ECO250: Intermediate Macroeconomic Analysis for Management, Sections A and B
Class schedule: Section A: Tuesdays, Thursdays 8:30-9:50; Section B: Tuesdays, Thursdays 1:00-2:20, both in 1E1.
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I.1. Introduction and Overview
I.2 The science of macroeconomics
I.3 Data in macroeconomics - how output is measured
II.6 Money and Inflation
III.9 IS-LM part 1
III.9 IS-LM continued
I.1. Introduction and Overview
October 25-October 27
A long article on the Governor of the Bank of Canada
The governor of the Bank of Canada, Mark Carney, is the leading candidate to become the next head of the Financial Stability Board, an international body established in 2009 to develop and coordinate financial regulation and supervision across countries. While this s a part time job, it is important as lax regulation of financial institutions contributed to the severity of the Great Recession.
Mr. Carney left a career in the financial industry (he was a Managing Director at Goldman Sachs) to join Bank of Canada as Deputy Governor in 2003. He then spent three years as a senior official in the Department of Finance and returned to the Bank of Canada as Governor in 2008. As the article points out, Mr. Carney did an excellent job at the Bank of Canada. In combination with his private sector experience it earned him respect in the central banking circles. This is an important qualification for the job as the Board would have to persuade countries to adopt its recommendations, and stand up to the banking sector that would push to minimize additional regulation.
One of the main issues is regulating the capital of banks. In the Great Recession many banks were at risk of failing as their capital was too low. The governments had to step in and provide financial support. So the tendency is to increase the capital requirements. Of course banks do not like it because capital is costly. Also, in the opinion of many officials, very large banks should hold more capital to make them less likely to fail. A collapse of a large bank would, as we have learned from Lehman Brothers, may cause a financial crisis. Mark Carney supports both ideas.
A recession in Europe? As we discussed last week, predicting business cycles is very difficult. One tool is the Purchasing Managers' index. It is the result of a survey of purchasing managers from private companies. The value of the index indicates worsening economic conditions and so the title of the article is that a recession in the Euro-area (Eurozone) may have started.
More precisely, the index is calculated as follows. Managers are asked whether the situation has improved, remained unchanged or worsened. "Improved" gets a value of 1, "no change" the value of 1/2, and "worse" the value of 0. So the value of the index of less than half means that more managers answered "worse" than "improved".
More details are
in the press release. As you can see, the index has been a good indicator of what is happening with GDP in the Eurozone since 2008; a bit worse before that.
Another interesting point from the press release: the index is above 0.5 for the German economy, has just fallen below 0.5 for the French economy, and has been below 0.5 for the rest of the Eurozone for the last five months.
3. As of 9:30 pm Wednesday the grand plan to fix European debt problem
failed. The plan consisted of three elements:
- increase the size of the European rescue fund to around 1 trillion Euro (roughly the size of Canadian GDP)
- recapitalize European banks so they can survive Greek default
- convince banks to write off 50% to 60% of Greek debt
The first two elements are in place. The German parliament approved the increase in the size of the rescue fund (called European Financial Stability Facility); this allows the increase to go ahead. It is not clear how this will be accomplished but there is no rush: the details will be negotiated in the next few weeks. There is also an agreement on recapitalizing European banks: they need 106 bln Euro, to be obtained from private investors or, if that does not work, their governments. But banks are unwilling to agree voluntarily to the reduction in debt demanded by European leaders.
How big is the problem? The German Chancellor, Ms. Angela Merkel, called it the biggest crisis since the second world war. So I guess it is a bigger crisis than the Great Recession.
4. Here is a great
graphic from the New York Times which shows why the problems in small Greece can spill over to other countries. Everything is connected!
October 18-October 20 to government spending multiplier
1. Once a month Statistics Canada publishes unemployment and employment numbers. Here is a
summary of the latest unemployment figures
Note that, while total employment has increased, changes were not uniform across industries. Employment in education increased a lot, but employment in industry fell.
2. The detailed report is
here. Chart 1 in Highlights shows both employment and unemployment in Canada since 2008. As you can see, by mid-2010 the number of people employed had returned to the level from before the Great Recession. But the unemployment rate is higher than it was before the Great Recession. Why? Because the labour force grows over time. So, with the same number of people employed and a larger number of people willing to work, the proportion of unemployed is higher.
