Transcript Document

ECN202: Macroeconomics
1960s: End of the Business
Cycle?
recessions "are now generally considered
fundamentally preventable, like airplane crashes and
hurricanes."
Zenith of Keynesian Economics
After WW II and the Korean War macroeconomics once again was
THE issue in a presidential election in 1960. A sitting Vice President
was defeated by a relative unknown CATHOLIC promising to get
the economy moving. To do that he turned to the rising number of
academic scribblers working on turning Keynesian anti-depression
economics into anti-recession economics. It was a period of
significant developments in macroeconomic theory, and we look at
those in this nit. We begin with a more detailed look at
consumption and investment spending since Keynesians focused
on managing AD, and then we look at the issues of timing and
forecasting that were central to effective macro policy. The unit
closes with a discussion of the Phillips Curve that symbolized the
tradeoff between inflation and unemployment that policy makers
must now confront. We open our work with some warnings from
Eisenhower as he left office and some headlines from the 1960s.
Eisenhower opens 1960s with a warning
1. “America’s leadership and prestige depend not
merely upon our unmatched material progress, riches
and military strength, but on how we use our power in
the interests of world peace and human betterment.”
2. “In meeting them, whether domestic or foreign, great
or small, there is a recurring temptation to feel that
some spectacular and costly action could be come the
miraculous solution to all current difficulties.”
3. “As we peer into the future, we – you and I, and our
government – must avoid the impulse to live for today,
plundering, for our own ease and convenience, the
precious resources of tomorrow.”
4. Balance “between public and private economy”
In the news: Growth is good
1. “Democratic and Republican platform writers have
committed their parties, and the nation, presumably,
to the goal of more rapid economic growth.” 1960
2. “Kennedy Terms Action to Spur Economic Growth
the Major Election Issue” 1962
3. “Economic Growth No Cure-All for Jobless” 1965
4. “The United States apparently moved last year into
first place among the leading industrial nations in its
rate of economic growth after being near the bottom”
1966”
5. “RECESSION VIEWED AS A 'POSSIBILITY';
Economy Has Not Declined Despite Dip by
Indicators, Arthur Burns Declares” 1967
In the news: Unemployment gets noticed
6. “Prof. Paul Samuelson's letter published Nov. 12
illustrates the growing tendency of economists close
to the Administration to minimize the unemployment
problem.” 1961
7. “ECONOMY ABSORBS TEEN-AGER INFLUX;
Unemployment Rate in June Lowest Since Fall of
'57” 1965
8. “U.S. Will Change Definitions of Unemployment”
1966
9. “Whether or not a 4 per cent or even higher rate of
unemployment is "acceptable," as Secretary David
Kennedy would have it, remains to be seen.” 1969
In the news: So does inflation
10. “PROGRESS NOTED IN INFLATION WAR; Top
Economic Aides Doubt Serious Price Rises” 1960
11. “'LITTLE INFLATION' CALLED NO THREAT;
Administration Unperturbed at 1-1 % a Year Rise in
Consumer Price Index” 1962
12. “Labor Costs Blamed for Inflation” 1965
13. “G.O.P. Dramatizes Inflation as Key Issue; High Cost
of Living to Be Stressed in Drive for Votes” 1966
14. “Inflation; It's Mainly Psychological, but Oh How It
Hurts!” 1969
In the news: The end of Nirvana?
