lecture notes - chapter 8 - week 8 - macro
TRANSCRIPT
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8/13/2019 Lecture Notes - Chapter 8 - Week 8 - Macro
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Reminder:TEST NEXT WEEK!!!
Chapters 6-8
Chapter 8Perspectives onMacroeconomic Policy
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Chapter 7 explained how the government can use: an easy money policy of lower interest rates, and budget deficits (government spending > tax revenues)
to counter recessions and reduce unemployment,by boosting aggregate demand.
Why, then, has the number of unemployed Canadiansnot gone below 1 000 000 since 1981, and theunemployment rate averaged 9% of the labour forceand only gone below 7% in 5 of those 31 years?
Chapter 8Perspectives on Macroeconomic Policy
Unstable from early 1970s to early 90s
but betterafter late 1990s(until 2009)
Rate ofinflation
Unemploymentrate
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Why Hasnt Canada done better re: Unemployment and Inflation?
A. Partly due to real-world limitationson what can be achieved
B. Partly due to failure of governments in the pastto keep control over two key factors:
1. Obstacles to getting unemployment rate below 7%2. Obstacles to remedying economic prob lems quickly3. International limitations on Canadian economic policies
4. Inflation5. Government budget deficits and debt
The problem of unemployment,and why Canadas unemploymentrate is as high as it is.
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Reasons for Unemployment
1. Cycl icalDue to periodic recessions; adds about 4% points
(700 000 people) to unemployment in recessions .
If govt boosted AggregateDemand:Woulddecreaseconsiderably
2. FrictionalDue to changing of jo bs; br ief. On average, adds about1% point to the unemployment rate .
3. Seasonale.g. agriculture; tourism
Littleeffect
Littleeffect
4. StructuralMismatch of skills required by employers & those ofthe unemployed; can be serious & long-term in nature.
Littleimprovement
Even in a boom , there will still beconsiderable unemployment but how much?
One reason why unemployment is so high is thatcertain groups have a tendency toward highunemployment, and so have high unemploymenteven during economic booms.
In the next 2 slides, we will look atunemployment rates:
(a) in different provinces/regions of Canada, and
(b) among different age groups.
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0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
U n e m p
l o y m e n
t R a
t e
Unemployment Rates by Province, 2012
0
5
10
15
20
25
Overall (age15+)
15 to 19 years 20 to 24 years 25 years andover
P e r c e n t o
f L a
b o u r
F o r c e
U n e m p
l o y e
d
Unemployment Rates by Age, 2012
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Monetary and Fiscal Policies to Reduce Unemployment
Easy MoneyPolicies
BudgetDeficits
Higher Aggregate
Demand
Increased Employment/Lower Unemployment
Higher Ratesof Inflation,
if
Full employment is considered to have been reached when aggregate demand is high enough to generate inflation that is gaining momentum,or accelerating . At that point, unemployment is as low as it can go.
& but also
But how low an unemployment rate is full employment?
demand nearscapacity
How low can the unemployment rate can go withouta problem of accelerating inflation developing?
In the booms of 2000 and 2007, the unemployment ratereached the lowest monthly levels since the mid-1970s(6.0-6.4%), and without inflation accelerating seriously
Full Employment
There is no one number that is the right answer to thiskey question we have to look at how the unemploymentrate actually gets at the peak of economic booms .
full employment appears to nowbe an unemployment rate in the6.5% range
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Even at the very low unemployment rates of 2000 and2007, more than 1,100,000 Canadians were unemployed.Why so many?
What would have happened if the government had triedto push unemployment lower than 6.0%, by boostingaggregate demand even higher ?A potentially serious inflation problem.
But why cant we get unemployment lower?
UnemploymentRate in 2007
Youth (age 15-19) 14.8%Newfoundland 13.6%Prince Edward Isld 10.3%Nova Scotia 8.0%New Brunswick 7.5%National average 6.0%
High-unemployment regions and groups keep the national average high.
The problem of inflation, andhow we learned the hard waywhy it is important to keepinflation under control.
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The Importance of Keeping Inflation under Control
If not kept at low rates, inflation can accelerate .
