Principles of Macroeconomics

Y=C+I+G+NX

Encourage saving and investment.
Encourage investment from abroad.
Encourage education and training.
Establish secure property rights and maintain political stability.
Promote free trade.
Promote research and development.

Unemployed: A person is considered as unemployed, if that person does not have a job and(!) is able and available (willing) to work at current wage rates

1. Frictional unemployment due to job search, and
2. Structural unemployment due to
   1. minimum wage laws
   2. unions
   3. efficiency wages (above-equilibrium wages paid by firms in order to increase worker productivity.

Credit default swaps (CDS) is a means by which a bondholder can insure against the risk of default.

Y=C+I+G+NX => closed economy, NX=0

Y-C-G=S=I

S=(Y-T-C)+(T-G) private and public saving

It is attractive to save so the supply of loanable funds increases

increases the incentive to borrow => increases the demand for loanable funds.

Government borrowing to finance its budget deficit reduces the supply of loanable funds available to finance investment by households and firms. This fall in investment is referred to as crowding out.

It is where consumption is maximized, which means Y'=D

1. Medium of exchange
2. Unit of account
3. Store of value

• Act as a banker’s bank, making loans to banks and as a lender of last resort.
• Conducts monetary policy
  • by controlling the money supply
  • by controlling the internal value of the currency (price stability)
  • by controlling the external value of the currency (exchange rate)

• Open-Market Operations
  • The CB conducts open-market operations when it buys government bonds from or sells government bonds to the public:
    •  When the CB buys government bonds, the money supply increases.
    • The money supply decreases when the CB sells government bonds.
• Reserve Requirements
  • Reserve requirements are regulations on the minimum amount of reserves that banks must hold against deposits.
    • Increasing the reserve requirement decreases the money supply.
    • Decreasing the reserve requirement increases the money supply.
• The Discount Rate
  • The discount rate is the interest rate the CB charges banks for loans.
    • Increasing the discount rate decreases the money supply.
    • Decreasing the discount rate increases the money supply.

\(MM= \frac {1}{R}\)

R=Reserve requirenment

An Unconventional Policy Instrument used by Central Banks when other instruments are not effectful anylonger in the event that bank do not lend sufficient money to each other (financial crisis 2008).

The central bank injects money into the system.

• It buys assets from private sector institutions such as banks, pension and insurance companies.
• So the reserves of the private sector institutions increase.
• In theory these institutions should have more money to lend.

• since late 1990 banks broadened the scope of their activities to generate higher profits
• Deregulation of financial markets allowed to give out higher amount of loans to riskier customers (sub primes)
• Securitization of the loans via
  • Mortgages lenders were allowed to package up loans and sell them, rating firms gave ratings for such packages
  • Set up a subsidiary company, known as a special purpose vehicle (SPV). The SPV issues shares that may be bought by other investors and then buys the packages of debt
  • insurance in the form of credit default swaps (CDS).

=> complex web of financial transactions that built high levels of interdependence amongst those involved, but few had any real knowledge of the extent of this interdependence

=> whole structure depended on the ability of mortgage borrowers

=> in the 2000s number of borrowers defaulting on their repayments increased

=> system got destabilized

\(V=\frac { (P\cdot Y) }{M}\)    =>   \(V\cdot M=P \cdot Y\)

V: velocity

P: price level

Y: quantity of output

M: quantity of money

When the government raises revenue by printing money, it is said to levy an inflation tax.

An inflation tax is like a tax on everyone who holds money.

No, it doesn't!

This is true only in the short run, when nominal wages are fixed by contracts. In the long run, the real wage is determined by labor supply and the marginal product of labor, not the price level or the inflation rate.

1. Shoeleather costs

2. Menu costs

3. Relative price variability

4. Tax distortions

5. Confusion and inconvenience

6. Arbitrary redistribution of wealth

Because the CB cannot control the amount bankers choose to lend or the amount households choose to deposit in banks, the CB’s control of the money supply is imperfect

An allocation is Pareto efficient if no individual can be made better off without another being made worse off

Both tariffs and import quotas . . .
raise domestic prices.
reduce the welfare of domestic consumers.
increase the welfare of domestic producers.
cause deadweight losses

• protecting jobs
• defending national security
• helping infant industries
• preventing unfair competition
• responding to foreign trade restrictions

• The tastes of consumers for domestic and foreign goods.
• The prices of goods at home and abroad.
• The exchange rates at which people can use domestic currency to buy foreign currencies.
• The incomes of consumers at home and abroad.
• The costs of transporting goods from country to country.
• The policies of the government toward international trade.

S=I+NX or

S=I+NCO

=> NX = NCO

\(Exch_{real}=\frac {(\frac{\text{foreign currency}}{\text{local currency}})\cdot \text{domestic price}}{\text{foreign price}}\)

Involved markets:

1. Market for loanable funds (real interest rate / Quanitity of loanable funds)
2. Market for foreign-currency exchange (Real exchange rate / Quanitity of CHF)

Link: Net capital outflow with respect to the real interest rate

• reduce the supply of loanable funds,
• drive up the interest rate,
• crowd out domestic investment,
• cause net foreign investment (net capital outflow) to fall.