this article "very useful in understanding free trade:" A Primer on Free Trade :
http://www.mises.org/fullstory.asp?control=1084
        Note: Ludwig von Mises was a brilliant libertarian economist, so I assume this site will be very much in favor of free trade.

Ann-Charlotte liked "this article, which I found really informative about globalization.  Although it is slightly dated (from 1998), it discusses the downsides of globalization and gives examples from several countries -- New Zealand, Former Soviet Union, Yugoslavia, Rwanda, etc.
http://canterbury.cyberplace.org.nz/community/CAFCA/publications/Trade/GlobalisationPoverty.doc

Sheetal Shah sends "a couple of article on exchange rates:
        An older article (March 2002) talks about how fixed exchange rates do more harm than good, using Argentina as the example.
http://www.iie.com/publications/papers/truman0302.pdf
        Another article on fixed vs. floating exchange rates:
http://www.cato.org/pubs/journal/cj20n1/cj20n1-13.pdf
        Again an older article from the IMF (1998) ­ a series on fixed vs. floating (flexible) exchange rates and how countries have switched from fixed to flexible rates.
http://www.imf.org/external/pubs/ft/issues13/

Mary Francis sends "This article on the WTO's response to
US cotton subsidies is relevant to today's reading.  It adds an interesting reelection/ political angle to the mix.  Weaning people off of less productive/competitively disadvantageous industries is not just a matter of teaching them about economics.  http://www.nytimes.com/2004/04/27/business/worldbusiness/27COTT.html?ex=1083643200&amp;en=26824e27c22f3f0f&amp;ei=5062&amp;partner=GOOGLE 

Chris Lai sends an article about China's fixed exchange rate policy and monetary policy:
http://cbs.marketwatch.com/news/story.asp?guid=%7BA77870E8%2DADE4%2D41BC%2DB8E4%2D0F841A2E2CB6%7D&siteid=mktw

 Jason Schaeffer writes:
http://www.wired.com/news/business/0,1367,62780,00.html
        This article on outsourcing focuses on the breakdown of school and education as the main catalyst for moving jobs overseas. "50 percent of all engineering, math and science degrees awarded by
U.S. universities now go to foreign nationals."

Section Room F320 Saturday-May 1st from 10:00AM-12:00PM

 

8. Unemployment, Inflation, and Policy: May 3 and 4

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Note: Catered meals in Wells Fargo Room during break.

Read: "Aggregate Supply: Inflation, Unemployment and the Phillips Curve," Mankiw, Section 13-2 of Chapter 13.

Homework # 8:

The class will focus on the expectations-augmented Phillips curve:

Inflation = expected inflation - b (unemployment - NAIRU) + supply shocks

  1. The parameter b is the slope of the Phillips curve; that is, the responsiveness of inflation to unemployment. b is positive, so when unemployment is above the NAIRU, inflation is less than the expected rate of inflation. Explain why high unemployment reduces inflation and low unemployment increases inflation.
  2. What are four reasons for b to not be that large; that is, for recessions to only lower wage and price inflation slowly?
  3. What causes expected inflation?  (Hint: A good answer will refer to both backward-looking or "adaptive" expectations, and forward-looking or "rational" expectations.)
  4. How might fixing your exchange rate change expected inflation? (Hint: Your answer should use the word "credibility.")
  5. Identify an additional policy a country might follow that might affect expected inflation (other than through recession and unemployment). Explain. (Hint: Your answer should use the word "credibility.")
  6. Why does expected inflation affect the actual inflation rate? (Hint: Think about decisions of firms to set prices, and their willingness to grant wage increases. How do institutions such as cost-of-living agreements matter?)
  7. What are two recent examples of price shocks around the globe that might lower or raise inflation at a given rate of unemployment?
  8. Assume you are appointed the Central Banker of a nation with high inflation. How will you lower inflation?
  9. Assume that after you lower inflation, an inflationary shock hits oil prices. How might you respond to stabilize output? How might you respond to stabilize inflation? What are the long-run implications of each response? Which do you prefer?

BULLET POINTS

The first part of class's bullet points are roughly the homework answers, which should arrive soon.

Ending an inflation
* Mostly a recession is required. Tight monetary and fiscal policy cause unemployment.  Unemployment moves along the Phillips curve to lower actual inflation.  Lower actual inflation -- after a few years -- reduces expected inflation and shifts the Phillips curve inward so the economy can return to the NAIRU at lower inflation.
* A credible policy to have lower inflation can help (although the evidence is not strong).  Providing the central bank independence, giving the central bank a clear mandate to care about inflation (perhaps coupled with an incentive contract as in
New Zealand), a fixed exchange rate, or a targeting rule might help.  Each rule has downsides, as we will discuss next week.

Responding to an unfavorable supply shock.
* Accommodate and live with permanently higher inflation.
OR
* Fight inflation by suffering a recession. Over time you might accumulate such a powerful reputation that later fights versus inflationary shocks are less painful.

