Junior Lecturer in Economics, Kemmy Business School, University of Limerick, Ireland.

n

Here are some questions I didn’t get to answering on the text message doo hickey. 

1. For the online exam, what chapters is it based on?

Chapters 1-6 of Barro.

2. Say Hi to James that was in d New Zealand Jersey in d lodge last nite…we remember u!!

Hi James, you stud.

3. Was that a genuine or sarcastic comment about the shoes babe?

Genuine, babe. I happen to like leopard print shoes (but only because Off the Rails tells me to).

4. How many marks per question and is there negative marking?

1 mark per correct question, -0.25 per incorrect answer in the exam. No negative marking on the online tests. 

5. Is there any way we can see the qs we got right or wrong on sulis because it would really help. 

Sorry, University policy on exams won’t let me release them.

6. What’s the difference between big R and little r?

Big R is the rental rate for the entire economy, little r is the rental rate an individual household experiences.

The business cycle is a tricky concept. Economists have studied why economies experience large shifts in demand for good and services for centuries. Many indicators of economic performance (or lack thereof) exist, and as many theories exist to explain them.

You’ll also want to read Barro, chapter 8, before this lecture.

Economists pretend we can measure the business cycle, and make serious and deep efforts to understand it as a profession, but economists are largely powerless to do anything about business cycles. We experience them like anyone else. Even the wikipedia article defining it is continually in dispute.

What is a business cycle?

Well, we call it a ‘cycle’ because there seems to be an up and down relationship between real (or actual) GDP and trend (or potential) GDP. When an economy is below it’s trend GDP, it might be heading into a recession. When an economy is above it’s trend GDP in terms of it’s real GDP, it might be experiencing a boom period.

GDP is assumed to break down into two parts, Real trend and cyclical. The cyclical part of GDP is the real part minus the trend part, and that is what we want to explain in this section of the course.

Barro shows us the proportionate deviation from trend GDP of the US Economy. What does it look like for Ireland?

It looks like the figure below, where our ‘output gap’ to 2005 is shown. 

We’d like to explain the existence and movement of business cycles through an equilibrium framework, so we’d like to consider changes in GDP, Y, C, etc, as they are affected following a shock, say, to technology, , or to investment, , or access to credit (as we’ve seen recently).

The starting place for an equilibrium business cycle model is the production function,

.

In the short run, the capital stock , is fixed. The assumption is that if changes (say, computers fall out of the sky), that will effect only.

We derived the following two results in a previous lecture: the marginal product of labour will equal the real wage rate in equilibrium . Similarly, the interest rate will equal the marginal product of capital, which will equal the return on capital minus the depreciation rate: .

Our equilibrium business cycle model will have to explain changes in consumption, saving, and investment, over the business cycle.

So, we need an expression for a household’s budget constraint at any moment. Luckily, we have one:

.

This equation tells us the household’s consumption and saving decision is dependent on it’s real wage rate and it’s real asset income, .

If we aggregate all the household’s budget constraints in the economy, we have

,

which says that consumption and net investment is equal to real GDP minus depreciation, or real net domestic product.

If we substitute in the production function , we get

What will the income effect be on from a change in ? Because depreciation is fixed in the short run, we have technology increasing real income, and consumption will rise. The intertemporal substitution effect fights against the income effect on this, so no sharp prediction can be made.

Consumption and Investment

What does consumption and investment look like over the business cycle in Ireland?

We’ll go through more examples in the lectures.

Related articles

• Recession fears as US economy shrinks for first time since 2001
• Beware the dreaded R word
• Economics for Business Lecture 15: Growth Models
• China announces $586-B stimulus plan
• Global stocks shaky amid economic woes

n

Following on from this article, as I argued on The Last Word last night, the question is not if, but when, the big banks are bailed out by the State. The operative question is where the money comes from, how long it is lent for, what conditions are attached to the money, and what practices the banks currently operate will change in response to this bailout. 

