MACROECONOMICS

MACROECONOMICSMacroeconomic AccountingMoney SupplyClassical Growth model: IS-LM model

Angelo Gabrielle F. SantosOUTLINEMacroeconomic AccountingWhat are the different measures of economic performance?What are the components of the Balance of Payment (BOP) account?When does the BOP surplus/deficit arise?Angelo Gabrielle F. SantosMacroeconomic AccountingOR:Wherein:Y = Gross Domestic ProductNX = Net exports

Note: CA = NX + net unilateral transfers

Angelo Gabrielle F. SantosDifference between GDP and GNPGNP is a measure of economic activity by every citizen of a country, regardless of location; while GDP is a measure by location.E.g. GNP- output produced by every Filipino around the world; GDP- output produced in the Philippines including those of foreigners. Angelo Gabrielle F. SantosDifferent measures of economic activityNet National Product (NNP):= GNP depreciation2. National Income:= NNP indirect business taxes3. Personal Income (PI):= NI income earned but not received + income received but not earned4. Private Disposable Income (Y-T) or (Yd)= PI personal taxes

Angelo Gabrielle F. SantosMacroeconomic AccountingBalance of Payment (BOP) Accounts

Where:CA = Current AccountKA = Capital AccountFA= Financial Account

Angelo Gabrielle F. SantosCurrent Account (CA)Includes (X-M) goods and services, and unilateral transfers.Exports and inward remittances are positive entries in the BOP sheet.Example: OFW sends money to relatives in the Philippines. This is recorded as a positive entry in the balance sheet.

Angelo Gabrielle F. SantosCurrent Account DerivationWherein:T= taxesSp= household savingsSg= government savingsSn= national savings

Angelo Gabrielle F. SantosFinancial Account (FA)E.g., portfolio investments, foreign direct investments, paper assets, etcInflows of these instruments are recorded as positive entries in the balance sheet.Example: A Japanese corporation buys treasury bonds in the Philippines. This is a positive entry for the Philippines balance sheet, while it is a negative entry for Japans balance sheet.

Angelo Gabrielle F. SantosBOP Surplus or Deficit

Wherein FA(official) is the official reservesettlement balance. Angelo Gabrielle F. SantosBOP Surplus or DeficitFA (official) is negative (positive) in order to offset the change in CA and/or FA (private). I.e., if CA + FA (private) > 0, then FA (official) is negative (positive), and there is a BOP surplus (deficit).For deficit (surplus) to clear out, the Central Bank has to sell (buy) currency at the Foreign Exchange market. International reserves would fall (rise).Angelo Gabrielle F. SantosOUTLINEMoney SupplyWhat are the functions of money?How did money evolve?What are the classification of monetary aggregates?What are the components of the central banks and the banking systems balance sheets.What are the quantitative tools of monetary policy?

Angelo Gabrielle F. SantosFunctions of MoneyMedium of ExchangeSuppose: a barter economy with n commodities. Then, there are set of prices due to the problem of double coincidence of wants. 2. Unit of Account- prices in terms of money rather than other goods.3. Store of Value- money used to purchase future goods by foregoing current purchases.

Angelo Gabrielle F. SantosEvolution of MoneyCommodity moneyE.g., gold, cigarettes in POW camps (see Radford,1945)*Fiat money- Faith that a paper bill, with almost no intrinsic value is recognized by law.E.g. paper bills, coinsE-moneyE.g., Globe G-cash, Paypal, credit card payments

Angelo Gabrielle F. SantosRadford,R. (1945), The Economic Organization of a POW Camp, Economica. http://www.clsbe.lisboa.ucp.pt/docentes/url/jcn/ie2/0POWCamp.pdfMishkin, Economics of Money and Banking14Monetary Aggregates

Angelo Gabrielle F. SantosMonetary AggregatesM1 includes currency in circulation, demand deposits and travellers checksM2 includes M1 and quasi-money (e.g., savings deposit, small-term time deposits)M3 includes M2, long-term time deposits, and repurchase agreements.Note! The Central Bank looks at M3

