Econ Macro Exam 2

How inflation is measured? What causes inflation? What causes deflation? When was the last time we had high inflation, over 10%? What has the price level done overtime? What was inflation typically, not counting the last two years? Index? What is the base year?

-477 govers workers are sent off at a grocery stores to check prices every month (article in canvas) -We see high inflation during world wars, price rises -We see low inflation during recessions, prices falls -1981 -Increased 3x higher, about 9%, CPI is 295.3 -It was around 2% the last 40 years. Over the last two years it has increased about 3x -index= in base year it was a number and not a percentage -CPI has to be equal to 100 so what year was it?-1982-1984

Fred real GDP/ inflation/CPI

-Growing over time (long time) -What is it going to be like when you retire -No evidence inflation is slowing down, 8.2%. New CPI for semptember 296.8

Unemployment rate

-Higher because slower economy because of the raising interest rate to fight inflation -Really really low, living through historical times. There is a lag because the fed policies hitting too hard, maybe recession? -Jobs not rising as fast as it was remains solid. 200,000 jobs a month -3.5% (September) fell from 3.7% (August). About 4%. -Hiring remains relilent 1982: 10.8% unemployment rate

Poorest countries around the world

-Losts of these countries were colonies by Europeans which held them back because they abtracted all their resources (Subsarharian, Africa) -someone living on $2 or less per a day (global poverty)

Deflation

-Opposie of inflation -don't see this very often -where do we see this on the pink sheet? during recessioins= 1929-39 (great Depression),2009 (great recession 2007-2009) What was The Great Depression?-Finacial crisis due to the stock market crash in 1929. Why didn't covid have a financial crisis?-Gov poured trillions of dollars into the economy to help consumers.

Example of real and nominal interest rates

-Suppose you earn 5% interest per year on your savings account, but the inflation rate is 2% per year. How much interest do you earn after inflation (or in purchasing-power terms)? real interest rate = nominal interest rate - inflation 3% = 5% - 2% (car loans set their interate rates this way) -In General: real interest rate = nominal interest rate - inflation or nominal interest rate = real interest rate + inflation -In 1980 15% Interest rate, inflation was really high, say 13%. How much interest do you have after inflation? *2% which is not so great -Suppose you get loan in 1980 and borrow a loan with 15% interest rate. 13% is a good bet your salaries will go up to 13% per year. Do you want to borrow money at 15% intereset rate *not so bad if salary increases by 13% per year

Income and spending (check google docs)

-Where does the rest of income go?-savings (consumptions and taxes) The remainder of incom - after paying for consumption and taxes - goes to saving What makes up spending?-investment (government + consumption. Remember that Y = C + I + G in a closed economy.) -The consumption (C) slice from the income pie shows up here. If government spending equals taxes, then the G slice here is the same as the T slice in the income pie. -What is the last slice in the spending pie equal to? We can see that in the aggregate (in a closed economy), Saving must equal Investment. -Freeing up resources like not buying much consumption to allocate these reources for investment, using resources of consumption that is not used .

Some comparisons

According to the World Bank, per capita income in the U.S. in 2020 ($61,462) was: •more than three times as high as in Mexico ($17,235). •almost four times as high as in China ($16,201). •27 times as high as in Ethiopia ($2,280).

Inflation

After we've learned how to calculate a price index to measure the price level, then we can easily define inflation. ¨Definition: Inflation is a sustained increase in the price level. ¨The rate of inflation is simply the percentage change in the price level from one year to the next. ¨If there's inflation, the purchasing power of the dollar must be falling. Increasing the price of goods/services, means decrease in the number of goods/services you can buy with a dollar in the future. ¨In our Simple Example, the CPI rises from 100 in 2015 to 110 in 2016, so the rate of inflation is equal to 10%. Getting acquainted with inflation trends: ¨Deflation is a sustained decline in the price level (or a period of negative inflation). ¨In the last hundred years, the U.S. has experienced inflation, not deflation, almost every year. ¨Exceptions: the U.S. experienced deep deflation in the Great Depression (1929-33) and in the late 1800's. ¨Japan experienced deflation in many years after about 2000. ¨Many European countries experienced mild deflation for a few years around 2012-14. While we've come to expect that there's inflation every year in the U.S., it's interesting to note that the U.S. had steady deflation in the late 1800s. If you took this course one hundred years ago, we would talk more about deflation than inflation! *When GDP deflator, CPI, and Fed reserve increase=inflation