Risingrate ofinflation
Inflation psychology
Larger paydemands labour costs rise
Buy nowbehaviour demand rises
Rate of inflationcan spiral upwards
0
2
4
6
8
10
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14
70 71 72 73 74 75 76 77 78 79 80 81
R a
t e o
f I n f l a
t i o nThe experience of
the 1970s:inflation that accelerated
How inflation Affects Interest RatesLender/investor earning 6% interest on a loan/investment of $100:
If the rate of inflation were 3%:Your interest incom e would be
While inflation would reduce thepurchasing pow er of your $100 by
$6
-3
For a net gain (before tax) of +$3
If the rate of inflation were 8%:Your in terest income woul d be $6While inflation would reduce thepurchasing pow er of your $100 by
For a net gain (before tax) of
-8
-$2(loss)
What could/would investors do about such losses due to inflation?
They would require higher in terest rates. 11% interest rate- 8% loss to inflation
= 3% real return
CAUSE
HIGHER(EXPECTED)
RATES ofINFLATION
HIGHERINTEREST
RATES
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Inflation, Taxes and the Saving-Investment Process
Economy with low
inflation (3%) & lowinterest rates (6%)
Interest income $6.00
LessLoss to inflation - 3.00= Real return 3.00
Economy with high
inflation (8%) & highinterest rates (11% )
$11.00
- 8.003.00
- 4.40
-$1.40
Discourages business investment spending
Discourages saving
Rapid inflation damages the saving-investment process that is vital to prosperity, by reducing incentives both for people to save and for businesses to invest.
LessIncome tax (33%)
= Return afterinflation & taxes: $1.00
- 2.00
Why High Rates of Inflation became Unacceptable
1970s& 80s:High ratesof inflation
High interestrates & lowreturns to savers
Hurts theeconomically
weak
Less abilityto competeinternationally
Governmentpolicies tocombatinflation
Depressed saving &investment slower productivity growth
Higher unemploymentin export & import-competing industries
Social strains
Eventualrecession(1981-82, 1990-92)
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Inflation Targets
Since 1993, the Bank of Canada & federal government haveagreed upon a target for the rate of inflation of 1 to 3% peryear, with the objective of preventing inflation from againbecoming the problem that it became in the past.
Due to:
this objective requires that the Bank of Canada takeearly action (in the form of higher interest rates) as soonas signs of inflationary pressures appear in the economy.
the long time lags with which anti-inflation policies work
the tendency of inflation to gain momentum
The question of governmentfinances, and how we learnedthe hard way why it is importantto keep budget deficits from
becoming excessively large.
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Year GovtSpending TaxRevenues BudgetDeficit NationalDebt20x1 $50 $50 $0 $100
20X2 60 55
20X3 70 56
20X4 78 68
20X5 76 72
Government Budget Deficits and Debt
What does it take for the government to reduce its debt?Budget SURPLUSES (taxes > government spending)
5 105
14 119
10 129
4 133
Government budget deficits, borrowing and debt are
NOT always badThere are good reasons for governments to borrow :
1. For periodic anti-recessionprograms (Chapter 7)
1.8
1.9
2
2.1
2.2
2.3
2.4
2.5
1 2 3 4 5 6 7 8
G o v
' t D e b
t
Recession(G > T)
Boom(G < T)
Govt Debt
2. To finance social assets(hospitals, schools, etc) ,with the debt paid downover the life of the asset
0
0.2
0.4
0.6
0.8
1
1.2
1 2 3 4 5 6 7
G o v
' t D e
b t
Repay Debt
However,
(offset by budget surpluses duringbooms that are used to pay downgovernment debt)
Borrowonce
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However,Regular annual budget deficits (such as Canada had from themid-1970s to the mid -19 90s) are a very di fferent situation:
These will lead to an upwardspiral of governmentborrowing and debt:
Largeannualdeficits
Steadilygrowinggovt debt
Rising Interest Expenditures
0
2
4
6
8
10
12
14
16
1 2 3 4 5 6 7 8 9 10
GovtDebt
InterestPayments
0
10 0
20 0
30 0
40 0
50 0
8 0 8 2 8 4 8 6 8 8 9 0 9 2 9 4
$ b i l l i o n s
TotalDebt
AnnualDeficits
Federal Government Budget Deficits & Debt
How long can such a situation continue?