Neither choice is great. Thus, never run for re-election after oil prices double.


NEXT WEEK

9. Macroeconomics Policy Debate: May 10 and 11

Read:

"Stabilization Policy," Mankiw Chapter 14.

Janet Yellen,
The Binge Mentality in the Federal Budget,2003. http://faculty.haas.berkeley.edu/levine/macro/Yellen_binge.PDF

"Epilogue"Mankiw after the last chapter.

Homework # 9:

  1. Under what (if any) definitions of "budget" or of "balance" would you agree: "A federal balanced budget amendment would be good"?
  2. What (if any) is a good rule for monetary policy?
  3. Bonus question we will discuss: Consider the fiscal policy (spending, tax-cut, or tax-increase) proposal of a candidate from the U.S., and one from a foreign government. What are the good and bad points of each proposal?

Extra office hours to be announced. 

Review session Saturday, May 15 10-12 in Room C230. Please bring your questions to the review session. Please email your questions to the graduate student instructor in advance.

REMINDER: Final exam for BOTH sections: Tuesday May 18 in C230 (note room change)

 

Optional Readings:

·        Tax Cuts and Growth analyzes why tax cuts may not increase economic growth; that is, why the strongest claims of supply side economics may not hold.

·        Board of Governors of the Federal Reserve System
The Board of Governors of the Fed (whose Chairman is Alan Greenspan) has a Web site offering a wealth of information, analysis and data on
US monetary policy.

 Section in Room C230 Saturday May 8th from 10:00AM-12:00PM

Your Questions

Hari asks:

The text (page 95) says "suppose the Fed announces that it will raise money supply in future, but it does not change the money supply today. This  announcement causes people to expect higher money growth and higher inflation. Through Fisher effect, this increase in expected inflation raises the nominal interest rate"
        This situation is opposite of today i.e. the Fed is saying that it is going reduce the money supply in future by raising the interest rate. It seems contradictory to me.


The text implies if people expect inflation to be lower in the future than otherwise, long-term nominal rates will be a bit lower even as long-term REAL rates are a bit higher. 

Consider 2 cases:
1. Assume people expect no Fed reaction to rising oil prices and weaker dollar and rising employment.  Thus, r = 2, and expected inflation = 5, so i = 7.

2. Assume people expect a strong Fed tightening to rising oil prices and weaker dollar and rising employment.  Thus, r = 4, and expected inflation = 2, so i = 6.

Case 2 has lower i, but might have lower investment as well, as I = I(r).

Your clippings

Peter Birch writes about inflation:  A Business Week article talks about how Mr. Greenspan still feels that inflationary fears are overblown, but he must tread carefully: http://www.businessweek.com/bwdaily/dnflash/apr2004/nf20040419_1475_db035.htm

Meanwhile, at the NY Times, it seems that consumers are starting to notice inflationary pressure:
http://www.nytimes.com/2004/04/17/business/17prices.html?ex=1082865600&en=040bcbfdb81f7014&ei=5040&partner=MOREOVER

Saradhi points us to "a comprehensive report on the facts and rhetoric about the recent wave of outsourcing by US companies. It also includes a survey of 500 key decision makers in companies that outsource some of their work. http://news.com.com/2009-1022-5198090.html   

Sheetal Bhansali passes along "an interesting article from the economist that discusses the pros and cons of countries like Malaysia and China pegging their exchange rate to the US dollar. Malaysia pegged to the dollar in 1998 to bring more stability to the economy. But now that Malaysian exports are soaring and the economy is doing well, economic advisors are making suggestions to switch the exchange rate system.  http://www.economist.com/finance/displayStory.cfm?story_id=2577310

Greg Schaffer found an article written by a fellow Berkeley professor who "speaks to your same concerns about the large US deficit: http://www.taipeitimes.com/News/edit/archives/2004/05/03/2003153980

Tony Chen writes: The author, portfolio strategist Marchall Auerback, believes that even if Bob Woodwards assertion that the House of Saud struck a deal with Bush to lower oil prices for the election... the Saudis will probably back out of that promise.  The author offers several economic and political developments to support his argument
        As oil prices keep heading up, we will definitely see a strong adverse inflationary shock.  How will the shock affect consumption?  Fed monetary policy? 
http://www.tompaine.com/feature2.cfm/ID/10326


9. Macroeconomics Policy Debate: May 10 and 11

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Read:

“Stabilization Policy," Mankiw Chapter 14.

Janet Yellen, “The Binge Mentality in the Federal Budget,” 2003.

“Epilogue” Mankiw after the last chapter.

Homework # 9:

  1. Under what (if any) definitions of "budget" or of "balance" would you agree: "A federal balanced budget amendment would be good"?
  2. What (if any) is a good rule for monetary policy?
  3. Bonus question we will discuss: Consider the fiscal policy (spending, tax-cut, or tax-increase) proposal of a candidate from the U.S., and one from a foreign government. What are the good and bad points of each proposal?