New york times Macro news

Britain Economic experience stumbles -Prime minister Liz Truss a miz of tax cuts and deregualtion is needed to jump start Britain's Sluggish economy *Tend to raise inflation rate, already have high inflation, higher than U.S *Didn't pass OPEC moves show the limit of Biden's First Bump Diplomacy with Saudis -Cut back on oil= decrease in supply, increase in price, and decrease in quantity -CPI is going to jump up which means inflation will go up -Demand for oil is steep

Calculating CPI

Calculating an index like the CPI involves five steps: ¨Step 1 -- choose a base year. ¨Step 2 -- identify a standard market basket of goods and services whose prices are to be included in the index. ¨Step 3 -- calculate the cost of the standard market basket of goods and services in the base year. ¨Step 4 -- calculate the cost of the standard market basket of goods and services in the year in question. ¨Step 5 -- calculate the price index: CPI =cost of standard market basket in the year in question/cost of the standard market basket in the base year X 100 *CPI base year is 100. *If prices has doubled the base year would be 200 See example in notebook

Trends in courntries: nominal/real interest rates and inflation

Each dot in this chart represents a different country's combination of (nominal) interest rate and inflation rate. As you can see, countries that have higher inflation rates also tend to have higher (nominal) interest rates, as we would expect.

The price level example

Example Suppose there's just one good in the economy: jars of peanut butter. ¨Initially the price of a jar of peanut butter is $2. Since there's only one good in the economy, this price measures "the price level" in this example. - then one dollar buys ½ jar of peanut butter. (1/P = ½.) ¨Then suppose the price of a jar of peanut butter rises to $4, so "the price level rises." -now one dollar buys only ¼ jar of peanut butter. (1/P = ¼.) ¨So we see that the purchasing power of a dollar falls if the price level rises. Fred price level, CPI, GDP Deflator -Prices has been goung up faster in the last year or so, higher inflation Fred GDP: -GDP grows in 3rd quarter 2.6%, really talking about real GDP.

Different Growth Rates

Growth rates differ widely between countries. Some Examples •The average annual growth rate of real GDP in the U.S. has been 3% since 1947, and about 2.5% since 1990. •The average annual growth rate of real GDP in China has been almost 7% since 1980. •Economies in sub-Saharan Africa have grown at an average rate of about 6% per year in the last 15 years. The simple mathematics of growth: The Rule of 70 If something is growing at a rate of X% per year, then it will double in approximately 70/X years. Example: if real GDP grows at a rate of 7% per year, then it doubles in 10 years. -Average annual growth rate of real gdp is 2.5% since 1990

The determinants of interest rates (check google docs)

How do savings and borrowing balance out in a country's economy? We can understand this using a simple supply and demand model, and this gives us some insights into what determines interest rates. In this case, the markets in question are markets for credit or loanable funds. •Borrowers are the demanders of credit •Savers are the ultimate suppliers of credit Like prices of goods and services, interest rates are established in markets by the interactions of demanders and suppliers. The interest rates we observe in the economy are those that equate the quantity of credit supplied by savers with the quantity demanded by borrowers. In this simple supply and demand graph, given the amount of savings and the demand for loans (represented by the supply and demand curves), the credit market sets the economy's interest rate at 5%. If there's a shift in the supply of savings or in the demand for loans, then the interest rate will change. For example, if the demand for loans rises (so demand shifts up to the right), then this would push interest rates higher.

Measure of price level

How do we measure the price level? ¨Consumer Price Index (CPI) -- a weighted average of the prices of a market basket of consumer goods and services. (Check out the historical CPI data in Canvas.) ¨GDP deflator -- a price index derived from measures of GDP and real GDP. ¨The Federal Reserve System tracks the price level by following data on the prices of Personal Consumption Expenditures Excluding Food and Energy. ¨ ¨Since these price indexes all measure the price level, but in different ways, they generally tend to move together; but they're not exactly the same.

