Politica Economy of Italy prof. Magliulo

MAIN DATABASE

FRED: https://fred.stlouisfed.org/

OECD: https://data.oecd.org/

UE AMECO: https://ec.europa.eu/economy_finance/ameco/user/serie/SelectSerie.cfm

EUROSTAT: https://ec.europa.eu/eurostat

ISTAT: http://dati.istat.it/?lang=en

IMF: https://www.imf.org/en/Countries/ITA

LECTURE 3 – EXPLAINING THE ECONOMY

Key Question: How Can We Explain the Working of an Economic System in the Short and in the Long Run?

1. Some Evidence

   • Positive and negative correlation between macroeconomic goals (full employment, price stability) and also variables. The meaning is we are going to face a twofold challenge
   • A twofold hard challenge:
     1. LR: sustainable growth (stabilize the economy)
     2. SR: full employment equilibrium (stabilizing actual GDP around potential GDP, i.e. mitigating business cycles), exploit at best

2. The Condition of Equilibrium

3. The AD-AS Model, simplest model to show the working of an economy in the SR or LR

The existing resources. Take the actual GDP to the potential GDP

ECONOMIES ACROSS TIME AND SPACE Real GDP per capita.

US strong.

China: is going to converge, they are closer.

In general, first impression is the positive trend of growth.

Looking at China and India: stagnation economy. In US instead, cyclical growth and business cycle.

Someone could say: the peak is during WWII, but they were producing dangerous goods. Not a linear growth, but cyclical.

Period of great recessions and other of bad growth.

US UNEMPLOYMENT RATE, 1920- 2003 Positive or negative correlation between growth output and unemployment. When the economy experiences a drop in production, at the same time experiences a raise in unemployment.

US ANNUAL INFLATION RATE, 1922-2003 In 1930 drop: deflation. During the great depression, they experiences a drop in production, a raise in unemployment a drop in price level. Negative price level, below zero: deflation.

After the end of WWII big inflation. Output, GDP, unemployment, inflation: reciprocal

relationsGDP for China. Percentage change in GDP: fluctuation in GDP. Positive and negative relations with employment and inflation. Nowadays the inflation rate is more or less 1%, during the '70 more than 20%. Then, a drop. Advantages and disadvantages of euro: before euro, more than 20%. 2 POTENTIAL AND ACTUAL REAL GDP In the SR the challenge, every year the goal is to achieve potential output. In the LR the challenge is to increase potential output. Deflationary gap at half (below potential), at the end inflationary gap (above potential). POTENTIAL AND ACTUAL GDP • Potential GDP: the maximum sustainable level of output producing with the available resources, without triggering an inflation process. Massimo livello di produzione ottenibile con K, L senza generare pressioni inflazionistiche. • The level of output economy could produce if the resources were full employed. In particular it indicates what the economy would produce if labour were fully employed at normal level and plants and

machines were used at their normal rates

Actual GDP can temporarily exceed potential GDP: workers may be willing to put in extra overtime (machines also)

OUTPUT GAP

Output gap is the difference between actual (Y) and potential GDP (Yp) in percentage terms

Output gap = (Y-Yp) / Yp (90-100)/100=-10/100 = - 10%

When the Output gap > 0, output is above potential. - Labour and capital are employed above their normal levels.

When the Output gap < 0, output is below potential. - Labour and capital are employed below their normal levels.

During booms the output gap is positive. We are experiencing an inflationary gap.

During recessions the output gap is negative. We are experiencing a deflationary gap.

A TWOFOLD QUESTION

How to increase potential GDP? (economic growth). Theory of economic growth, how can I improve the standard of living of our country looking at the next decade, future

How to stabilize actual GDP

Around potential GDP? (business cycles). Mitigate business cycle, economic fluctuation.

A simple model: AD-AS. It should be able to provide a tool for understanding. Evidence shows us that growth and business cycles are the main phenomena of macroeconomics. Inflation and unemployment are connected to them.

32. MACROECONOMIC EQUILIBRIUM

In order to explain cycles and growth, we have to describe the equilibrium condition. If we could, we would like to stay day by day alongside the potential line, but it is not possible. The basic condition of macroeconomic equilibrium is that aggregate demand is equal to aggregate supply, that is to say when something happens within the economy. We have macroeconomic equilibrium when savings are equal to investments. St = I. St (total saving) is national saving and foreign saving. St = Sn + Sf.

Static (and Dynamic) Equilibrium

MACROECONOMIC EQUILIBRIUM /1

If a company cannot sell the entire production, for ISTAT it is not important: for ISTAT considers

the unsold goods as unplanned inventories (Fiat produce 100 auto, ne vende 90. Le restanti 10 è come se fossero vendute alla FIAT stessa: scorte indesiderate). So, for the ISTAT the unplanned inventories is a component of aggregate demand, but is different from a macroeconomic perspective because if a country is experiencing a drop in aggregate demand, in the SR adapts the production to a lower level of AD. Here we transform identity in an equation.

