J. Bradford DeLong's Grasping Reality with All Eight Tentacles

Ryan Lizza, Dean Baker, and the "Worst Fears" of Advocates of More Expansionary Fiscal Policy

Dean Baker complains about Ryan Lizza:

New Yorker Rewrites Economic History/a>: We get no mention of the stock bubble when the piece extols the wonders of the economy in the Clinton years. Nor do we get any mention of the over-valued dollar, a direct outcome of the Rubin-Summers management of the East Asian financial crisis. The collapse of the stock bubble in 2000-2002, coupled with the over-valuation of the dollar, created the serious downturn from which the housing bubble arose. Summers role in ignoring financial bubbles and touting financial deregulation gives him a good share of the credit for the current crisis.

Finally, we are told in conclusion that: "So far, none of the worst fears of those who believed that the stimulus was too small or that nationalization was the only option or that taking over car companies would destroy the fabric of capitalism have materialized." Sorry, but this is wrong, big time. The worst fears of some of us who said that the stimulus was too small were that we would be sitting around with 10 percent unemployment for a long period of time and that stimulus would be discredited. That pretty well describes the world we live in, even that may not be the case in New Yorker land...

Now, now, Dean. Expansionary. is not discredited--in large part because we have been loudly yelling for nine months now that it looked too small to do the job properly.

And Ryan Lizza is careful: he does not say "none of the fears of those who believed that the stimulus was too small have materialized"; he says "none of the worst fears of those who believed that the stimulus was too small... have materialized." Our worst fears were that right now the unemployment rate would be screaming upwards toward fifteen percent. And it hasn't even breached twelve yet.

Tyler Cowen Learns Four New Things

Tyler Cowen is the Shiva Nataraja of economists--eight arms at least, and always unwilling to say that issues are settled for certain for there is always an "on the other hand." He says he has learned four new and surprising things:

So We Thought. But Then Again: Here are a few of the things we learned in the last 12 months:

REVISING THE CHINESE ECONOMY Many of the prices in China had not been accurately measured since the late 1980s; in 2007, new data indicated that food, rent and other items had become a lot more expensive than had been accounted for in official measurements. Higher prices, of course, mean lower Chinese real wages and a smaller size for the Chinese real economy.... China has 300 million workers — about the size of the entire United States population — earning less than a dollar a day....

IT’S NOT JUST THE LENDERS There has been plenty of talk about “predatory lending,” but “predatory borrowing” may have been the bigger problem. As much as 70 percent of recent early payment defaults had fraudulent misrepresentations on their original loan applications.... Many of the frauds were simple rather than ingenious.... Too often, mortgage originators and middlemen looked the other way rather than slowing down the process or insisting on adequate documentation....

IN MUSIC, HARDWARE RULES In 2007, album sales fell 15.3 percent.... Even if sales of 10 singles are counted as one album, sales were still down 9.5 percent. Economists... thought that greater exposure to music and the ease of online access might lead people to buy more. But in 2007 the outcome became clear: people tend to buy their favorite song from an album, online, rather than buy the whole album.... When it comes to piracy, illegal file-sharing on computer networks is not the main problem; instead, computer users, especially teenagers, burn CDs for one another. The music companies don’t have a good business model for making money from this...

LETHAL COLD FRONTS Spells of extreme cold kill over 27,000 Americans each year.... [D]ays with an average temperature below 30 degrees... have more significant and longer-lasting effects on human mortality.... Extreme cold brings cardiovascular stress.... Heat waves tend to kill people who were already weakened and would have died soon anyway; cold periods bring additional people to the verge of death.... 8 to 15 percent of the increase in American life expectancy over the last 30 years comes from people moving to warmer climates, according to research done by two economics professors, Olivier Deschenes at the University of California, Santa Barbara, and Enrico Moretti, at the University of California, Berkeley....

Many major debates of economics remain unsettled.... Knowledge is a wonderful thing, but sometimes simply knowing what we don’t know is a form of understanding. So beware the one-armed economist; sometimes a good economist could use two or even three arms or more.

I think only three of these are new and surprising--"it's not just the lenders" seems to me to be mischaracterized, and not to carry the implications Tyler wishes us to drawn from it.

Problem Set 8: Econ 101b: Fall 2005

The fall 2005 problem set 8.

Due in lecture on November 16.

Problem Set 7: Econ 101b: Fall 2005

The fall 2005 problem set 7.

Due in lecture on November 9.

Connecting to JSTOR

To read the extra readings on JSTOR from a computer outside the berkeley.edu domain, you may have to set up your web browser to use Berkeley's proxy server service:

UC Berkeley Library Proxy Server Service: Proxy Server Setup Instructions

Syllabus Part II: Economics 101b Fall 2005

Economics 101b Fall 2005

Syllabus Part II

October 14, 17: Japan's Decade-Long Slump

Readings: Paul Krugman, “Japan’s Liquidity Trap” < http://web.mit.edu/krugman/www/japtrap.html#Figure%201>
Paul Krugman, “Japan: Still Trapped” http://web.mit.edu/krugman/www/japtrap2.html
Adam Posen, “Macroeconomic Mistake, Not Structural Stagnation” http://www.iie.com/publications/chapters_preview/35/1iie2628.pdf
Adam Posen, “Recognizing a Mistake: Not Blaming a Model” http://www.iie.com/publications/chapters_preview/35/6iie2628.pdf

October 19, 21, 24: Europe's High Unemployment

Readings: Olivier Blanchard and Lawrence Summers (1986), "Hysteresis and the European Unemployment Problem" http://papers.nber.org/papers/w1950
Olivier Blanchard and Justin Wolfers (1999), "Shocks and Institutions in European Unemployment" http://papers.nber.org/papers/w7282
Olivier Blanchard (2004), "The Economic Future of Europe" http://papers.nber.org/papers/w7282