15. “Advocates of Slower Development Are Gaining
Ground in Latin Nations” 1965
16. “Jobs and Inflation; Truce Is Developing in Debate on
When Falling Unemployment Raises Prices” 1966
17. Predictably the rise in unemployment to 4 per cent -- a
consequence of efforts to check inflation by fiscal and
monetary restraints -- has produced a political
outburst” 1969
18. “U.S. JOBLESS RATE ADVANCES TO 4%, HIGHEST
SINCE '67; Administration Aides Greet Rise as Sign of
Restraint on Boom Spurring Inflation” 1969
19. “Economy; How to Cool It Without the Chill of
Recession” 1969
In the news: Trade becomes an issue
20.“KENNEDY ROUND OF TARIFF TALKS WILL OPEN
TODAY” 1964
21.“Pastore Urges Efforts by U.S. To Aid Textile-Trade
Balance” 1965
22.“Nixon Asks For Lower Tariffs” 1969
23.“Stans Suggests Tax Plan To Help Balance of Trade”
1969
24.“Morgan Trust Hints Huge Loss For U.S. Payments in
Quarter; BIG LOSS HINTED IN U.S. PAYMENTS”
1969
25.“FOREIGN TEXTILES FOUGHT BY STANS;
Secretary, in Italy, Presses for Curbs on Exports”
1969
The Macro Problem: Get the economy
moving
Unemployment Rate
16
The unemployment rate has been trending
upward since the end of the Korean War
12
8
4
0
1940
1945
1950
1955
1960
A call to action
"get the country moving again."
1960 Presidential Election
An incredibly close election
1964 Presidential Election
What happens when you nominate a fringe candidate and what happened in the South to have them shift
from solid Democrat to solid Republican?
The Solution: again
Keynes’ theory
If it could cure a depression
imagine what is could do for
a recession
The solution: in theory
recessions "are now generally considered
fundamentally preventable, like airplane crashes
and hurricanes.” Arthur Okun, president Johnson's economic
advisor
Aggregate Demand “Rules”
Aggregate demand is central to Keynes’ view, so let’s look at
it. First we look at consumption spending (C) that is
important because it is HUGE and because it is stable and
may be managed. In this period newer theories of
consumption surfaced including the permanent income and
life cycle theories that altered how we looked at C. What we
spend on has also changed since the mid 1970s with the
declining importance of nondurables. Investment spending is
important because it has a supply-side effect – if we invest in
more factories and machines our workers become more
productive and this increases our productive capacity. This
make investment a favorite target of discretionary fiscal
policy.
Consumption
•
•
•
•
BIG
STABLE
MANAGEABLE (relationship to disposable income)
Theories (MPC?)
– Keynes
– Permanent income hypothesis (wealth)
– Life-cycle model
Personal income & consumption
expenditures
12,000
C
10,000
Very strong relationship between income
and consumption
8,000
6,000
4,000
2,000
Y
0
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
Components of Consumption
50
40
You can see where more of our money is
going – and how durable spending is the
most volatile
Services
30
Durables
20
Nondurables
10
0
1960
1970
1980
1990
2000
2010
Personal saving rate: US
What happened to the savings rate after 1980
and was that a good thing, and what happened
to the rate since the mid 2000s?
And how do we get Americans to save more?
What is so different about China from the US – and why
do American policy officials what could be done to
decrease the savings of the Chinese people?
Saving
Investment
The savings glut. Controversy guaranteed. Council of Foreign Relations
How do we change savings behavior?
You have all had microeconomics so this should be an
easy question. If we try to alter behavior we need to look
at why people do what they do and then try to alter the
incentives to alter their behavior. In the US the problem
is that there are very low incentives to save – either
people do not have to save or it is very easy to access
funs, while in China there is a need to save or it is
difficult to access funds. Here are a few possible options
for altering the savings patterns.
How do we get Americans to spend less?
Make it easier to save
1. Financial deregulation
2. National savings plan (SS example)
Make it more rewarding to save
1. Tax policies
1. Sales / consumption tax rate
2. Interest income tax rate
How do we get the Chinese to spend more?
Make saving less attractive
1. Expand public pension system
2. Expand public health care system
3. Unionization
4. Urbanization (rural to urban)
5. Industrialization (agriculture to manufacturing)
Make it easier to spend
1. Expansion of credit
Wealth Effect
One of the implications of the expanded theory of
consumption spending was the acknowledgement of a
wealth effect. Consumption spending ( C ) depends on
wealth as well as income, and there is a marginal
propensity to spend wealth (MPC). [MPC = DC / D W]
Research has shown the following estimates of their
values.