Will anyone’s head roll? I highly doubt it. Will the government appoint a soft form of oversight to represent taxpayers’ interest on the board? Most likely, in the form of retired or senior civil servants. Will the government purchase equity in the banks, diluting the shares already held by shareholders, or will there be a straight transfer of funds? And where is this money coming from? The National Pension Reserve?

These details matter. The devil is in the dynamic though. We are talking about the partial nationalisation of the State’s major banks, which implies the State will have to take over some of the toxic debt on the banks’ balance sheets. The taxpayer is exposed to further risk. What will be the return on this investment? 

All of these questions and more must be answered by the banks, and their new owners, before moving forward in a coherent and credible manner. 

Image via Wikipedia

Mathematica 7 has just been released from Wolfram research today. I’m a huge fan and daily user of the technology in my research and my teaching, and the key feature this release will help me with is automated charting. Check out a video of this feature here. 

Last week we saw the first parts of a micro-founded macroeconomy. Following Barro, chapter 6, we defined four markets: the product market, the labour market, the money market, and the bond market. We assume there was only one type of economic agent: households.

Firms are only  ’placeholder’ entities which consist of rental agreeements between households, who actually own all the capital, and labour, . Households rent capital to firms at a rate , and labour at a rate . The firm produces output according to , our simple production function. The total supply of labour is assumed to be used in production, so , and the total capital available is used in production, thus . Money is present in the system only as a lubricant,or medium of exchange: agents hold it temporarily while trying to get more consumption rather than for it’s own sake. Money is measured in nominal terms.

The price level, , allows us to deflate nominal values to real values. So, is the real exchange rate of goods for money, so will purchase you units of the good. The real wage rate, , in equilibrium, is equal to the marginal productivity of labour, . Similarly, the real return on capital, , is equal to the marginal product of capital, .

Now, each market is assumed to find itself in equilibrium, so the budget constraint faced by the households is going to come from it’s income in each of the four markets.

Market | Nominal Income | Real Income

Product Market | Profit, |

Labour Market | Wages, |

Capital Market | Rent, |

Bond Market | Interest, |

Now, this economy is populated by the households. The households want to maximise their total incomes for consumption given the price level, , subject to the budget constraints imposed by their holdings of their total assets (in this particular period).

The household’s total income is given by

Total Household nominal income = nominal profit + nominal wage income + nominal rent income + nominal rent income.

or:

Household nominal income = .

Now, Barro defines savings as the change in assets over time. The assets in this economy are money, , bonds, , and capital, , so the nominal value of assets = . The change in the nominal value of the assets, or the savings, will look like

Assuming the change in money is zero, then we have that nominal saving is the difference between nominal income and nominal consumption.

The household budget constrain in nominal terms is given by

.

This equation tells us the household in each period has to balance their consumption and their saving against their incomes from the various sources.

The real valued version of the budget constraint is given by

Or, in words: consumption + real saving = real income.

Again, in equilibrium, the , and .

Consumption and Saving

Now, the previous section spent itself working out the details of the equilibrium macroeconomic model.

We’ll study the household’s choice of consumption profiles over time. The household has to choose how much consumption and real saving to do in each period. This amount, consumption plus saving, has to equal the amount of real income in the period.

We know from the equation above that the real budget constraint is:

Now, we want to extend it over time.

Starting at year 1, the year which follows year 0 (I know it sounds stupid, but it’ll make the equation easier to read, so bear with me), the budget constraint will be

In year 2, the budget constraint will be

.

Now, the important point to note here is to see the relationship between year 1 and year 2. Combining the two years using the relationship between bonds and price levels, we have

.

This two year budget constraint is discounted into the present by the value of the interest rate, , which divides the value of, say, consumption, in period 2 by a discount factor to obtain it’s present value. The basic idea is consumption tomorrow is less highly valued than consumption today. We would like to measure how much tomorrow’s consumption is worth in today’s terms. We use the discount factor to achieve this.

Using the discount factor approach, we can derive (see Barro pages 157-158) an expression for the present value of consumption being equal to the present value of the source of funds minus the present value of assets at the end of the second year.

.

where .

We can use this equation to examine changes in consumption and savings behaviours of households over time, using the familiar income and substitution effects.