October 26, 28, 31: America's "New Economy"

Readings: Alan Blinder and Janet Yellen (2001), The Fabulous Decade: Macroeconomic Lessons from the 1990s (New York: Century Foundation)
William Nordhaus (2004), "The Story of a Bubble" http://www.nybooks.com/articles/16878

November 2, (no class on the 4th), 7, 9: Emerging Market Financial Crises:

Readings: Michael Mussa (2002), Argentina and the Fund: From Triumph to Tragedy http://bookstore.iie.com/merchant.mvc?Screen=PROD&Product_Code=343
Morris Goldstein (1998), The East Asian Financial Crisis http://bookstore.iie.com/merchant.mvc?Screen=PROD&Product_Code=22

November 14, 16: America's Current Macroeconomic Dilemma

Readings: Lecture notes to be issued...

Problem Set 5: Econ 101b: Fall 2005

The fall 2005 problem set 5.

Lecture: October 12: Stabilization Policy and Expectations: Extensions

Stabilization Policy and Expectations: Extensions: Handout

Lecture: October 10: The Phillips Curve, Expectations, and Monetary Policy

• The Phillips curve, expectations, and monetary policy

  • Aggregate supply and the Phillip curve
    • Unemployment
      • Unemployment and Okun's Law
      • (Y - Y)/Y = 2.5(u* - u)
      • Where Y* is potential output and u* is the "natural" rate of unemployment
      • Costs of high unemployment
    • Aggregate supply
      • The modern Phillips curve: π = π^e - B(u - u*) + S
      • Where: π is the inflation rate, π^e is expected inflation, u* is the natural rate of unemployment, and S is a supply-shock term.
      • What is expected inflation? We will deal with that later...
      • When unemployment is at its natural rate u*, inflation is at its expected value π^e, and vice versa
  • Monetary policy, aggregate demand, and inflation
    • Think of the Federal Reserve choosing three numbers--a "normal" level of unemployment, a target level of inflation, and a degree of aggressiveness in response to deviations of inflation from the target--as follows:
    • The Federal Reserve chooses a value of the interest rate r
      • (A gross shortcut, but let's make it)
    • When the Federal Reserve's choice of the interest rate r is at its normal value, then we go to the IS curve:
      • Y = A₀/[1-MPE] - (I_r + X_ee_r)/[1-MPE]
        • Where A₀ = C₀ + I₀ + G + X_fY^f + X_ee₀ + X_ee_rr^f
      • And find that Y is at some value Y₀, and thus that the unemployment rate is at value u₀--what the Federal Reserve thinks is the "normal" value of the unemployment rate
        • This should be, but may not be, the natural rate of unemployment u*
    • When inflation is higher than the Federal Reserve's desired target value π^T, the Federal Reserve gets nervous and pushes interest rates up--pushing investment and exports down, pushing output down, and pushing unemployment up above u₀
    • When inflation is higher than the Federal Reserve's desired target value π^T, the Federal Reserve gets nervous and pushes interest rates down--pushing investment and exports up, pushing output up, and pushing unemployment down below u₀
    • We model this with John Taylor's Monetary Policy Reaction Function (MPFRDF):
      • u = u₀ + o(π - π^T)
  • Equilibrium
    • We have:
      • u = u₀ + o(π - π^T)
      • π = π^e - B(u - u*) + S
    • And thus:
      • π = π^e/(1+Bo) + π^T/(1+Bo) - B(u₀ - u*)/(1+Bo) + S/(1+Bo)
    • Give us a rule for understanding how inflation expectations are formed, and we will be done.

• Inflation expectations

  • Three kinds:
    • Static
    • Adaptive
    • Rational
  • Static inflation expectations
    • Will exist only if fluctuations in inflation are small
    • Produces an economy that moves back and forth along a stable downward-sloping Phillips curve
      • π = π^e/(1+Bo) + (Bo)π^T/(1+Bo) - B(u₀ - u*)/(1+Bo) + S/(1+Bo)
      • u = u₀ + o(π - π^T)
    • With static expectations, only the sticky-price model is relevant
    • The U.S. in the 1950s and 1960s
  • Rational inflation expectations
    • Will exist in a sophisticated economy if the variation in government policy and in inflation is large
    • Produces an economy with a vertical Phillips curve (except for supply shocks): unemployment = u* plus supply-shock terms; changes in government policy and in the economic environment affect the rate of inflation only
    • π = π^T - (u₀ - u*)/o + S/(Bo)
    • Mitterand 1981
    • Only the flexible price model is relevant
  • Adaptive inflation expectations
    • Exponential convergence
      • [π_t - (π^T - (u₀ - u*)/o)] = (1/(1+Bo))[π_t-1 - (π^T - (u₀ - u*)/o)]

• The natural rate of unemployment

  • Natural rate vs. NAIRU
  • Demography
  • Institutions
  • Productivity growth
  • Past unemployment rates

Lecture: October 7: Optional: The Money Market and the LM Curve

• Optional: The money market and the LM curve
  • The money market and the money stock
    • Wealth, bonds, and the demand for money
    • Money supply
    • Money supply and money demand
      • Liquidity preference and the quantity theory of money: what's the relation? 8 Bond prices and interest rates
  • The LM curve
    • Interest rates and the LM curve
    • Drawing the LM curve
    • When is the LM curve relevant
      • When central banks are passive--or target money stocks
      • When the supply of money is given--as under a gold standard
  • The IS-LM framework
    • IS-LM equilibrium
    • IS shocks
    • LM shocks
    • Classifying disturbances
• Optional: Aggregate supply and aggregate demand
  • The price level and aggregate demand
  • The price level and aggregate supply
  • Prices: stuck? sticky? flexible?
  • The AS-AD diagram
    • Understanding demand and supply shocks

Problem Set 4: Econ 101b: Fall 2005

The fall 2005 problem set 4.