–MPC for wealth in homes = .09
–MPC for wealth in stocks = .04
Based on this try this: what would be the impact on C
of a $5 trillion decline in housing values in the Great
Recession?
Shiller-Case Home Price Index
5.0
4.5
A BIG hit in housing values
4.0
3.5
-$5T*.09 = -$450 billion = decline in C
SF
3.0
BOST
CH
2.5
LV
MI
2.0
DC
TAMPA
1.5
1.0
0.5
0.0
1985
1990
1995
2000
2005
2010
A lost decade = or two?
A BIG hit in stock market values in Japan
A huge hit in real estate values in Japan
Investment
•
•
•
•
SMALL / UNSTABLE
SUPPLY-SIDE EFFECT
MANAGEABLE?
LEADING INDICATOR
The Challenge of fine tuning an economy
In the next few graphs you will see the problem of fine
tuning in a world without instantaneous change and the
potential solutions. The goal is to flatten out those
recessions and the problem is that because of lags the
impact may not be felt until after the problem disappeared
so it may actually worsen the cycle. One “solution” is to
build in automatic stabilizers like unemployment benefits
so as the economy slides into a recession the
unemployment benefits increase and this additional
income is spent. The second option is to forecast the
problem and use preemptive policies such as a tax cut
before a recession happens.
Fine tuning: A timing problem?
18
GDP
We want to avoid the recession that begins in 1975
16
14
A
12
Too much too late
10
1. Recognition lag
8
2. Discussion lag
6
3. Action lag
4
R
A
Monetary
Fiscal
2
0
1960
D
1965
1970
1975
1980
1985
1990
1995
2000
2005
One possible solution? Automatic stabilizers =
autopilot
Automatic stabilizer reduces changes in AD
1. Income tax
2. Unemployment benefits
18
GDP
16
14
Income rises
12 rise
Taxes
Spending
rises slower
10
8
Income falls
Taxes fall
Spending falls slower
6
4
2
0
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
Another possible solution? Preemptive
Discretionary policies
18
We want to avoid the recession that begins in 1975
GDP
16
Just right, just in time
14
12
A
10
1. Recognition lag
8
2. Discussion lag
6
3. Action lag
4
2
0
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
Fine-tuning requirement: Forecasting ability
This was a time when we saw an increase interest in
forecasting – a perfect storm of sorts – that increased
demand for forecasts at the same time as that we had
what we needed – computers to analyze the macro
numbers now being produced regularly, a theory on
how to manage the economy, and liberals in power
who believed in managing. Here we look briefly at
three techniques. , so here we look at some
techniques. Also when you are forecasting be sure that
the variables you choose matches the time horizon. All
time series can be decomposed into seasonal, cyclical,
and trends and the influences on each of these is likely
to be different.
On the next slide you will see a few of my “favorite”
forecasts.
The forecasting track record?
1. “Brain work will cause women to go bald” Berlin professor
1914
2. "Who the hell wants to hear actors talk?" H. M. Warner,1927
3. “The Japanese don’t make anything the people in
the US would want.” (Secretary of State John Foster Dulles in
1954
4. "And for the tourist who really wants to get away from
it all, safaris in Vietnam." Newsweek's 1963 prediction of popular
holidays for the late 1960s.
5. "Rail travel at high speeds is not possible because
passengers, unable to breathe, would die of
asphyxia." Dionysius Lardner, 1828
6. "I think there is a world market for maybe five
computers." Thomas Watson, chairman of IBM 1943
7. "1930 will be a splendid year for
employment." Department of Labor in 1929
Forecasting basics: seasonal patterns
• Seasonal
(big summer)
• Cyclical
• Trend
• Match timeframe with
factors
Forecasting basics: Develop a forecast of company
.