Global debt problems

If a country's debt grows too large, then lenders might refuse to buy more of the country's bonds. •If the country can't pay off its bonds, then the country might have to default on its debt. •Example: Greece has faced defaults and received bailouts from other European countries three times since 2009. •If a country's debt grows too large, it must pay a higher interest rate on its bonds, since there's a higher risk of default. Most economists believe that the U.S. and other affluent countries don't need to worry very much about running large deficits and increasing their national debt these days, since interest rates are so low. In other words, "crowding out" does not seem to be a serious risk now. For example, Japan's national debt is now equal to about 250% of its GDP, but it still can borrow at very low interest rates.

The simple mathematics of growth: The Rule of 70 and an example in notes

If something is growing at a rate of X% per year, then it will double in approximately 70/X years. Example: if real GDP grows at a rate of 7% per year, then it doubles in 10 years. The Rule of 70 shows us that a small difference in growth rates between countries can make a huge difference in the long run. For example, suppose two countries start out with the same per capita income now - say $10,000. In one country, per capita income grows at a rate of 1.4% per year, and in the other country it grows at 2.8% per year. How will living standards in the two countries compare after one hundred years? In the slower-growth country, per capita income will double every 50 years (since 70/1.4 = 50). So it'll be $20,000 after 50 years, and $40,000 after 100 years. In the faster-growth country, per capita income will double every 25 years (since 70/2.8 = 25). So it will grow to $20,000 after 25 years, double again to $40,000 after 50 years, again to $80,000 after 75 years, and $160,000 after 100 years. A small difference in growth rates makes a big difference after a century!

Crowding out (see google docs)

In the graph that follows - a simple graph of supply and demand in the market for credit - a $10 billion increase in the government deficit "crowds out" $5 billion in private-sector borrowing (by businesses and households). The economy starts at point A, and then the $10 billion increase in the deficit shifts the supply of credit to the left by $10 billion. At the new market equilibrium (at point B), real interest rates in the economy are higher. These higher real interest rates cause borrowers to move along their demand curve for credit from point A to point B, resulting in a reduction in the amount they borrow.

"The Most Important Thing, and It's Almost a Secret"

In the last 20 years the proportion of the world population living in extreme poverty has... •Almost doubled? no •Remained more or less the same? nopr •Almost halved (yes)-never have happened in world history. 35%-14%

Real vs Nominal example

Inflation distorts our measures of dollar quantities, so we need to be able to calculate real quantities to eliminate the distortion. There's a simple way to do this! An Example Babe Ruth earned $80,000 when he played for the Yankees in 1931. The CPI in 1931 was equal to 15.2 (based on 1982-84 prices). What is the equivalent salary in today's dollars? To calculate an equivalent amount in today's dollar's (or the dollars of any other year), we need to know the price level today (or in the year we're converting to). Let's suppose the CPI today is equal to 295. Then we do this calculation: ($80,000)/(15.2) = $X/295 $X=$1,552,632 (A comparison: The New York Mets are paying Max Scherzer $43,333,333 in 2022. If he starts 30 games, that's $1,444,444 per game.) How does this calculation work? ¨Note that on the left-hand side of the equation, we have the dollar amount from 1931 and the CPI from 1931. ¨On the right-hand side, we have the equivalent dollar amount from the other year ($X, which we want to solve for) and the CPI for the other year. ¨We can use this method to convert from dollars of one year to dollars of any other year. Just put the CPI from each year in the denominator on that side of the equation!

why are interest rates so low?

Interest rates have been broadly falling for the last forty years, and they have reached historically low levels in the last couple of years. Why?? Some possible explanations: •Incomes have risen in China and other emerging economies, where people have high savings rates. •The populations of many countries are aging, and older people generally want to save, not borrow. •Innovation and growth have slowed in the U.S., Europe, and Japan, so growth in investment spending has slowed. •In the last ten years, the Federal Reserve System has followed policies to boost the economy, which increases the supply of savings. -If interest rates are lower=people want to borrow more money which means downward sloping demand curve -If interst rates are higher=people want to save more money which means upward sloping in the supply curve while interest rates went downn and saving went up. Examples are stimulus checks. -Demand for credit shifts down=interest rates fall -Interest rates going down until last uear -low interest rates come from the supply of credit is getting higher or because the demand of credit has gone down.

Who provides information nominal/real interest and inflation?