Note: I forgot to hand this out in lecture today, but here it is...

First Midterm Exam: Fall 2005: Economics 101b

The fall 2005 first midterm exam.

Lecture: October 5: The IS Curve

October 5: Investment, Net Exports, and the Real Interest Rate: The IS Curve

Last time we started with our behavioral relationships:

C = C₀ + C_y(1-t)Y; consumption function
I = I₀ - I_rr; business investment demand
G = G; government purchases
IM = IM_yY; import demand
X = X_fY^f + X_ee; export demand
e = e₀ + e_r(r^f - r)

And we made the key sticky-price assumptions:

r is now a fixed, given variable--the result of Federal Reserve policy (or of the current money stock and money demand) plus other influences
C + I + G + (X - IM) = Y is now an equilibrium condition--not an identity

And we derived:

Output as a function of autonomous spending A:

A = I + G + X + C₀
Y = A/(1-(C_y(1-t) - IM_y))

The multiplier: 1/(1-(C_y(1-t) - IM_y))

Now let's go one step further...

Investigating the dependence of autonomous spending on the real interest rate r, and thus of output on the real interest rate r...

• Interest Rates and Planned Expenditure

  • The importance of investment spending
  • The interest rate is not set in the loanable funds market in the sticky-price model
  • The interest rate is set by a combination of
    • Demand and supply for liquidity--money, and
    • The term structure of interest rates
  • Hence no presumption that fluctuations in investment--whether driven by "animal spirits" or movements in interest rates--are stable or stabilizing
  • Why investment depends on the real interest rate
    • The long-term, risky, real interest rate
  • Exports and autonomous spending
    • The exchange rate depends on the interest rate
    • Exports depend on the exchange rate
    • Hence exports are another interest-sensitive component of autonomous spending
  • The stock market as an indicator of investment

• The IS Curve

  • Autonomous spending and the interest rate
  • From the interest rate to investment to planned expenditure
  • The slope and position of the IS curve
    • (Inverse) Slope: (1-MPE)/(I_r + X_ee_r)
    • Position: A₀/((1-MPE)

• Equilibrium

  • Moving the economy to the IS curve
  • Interest rates adjust immediately
  • Inventories: output and demand levels adjust more slowly
  • Shifting the Is curve
    • Example: a change in government purchases
  • Moving along the IS curve
    • A change in monetary policy: open market operations
    • Difficulties in monetary management

• Using the IS curve to understand the U.S. economy

  • The 1960s: Federal Reserve keeps interest rates stable; Great Society and Vietnam War shift the IS curve outward
  • The late 1970s: The Volcker disinflation--raising real interest rates
  • The early 1980s: The Reagan deficits
  • The late 1980s: easing monetary policy as inflation dangers recede
  • The 1990s: initial sharp inward shift of IS curve; subsequent "new economy" boom
  • The 2000s: inward shift of IS curve coupled with substantial reduction in real interest rates...

Lecture: October 3: Sticky-Price Unemployment Business-Cycle Model

October 3: Sticky-Price Unemployment Business-Cycle Model

We now consider a time span too short for wages and prices to adjust to guarantee "full employment"...

So output Y is not necessarily equal to full-employment potential-output Y*...

We need a new equilibrium condition. Here it is: businesses adjust employment and production to keep their inventories stable--to match aggregate demand...

Other than this change of equilibrium condition, the model remains pretty much the same--but it behaves very differently.

We still have our behavioral relationships:

C = C₀ + C_y(1-t)Y; consumption function
I = I₀ - I_rr; business investment demand
G = G; government purchases
IM = IM_yY; import demand
X = X_fY^f + X_ee; export demand
e = e₀ + e_r(r^f - r)

But there are two differences:

r is now a fixed, given variable--the result of Federal Reserve policy (or of the current money stock and money demand) plus other influences
C + I + G + (X - IM) = Y is now an equilibrium condition--not an identity

• Sticky prices
  • Consequences of sticky prices
    • Flexible-price logic: prices adjust
    • Sticky-price logic: quantities adjust
    • Expectations and sticky-price logic
      • If expectations are fulfilled, then there will never be cases when price stickiness matters: it's only price stickiness plus surprising changes to economic policy or the economic environment that causes deviations from the full-employment model of chapters 6 and 7 *Why are prices sticky?
    • Menu costs
    • Lack of information--confusion of real and nominal magnitudes
    • Sociology: the social consequences of wage cuts
    • Simple "money illusion"
• Income and expenditure
  • Building up total planned expenditure
    • Consumption function
    • Investment spending
    • Government purchases
    • Net exports: exports minus imports
  • Autonomous spending A
  • The marginal propensity to expend on domestic goods: C_y(1-t) - IM_y
  • Sticky-price equilibrium: Y = A/(1-(C_y(1-t) - IM_y))
  • The multiplier: 1/(1-(C_y(1-t) - IM_y))
    • The multiplier used to be much more important than it is today...
• The process of inventory adjustment

First Midterm Exam: Fall 2005: Economics 101b

The fall 2005 first midterm exam.