Income and Substitution Effects.

You have studied income and substitution effects in Prof. Dineen’s class last semester.

The household wants to choose a path of consumption over the periods it is alive which maxmises consumption, given the budget constraint. The household can change the profile of it’s consumption, choosing to consume less today and more tomorrow, or vice versa. The interest rate, , allows the household to choose which course of action to take. The higher the discount factor, , the higher the reward for waiting. There is an intertemporal substitution effect brought on by a changing interest rate.

Take, for example, the SSIA scheme. This was a scheme funded by the Irish government which gave €1 for every €4 invested in a particular savings scheme, the SSIA. The savings scheme was very popular, and many people were drawn into the scheme. Because people were saving more, their consumption would go down, and they would trade off present for future consumption because of this.

This is exactly what happened, albeit in a growing economy. More details on an economic analysis of the SSIA scheme can be found here.

In our model, the household responds to a change in the interest rate (and, obviously, the discount factor), by changing it’s consumption and savings mix over time. In each period, consumption + real saving must equal real income. Because the savings rate is dependent on the interest rate, when rises, the savings rate goes up, and the level of consumption drops.

The income effect from a change in the interest rate comes when interest earned on bonds issued in the previous period comes back–when the SSIA matured, or, in period 1, . The ownership of capital, , gives us the rental income received on these assets at the end of the first year.

Putting these two effects together, assuming an increase in the interest rate, the substitution effects sees consumption in the first period drop, in favour of consumption in the next period. The income effect sees an offset in the substitution effect, because if real income rises, then consumption will rise with it and will fall. So there is a tradeoff.

Handout

EC4004_L5_NUmericalExample.pdf

Related articles

• Economics for Business Lecture 17
• Economists React: Consumer in ‘Eye of the Storm’
• EC4004 Lecture 3: Individual Demand
• Crude Oil Prices: 1861-2008

I wrote this quarter’s daft.ie report, full text is here. The main point of the report is that rents are down by 3%, but the supply of available rental properties is up by 133%. You don’t need a PhD in economics to know you should expect further falls in rents in 2009.

Right click the link below to download the sample exam. There are only 5 short questions, and 2 longer ones in the sample, but it should give you a feel of the type of exam I’ll be giving.

Right Click this link to download the sample exam.

The figure below is taken from the latest construction employment index. The numbers point to a significant slow down in construction activity, and mirror the rises in unemployment, for a comparison, see here. 

In this lecture, we will introduce students to the institutional, legal and political context of enlargement within the EU, and preview and examine the fifth enlargement’s likely effects. We will examine the preconditions for reform, and develop a simple model of development, trade policy, and mobility.

Over the weeks we’ve seen a series of increasingly analytical approaches to exploring European integration. This week we’ll look at putting two approaches together: a descriptive, political economy framework for describing the system as a whole, and an analytical model describing the potential effects of trade policy on integration for the accession countries.

In May 2004, 10 new countries joined the EU, and Bulgaria and Romania became members in 2007. Croatia, Turkey and Macedonia are candidate countries. The EU is considering the possibility of further enlargements to countries in the Western Balkans, which could eventually include Bosnia & Herzegovina, Serbia, Kosovo, Montenegro and Albania.  

Image via Wikipedia

The ongoing EU enlargement process raises fundamental questions about the future of the Union. Will expanding membership lead to a change in identity of the EU? Is widening on this scale compatible with deepening? Will the EU be condemned to endless arguing about the relative size of contributions to and receipts from the Community budget? Will an expanded membership require fundamental changes in EU economic and cohesion policy and the Common Agricultural Policy after 2013 (when a new financial perspective begins)?  Will the Lisbon Treaty be ratified, and will it provide the EU with an institutional framework that enables it to avoid deadlock in decision-making, and at the same time increase its transparency and democratic accountability? The EU is committed to further enlargements, but where should its borders end?

Lecture Slides

| View | Upload your own

Handout. (Right click to download)

Further Reading/Viewing

Antonis Adam and Thomas Moutos, The Political Economy of EU Enlargement: Or, Why Japan is not a Candidate Country?