Market yields on U.S. Treasury bonds provide information on nominal interest rates, real interest rates, and inflation expectations. •The U.S. Treasury issues Treasury Inflation-Protected securities (TIPS) whose value is adjusted for inflation - so the yield on these bonds is a measure of the real interest rate. Yield data from FRED: https://fred.stlouisfed.org/series/DFII10 •Market yields on ordinary Treasury bonds are a measure of nominal interest rates.

Measuring employment and unemployment

Measures of employment and unemployment are simple in principle (but very complicated in practice). Basic concepts: ◦The labor force includes all adults now working or willing to work at current wage levels. labor force participation rate= (labor force)/(adult population)×100 ◦Of course, the employed includes people who are working. ◦The unemployed are those who are in the labor force, but not currently working. Note that to be counted as unemployed, someone must be in the labor force, or willing to work at current wages. The Unemployment Rate unemployment rate=% of the labor force who are unemployed **unemployment rate=unemployed/(labor force)×100 How do we define umployment? -The definition of "unemployment" is simple in principle, but it's hard for the government to measure it in practice. How can we determine whether somebody who's not currently working is "willing to work" (and therefore should be counted as being in the labor force)? The government defines somebody as unemployed if they're not currently working and they looked for work in the last four weeks. So the government defines "willing to work" as "looked for work recently." Here's the official definition: Unemployed: Persons aged 16 years and older who had no employment during the reference week, were available for work, except for temporary illness, and had made specific efforts to find employment sometime during the 4-week period ending with the reference week. Persons who were waiting to be recalled to a job from which they had been laid off need not have been looking for work to be classified as unemployed.

Effects of Unemployment on Individuals and the Economy

Of course, unemployed workers suffer due to their loss of income while unemployed. But research suggests that the effects of involuntary unemployment last longer for some workers. Workers who have suffered involuntary unemployment have lower earnings later, on average. -In some cases, workers' human capital "depreciates" during unemployment spells. -Perhaps employers are reluctant to hire workers who have been unemployed. Research shows that workers who have been unemployed have poorer health and higher mortality rates, on average. -One study found that the life expectancy of workers who were laid off after factory closings was about one year less, on average. (Source: http://www.epi.org/publication/long-term-unemployment-scarring/) Involuntary unemployment often has an impact on the worker's children later. -On average, children whose father experienced involuntary unemployment perform less well in school and have lower future earnings. (Source:

Nomial vs Real interest rates

Ordinary interest rates are nominal interest rates -- they express rates of return in terms of "current" dollars. But when there's inflation, it steals some purchasing power over time, so we have to consider real interest rates. When interest rates are higher, inflation is higher which means nominal interest rates are also higher. Real interest rates are interest rates that are adjusted for inflation. So when you take out inflation, interest rate= real interest rate. Bank cannot tell you this The interest rates we observe every day - the interest rate on your savings account or on a loan - are nominal interest rates. Real interest rates are more important, since they tell us how much we really sacrifice (in terms of purchasing power) to get a loan or how much we earn when we lend. Real interst rates are the true cost of credit. Real interest rates can be low with high in inflation (vice versa) But we don't see real interest rates directly.

Determinants of the Unemployment Rate in the Short Run

People typically are unemployed for a period of time when they first enter the labor force, when they are laid off or fired from another job, or when they voluntarily leave a job to search for a better opportunity. Much unemployment is search unemployment; people are unemployed while they gather information about their opportunities and learn what their skills are worth. People often turn down job offers to continue their job search. "Search unemployment" is sometimes called "frictional unemployment," since it is due to "frictions" - lack of information - in the labor market. Question: To what extent is unemployment "voluntary"? The answer to this question has important policy implications: how generous should the government's unemployment compensation be?. The number of people who are unemployed at any given time depends on: the rate at which people are entering the labor force. the rate at which workers are being laid off or fired. the rate at which unemployed people are being hired for new jobs. how long unemployed people and employers choose to explore market opportunities before making a match. Therefore the unemployment rate can depend on things such as: the business cycle (recessions and business expansions). unemployment compensation levels.