Until lenders become so concerned about the borrowersdebt that they demand changes.
$28 billion deficit in 1990 debt rises by $28 billion
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1993: The Critical Point1992-93:
Massive government budget deficits, heavy borrowing fromforeign lenders, government debt rising rapidly; danger ofa debt spiral due to heavy interest payments.
foreign lenders very concerned; credit ratings ofsome provinces downgraded; interest rates increaseddue to risk.Governments were forced to take action to cut deficits:
increase taxes or
Major cuts to government spendingover the 1994-98 period.
reduce government spending
Government Spending Cuts, 1994-98
FederalGovernment
Transfer Payments
ProvincialGovernments
Healthcare
Postseceducation Welfare
The federal governmenttransfers billions of $of its revenues to theprovincial governments,which are responsible formajor social spendingprograms such as healthcare, postsecondaryeducation, and welfare.
When the federal government was forced to cut itsspending, most of the cuts were to transfer paymentsto the provinces cuts to health care, postsecondary education, & welfare
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Cuts in government spending 1994-98+ a surge in government tax revenues due to
rapid economic growth
The Great Budget Turnaround
-50.0
-40.0
-30.0-20.0
-10.0
0.0
10.0
20.0
30.0
Budget Defic its (-) and Surpluses (+)
Budget SURPLUSES after 1997
After 1997, the federal government had budget surpluses (i. e., government revenues in excess of expenditures) for overa decade.What are the three possible uses of such surpluses?
Pay down government debt .
Increase government spending.(eg health care; education)
Reduce taxes.(eg personal & business income taxes)
Federal Government Budget Surpluses
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The Turnaround inFederal Government Finances
1996:66% ofGDP &rising
2008:32% ofGDP
0100200300400500600700
Net Federal Government Debt (Billions of $)
Why the increase in debt after 2008?The recession
Past (Actual) Projected (Future)
But because of the recession, budget deficits occurred.
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The deficits were large in dollar amount, but as a percentageof GDP, appear to be manageable.
The Problem of Time Lags (No quick cures)
Problem (recession or inflation) arises
Problemis clearly recognized
Corrective policies enacted
Policestake effect on economy
RecognitionLag
ImpactLag
(6-12 months)
PolicyLag
Total of these time lags can be 1-2 years.
Implications for government policymakers:
1. Take longer-term view;do not change policies in reaction to short-term situations.
2. Take policy action as soon as possible, to prevent problemsfrom becoming worse.
3. Do not make mistakes and be patient!
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International Limitations on Canadian Economic Policies
In todays globalized world economy, competition between countries for
exports, business i nvestment and skilled people is stronger than ever.
In order to:1. make Canadian industry competitive internationally,2. make Canada attractive to foreign investors, including businesses,3. make Canada an attractive location for skilled people,
Canadian governments have to:
keep taxes (personal & business) reasonable
keep government deficits/borrowing/debt under control keep inflation low (& thus interest rates reasonable)
1. By year 4, the main economic problem is __________________.2. The basic cause of this problem is _______________________.3. The appropriate fiscal policy is _____________,
which would ________________________ aggregate demand.4. The appropriate monetary policy is _____________,
which would _____________________ aggregate demand.5. The undesirable side-effect of these policies is that if used
too strongly, they would _________________.
unemploymentlow aggregate demand
budget deficits
stimulate (increase)Easy Money
stimulate (or increase)
risk of high inflation
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1. By year 4, the main economic problem is _________________.2. The basic cause of this problem is ______________________.3. The appropriate fiscal policy is _________________________,
which would ____________________ aggregate demand.4. The appropriate monetary policy is _______________,
which would ____________________ aggregate demand.5. The undesirable side-effect of these policies is that they
would _______________________________________.unemployment / could push into a recession
high aggregate demandbudget surplus
depress (or decrease)Tight Money
depress (or decrease)
risk of high inflation
Next:Chapter 9: International Trade
Do the Self-Check questions on SLATE.Do the Review Questions and CriticalThinking questions at the end of Chapter8, and check your answers in theappendix to the text.