J. Bradford DeLong: August 28, 2009
Principles of Macroeconomics J. Bradford DeLong University of California at Berkeley and NBER delong@econ.berkeley.edu August 28, 2009
Financial Markets: • • •
Pool saviings Oversee managers Share risks
Financial Markets Never Subject to Laissez-Faire • • • • •
Not since 1825 Even the most hands-off government is hands-on where finance is concerned Market prices of financial assets are too important to be left to the market Governments have decided they must manage the flow of spending Managing financial asset prices is the best way they have found to do that
Spending: • • • • •
Consumption spending by households Investment spending by businesses seeking to maintain or extend capacity Government purchases by the government Exports by foreigners Balancing item: minus imports
Federal Reserve affects spending: • • •
When Federal Reserve raises asset prices, spending goes up When Federal Reserve losers asset prices, spending goes down Federal Reserve affects asset prices by buying and selling bonds
J. Bradford DeLong: August 28, 2009
• •
Supply and demand: lower supply of bonds means higher prices High bond prices mean high stock and real estate prices as well • Businesses can raise money on easy terms and spend to expand • Households feel rich and spend to consume • Also: when Fed buys bonds for cash, cash burns holes in people’s pockets
Spending, capacity, and prices: • • • • •
Compare spending and capacity Businesses post their prices • Depending on their expectations If spending greater than capacity, we have inflation If spending less than capacity, we have deflation Not on-off—conditions shade by sectors, regions, firms
Normal inflation economics: • • • • • •
When spending is more than capacity Businesses twist arms to get workers to work more Businesses raise prices because the demand is there Businesses raise wages as they bid workers away from other businesses Prices and wages rise faster than expected Production, demand, and employment are high
Normal deflation economics: • • •
• •
When spending is less than capacity Businesses find that they have a hard time selling what they make And here we have to get behavioral • Cutting people’s wages makes them angry • Low morale—and low productivity • Better (from the firm’s point of view) to fire some people • The people who are fired are really mad—but they are no longer around • ”You cannot deflate a modern economy without mass unemployment” Hence pronounced asymmetry Should we make wages more flexible on the downside? • Smash unions, etc.? • Need to be very careful: could easily tip us over into depression economics
J. Bradford DeLong: August 28, 2009
Managing the economy in normal times: • •
• •
Federal Reserve tries to hit the “sweet spot” What if the Federal Reserve gets a reputation for inflation? • People’s expectations change • People expect inflation to be higher than they expect • You can see how this might cause a problem What if the Federal Reserve hits on the low side? • Lots of pointless high unemployment This is not easy
Fiscal and monetary policy in normal times: • • • • •
Federal Reserve’s decision-actin loop is shorter than congress’s Federal Reserve is still trying to hit the sweetspot So—in normal times—Federal Reserve tries to hit the “sweet spot” And so moves to undo whatever congress and the president do How did the Fed acquire and how does it use its technocratic power>
Abnormal economics: • •
Hyperinflation economics—which we won’t cover Depression economics—which we will cover
Depression economics: • • •
Asset prices control spending Risky assets sell for lower prices than safe one—the risk tolerance of the market What happens if the risk tolerance of the private market suddenly collapses?
Panics and crashes • • •
Risk tolerance collapses Risk bearers are now poor—and want to bear even less risk
The limits of monetary policy What can you do?—first, don’t go there...
J. Bradford DeLong: August 28, 2009
What can you do?—second, try to fix things... • • •
Fiscal policy Banking policy ”Quantitative easing” policy
When total spending at posted prices is greater than capacity, then there is upward pressure on production—firms pressure workers to work longer and harder than they really want to—and also upward pressure on prices and wages: firms find that they can charge customers higher prices, and then have an incentive to offer higher wages to bid workers away from other employers. So wages and prices rise faster and higher than people had expected when they posted them. When total spending at posted prices is less than capacity, then there is downward pressure on production, employment, and prices. And here we have to get behavioral: people really hate to have their wages cut. Cut your workers’ wages, and they will take it as an insult—you will have low morale and low productivity for quite a while. It is better, from the boss’s point of view, to fire some workers outright: the ones you fire will be really angry, but they will not be around, and the ones you keep will be (a) somewhat grateful that you did not cut their wages or fire them and so (b) may work harder. (See Truman Bewley.) The upshot is, as Robert Lucas says, you simply cannot deflate a modern economy without causing mass unemployment. When the volume of total spending fall—or even rises significantly slower than people had expected —unemployment rises and production drops. You can see this pronounced asymmetry in charts of the labor market. 709 words