Economics 101b Lecture: October 5: The IS Curve

October 5: Investment, Net Exports, and the Real Interest Rate: The IS Curve

Last time we started with our behavioral relationships:

C = C₀ + C_y(1-t)Y; consumption function
I = I₀ - I_rr; business investment demand
G = G; government purchases
IM = IM_yY; import demand
X = X_fY^f + X_ee; export demand
e = e₀ + e_r(r^f - r)

And we made the key sticky-price assumptions:

r is now a fixed, given variable--the result of Federal Reserve policy (or of the current money stock and money demand) plus other influences
C + I + G + (X - IM) = Y is now an equilibrium condition--not an identity

And we derived:

Output as a function of autonomous spending A:

A = I + G + X + C₀
Y = A/(1-(C_y(1-t) - IM_y))

The multiplier: 1/(1-(C_y(1-t) - IM_y))

Now let's go one step further...

Investigating the dependence of autonomous spending on the real interest rate r, and thus of output on the real interest rate r...

• Interest Rates and Planned Expenditure

  • The importance of investment spending
  • The interest rate is not set in the loanable funds market in the sticky-price model
  • The interest rate is set by a combination of
    • Demand and supply for liquidity--money, and
    • The term structure of interest rates
  • Hence no presumption that fluctuations in investment--whether driven by "animal spirits" or movements in interest rates--are stable or stabilizing
  • Why investment depends on the real interest rate
    • The long-term, risky, real interest rate
  • Exports and autonomous spending
    • The exchange rate depends on the interest rate
    • Exports depend on the exchange rate
    • Hence exports are another interest-sensitive component of autonomous spending
  • The stock market as an indicator of investment

• The IS Curve

  • Autonomous spending and the interest rate
  • From the interest rate to investment to planned expenditure
  • The slope and position of the IS curve
    • (Inverse) Slope: (1-MPE)/(I_r + X_ee_r)
    • Position: A₀/((1-MPE)

• Equilibrium

  • Moving the economy to the IS curve
  • Interest rates adjust immediately
  • Inventories: output and demand levels adjust more slowly
  • Shifting the Is curve
    • Example: a change in government purchases
  • Moving along the IS curve
    • A change in monetary policy: open market operations
    • Difficulties in monetary management

• Using the IS curve to understand the U.S. economy

  • The 1960s: Federal Reserve keeps interest rates stable; Great Society and Vietnam War shift the IS curve outward
  • The late 1970s: The Volcker disinflation--raising real interest rates
  • The early 1980s: The Reagan deficits
  • The late 1980s: easing monetary policy as inflation dangers recede
  • The 1990s: initial sharp inward shift of IS curve; subsequent "new economy" boom
  • The 2000s: inward shift of IS curve coupled with substantial reduction in real interest rates...

Economics 101b: October 3: Lecture: Sticky-Price Unemployment Business-Cycle Model

October 3: Sticky-Price Unemployment Business-Cycle Model

We now consider a time span too short for wages and prices to adjust to guarantee "full employment"...

So output Y is not necessarily equal to full-employment potential-output Y*...

We need a new equilibrium condition. Here it is: businesses adjust employment and production to keep their inventories stable--to match aggregate demand...

Other than this change of equilibrium condition, the model remains pretty much the same--but it behaves very differently.

We still have our behavioral relationships:

C = C₀ + C_y(1-t)Y; consumption function
I = I₀ - I_rr; business investment demand
G = G; government purchases
IM = IM_yY; import demand
X = X_fY^f + X_ee; export demand
e = e₀ + e_r(r^f - r)

But there are two differences:

r is now a fixed, given variable--the result of Federal Reserve policy (or of the current money stock and money demand) plus other influences
C + I + G + (X - IM) = Y is now an equilibrium condition--not an identity

• Sticky prices
  • Consequences of sticky prices
    • Flexible-price logic: prices adjust
    • Sticky-price logic: quantities adjust
    • Expectations and sticky-price logic
      • If expectations are fulfilled, then there will never be cases when price stickiness matters: it's only price stickiness plus surprising changes to economic policy or the economic environment that causes deviations from the full-employment model of chapters 6 and 7 *Why are prices sticky?
    • Menu costs
    • Lack of information--confusion of real and nominal magnitudes
    • Sociology: the social consequences of wage cuts
    • Simple "money illusion"
• Income and expenditure
  • Building up total planned expenditure
    • Consumption function
    • Investment spending
    • Government purchases
    • Net exports: exports minus imports
  • Autonomous spending A
  • The marginal propensity to expend on domestic goods: C_y(1-t) - IM_y
  • Sticky-price equilibrium: Y = A/(1-(C_y(1-t) - IM_y))
  • The multiplier: 1/(1-(C_y(1-t) - IM_y))
    • The multiplier used to be much more important than it is today...
• The process of inventory adjustment

September 30: Lecture: First Midterm

September 30: Lecture: First Midterm

Economics 101b: September 28: Lecture: Review

September 28: Lecture: Review

Economics 101b: September 26: Lecture: Money, Prices, and Inflation

September 26: Lecture: Money, Prices, and Inflation

• Money

  • "Outside" money

  • "Inside" money

  • Money as readily-spendable wealth

    • Its convenience yield

    • Avoids the problem of the coincidence of wants

  • Medium of exchange

  • Store of value

  • Unit of account

• The Quantity Theory of Money

  • Demand for money

  • The quantity equation: MV = PY

  • Supply of money: reserves, cash, and the banking system
    • Definitions of money...

• Money and prices

  • The price level
  • Measuring the price level
  • The inflation rate
  • Inflation and the nominal interest rate: the Fisher effect
• The costs of moderate inflation
  • Disrupting the tax system
  • Degrading the efficiency of the price system
  • Expected and unexpected inflation
• The costs of hyperinflation
  • The sources of hyperinflation
    • If the government doesn't balance its budget, the market will--by levying the inflation tax...
• When money demand depends on the interest rate...
  • Stopping hyperinflation then requires a large increase in the real money stock--a neat trick if credibility depends on not printing too much money...