Saving and Investment in the Aggregate

Recall the basic national income accounting identity: Y = C + I + G + NX For simplicity, assume that we have a closed economy - a country that does not trade with other countries. Then net exports (NX) are assumed to be zero, so: Y = C + I + G We can obtain this same result using some simple algebra. National saving (S) is the economy's total saving, or the amount of national income that is not spent on consumption by households, the government, or foreigners. National income- not spent on anyone's income. Income is not spent by gov/consumer spending. Increase in spending=increase in investment= increase in economy growth. •So in a closed economy, national saving (S) is equal to total income (Y) minus total consumption by households (C) and government (G): S = Y - C - G •We also know that Y = C + I + G in a closed economy, so I = Y - C - G So we conclude that S = I or saving = investment in a closed economy. In order to have investment (which drives economic growth), a country needs to have plenty of savings to fund the investment (if it has a closed economy). An important implication: If a closed economy has a high saving rate, then it will have more funds available for investment, and it is likely to grow faster than other countries.

convergence

Some lower-income economies grow quickly, so their living standards tend to converge toward those in more affluent countries. •Investments in physical capital tend to be very productive if an economy has a lot of room to grow. -investments=move more farmers in factories -Diminshing return=once you are the most advanced technology in the world it's hard to make improvement, returns will be positive but slow in return *U.S is hitting a Diminishing return. U.S econ is going to grow slow in the next few years. Growth tends to be slower in affluent countries, whose economies are more "mature." •Investments in physical capital face diminishing returns.

Structure of financial system

The financial system facilitates exchanges between the nation's savers and borrowers. •Savers - people or institutions that wish to postpone current consumption. Given current interest rates, savers wish to lend some of their current income in exchange for repayment with interest sometime in the future. -choose not to spend income right away so they can have more in the future. Lend money to borrowers -investment and physical capital are important factors for economy to grow which relies on savings. •Borrowers - people or institutions who wish to move future consumption up to the present. Given current interest rates, borrowers are willing to pay a premium in the future (the interest payment) in order to obtain funds today. -Want to spend more today and willing to pay it in the future for ex loans, pay less in the future. How does this happen? Financial market: where savers and borrowers exchange money. *borrowers and savers compliment each other *savers earn interest and borrowers pay interest Financial markets - markets in which borrowers and savers (or lenders) can directly enter into transactions. -An efficient way for savers money to get to borrowers (purpose of banks) •Stock markets - savers buy shares of firms, so in the future they will share in the firm's profits. No investments, savings. Investment is business buying more physical capital. A country's saving funds investments. They are linked together (saving and investment) •Bond markets - firms (or government entities) issue bonds (or IOUs) as a form of borrowing. Savers (or lenders) provide borrowers with funds when they buy their bonds, and then the bond holders are compensated with interest payments during the term of the loan. Financial intermediaries - firms (such as banks, mutual funds, or insurance companies) that collect savers' funds, "re-package" them in another form, and lend them to borrowers.

How high is the natural rate of unemployment?

The natural rate of unemployment can't be observed directly, so economists can only estimate how high it is. Most estimates put the natural rate of unemployment at about 4.5% to 6%.

Determinants of the Natural Rate of Unemployment

The natural rate of unemployment is the percentage of the labor force who are unemployed in "normal" times, or in long-run equilibrium. This depends on factors such as: availability of labor-market information. job turnover rates. the rate of structural change in the economy. unemployment compensation levels. Factors like these help to explain changes in average unemployment rates over time and international differences in unemployment rates.

What does size of the deficit

The size of the deficit (T - G) depends on two factors: •fiscal policy, or deliberate changes in G and T. •the state of the economy: As the economy goes through business cycles, the deficit tends to grow during recessions and fall (or turn to a surplus) during periods of business expansion. There are two reasons for this: •national income falls during a recession, so the government's tax revenue tends to fall. •government payments to the poor and unemployed are higher during a recession, so G rises. What Determines the Size of the Deficit? In the next slide, we'll look at some evidence on the determinants of the deficit. •Here we'll measure the deficit by looking at the deficit as a percentage of GDP. •In the next slide, we'll use the nation's unemployment rate as a measure of how the economy is doing. If there's a recession, then the unemployment rate is higher. So if the deficit depends a lot on the state of the economy, then we'll expect the deficit graph and the unemployment rate to move in opposite directions over time - the unemployment rate rising and the deficit getting deeper in recessions. In the next slide, how much do the two graphs move in opposite directions? *Fed gov budget deficit is grown less negative because the deficit T-G because T is getting bigger now because paying more taxes while G is getting smaller. Deficit so big in covid-19 pandemic becuase the gov was spending more on stimulus checks and tax revenue was higher. 2010 recession was a deficit, G increases while T decrease. In the late 1990s budget surpluses, national debt goes down, buys back some of those bonds. Tax cuts make national debt go up. -In a business expansion, pay more in taxes and deficit go away.

