Transcript Good Morning! - Pennsylvania State University

The New Economy Slides: The
Goldilocks Economy

We discussed the fact that increases in
productivity growth rates resulted in a very
happy situation in virtually every aspect of
the US economy!
 We recall the phrase that increases in
productivity growth allows firms to pay
higher wages and increase profits without
raising prices.
Before looking at the facts, let’s
refresh ourselves with the AS, AD
and the cruise ship!
Aggregate Supply

AS = f [ Wages (W), Prod Growth (PG), Costs of
inputs (COI) , other costs (OC)]
 In words, AS is increasing in PG and decreasing in
W, COI ,OC.
 Most economists believe that 1) policy makers
have little if any influence of AS and 2) AS
conditions determine output, especially in the long
run (think of a vertical AS curve)
Aggregate Demand

AD = C + I + G + X-M
 Model each:
 C = a0 + a1 (Yd) + a2 (r) + a3 (WSM) + a4
(WRE) + a5 (CC) + a6(EX)
 Where the ai ‘s are sensitivity parameters
(a0, a1, a3, a4 > 0 ; a2, a6 < 0)
 Draw a consumption function and discuss
all the shift variables.
AD - continued
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Investment
I = b0 (IC) + b1(r)
Where b0 > 0 ; b1 < 0
Draw an investment demand function
Government Purchases
Net Exports
We will focus on C and I (accounts for about 86%
of economy) only and we will only comment
about NX.
Now set up our AS – AD model of
the economy: Draw the picture
beginning in 1995 (use 95 as our
subscripts)
From the WSJ

The Navigator
Fed Chief's Style: Devour the Data, Beware
of Dogma
 As Retirement Looms in 2006, Greenspan's
Strong Record Will Be Hard to Replicate.
Did He Help Create a Bubble?

By GREG IP
Staff Reporter of THE WALL STREET JOURNAL
November 18, 2004; Page A1
WASHINGTON – “In September 1996, Alan
Greenspan was fixated on a statistic neglected
by most economic forecasters. It was servicesector worker productivity, a measure of
how much an employee could produce in an
hour.
Government data suggested it was falling. The
chairman of the Federal Reserve was
convinced they were wrong. Casting his eye
across the American economic landscape, he
focused on other signals: rising orders for hightech equipment and higher profits at the
companies that bought the gear.

He knew it had taken decades for the
innovation of electricity to boost
productivity. Now, he thought, the advent of
computers was finally having a similar
delayed effect. Mr. Greenspan was so sure
of his insight, he was ready to bet the
fortunes of the U.S. economy.

That fall, his fellow Fed officials worried
that economic growth was so robust it
would push up inflation. Eight of the
Federal Reserve's 12 regional banks wanted
to cool things down by raising interest rates.
Two Fed governors took the rare step of
warning Mr. Greenspan they might publicly
dissent if he didn't recommend such a move.

At a meeting to vote on interest rates, Mr.
Greenspan refused and argued that rates
should be held flat, according to a
transcript. Following his analysis of the
productivity data, he believed companies
could now make and sell more without
having to hire more employees, reducing
the threat of inflation.

Today, it's clear Mr. Greenspan was correct. By
not raising rates, the Fed allowed the economy to
continue growing and unemployment to drop to its
lowest level in a generation, even as inflation
edged downward. Other central banks "would
have clamped down," says Nobel Prize-winning
economist Robert Solow of the Massachusetts
Institute of Technology. "[Mr. Greenspan] refused
to be slave to a doctrine. He kept saying, 'Let's
look around us and see what's happening, and act
accordingly. "
SO GREENSPAN SAW THE ‘NEW
ECONOMY’ BEFORE ANYONE ELSE
AND THUS, DID NOT TAKE AWAY THE
PUNCH BOWL
 NOTE PART OF THE TITLE OF
ARTICLE: Did He Help Create a Bubble?

NOW, ON TO THE FACTS
And remember the phrase,
higher productivity allows firms to
pay higher wages and increase
profits without raising prices.
ALSO, RECALL THE OLD
(‘TRADITIONAL SPEED LIMITS
OF THE ECONOMY’)

PGE 2.5%
 NAIRU 5.5%
Interpret the following in terms of
the traditional ‘speed limits’ of the
economy
Recall the implications of a surge
in productivity growth: What are
some priors???

What about Real wages??
 What about profits and thus the value of the
stock market?
 What about labor market conditions?
 What about economic growth?
 What about inflation?
First pic – the percent change in
nominal wages.
The second pic – some inflation
numbers.
So inflation was very well
behaved (leave punchbowl!)
So real wages were rising, since
the percent change in nominal
wages exceeded, for the most
part, the percent change in prices
What are the implications on the
amount of people employed?
So more people are working and
they are making a higher real
wage since they are more
productive – so what is
happening to the size of the
economic pie?
What is happening to tax
(personal income tax and
corporate income tax) revenue ?
Why?
Government outlays???
What about profits? The stock
market? Two pics

The Dow since 1995
The Nasdaq since 1995
So this was the goldilocks
economy – people were working,
making higher real wages,
making gains in wealth in the
stock market, had job security
and were very confident in things
(the future was so bright you had
to wear shades!)
Check out this pic – remember,
consumption accounts for 70% of
our economy (the economic pie)
What about investment?
Inv es tment as a Perc entage of GDP
19
18
17
16
15
14
13
80
82
84
86
88
90
92
94
96
98
00
02
Discuss two important facts:
One – the impact of capital flows on interest
rates.
 Two – the implications of all this
investment on future productivity growth
(thus the phrase, the future was so bright we
had to wear shades – or alternatively, the
bubble had formed!)

Show what all this looks like in
aggregate demand and
aggregate supply space
Discuss the value of the US
dollar during this time and it’s
influence of AS and AD.

AS: The value of the US Dollar and its
impacts of commodity prices.
 AD: The value of the US Dollar and its
impact on NX (a drag on economy)
End of New Economy
Introduce the Loss Function with
help from the misery index

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