Economics 101b: September 23: Lecture: CANCELED

September 23 Lecture CANCELED

Economics 101b Lecture: September 21 Equilibrium in the Flexible-Price Full-Employment Business-Cycle Model

September 21: Lecture: Equilibrium in the Flexible-Price Full-Employment Business-Cycle Model

Full-Employment Equilibrium

• Flexible prices and full employment
• Look at the flow of funds through financial markets to understand what's going on
  • Equilibrium prices: the real interest rate r and the exchange rate e
  • The circular flow principle: balance in the flow of funds through financial markets means balance in the sense of aggregate demand equals output
  • We could also look at the flow of purchasing power for output in the "goods market"--but that is less transparent
  • Savings = Investment
    • The real interest rate adjusts to make the flow of funds balance...
  • What things depend on the real interest rate?
    • Exports (indirectly through the exchange rate)
    • Investment

Using the Model: Examples

• Changes in saving
  • Household saving
  • Government saving (the deficit)
  • Foreign saving
• Changes in business demand for funds for investment
• More examples...

Economics 101b Lecture: September 19: Introduction to the Full-Employment Business-Cycle Model

September 19: Lecture: Building Up the Flexible-Price Full-Employment Business-Cycle Model

For the past couple of weeks we have been looking at long-run growth. Now we turn to looking at much shorter-run phenomena: business cycles. For the next couple of weeks we are going to be in a halfway house: looking at the economy over a period short enough that we can take its productive capacity to be fixed, but long enough that we can take wages and prices to be sufficiently flexible that supply and demand in the labor market balance and that the economy is as a result at "full" or "normal" employment.

Potential Output

• In this model, actual output is equal to the economy's productive potential (as discussed in the long-run economic growth section).
  • And by the circular flow principle output == national income == aggregate demand
  • Why? Because wages and prices are flexible so that unused and idle resources are few
    • A mystery: why is the average--the "natural"--rate of unemployment so high? Why is it 5% or so rather than 1%?
• The production function (go back to your "economic growth" notes and to chapter 4)
• Supply and demand in the labor market
  • Labor demand: firms with fixed capital stocks and diminishing returns to labor...
  • Labor supply: fixed (we may relax this assumption later)
  • Labor market equilibrium: supply equals demand
    • With our Cobb-Douglas production function, the economy-wide equilibrium real wage is (1 - [alpha])(Y/L)

Domestic Spending

• Consumption spending

  • Household decisions
    • Taxes
    • Saving
    • Spending
  • Our consumption function: C = C₀ + C_y(1-t)Y
    • Note our notation convention for parameters like C₀ + C_y...
  • Baseline consumption and consumer confidence
  • The marginal propensity to consume
  • What's left out
    • Consumption depending on wealth...
      • Using your house as an ATM: how much does consumption depend on the interest rate?
    • Consumption depending on ability to borrow
    • Financial sophistication, the relaxation of liquidity constraints, and the falling MPC C_y

• Investment spending

  • Firm decisions
    • Expected profits
    • Interest rates
      • Real, long-term, risky interest rates (not the short-term nominal safe interest rates the Federal Reserve directly controls)
  • Our investment function: I = I₀ - I_rr
  • Types of investment
    • Residential construction
    • Non-residential construction
    • Business equipment
    • Inventories
    • Government capital
  • Baseline investment and animal spirits
  • The interest sensitivity of investmen
  • Tax credits and investment
  • How much does investment depend on cash flow--and thus on the level of output Y?

• In this our model, we say that consumption depends on Y (but not on r) and that investment depends on r (but not on Y). If we have time we may relax this assumption and allow both to depend on both)

• Government purchases G we leave to the political scientists

  • Note: government purchases, not government spending

The International Sector

• Imports depend on Y alone: IM = IM_yY
• Exports depend on foreign incomes and on the exchange rate:
  • Our exports equation: X = X_fY^f + X_ee
    • Note: the peculiar sign of our exchange rate convention...
• The exchange rate
  • Greed and fear--speculators fear capital losses but want current income
  • Our exchange rate equation: e = e₀ + e_r(r^f-r)

Today we have done nothing but build up the behavioral relationships that are the building blocks of our flexible-price full-employment business-cycle model. Putting the pieces of this model together we will do on Wednesday.

Even after Wednesday, we will still be far from having a complete picture of business cyles. We won't have integrated cycles with growth; we won't have even started to think about demand-driven fluctuations in output and unemployment; and we won't have thought about the price level and the inflation rate.

Economics 101b Lecture: September 16: Drawbacks of and Extensions to the Solow Model

Lecture: September 16: Drawbacks of and Extensions to the Solow Model

Productivity Speed-Ups and Slow-Downs...

More Heads vs. Exhaustion of Ideas...

• Eventual stasis
• The revenge of Malthus?
• Singularities

Important Things Left Out of the Solow Model

• Government Capital: Infrastructure
• Government Capital: Rule of Law
• Government Capital: Basic Research
• Private Capital: Ideas
• Private Capital: Organizations
• Human Capital

The Problems of Intellectual Property...

Paying for Goods with Increasing Returns...

Economics 101b Lecture: September 14: Our Unequal World

Lecture: September 14: Our Unequal World

*We live in a world in which output per worker levels vary by a factor of nearly 100--evenat purchasing power parities.

We live in a world in which America today is roughly eight times as rich as China today...*

Using the Solow growth model to decompose differences in productivity today:

• E(0): differences in where countries started (guns, germs, steel, and colonialism-imperialism)
• g: differences in ability to adapt (or invent) better technologies and organizations
  • These two are most of the ballgame
• n: countries that have not yet gone through the demographic transition are at a deep disadvantage
  • Vicious circle: if you're poor, you probably have high population growth--making you poorer
  • Aside: what to do when your model can be used by the architects of China's "mandatory abortion" policy?
  • Amartya Sen: take the objective to be not GDP per capita but human freedom
• s: savings and investment
  • Budget deficits, et cetera
  • Vicious circles: if you're poor capital goods are very expensive--especially imported capital goods

This model provides a framework for understanding and evaluating differences in growth...