In Analysis ó September 2011, you can find details of the changes. One important piece of information is that, in 2011, all increase in the number of jobs (almost 300 000) was in full-time jobs. The number of part-time jobs actually fell.
Chart 1 shows employment index for various groups and types of jobs. Employment among young people is still significantly lower than in 2008. Also, since 2008 the number of part-time jobs increased 6% while the number of full time jobs increased only 2%.
Chart 2 shows unemployment and employment rates and labour participation. The unemployment rate for young people is 14% - double the national average. It has declined little from its peak.
As can be expected in a recession, employment rates fell for both men and women under 55. They increased for older men and women, though. This is not surprising: as people lost money, they delay retirement or come back to work from retirement
Finally, note the participation rates (proportion of people who are in the labour force). 90% of men 25-54, 80% of women 25-54 and 65% of young people are in the labour force. The participation rate of older people is much lower: only 40% for men and 30% for women over 54.
Lessons From the Financial Crisis for the conduct of monetary policy.
At a recent conference the chairman of the US central bank, Ben Bernanke, discussed the lessons from the financial crisis. The main point is that central banks neglected the pursuit of financial stability. They concentrated on stable inflation and, in some cases, output and unemployment. He argues that inflation will remain a central concern of central banks, but assuring financial stability should become an equal goal.
How can financial stability be promoted? Bernanke stresses that the right tool is not changes in the interest rates, but rather financial regulation and supervision.
What are the elements of monetary policy after the Great Recession?
(a) Flexible inflation targeting. Central banks aim to achieve price stability (which is defined as inflation rate of around 2%) in the medium term. This allows them to react to changes in output and unemployment in the short term.
(b) Transparency. An innovation in the conduct of monetary policy, which is attributed to the Bank of Canada, is transparency: announcing the outlook for the economy, objectives of the central bann and strategy it is going to pursue to achieve these objectives. In April 2009 the Bank of Canada announced that is planning to maintain a very low interest rate until the second quarter of 2010 (the bank makes decisions every six weeks, so this was a very long commitment not to change the interest rate).
(c) Buying a wide range of assets, apart from short-term government bonds, to affect interest rates on those assets and to provide liquidity.
We will talk about those issues later in the course.
Revising Bank of Canada goals Bank of Canada is operating under an inflation targeting framework. It is to maintain the rate of inflation in the 1% to 3% band, and try to keep it in the middle of the band. This framework is revisited (and renewed or changed) every 5 years - next time in December. This article speculates that the framework will become more flexible. When inflation departs from the target, the Bank will allow itself a longer time to bring it back to target. This would allow it to take into consideration other issues in the economy - primarily output growth and unemployment.
October 11-October 13 to Unemployment
Merkel, Sarkozy tackle differences over euro crisis And in Europe....
The two most important European countries for dealing with the crisis are Germany and France. They have the largest economies, and contribute the most funds to various financial programs aimed at avoiding the spread of the crisis. The most important such program is European Financial Stability Facility (EFSF) which at present has 440bln euros to help countries that cannot borrow money in the market at reasonable rates. Germany is the biggest contributor, France second biggest. As the article suggest, Germany is more conservative with the use of funds. France would like to use the funds to recapitalize its banks, while Germany insists they should only be used as a last resort for countries that cannot do it themselves.
Banks need to increase capital to cover potential losses from bankruptcy of Greece (or a writedown of Greek debt) and subsequent problems in the banking sector.
The first large bank in trouble Here is a good example of bank problems arising in the Eurozone. Dexia is a Belgian-French bank that was rescued before, during the Great Recession. Now it is in trouble again. It is going to be dismantled, and the Belgian part will be nationalized.
Like many banks, Dexia has been borrowing short-term funds and giving out long-term loans. Now it finds it difficult to raise short-term funds and pay back maturing loans.
How big is the bank? It s liabilities are around $700bln, or 40% more than the debt of Greece. Of course Dexia has significant assets and the potential loss is nowhere near $700bln. But, as the article suggests, France and Belgium may need to guarantee almost 200bln euro of assets, a very large amount.