 

Extra office hours to be announced. 

 

Review session Saturday, May 15 10-12 in Room C230. Please bring your questions to the review session. Please email your questions to the graduate student instructor in advance.

Optional Readings:

TBA

 

 

10. Final exam for BOTH sections: Tuesday May 18 in C230 (note room change)

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Feel free to bring a laptop computer.  If you use a computer, you should hand a diskette to me at the end of the exam and also email me a copy of the exam. 

Past exams.

How to Answer Macroeconomic Questions


General Indices and Links of Interest

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Indices

The Global Macroeconomic and Financial Policy Site maintained by Nouriel Roubini is the best source for links to recent writings on a vast array of current macroeconomic topics.

 

Mankiw's textbook site has many useful links organized by chapter.  The site also has flash cards, sample essay questions, etc. that I found less useful than the links.

Berkeley Long Library Business Guide No. 18 has Internet Resources in Business & Economics.

Resources for Economists on the Internet is a standard starting place for economists.

The Harvard Business School list of recommended sites has a section on macroeconomic data and analysis. The sites have short but useful quality ratings.


News Sources & Policy Analyses

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Financial Times

The Economist

The following sites cover a number of policy topics from free trade and the Euro to independence for the Federal Reserve and the minimum wage.

·        Conservatives agree on ending big government (except for the military and police).  All these flavors include an expectation that taxes, government regulations, and other interventions in the economy almost always lead to inefficiency and are inherently unfair.  Conservatives come in various flavors. 

o       Mainstream conservative policy positions are found at the National Center for Policy Analysis, the National Review, the Heritage Foundation, and the White House economic policy site.  There is a consistent emphasis on the benefits of lower taxes.

o       Libertarians dislike government intervention even most police and military. On economic policy, see The Cato Institute.  Libertarians are quite critical of the Bush administration for raising steel tariffs and for Ashcroft’s approach to civil liberties.

o       Nationalist conservative positions are much less into free trade than are other conservatives; see, for example, The American Conservative, an outlet associated with Pat Buchanan. Such conservatives are quite critical of the Bush administration for favoring NAFTA and the WTO and for being too lax on immigration.

·        Liberals also tend to like markets, but see more rough edges.  Pollution, monopolies, and recessions are examples of the concerns that loom larger for most liberals than most conservatives.

o       Moderate liberals tend to worry about government failure a lot, complementing their concerns about market failure.  (Face it, these folks just plain worry a lot.)  Moderate liberal positions can be found at the Brookings Institution Economic Studies.  Eventually John Kerry’s web site should mostly have such policies.  In a break with tradition, in the last dozen years moderate liberals have emphasized the importance of following sustainable fiscal policies, where the federal budget balances over a business cycle.

o       Liberal liberals are the most suspicious of markets.  Their views on government are complex (or should I say confused?): They believe current government policies are usually tilted toward the rich; nevertheless, they have confidence in the potential for government policies to solve market failures.  See, for example, the Economic Policy Institute, Moving Ideas Electronic Policy Network, and Ralph Nader’s Web site.


Data Sources and International Overviews

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The Bureau of Labor Statistics (BLS) has U.S. unemployment and inflation figures.


The Bureau of Economic Analysis has U.S. national income and product accounts: GDP, C, I, G, NX, etc. 

The IMF website has some good articles. You can search for articles on particular countries.

OECD surveys give 2-3 pages on macro policy for different countries.   It looks like this page was made for MBA Macro students. Watch out for the date of the surveys to avoid some older material.

Dismal Scientist - A free website with latest economic updates


Sites Suggested by Classmates

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  • Sheetal B. wrote: Both when I was in college and at work, I have used the World Bank web-site. The country section and the data and statistics sections are very helpful for country specific data.  http://www.worldbank.org/

  • Relura Horton wrote: Hi Professor, I thought this article on China did a decent job of hitting on the over-heating issue. I especially like the mention of "dubious project" investment -- just adding fuel to the fire at this point. Wouldn't you think responsible investors would be aware of the bubble and would try to help create a slow-burn style growth as opposed to a firecracker explosion? I guess that's not how investment works, but the long term ramifications could be huge. The situation is obviously unsustainable, and the amount of paper being issued and foreign investment is just adding to the problem.  Venture Capitalists Catch China Fever http://businessweek.com/magazine/content/04_12/b3875052.htm

  • Saradhi pointed to an article on the importance of measuring the CPI: http://www.thestreet.com/funds/jubak/10146428.html This is an article about the suggestions Greenspan made to Social Security benefits to combat the problem of running out of money in the trust fund by 2075.

 


Humor

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The Dilbert Zone offers a funny respite from daily life.

Top Ten Signs the U.S. is Headed for a Recession

The Onion present irrelevant fake news stores, some of which are on macroeconomic topics.

When you find outdated links or other problems with this page, please e-mail David I. Levine.
 

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Last updated: March 14, 2004.