The case for neoliberalism and free trade as a way of maximizing economic and cultural contact--and we don't know how else to aid technology-and-organizational transfer.

Economics 101b Lecture: September 12: Using the Solow Model

Lecture: September 12: Using the Solow Model

How to Use the Solow Model: Three Steps

1. What is the steady-state growth path?
2. Figure out where the economy is now relative to its steady-state growth path?
3. Calculate how the economy converges to its steady-state growth path

Basic Formulas:

(K/Y)(t) = [(s/(n+g+d)) + [(K/Y)(0) - (s/(n+g+d))]exp[-(1-a)(n+g+d)]]

(Y/L)(t) = ((K/Y)(t))^(a/(1-a))E(0)exp(gt)

Steady State:

(K/Y)* = s/(n+g+d)

(Y/L)* = (s/(n+g+d))^(a/(1-a))E(0)exp(gt)

Numerical Experiments:

1. Raise g
2. Lower n
3. Raise s

Econ 101b: Fall 2005: Problem Set 2

Problem Set 2, due at start of lecture on September 16.

Lecture: September 7: The Solow Growth Model

The handout here http://www.j-bradford-delong.net/macro_online/gt_convergence.pdf serves as lecture notes for this lecture.

Lecture: September 2: Economic Growth Since Deep Time

Lecture: September 2: Economic Growth Since Deep Time

U.C. Berkeley Economics 101b, Fall 2005

The East African Plains Ape Becomes Human

• Very big brains
• Tools
• Culture
• Manipulation of environment

(Some) Humans Move Out of Africa

• 50000 years ago?
• No signs of interbreeding with other non-African proto-human populations
• Genetic differences?
  • 2000 generations is not a long time for Uncle Charles Darwin to work
  • Facial features, hair, lactose-tolerance, sickle cell and anemia resistance, Tay-Sachs
  • And, of course, melanin: rickets, vitamin D, melanoma
    • Skin color as a marker of slave status in the Americas: it kept slavery going for centuries after indentured servitude (which did not use skin color as a marker) broke down
  • Woolier and unsubstantiated stories:
    • Jared Diamond on how people in Papua New Guinea are smarter than the rest of us
    • In northern latitudes keeping warm is important: selection for dumpy and less athletic body types?
    • But don't go there: evolutionary behavior is still nothing more than a source of just-so stories, and has been a source of immense ignorance and terror in the past
  • The way to think of it, I have been told, is that there is less genetic variation in the entire human race than in a single baboon troop

Hunter gatherers * Pretty ferocious--even East African Plains Apes of two million years ago could drive hyenas from their dens * Sophisticated Cro-Magnon technology * Sophisticated Cro-Magnon culture--doing a lot of things that mark them as fully human * Life was nasty, brutish, and short--but athletic * Cro-Magnon hunter-gatherers * Average menarche at 16? * Life expectancy of 25? * Seven pregnancies to term? * But infinitesimal population growth means ferocious infant mortality * But they were buff: adult male heights of 5'8" or so

Neolithic Revolution

• Herd animals to be domesticated
• Plants with big seeds
  • Wheat
  • Rice
  • Corn--an amazing plant
• Agriculture sees like an enormously good deal at the start
• Well-nourished and easy-living agricultural populations expand rapidly
  • Farm sizes diminish
  • And Thomas Robert Malthus shows up
• Agriculture allows human race to grow from ca. 3 million (or less) in 10000 BC to ca. 170 million (or so) in 1
• Agriculturalists stomp hunter-gatherers, and usually herdsmen
  • Exception: people on horses with bows can hold their own
  • In fact, people on horses with bows can sometimes do much more than hold their own: Atilla, Temujin--until reliable firearms

What Is Agricultural Life Like?

• Nasty, brutish, short--and definitely not buff
• Menarche at 18?
• Life expectancy of 25?
• 6? pregnancies to term
• Huge childhood mortality--population growth is once again glacial--except for initial settlement phases
  • Alleviation of Malthusian misery (partial) by European household marriage or Asian lineage family
  • Psychological stress produced by these social institutions--telling your daughter she can't marry her boyfriend until he has a farm, or telling your younger brother he can't have a wife...
• Agriculturalists definitely not buff--adult male heights of 5'2" or so
• Plus
  • Agriculture means thugs with spears--rulers and warrior castes
  • Agriculture means thugs with pens--star watchers who keep records and can tell you when to plan become priests

By the Yeqr 1, the Human Race Was Biologically and Technologically Successful--But Pretty Miserable

Lecture: August 31: Thinking Like a Macroeconomist

Lecture: August 31: Thinking Like a Macroeconomist

U.C. Berkeley Economics 101b, Fall 2005

Macroeconomics and Microeconomics: Similarities

• Retains focus on incentives and opportunity cost
• Retains focus on aggregating up behavior
• Retains focus on equilibrium conditions

Macroeconomics and Microeconomics: Differences

• Ruthless simplification: representative agents
• Focus on general equilibrium: this is a system, not a market
• Differences in equilibrium conditions: balanced growth, quantity adjustment

Six Key Macroeconomic Variables

• Real GDP (also per capita for living standards, and per worker for productivity)
• The unemployment rate
• The inflation rate
• The real interest rate (term structure)
• The real value of the stock market
• The real exchange rate

Uncle Simon Kuznet and the Creation of the National Income and Product Accounts

The Circular Flow of Economic Activity

• The flow of spending power
• The flow of goods produced
• The flow of incomes
• All of these should add up to the same thing--a system with checks and balances

