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N i k o l a o s L i o n i s
U n i v e r s i t y O f A t h e n s
( F e b r u a r y 2 0 1 7 )
1
Economic Policy
Government in the Marketplace 2
Public Policy
Competition (antitrust) policies
Regulation policies
Taxation and subsidizations
Trade regulations
Price and wage controls
Investment incentives
Employment incentives
Macroeconomic policies
etc.
Macroeconomic Policies Microeconomic policies
Fiscal
Monetary
Regulation
Competition
Industrial
Technological
Environmental
Public enterprises
etc
3
Government in the Marketplace
4
Macroeconomics
vs. Microeconomics
Macroeconomics Microeconomics
Behaviour of entire economies No matter how small
Assume most details Resource allocation & income
distribution is relatively unimportant
Aggregation
Combine many individual markets into one overall market
Macroeconomic variables: aggregate output, inflation, unemployment, …
Top-down approach to analyzing economy
Behaviour of individual units No matter how large
Focus on individual markets Allocate resources and distribute
income
Ignore macroeconomics issues
Bottoms-up approach to analyzing economy
5
Macroeconomics vs. Microeconomics
6
Microeconomics
Microeconomics 7
Behavior of economic agents. No matter how large (individuals, firms, governments).
Study agents’ decisions regarding the allocation of scarce resources (goods) and agents’ interactions in narrowly-defined markets.
Analyze market mechanisms (supply and demand) and determine market (partial) equilibrium. Conditions under which (free) markets lead to desirable allocations
and ...
... market failures, i.e. where markets fail to produce efficient results.
Areas of Microeconomic Research 8
Industrial organization/economics examines structure , behavior and equilibrium in imperfectly competitive markets.
Labor economics examines structure and equilibrium of the labor market (wages, employment, and labor market dynamics).
Financial economics examines risk and return of assets, structure of optimal portfolios, corporate financial behavior.
Public economics examines the design of government tax and expenditure policies and economic effects of these policies.
Political economy (new) examines the role of political institutions in determining policy outcomes.
Health economics examines the organization of health care systems and health insurance programs.
Urban economics examines the challenges faced by cities (air and water pollution, parking spaces, traffic congestion, poverty).
Law and economics examines law, legal regimes and institutions (design, enforcement, efficiencies).
etc
Supply & Demand in Microeconomics 9
Individual Demand It represents the quantity of a good that a single consumer would buy at a specific
price.
Market Demand It represents the total quantity demanded by all individuals (consumers) Sum of all individual demands.
Individual Supply It represents the quantity of a good that a single producer would produce at a
specific price.
Market Supply
It represents the total quantity supplied by all producers (firms) Sum of all individual supply schedules.
Market Equilibrium 10
0
Quantity
Pri
ce
D
D
Q0
S
S
P0
E
11
Macroeconomics
Macroeconomics 12
Behavior of the economy as a whole. No matter how small (national, regional, and global economies).
Study aggregated indicators such as GDP, national income, unemployment, price indices, inflation, consumption, savings, investment, international trade and international finance and the interrelations among the different sectors of the economy.
Analyze how the whole economy functions. Deals with the performance, structure, behavior and decision-
making of an economy as a whole.
Supply & Demand in Macroeconomics 13
Aggregate demand (AD) curve Quantity of domestic product
demanded at each possible value of price level
Aggregate supply (AS) curve Quantity of domestic product
supplied at each possible value of price level
0
Quantity
Pri
ce
AD
AD
Q0
AS
AS
P0
E
Gross Domestic Product (GDP) 14
GDP measures the monetary value of final goods and services, i.e. those that are bought by the final user, produced in a country in a given period of time Add up money values All final goods & services
Produced - domestic economy Sold – organized markets
Nominal GDP
GDP in current monetary units (€) Value outputs at current prices
Real GDP
GDP in constant monetary units (€) Value outputs of different years at common prices
Components of GDP by Expenditure 15
GDP (Y) is the sum of consumption (C), investment (I), government spending (G) and net exports (X – M).
Y = C + I + G + (X − M)
C (consumption) consists of private expenditures in the economy (household final consumption expenditure).
I (investment) includes, for instance, business investment in equipment (not exchanges of existing assets) and spending by households (not government) on new houses. Note that I does not include purchases of financial products. Buying financial products is classed as 'saving‘.
G (government spending) is the sum of government expenditures on final goods and services. It includes salaries of public servants, purchases of weapons for the military and any investment expenditure by a government. It does not include any transfer payments, such as social security or unemployment benefits.
X (exports) represents gross exports. GDP captures the amount a country produces, including goods and services produced for other nations' consumption, therefore exports are added.