Friedrich Heinemann, The political economy of EU enlargement and the Treaty of Nice

Baldwin, Richard, Joe Francois, and Richard Portes, 1997, The costs and benefits of EU enlargement to the East, Economic Policy 24, 125-176,

(You must be in college to download these papers)

Catherine Drew and Dhananjayan Sriskandarajah, EU Enlargement in 2007: No Warm Welcome for Labor Migrants

Related articles

• EC4333, Economics of European Integration, Module Outline 2008
• UK businesses back EU expansion
• In the slow lane
• Montenegro gets boost for EU bid
• EU: Poland threatens Sarkozy’s scheme to rescue Lisbon treaty
• EU deal will last a decade, says Brown
• Sarkozy warns EU on treaty debate

EC4333 Students should find this interesting:

Nice one.

Embedded Video

Blogged with Flock

I think no, Tom O’Connor thinks yes. Fulltext below the fold. 

[Read more →]

Arthur Laffer is a rare economist. He has lived to see his theories enacted as policy at the highest level over many years, and those theories have been shown, everywhere they’ve been tried, to be false. Here he is debating Peter Schiff two years ago. 

Listen to what both men are saying, and ask yourself, with the benefit of your hindsight, who was right: Schiff or Laffer. Schiff should go on the programme again, and this time, his interviewers won’t be so smug.

Though all the talk is about the US economy, their analysis holds pretty well for Ireland. 

T. Boone Pickens is a man with a plan: save the US from itself by creating an energy strategy for the next 10 years to wean the US off of foreign oil. Check out the presentation below.

The world’s financial governance structures are in need of a comprehensive overhaul. The G20 ministers met over the weekend, and produced this document, which says, in effect, we’ll try really, really hard to do something, m’kay? You find steaming phrases like this:

We will: Continue our vigorous efforts and take whatever further actions are necessary to stabilize the financial system

The short term todo list is vague, vanilla stuff, sadly, with no real changes mooted other than inclusiveness with developing nations, but that was a given (remember, this used to be the G7. How long before it’s the G168?). The core recommendations are to do whatever we are doing right now, but harder, faster, and, eh, harder. And faster, ’cause, like, this is important, yeah?

Watch for the next G20 meeting at the end of April—will the language have changed? Will the tone be substantially altered? Will there be the sweeping reforms people like Robert Shiller, Paul Krugman, and others have called for? 

Or will we just wait for Obama to save us?

Related articles

• G-20 Drafts Blueprint for Repair
• G-20 declaration on financial crisis
• Need for more fiscal stimulus
• IMF Meets In Washington
• EU Billion Update
• Update on the EU Food Facility: Chasing the €1 Billion
• Bailout Plan, Redux

What’s the answer? Huge fiscal stimulus, to fill the hole. More aggressive GSE lending. Maybe a “pre-commitment” by the Fed to keep rates low for an extended period — that’s a more genteel version of my “credibly promise to be irresponsible.” And maybe large-scale purchases of risky assets.

Macro policy in a liquidity trap (wonkish) - Paul Krugman Blog - NYTimes.com

n

In the last few lectures, we’ve looked at growth theory and the stakes involved in getting the basics wrong. We saw the Solow model’s predictions about sustained capital accumulation (): keep population growth low, keep savings () and therefore investment() rather high, and try to curb depreciation on assets. Technical progress and human capital move the economy forward, potentially stimulating convergence of growth rates.

Now we’ll move onto a micro-founded macro model developed in the later chapters of the Barro book. The basic idea is to specify four markets inside the economy: the products market, the bond market, the money market, and the labour market. We’ll build our macroeconomic equilibria from behavioural assumptions about the actors in the model: households and firms. Households are assumed to want to maximise their incomes from all of these markets, subject to a budget constraint. Firms want to maximise profits. Their interactions, along with the usual macroeconomic accounting identities, such as , give us the macroeconomic equilibrium, called a general equilibrium.

Click the link below to download slides, handouts, etc.

Click the link below to download papers and interviews about growth, technical progress, and the micro-founded macro model.

[Read more →]