Differences in Unemployment Rates by Race

Unemployment rates differ significantly by race. This illustrates the deep, pernicious effects of racism in the U.S. economy. Unemployment rates are higher for African Americans (and other people of color) than for whites. Unemployment spells last longer, on average, for people of color than for whites. People of color are hit harder by recessions. Why are unemployment rates higher for people of color? Less-educated workers tend to have higher unemployment rates and get hit harder in recessions than more-educated workers; and African Americans have less education than whites, on average. Less-experienced workers tend to have higher unemployment rates than more-experienced workers; and on average African Americans have less work experience than whites. Why are unemployment rates higher (on average) for people of color? Evidence suggests that African Americans are more likely than whites to be laid off from work, and (as we have seen) on average they remain out of work longer. So job turnover rates are higher among African Americans. In addition, direct labor-market discrimination in hiring and firing explain some of the difference.

Government budget and deficits and debt

Using what we know about savings, investment, and credit markets, we can talk about government budget deficits and the national debt. The nation's budget deficit is the gap between government tax revenue (T) and government spending (G). •There's a deficit if T - G < 0. This is when government is spending. If the number is negative we have a deficit. •If T - G > 0, there's a budget surplus. If the number is positive, we have a budget. WI has a record buget surplus this year. Example: if G this year equals $6000 billion (or $6 trillion) and T equals $4000 billion (or $4 trillion), then the deficit is −$2000 billion (or −$2 trillion). (In talking about the deficit, people often ignore the minus sign. So in this example they'd say the deficit is $2 trillion.) Whenever there's a deficit, the U.S. Treasury Department must borrow funds to cover the deficit, and it does this by selling bonds to the public. If the federal governemnt is spending more than it can take in economy taxes has to borrow money=does that by issueing bonds to the public. What are bonds=I owe you, a way of borrowing money. -U.S gov has always paid back their bonds -U.S treasury rating is best in the world -indivuals can't get away with this -National debt falls (does not happen very often_ -Usually fed gov in the neg (deficit) vs surplus . Deficit is a % of GDP shows deficit in WWII and pandemic The deficit is related to the national debt: national debt = total government debt accumulated from the past Therefore: •the national debt can be thought of as the total amount of government bonds in the hands of the public. •the deficit is one year's addition to the national debt. •the national debt falls when there's a budget surplus. -When G is bigger than T, we have a gov budget deficit. Federal budget deficit fell to 1.4 trillion as pandemic spending eased tax revenue going up, gov spending went down 2021 2.8 trillion. 5.5% of gdp (that's big) usually around 3.7%. National debt will go up because treasurey has to sell bonds in 1.4 trillion dollars so natonal debt will rise by 1.4 trillion. **** If deficit: 1.4 trill,so national debt will rise by 1.4 trill in new bonds=U.S national debt rises by about 1.4 trill. American gross national debt exceed 31 trillion for the 1st time in history

The Unemployment Rate in the Long Run

We know how the unemployment rate is affected by various factors (such as business fluctuations or the entry of new workers) in the short run. If there were no more changes in factors such as these, the unemployment rate would settle down to a "normal" rate in the long run. This long-run rate is called the natural rate of unemployment. The natural rate of unemployment is the rate the economy would tend to return to in the long run -- and the rate the economy would stay at -- if there were no short-run "shocks" that affected the labor market. Of course, there are always shocks to the economy, so the unemployment rate is always changing; but economists believe it always tends to return to the natural rate.