Angelo Gabrielle F. SantosFrom Mishkin16Central Bank Balance SheetAssetsLiabilitiesGovernment SecuritiesCurrency in circulationLoans to Financial Institutions (Discount loans)Reserves of the Banking SystemInternational ReservesAngelo Gabrielle F. SantosExample: BSPs Asset side of the Balance Sheet

Angelo Gabrielle F. SantosExample: BSPs Liabilities side of the Balance Sheet

Angelo Gabrielle F. SantosBalance Sheet of the Banking SystemAssetsLiabilitiesSecurities Deposits Reserves (liability of the BSP)Borrowings from the BSP and other banksLoans to individuals, corporations, etcAngelo Gabrielle F. SantosQuantitative Tools of Monetary PolicyOpen Market Operations (OMO)Example: BSP buys securities worth P10M from a bank

For the BSP: there is a net increase in MB

For the bank: no net effect

Assets (BSP)Liabilities (BSP) P10M securities P10M reserves Assets (Bank)Liabilities (Bank) P10M securities P10M reservesAngelo Gabrielle F. SantosQuantitative Tools of Monetary PolicyExample: BSP buys securities worth P10M from non-bank public

Net effect: IncreaseAssets (BSP)Liabilities (BSP) P10M securities P10M reserves Assets (Bank)Liabilities (Bank) P10M reserves P10M depositsAngelo Gabrielle F. SantosQuantitative Tools of Monetary PolicyCont: Then, non-bank public encashes the check and holds the currency

Assets (BSP)Liabilities (BSP) P10M securities P10M currency in circulationAssets (Bank)Liabilities (Bank) P10M securities P10M currency Angelo Gabrielle F. SantosQuantitative Tools of Monetary PolicyDiscount loans ()Reserve Ratio RequirementBSP uses the repo market

Angelo Gabrielle F. SantosSee (Mishkin) read Econ 121 ppt24Derivation of the Money Multiplier (mm)

Angelo Gabrielle F. Santos25Derivation of the Money MultiplierUsing (2)

Using (3)

Using (4)

Angelo Gabrielle F. SantosDerivation of the Money MultiplierUsing (1)Using (4.3)

Using (5)Let

Where MB= asset side of the CBs balance sheet Angelo Gabrielle F. SantosChannels of Monetary Transmission (Mishkin, 1996)Interest Rate Channel

Inverse relationship between price of bonds and the interest rate ( )Excess supply of money (ESM) => Excess demand for bonds (EDB)

Exchange Rate ChannelEquity Price Channel (Via Tobins Q) Others: see (Mishkin, 1996)

Angelo Gabrielle F. SantosInverse relationship between price of bonds and interest rateIs equal to the present value of cash flows arising from the asset.Present value formula:

Where: PV= present valueCF= cash flowFV= future valuei= interest rate

Angelo Gabrielle F. SantosDifferent Types of LoansSimple Loan

Fixed Payment (FP) LoanPrice of asset= present value of cash flows

Angelo Gabrielle F. SantosDifferent Types of LoansCoupon Bond: let C= coupon payment

Discount Bond

Angelo Gabrielle F. SantosDifferent Types of LoansConsol or PerpetuityIs a coupon bond with no maturity (FV=0).Coupons are paid forever.

Geometric Series:

Angelo Gabrielle F. SantosDerivation of the Price of ConsolUsing formula of infinite geometric series on the denominator

Angelo Gabrielle F. SantosESM and EDBAn increase in the money supply leads to excess supply of money (ESM). An ESM leads to an excess demand for bonds (EDB).Suppose there are only two assets: money and bondsThere is asset market equilibrium (i.e., asset supply = asset demand)Angelo Gabrielle F. SantosESM and EDBIn real terms: Asset market equilibrium

Where L is real money demand

Angelo Gabrielle F. SantosThree Cases for Asset Market EquilibriumMoney market equilibrium and bonds market equilibriumWhen and Excess supply for money and excess demand for bondsWhen and Excess demand for money and excess supply for bondsWhen and