GDP represent also the aggregate supply. Y+ Im = C + I+ G + Ex, that is Y = C + I + G + NX where Y = GDP; C = consumption; I = Investment; G = government expenditure NX = net export = export – import

Example:
• 100 (GDP) = 70+15+20–5
If C+I+G > GDP then NX = < 0
• If 70+15+20 >100 then NX= - 5

The sum of C, I, G is named domestic demand (domanda interna). Domestic production 100, domestic demand is higher.
• In a closed economy, a country couldn’t spend more than domestic production. In our example without

international trade, it wouldn't be possible to demand, consume, spend more than the domestic production. But if we introduce the economic international relation, in this example we see that this country is producing goods and services for a value of 100 and is consuming goods and services for a value of 105. Domestic demand exceeds domestic production. Someone could say this is a bad scenario, in imbalance. No, it is possible to run a trade deficit. The meaning is it is possible to spend more than the domestic production just because this country is running a trade deficit. It consumes 105 and it produces 100. It can consume 105 because it imports goods and services for a value superior to that of the goods it exports. In an open economy, the domestic demand of a country can exceed the domestic production but the country must attract foreign capitals/savings (see balance of payments). Europe and US before the last great recessions, had a picture like this one. In particular, America was.running a trade deficit attracting savings from China.

THE BALANCE OF PAYMENT

The balance of payment shows us the inflow/ outflow of capital.

• The balance of payments is a statistical summary of the transactions of a given economy with the rest of the world.
• It comprises three elements (but the main ones are the current account and financial account):
1. The current account covers international transactions in goods, services, income, and current transfers. Here we find exports and imports and travels (outgoing and ingoing tourism).
2. The capital account covers international capital transfers (e.g. debt forgiveness) and the acquisition/disposal of non-produced, nonfinancial assets (such as patents).
3. The financial account deals with transactions involving financial claims on, or liabilities to, the rest of the world, including international purchases of securities, such as stocks and bonds. DFI and investments in portfolio.

A country can have a current account deficit (imports more than it exports) and attract savings from other countries, such as China.

than export) and an inflow of K at thesame time.The trade world between America and China originated by the trade deficit. Trump wanted to reduceit, imposing duties to Chinese goods and services.Difficult equilibrium: to consume more and more you have to attract foreign countries.This table comes from ICEreport. 5MACROECONOMIC EQUILIBRIUM / 2• By definition, total output equals total income Y (with some arrangements)• Household income (Y) is divided between consumption and saving. First key choice ofhouseholds. Average propensity to consume: in Italy in the past 80% for consumption and 20%for savings, nowadays is 90% for consumption and 10% for savings, approximately.• Total Demand (D) is equals to C + I (at first we exclude G and NX). Example:Y = C + S 100 = 80 + 20D = C + I 100 = 80 + 20Savings is itself a leakage:• S = leakages = Income earned, but not spent, by households during a given year. Savings is itselfan act of leakage. In the macroeconomic system we

Leakages and Injections in the Economy

In the economy, there are leakages and injections. Leakages refer to savings that are not used for investment, such as money kept under the mattress or in banks' demand deposits that cannot be used for financing investments. On the other hand, injections refer to savings that are used for investments, such as buying shares. These savings come from households and are used to stimulate investments. When savings are not invested, it creates a gap in the economic cycle.

The following equations help us understand the relationship between leakages and injections:

• I = injections = Spending by firms and government
• When leakages equal injections, total spending equals total output
• If S = I (20 = 20), then Demand = Supply (100 = 100)
• If S < I (10 < 20), then Demand > Supply (110 > 100)

When internal demand exceeds internal production, internal investment (20) exceeds internal savings (10). In this case, savings are considered as income from public and private consumption. Therefore, attracting foreign savings becomes necessary to finance the trade deficit.

If internal demand exceeds internal production, it indicates that there is a

internal savings are not sufficient to finance investments and there is a need to attract foreign savings. Is the country in a position or indebt, and is it not using that foreign saving for investment but for unproductive spending? The sense is that a country in macroeconomic equilibrium can sustain a trade deficit, provided that it is able to attract foreign capital to finance investments.

MACROECONOMIC EQUILIBRIUM / 3

The role of uncertainty: data room (2/2019):

• If C + I + G > GDP then NX= < 0 and I > Sn (Europe and Usa: run exactly this situation.)
• If (70 + 15 + 20) > 100 then NX= - 5 and I = 15 > Sn=10

Where Sn = Y– C – G that is Sn