Real vs Nominal Quantities

We've seen that when the price level changes, this changes our unit of measurement for economic quantities (like prices and incomes). So when there's inflation, this distorts our measurements of dollar quantities. We can correct the distortion by looking at real quantities. (We already looked at real GDP in the last unit.) A nominal quantity is simply one that's measured in terms of money (or "current dollars"). ¨ A real quantity is one that is: ¨adjusted for changes in the price level. ¨measured in terms of real goods and services. ¨measured in terms of "constant" base-year dollars. *is adjusted to remobe the effects of inflation. National output measures in terms of actual quantities of goods/services, no current market values. GDP adjusted for inflation.

The price level

We've studied how markets set prices for goods and services (like gasoline). We know that supply and demand factors can push prices either up or down. But when we study macroeconomics, we see that the prices of goods tend to move together - usually up - over time, like a rising tide in the ocean. What does it mean when the price level changes? *When the price level goes up, the value of every purchsing dollar goes down. (purchasing power of money) How do we measure the price level? *There are three ways to measue price level 1. CPI 2.GDP Deflator: is one measure of price level 3. The Fed reserve system: Does not take in account of foods and energy because they both tend to bounce around a lot in prices What does it mean when the price level changes? ¨The price level reflects the value (or purchasing power) of money. ¨In particular, if P represents the price level, the value of a dollar is proportional to 1/P. ¨In other words, when the price level rises, this means that the purchasing power of a dollar falls. *If the nation's price level falls, nominal GDP grows more slowly than real GDP. If price level rises, nominal GDP grows faster than real GDP/

FRED Interest Rates FRED Inflation rates

What's happening to our interest rates? -Mortgage Interest Rates gone up, because nominal Interest Rate have gone up, high inflation built in with interest rates, and cost of credit going up -Paying back loans, dollars you pay back will be less of the dollar value so increase interest rate -Fixed year mortgage is down by 2%, very low (2021) Interest Rates has been rising, real interest rate rising or is it inflation? It's now up to 6% 10 year expected inflatioin -1.5% (2021) and now 2.5% (2022) What has real mortgage has done? 1/2%=0.5% (2021) to 3.5% (2022) *Fed reserve system works for this increase *Discourage people to buy homes= slow down the economy If Fed did not fight inflation, what would happen? 1 1/2%= 5 1/2% to 0.5% *0.5%=0.5% *Higher interest rates don't raise the real cost of credit mortgage, will be easier to make payments

Real and Nominal Interst Rates

You've learned about the difference between nominal and real quantities, and you've learned how to convert nominal quantities into real quantities. We encounter the same kind of distinction when we talk about interest rates. But since interest rates are measured in percentages instead of dollars, the relationship between nominal and real is different. It's much easier!

What can the relationship between real interest rate and inflation tell us?

nominal interest rate = real interest rate + inflation This relationship tells us something important: we can view ordinary interest rates as having two components - an underlying real interest rate, and an inflation premium. So if you pay 6% interest on a loan, part of that interest is just a market adjustment to account for expected inflation.

Another example

this example, we'll convert a current figure into a past year's dollars. This is the opposite of the first example, but it's just as easy to do. Suppose the price of a house is $300,000 today. What would have been the equivalent price in 1950, after adjusting for inflation? To answer this question, we need to know the CPI in each year: now and in 1950. Assume the CPI now is 295. The table of historical CPI data on D2L tells us the CPI in 1950 was 24.1. Set up the calculation and solve! $X/(24.1) = ($300,000)/295 $X = $24,508 So a home price of $24,508 in 1950 would be equivalent (in terms of purchasing power) to a price of $300,000 now.

Different living standards

• The World Bank compares living standards across countries using a measure of gross national income per capita (similar to GDP per capita).• GNI per capita figures are expressed in dollars.