October 4-October 6 - to welfare costs of inflation
Greeks Turn to Barter Networks We will be talking about money this week. Here is an interesting article on an alternative: barter and private money.Br>
Actually, this is not quite barter, but more like an alternative currency. Here is an excerpt from the New York times:
"The groupís concept is simple. People sign up online and get access to a database that is kind of like a members-only Craigslist. One unit of TEM is equal in value to one euro, and it can be used to exchange good and services. Members start their accounts with zero, and they accrue credit by offering goods and services. They can borrow up to 300 TEMs, but they are expected to repay the loan within a fixed period of time.
Members also receive books of vouchers of the alternative currency itself, which look like gift certificates and are printed with a special seal that makes it difficult to counterfeit. Those vouchers can be used like checks. Several businesspeople in Volos, including a veterinarian, an optician and a seamstress, accept the alternative currency in exchange for a discount on the price in euros."
So, really, members of the group use an alternative currency, the TEM.
The biggest problem with an alternative currency is the control of the money supply: the mount of the currency in circulation. The article is not very clear about it, but it seems that its quantity is regulated: members get a loan but must repay it.
Congress addresses Chinese currency manipulation A sore point in US-China relations is the exchange rate of Yuan. The US claims that Yuan is undervalued (i.e. too cheap) and that this is a deliberate policy to make Chinese goods more competitive. The Chinese deny they manipulate the exchange rate. The Yuan was, for several years, pegged to the US dollar (i.e. its exchange rate was kept more or less constant). Since 2005, under US pressure the Yuan has been allowed to appreciate, (rise in value against the US dollar) but in a controlled way. The Chinese central bank buys large quantities of US dollars and sells Yuan. This increases the price of the dollar and reduces the price of the Yuan, slowing down appreciation. Economic estimates suggest that the Yuan is 25%-40% undervalued in comparison with the US dollar.
The US Congress would like to call China a currency manipulator and impose import duties on goods imported from China. But the issue is political and, as the article points out, both the previous and the current US administrations prefer "quiet diplomacy"
Finance Minister does not expect Canada to fall into a recession The economies of developed countries are slowing down; in particular the US economy is weak. But our Finance Minister believes that Canadian economy will continue to grow in the near future. He cites the IMF and OECD predictions, as well as his conversation with business readers as the reason for the optimism, but does not provide details. He does say, however, that if the situation aborad deteriourates, Canadian economy may fare worse than he is now predicting.
Holding China to Accounts Nobel Prize winner Paul Krugman argues that the US should press China on its undervalued currency. He says one reason for the slow job growth in the US is the large trade deficit.
The solution: lower the value of the $US in terms of other currencies, in particular the Chinese yuan. This would make US exports cheaper in China and Chinese imports more expensive in the US, reducing the trade deficit.
Krugman discusses various arguments against holding China to account. He mentions one that would work in normal times. Inflation is high in China, gradually eliminating the effects of undervalued currency. High inflation in China makes Chinese goods relatively expensive compared to US goods, just as an increase in the value of the yuan would. But this is too slow, given the poor shape of the US economy.
September 27 - September 29: to residential investment
1. Retailers warn euro crisis hitting consumers There we go again.
As we will discuss today, the main force in the Great Recession was the behaviour of consumers. Losses in the real estate market reduced their wealth and, consequently, consumption. Economic problems led to pessimism about the future, which in turn led to a reduction in consumer spending. When people worry about losing a job, they postpone purchases, in particular of big-ticket items.
According to a survey of major retailers, another round of consumer pessimism is coming. Note that while Western consumers are pessimistic, Asian consumers are optimistic about the future. As we have seen last week from the IMF World Economic Outlook (see item 4 in week 2) the world economy is dividing into slow-growing rich countries and fast growing developing countries.
Carney questions bank lobby's stand against financial regulations Bank of Canada Governor spoke to international bankers, stressing the need for stronger financial regulation. A central element is the requirement that banks hold larger reserves. Banks do not like it because reserves do not earn anything. But regulators are concerned that, if the next financial crisis hits, the current level of reserves is insufficient.