Problem Set 1

Economics 101b Fall 2005 Problem Set 1: Basics

A simple problem set to fix some concepts and give some confidence. Due at lecture on Friday September 9:

• A. Explain whether or not, why, and how the following items are included in the calculation of GDP:

a. Increases in business inventories.
b. Fees earned by real estate agents on selling existing homes.
c. Social Security checks written by the government.
d. Building of a new dam by the Army Corps of Engineers.
e. Interest that your parents pay on the mortgage they have on their house.
f. Purchases of foreign-made trucks by American residents

• B. Calculating real magnitudes:

a. When you calculate real GDP, do you do so by dividing nominal GDP by the price level or by subtracting the price level from nominal GDP?
b. When you calculate the real interest rate, do you do so by dividing the nominal interest rate by the price level or by subtracting the inflation rate from the nominal interest rate?
c. Are your answers to (a) and (b) the same? Why or why not?

• C. Suppose that the appliance store buys a refrigerator from the manufacturer on December 15, 2005 for $600, and that you then buy that refrigerator on January 15, 2006 for $1000:

a. What is the contribution to GDP in 2005?
b. How is the refrigerator accounted for in the NIPA in 2005?
c. What is the contribution to GDP in 2006?
d. How is the refrigerator accounted for in the NIPA in 2004?

• D. In what sense can a line on a graph "be" an equation?

• E. Why do DeLong and Olney think that the interest rate and the level of the stock market are importnant macroeconomic variables?

• F. What are the principal flaws in using GDP per worker as a measure of material welfare? Given these flaws, why do we use it anyway?

• G. Suppose a quantity grows at a steady proportional rate of 3% per year. How long will it take to double? Quadruple? Grow 1024-fold?

• H. What, roughly, was the highest level the U.S. unemployment rate reached in

  a. the 20th century?
  b. the past fifty years?
  c. the past twenty years?

• I. Do you think there is a connection between your answer to the qeustion above and the fact that Federal Reserve Chair Alan Greenspan received a five-minute standing ovation at the end of the first of many events marking his retirement last wekend?

• J. Suppose we have a quantity x(t) that varies over time following the equation: dx(t)/dt = -(0.06)x + 0.36.

a. Without integrating the equation, tell me what the long-run steady-state value of x--that is, the limit of x as t approaches in infinity--is going to be.
b. Suppose that the value of x at time t=0, x(0), equals 12. Once again, without integrating the equation, tell me how long it will take x to close half the distance between its initial value of 12 and its steady-state value. How long will it take to close 3/4 of the distance? 7/8 of the distance? 15/16 of the distance?

• K. Now you are allowed to integrate dx(t)/dt = -(0.06)x + 0.36.

a. Write down and solve the indefinite integral.
b. Write down and solve the definite integral for the initial condition x(0) = 12.
c. Write down and solve the definite integral for the initial condition x(0)=6.

• L. Suppose we have a quantity z = (x/y)b. Suppose x is growing at 4% per year and that b=1/4. How fast is z growing if y is growing at 0% per year? If y is growing at 2% per year? If y is growing at 4% per year?

• M. What is the difference between the nominal interest rate and the real interest rate? Why do DeLong and Olney think that the real interest rate is more important?

• N. What (briefly!) does Robert Heilbroner think of Karl Marx?

• O. What (briefly!) does Robert Heilbroner think of John Maynard Keynes?

Economics 101b: Fall 2005: First-Half Syllabus

Brad DeLong delong@econ.berkeley.edu Office Hours: W 11-1 Evans 601, or by appointment http://www.j-bradford-delong.net/

Suresh Naidu snaidu@santafe.edu Office Hours: MW 11-12 place tba

Lecture Meets: MWF 10-11, 70 Evans
Sections Meet: MW 9-10, WF 8-9, 41 Evans

This is the syllabus for the first half of Economics 101b, Macroeconomics. It carries the course up until October 12. The syllabus for the second half will be distributed at the end of September. It will depend on (a) how well the class does in the month of September, and (b) what are currently "hot topics" in the economic news. The U.S. budget deficit, the looming possibility of a major U.S. dollar-financial crisis, the dilemmas of Federal Reserve policy, and the ongoing industrial revolutions in East and South Asia will certainly be on the second-half syllabus, but there will be other topics as well.

This is the go-faster and do-more version of macroeconomics--the study of the determination of output, production, income, employment, and prices in the economy as a whole. Four books are required:

1. The intermediate macroeconomics textbook I am most comfortable with is the one that I and Marty Olney have written. DeLong and Olney (2005), Macroeconomics 2nd ed. (New York: McGraw-Hill/Irwin) http://www.amazon.com/exec/obidos/asin/0072877588. Here is our explanation of why we wrote it the way we did: http://www.j-bradford-delong.net/Teaching_Folder/manifesto.html
2. The Economic Report of the President, available online at http://w3.access.gpo.gov/eop/. (You might also browse, for recent economic data, the CEA-JEC Economic Indicators http://www.access.gpo.gov/congress/eibrowse/broecind.html.
3. Robert Heilbroner's The Worldly Philosophers (New York: Touchstone) http://www.amazon.com/exec/obidos/asin/068486214X/.
4. Alan Blinder and Janet Yellen's (2001) The Fabulous Decade (New York: Century Foundation) http://www.amazon.com/exec/obidos/asin/0870784676.

If you want alternative takes at the subject matter, let me recommend two alternative textbooks: Greg Mankiw's Macroeconomics http://www.amazon.com/exec/obidos/ASIN/0716752379, and Olivier Blanchard's Macroeconomics http://www.amazon.com/exec/obidos/ASIN/0131860267/.