M (imports) represents gross imports. Imports are subtracted since imported goods will be included in the terms G, I, or C, and must be deducted to avoid counting foreign supply as domestic.
Areas of Macroeconomic Research 16
Economic Growth
Understand the determinants of long-run increases in national income.
Business Cycle
Understand the causes and consequences of short-run fluctuations in national income
Economic Growth 17
0
Domestic Product
Pri
ce L
ev
el
D0
D0
Q0
S0
S0
D1
D1
Q1
E
S1
S1
C
Economic Recession 18
S
S
0
Domestic Product
Pri
ce L
ev
el
D0
D0
Q0
P0
D2
D2
P2
Q2
E
B
Recession Total output declines
(Production falls, People lose jobs)
Inward shift of AD curve
GDP in Greece 19
GDP in Eurozone 20
Business Cycles: Eurozone and Greece 21
Macroeconomic Policies 22
Stabilize the economy
Short run economic fluctuations (business cycle)
Long run economic growth
Fiscal policy
• Government revenue (taxation)
• Government expenditure
• ... Country’s debt
Monetary policy
• Money supply
• Interest rates (money demand)
• ... Exchange rates
23
Macroeconomic Stabilization
Macroeconomic Stabilization 24
Stabilization policy
Prevent or shorten recessions
Counteract inflation and stabilize prices
Economic Recession 25
S
S
0
Domestic Product
Pri
ce L
ev
el
D0
D0
Q0
P0
D2
D2
P2
Q2
E
B
Recession Total output declines
(Production falls, People lose jobs)
Inward shift of AD curve
Inflation 26
0
Domestic Product
Pri
ce L
ev
el
D0
D0
S
S
P0
D1
D1
P1
E
A Inflation
Sustained increase in price level Outward shift of AD curve
Stagflation 27
0 Domestic Product
Pri
ce L
ev
el
D
D
S0
S0
E
S1
S1
A
Stagflation
The effects of an adverse AS shift
Fight Unemployment 28
D1
D1
0 Real GDP
Pri
ce L
ev
el
D0
D0
S0
S0
E
A
Increase in output
Increase aggregate demand Government - Fiscal
policy Increase spending Cut taxes
Central Bank - Monetary policy Lower interest rates
Increase output Reduce
unemployment Raise prices
Fight Inflation 29
0
Real GDP
Pri
ce L
ev
el
D0
D0 S
S
D2
D2
E
B
Decrease in prices
Decrease aggregate demand Government - Fiscal
policy Cut spending Increase taxes
Central Bank - Monetary policy Increase interest rates
Decrease inflation (decrease prices)
Decrease output Increase
unemployment
Effects of Favorable Supply Shifts 30
0 Real GDP
Pri
ce L
ev
el
D0
D0
S0
S0
D1
D1
E
S1
S1
C
S2
S2
B
Growth enhancing structural reforms Micro policies
Increase output Reduce unemployment Price stability
31
Eurozone, Current Crisis and Stabilization
Maastricht Criteria 32
The Maastricht convergence criteria are the criteria for EU member states to enter the third stage of European Economic and Monetary Union (EMU) and adopt the euro as their currency. They impose control over inflation, public debt and the public deficit, exchange rate stability and the convergence of interest rates.
The purpose of setting the criteria is to maintain price stability within the Eurozone.
1. Inflation rates: No more than 1.5 percentage points higher than the average of the three best performing (lowest inflation) member states of the EU.
2. Government finance:
Annual government deficit: The ratio of the annual government deficit to GDP must not exceed 3% at the end of the preceding fiscal year.
Government debt: The ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year.
3. Exchange rate: Applicant countries should have joined the exchange-rate mechanism (ERM II) under the European Monetary System (EMS) for two consecutive years and should not have devalued its currency during the period.
4. Long-term interest rates: The nominal long-term interest rate must not be more than 2% higher than in the three lowest inflation member states.
Eurozone, ECB and Monetary Policy Inflexibility
33
Membership of the Eurozone establishes a single monetary policy for the respective states.
European Central Bank Fully independent Primary objective is to maintain price stability within the Eurozone (Treaty on the Functioning
of the European Union). The Governing Council defined price stability as inflation of under 2% over the medium term
(Harmonised Index of Consumer Prices for the euro area).
Member states can no longer use an isolated monetary policy to increase their
competitiveness (at the cost of other eurozone members) by Printing money and devalue, or Printing money to finance excessive government deficits or Pay interest on unsustainable high government debt levels.
If member states do not manage their economy in a way that they can show a fiscal
discipline (as they were obliged by the Maastricht treaty), they will sooner or later risk a sovereign debt crisis without the possibility to print money as an easy way out.