High inflation in Canada According to latest figures, the CPI inflation rate, which we will discuss today, exceeded 3% in August. Bank of Canada mandate is to keep inflation in the band between 1% and 3%, and close to 2%.
In normal circumstances the high inflation rate would be a cause of concern and may affect Bank's actions. But these are not normal circumstances. The Canadian economy is weak due to weak US economy and concerns about the crisis in Europe. So we can expect the inflation rate to fall.
The second reason is the fact that the high rate of inflation is mostly due to large price increases for food and gasoline. The rate of inflation for those two categories of goods is quite variable. The Bank of Canada looks also at the core inflation, which is calculated excluding these volatile components. The core inflation rate is moderate.
Should central banks tolerate inflation when the economy is weak? This article discusses the dilemma facing central bankers in some countries: weak economy and high inflation rate. The trend now is to concentrate on the economy, and ignore the inflation pressures. The reason is that economies are very weak, the unemployment rates are high and growth is slow. A "double-dip" recession is a distinct possibility. So central banks concentrate on the economy.
But the mandate of many central banks is to maintain a low inflation rate. How can this be reconciled with focusing on the state of the economy and not on the inflation rate? With a weak economy, the inflation rate is likely to fall. So until the central bank becomes convinced that high inflation is becoming entrenched, it plays a smaller role in monetary policy.
September 20 - September 22 - to real and nominal interest rates
1. The rescue package for Greece, which provides 110bln euro in loans from the IMF and Euro-area countries, operates in tranches. Funds are lent to Greece provided it meets deficit - cutting targets. Greece has not met those targets and the next payment in October, is in question. If Greece does not receive the payment it will run out of funds, with the possible consequences of defaulting on its debt or not being able to pay salaries to state workers.
In order to receive the payment, Greece is being asked to implement drastic measures: "firing another 20,000 state workers, cutting or freezing state salaries and pensions, increasing heating oil tax, shutting down loss-making state organizations, cutting health spending and speeding up privatizations."
More details are
A Little Inflation Can Be a Dangerous Thing says Paul Volcker, a former chairman of the Fed. During his term the US (and Canada) introduced antiinflationary policies which ended the high inflation of the 1970s.
There are not, at present, many voices arguing for higher inflation. The lessons from 1970s have been learned and it is a common agreement that inflation should be kept low. But there are short-term benefits from higher inflation and so economists remain concerned that central banks may let inflation rise.
IMF cuts Canada's economic outlook The International Monetary Fund has released its yearly World Economic Outlook report. It now sees the Canadian economy weaker than before, with growth projections reduced by 0.7% compared to April projections. The reason - weak US economy. The Canadian economy by itself is relatively strong but the difficulties in the US, which is our main trading partner, slow down the Canadian economy.
Global risks getting worse, IMF warns In the World Economic Outlook, the IMF warns that the economies of developed countries are facing difficulties. The main ones are the European debt crisis and the weak US economy. On the other hand, developing countries will grow fast: for 2011 the IMF predicts developing economies will grow 6.4%, richer nations by 1.6%; the figures for 2012 are 6.1% and 1.9%, respectively.
September 13 - September 15 - finished part I.2.
1. The crisis in Europe is reaching a critical stage. Some background:
Greece has problem paying its obligations. The reasons are massive tax evasion, a large, well paid government sector and general government overspending. As a result it has a large budget deficit and accumulated very large debt. Over a year ago it became clear that it will not be able to borrow in the international markets at sustainable interest rates. Greece then got a rescue package from the IMF and the European Union. The package provides money from IMF and EU at rates lower than the markets would have demanded. The condition is that Greece reduces its budget deficit, which forces it to introduce restrictive fiscal policies (reduce spending, raise taxes) The first package, 110 bln euro, proved insufficient and second package is being put together. Greece, however, is missing the deficit targets. Markets appear to be almost certain Greece will default on its debt. There will be high level talks Wednesday between the Greek, French and German leaders on how to save the situation.
2. What would happen if Greece defaults on its debt? Nobody knows, but people are afraid that the scenario would follow the Lehman Brothers collapse. Many banks in various countries will incur substantial losses and the markets can again panic. On Tuesday, two French banks were downgraded because of these fears.