production of growth and example of China

•A country's living standard depends on its productivity, or the amount of output produced per hour of work. (Principle #8 from Chapter 1) •A country's economy tends to grow faster if it has more investment spending. •Investment increases the country's stock of physical capital: more factories, machines, roads, etc. •How can the country pay for its investment? •Savings •Foreign investment •A country can grow faster if it has good social institutions: a strong legal system, solid property rights, etc. Living standards were relatively low in China forty years ago. •World Bank estimate: China's GDP per capita was $279 in 1977 (measured in 2010 $). https://fred.stlouisfed.org/series/NYGDPPCAPKDCHN But China had the ingredients for rapid growth: •High levels of education •Large population available for manufacturing employment •High savings rates In the late 1970s, China's government opened the country to foreign trade and investment. In the following years: •Foreign investment in China rose dramatically. •The manufacturing sector in China saw spectacular growth. •Hundreds of millions of people moved from the countryside into cities, where many took jobs in factories. •China's high savings have been directed toward investment in Chinese businesses. As a result, the Chinese economy has grown very fast (without a recession) for forty years. -Countries that grow rapidly alot of GDP will go to investment. *foreign investment-factories, if someone invests in another country to help them build factories China (large population)=-more resources, high saving rates, save big portion of income -Before 1970s, gov had a policey on economic growth (didn't like). -The manufactoring, more restaurants, a lot of chinese people moved to the cities which employed more people into the factory which increased productivity. Would grow 10% per year, now 6% per year. China can look forward having slow econ growth

Why does deficit matter?

•A deficit today must be paid back through higher taxes in the future. Therefore a deficit shifts a tax burden to later generations. •State and local governments (unlike the federal government) usually operate under rules that prohibit deficits. Eliminating a deficit (that is, "balancing the budget") can require painful cuts in government spending or tax increases. •An increase in the government budget deficit reduces national saving, since the government swallows up funds (by issuing new bonds) to finance the increase in the deficit. •This reduces the amount of credit available to the economy for investment (or private-sector borrowing in general), and this pushes real interest rates up. Your textbook has a nice explanation of this. Check it out! We can show the relationship between deficits and national saving using a little algebra. We know that S = Y - C - G It follows that S = (Y - C - T) + (T - G). (Here we just subtracted and added T, and then grouped the terms.) Note that Y - C - T just represents people's "private saving": what's left from our income after we pay taxes and spend money on consumption. So we can write the last equation as S = "private saving" + "public saving" where "public saving" is just another name for the deficit. So a bigger deficit (a more negative T - G) absorbs some of the economy's private saving. *Private saving: saving by households by us *Public saving: is just the deficit or surplus •The higher real interest rates associated with a deficit make it harder for households and businesses to borrow funds. •This hurts interest-sensitive industries, such as the housing and automobile industries, and tends to slow business investment (and thus long-term economic growth). •Economists say that the increased deficit crowds out some private-sector borrowing.

observations: what do we see? pic in google docs

•Countries or regions can break out from the pack and enjoy many years of fast economic growth. •What causes this fast economic growth? •Foreign trade allows countries to sell their output in expanding markets. •New technologies allow countries to produce and market goods more cheaply. •Investment in physical capital -- more factories and machines - raises worker productivity and increases the supply of goods. •Higher levels of education - more human capital - raise the productivity of workers. •Access to natural resources - good farmland, minerals, rivers - can spur economic growth. •However, after a country becomes more affluent, its growth tends to slow down.

A broad view of economic growth Ecnomic growth in the longrun

•Economic growth - that is, growth in real GDP - is characterized by short-term fluctuations (recessions and recoveries) around a long-term trend. •Macroeconomic policies usually focus on the short-term fluctuations: How can we prevent recessions, or make them shorter? •Our living standards depend more on the long-term trends. -The best estimates of historical economic growth rates over the longest time horizons are based on the work of Angus Maddison (1926-2010): -In the last 100 years rapid economic growth. It's from foreign trade (produce stuff and sell it around the world), new tech, manufactoring goods at a much higher level but after a country becomes more affluent-rapid econmic growth can't run forever

important implications

•If real interest rates are pretty stable over time, then we'll tend to see higher nominal interest rates when there's more inflation. •If real interest rates are about the same in different countries, then countries that have higher inflation tend to have higher interest rates. •You need to take inflation into account when you plan for your financial future. Example: From 1950 until 2009, an investment in the stock market in the U.S. yielded a (nominal) rate of return of about 11% per year. But the inflation rate averaged about 4% per year during those years, so the real rate of return was only about 7% per year. 7% = 11% - 4%

Observations and questions

•There is a huge gap between living standards in rich and poor countries. -some countries econ grow faster than others •Countries have very different growth rates over time. •What causes a country to grow faster? -lots of international trade, high exports, education, factories, technology, and oil exports •Can government policies spur faster growth in the long run? -Yes, government can help raise people's living standards