Eurozone and Ongoing Fiscal Compliance 34
Under the convergence criteria, member states must have their economies in order.
Stability and Growth Pact (1997) required ongoing fiscal compliance. Inflation below 1.5 %. Budget deficits below 3% of GDP. Debt-to-GDP ratio of less than 60%.
To meet these criteria, many countries had to adopt strict budgetary
reforms.
In practice, these standards were not consistently applied. weak due diligence in assessing the suitability for entry into the euro. equally weak application of the few rules that were supposed to police its operation. … paving the way for future problems.
“French” Philosophy “German” Philosophy
Discretion Active management
o Breaking rules if additional flexibility helps
Current crisis management
o Commit future to fix current crisis o No default (low interest rate) o No exit (no currency attacks)
But…. Time inconsistency problem
o What is optimal ex ante is not optimal ex post o eg. government’s temptation to default or monetize debt
Exposure in much more severe future crisis
Solidarity Fiscal union
o Fiscal transfers as an insurance /convergence mechanism o … but without fiscal control to Brussels???
Moral hazard problem
o Permanent fiscal transfers
Rules Autonomous rule-based framework – no ad
hocery o Rules guide market expectations o Commitment to rules yields long-term benefits
Future crisis prevention
o Safety valves for current crisis o (Some) debt restructuring
But … Unforeseen contingencies
Liability
No bailout clause/rule o Maastricht: Monetary bailout through monetization of
debt and fiscal bailout were made illegal.
Incentive for fiscal authority to behave
prudently o No bailout clause as a market discipline.
35
Eurozone and Stabilization Policies
“French” View “German” View
Output gap/Convergence theory Countries with lower GDP were catching up with the core
eurozone countries in which GDP was higher
Liquidity Current crisis’ funding shortages is a pure liquidity
problem.
A country’s finances are liquid if it can obtain enough funds to serve all its current funding obligations. o Financial frictions might prevent a country from
obtaining necessary funds. o A country can suffer from liquidity problems even
when it is solvent.
An illiquidity problem can easily morph into an insolvency problem.
Country’s illiquidity can be solved if central bank can print money.
Unsustainable credit boom GDP growth was simply driven by cheap credit and the
growth path was unsustainable
Solvency
Current crisis’ funding shortages is a sign of insolvency due to earlier fiscal or banking sector excesses.
A country is insolvent if providing an extra euro of
(bailout) funds yields less than the euro put in. o When tax revenues fall short of expenditures, the
extra euro will be partially used up for paying off existing creditors.
Liquidity won’t solve the underlying structural
problems.
Insolvency can be solved through structural reforms and an early debt restructuring. o Without debt default, only tax increases,
expenditure cuts or growth enhancing structural reforms can make the country solvent again.
36
Eurozone and Stabilization Policies
“French” Policy “German” Policy
Output gap and liquidity crisis
Keynesian Stimulus
(Demand side)
Increase government spending financed by government borrowing Government expenditure is more effective than tax cuts
But …
If supply does not react demand shock will simply translate into inflation
Fiscal stimulus might spill over to other countries than help the country itself (eg. imports)
Reforms in boom
Eurobonds with joint liability (solidarity)
Unsustainable credit boom and insolvency
Austerity/Reform (Supply side)
Fiscal rules to limit public debt level No extra government expenditure
Balance budget
Debt brake
Reforms in crisis Correct structural problems in public and private sector
But …
Disruptive in the short run and only boost the economy in the long run
Political economy problem (myopic politicians)
European Safe Bonds (ESBies) to avoid any joint liability
37
Eurozone and Stabilization Policies
Keynesian Stimulus: Demand Side Economics 38
D1
D1
0 Real GDP
Pri
ce L
ev
el
D0
D0
S0
S0
E
A
Increase in output
Increase AD Government - Fiscal
policy Increase spending Cut taxes
Central Bank - Monetary policy Lower interest
rates Print money
Increase output Reduce
unemployment Raise prices
Austerity and Reform: Supply Side Economics
39
0 Real GDP
Pri
ce L
ev
el
D0
D0
S0
S0
D1
D1
E
S1
S1
C
S2
S2
B
Growth enhancing structural reforms Micro policies
Increase output Reduce unemployment Price stability
40
Useful Data
Interest Rates on 10-year Government Bonds
41
Greek Current Account Balance (% GDP) 42
Greek Corporate and Household Deposits
Political Risks Business Confidence in Greece and Eurozone
44
Source: Berenberg
Nominal GDP, Real GDP, Real GDP Per Capita in the U.S.
45
The Growth Rate of U.S. Real GDP 46
Δείκτης ρύθμισης αγοράς και σχέση με την παραγωγικότητα
47