Year
1995
1996
1997
1998
1999
2000
2001
--2007
2008
2009
2010
2011
2012
2013
2014
2015
sales over the next five years
Sales
(units)
9073
9287
9853
10094
10500
11321
12216
--15057
15951
18120
Itzibitzi Sales
20,000
18,000
16,000
14,000
12,000
10,000
8,000
6,000
1995
2000
2005
2010
2015
Time-series analysis
“The ruler”
Actual and Estimated Sales
error
20,000
18,000
S = a + b S-1
Actual
Estimated
16,000
14,000
Sales today depend
upon sales last
year
12,000
10,000
8,000
6,000
1995
2000
2005
2010
Oil price forecast – look to past sales for guide to future
2015
Econometric analysis
error
“The relationship”
Actual and Estimated Sales
20000
error
Actual
S = a + b*P
18000
16000
S = -3299 + .546*P
Estimated
14000
12000
10000
Sales depend upon
8000
1995
2000
2005
2010
2015
price so with price
forecast we have
oil demand
Oil price forecast – look to past for relationships
forecast
Barometric analysis
Turning points
“The experts”
Leading indicators
16.00
Lead time
14.00
12.00
If you are forecasting,
how do you predict
turning points?
10.00
8.00
6.00
You want something that
turns before your
variable so when it
turns you know what is
coming.
4.00
2.00
0.00
1950
1960
1970
1980
1990
2000
Lead time
RI Index of Leading
Indicators
1. Manufacturing employment
2. Retail & wholesale employment
3. Index of Providence Help-Wanted
Ads
4. Passenger traffic at Green
5. Newport Bridge Tokens
6. Single-family housing permits
7. RI Industrial kilowatt hours
8. National average for weekly
unemployment claims
9. National vendor delivery
performance
An example of a leading indicator
Sotheby’s stock rises in booms but seems to fall before other indicators of macro decline
Derek Thompson, “The Art of Bubbles: How Sotheby's Predicts the World Economy,” Atlantic Monthly, Apr 5, 2011
Another problem!!
Inflation “arrives” in the late 1960s
Inflation rate
7%
6%
5%
4%
3%
2%
1%
0%
1960
1962
1964
1966
1968
1970
The inflation-unemployment tradeoff
By the late 1960s inflation was a problem facing
Keynesians who began to look into the work of an
economist, William Phillips, who a decade earlier had
identified a negative relationship between inflation and
wage growth: wages tended to rise faster when the
unemployment rate was lower because workers had
more bargaining power. If wages grew faster than
prices would rise faster, so we got the Phillips Curve.
This became seen as a possibility line of sorts where
policies could move us along the Phillips Curve, so you
should be able to see where Republicans and
Democrats would differ in terms of their goals. If you
used expansionary fiscal policy you would increase AD
and this would increase GDP (lower unemployment)
and increase prices. This was not great, so liberals
looked to policies to shift the curve inward.
Phillips’ Evidence
Where would Republicans
want to move the economy
and where would Democrats
want to go – A or B?
•A
•B
Republicans care about inflation so they choose B, while
Democrats care about unemployment so they would choose A
AS-AD & Phillips Curve?
AS-AD
18
Phillips Curve
18
Increase AD
Price
level
16
Inflation
16
rate
AS
14
14
12
12
10
10
8
8
AD2
6
4
*
6
*
Initial
situation
4
AD1
2
0
1960
New situation
1965
1970
1975
1980
1985
1990
1995
2000
GDP
2005
2
0
1960
1965
1970
1975
1980
1985
1990
1995 2000 2005
Unemployment
rate
Policy choices:
Move curve – or move on curve?
18
Same inflation – lower u
18
i
i
16
Expansionary policy
Monetary
Fiscal
16
14
14
Job training
Job information
12
12
10
10
8
8
6
6
B
4
B
A
A
4
2
0
1960
Less U and more inflation
2
1965
1970
1975
1980
1985
1990
1995
2000
u
2005
0
1960
1965
1970
1975
1980
1985
1990
1995
u
2000
2005
Summary of 1960s policy activism
Keynesian economics: anti
recession version
• Economic Theory
– John Maynard Keynes
P
• Key concept
– Multiplier
• DY/DG = 1/(1-MPC)
• “New” AS –AD model
– Upward sloping AS
• Implications
– Inflation-unemployment trade
off
– Temporary policies have limited
value
Q