Since this is a go-faster do-more course, we will go faster and do more. As a group, the class will be made up of people comfortable using calculus, so we'll feel free to use it in lectures, handouts, and in problem sets (and on exams). If you aren't comfortable using calculus, you probably don't belong here and may well not have a good time...

We--Suresh Naidu and I are keenly aware that almost everybody signing up for this course could alternatively take and do very well in Economics 100b. We are anxious not to have students vote with their feet for an easier course and learn less because they fear the consequences of lowering their grade point average. Therefore this course will have a high curve: the idea is that nobody should get a lower grade than they would have gotten had they decided to take Economics 100b instead: Grades will be based on the following:

• 30% from a (short: two hours long) Final Exam to be given Tuesday December 13 8-11 AM
• 20% from a first Midterm Exam to be given Wednesday September 28. (This is really early to give a midterm. Nevertheless it is important to give a midterm exam early in the course to serve as a reality check: so that students in trouble can figure out how much trouble they are in, and also--more important--so that at least one of us (DeLong) can figure out how unrealistic and detached from reality his beliefs about his teaching effectiveness are.)
• 20% from a second Midterm Exam to be given November 13.
• 20% from Problem Sets and other assignments to be due at the start of section. Problem Sets will be graded either 0 points (didn't hand it in at start of section), 1 point (handed it in but didn't make an effort), and 2 points (made an effort--whether successful or not--to solve all the problems).
• 10% on section participation.

No makeup exams will be offered. Students who miss one of the three exams will have their scores for the other exams reweighted to add up to 70%. Students who miss two of the three exams should not expect to pass.

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Preliminaries

Readings:

• DeLong and Olney (2005), Macroeconomics 2nd ed., chs. 1-3
• Heilbroner, The Worldly Philosophers, entire.

Classes:

M Aug 29: Introduction to Course, and National Income Accounting
W Aug 31: The Index Number Problem, and Key Economic Variables F Sep 2: How Macroeconomists Think (problem set 1 issued)

Sections: erosion of Okun's Law Handout http://www.j-bradford-delong.net/movable_type/2003_archives/002121.html.

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Long-Run Economic Growth

Readings:

• DeLong and Olney (2005), Macroeconomics, chs. 4-5.
• Michael Kremer (1993), "Population Growth and Technological Change: One Million B.C. to 1990," Quarterly Journal of Economics 108:3 (Aug 1993), pp. 681-716. (Alternative link.)

Classes:

W Sep 7: Patterns of Economic Growth and Divergence: Facts
F Sep 9: Theories of Economic Growth and Divergence: The Solow Model (problem set 2 issued/problem set 1 due)

Sections: only one section this week.

M Sep 12: Using the Solow Model
W Sep 14: Inadequacies of the Solow Model
F Sep 16: Extensions and Puzzles (problem set 3 issued/problem set 2 due)

Sections: Kremer (1993) QJE on the question was an industrial revolution inevitable?

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If There Were No Business Cycles Proper

Readings: DeLong and Olney (2005), Macroeconomics, chs. 6-7.

Classes:

M Sep 19: Components of Aggregate Demand: C, I, G, NX
W Sep 21: Flexible-Price Equilibrium
F Sep 23: Using the Flexible-Price Model (problem set 3 due/mock midterm handed out)

Sections: Go over problem set 2. Cover wealth in the consumption function; behavioral theories of consumption; cash flow and investment.

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Monetary Economics When Prices Are Flexible

Readings: DeLong and Olney (2005), Macroeconomics, ch 8.

Classes:

M Sep 26: The Quantity Theory of Money
W Sep 28: FIRST MIDTERM EXAM

Sections: one section only this week.

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Business Cycles Proper

Readings:

• DeLong and Olney (2005), Macroeconomics, chs. 9-12.
• Olivier Blanchard (1981), "Output, the Stock Market, and Interest Rates," American Economic Review 71:1 (March), pp. 132-43 http://links.jstor.org/sici?sici=0002-8282%28198103%2971%3A1%3C132%3AOTSMAI%3E2.0.CO%3B2-Q.
• J. Bradford DeLong (1997), "America's Peacetime Inflation," in Christina Romer and David Romer. eds., Reducing Inflation: Motivation and Strategy (Chicago: University of Chicago Press, 1997)http://www.j-bradford-delong.net/pdf_files/Peacetime_Inflation.pdf
• James Galbraith (1997), "Time to Ditch the NAIRU," Journal of Economic Perspectives Vol. 11, No. 1. (Winter), pp. 93-108 http://links.jstor.org/sici?sici=0895-3309%28199724%2911%3A1%3C93%3ATTDTN%3E2.0.CO%3B2-H.
• Joseph Stiglitz (1997), "Reflections on the Natural Rate Hypothesis," Journal of Economic Perspectives Vol. 11, No. 1. (Winter), pp. 1-8. http://links.jstor.org/sici?sici=0895-3309%28199724%2911%3A1%3C3%3AROTNRH%3E2.0.CO%3B2-C.

Classes:

F Sep 30: Sticky Prices, Consumption, and the Multiplier (problem set 4 issued)
M Oct 3: Investment and the IS Curve
W Oct 5: Using the IS Curve to Understand the Economy
F Oct 7: Inflation and the Phillips Curve (problem set 5 issued/problem set 4 due)

Sections. Go over midterm. Cover Blanchard (1981).

M Oct 10: The Natural Rate of Unemployment and the Federal Reserve
W Oct 12: From the Short Run to the Long Run
F Oct 14: Understanding American Business Cycles Using the Phillips Curve/Monetary Policy framework (problem set 6 issued/problem set 5 due)

Sections: go over problem set 4, and supply shocks.