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2 The Global Macroeconomy (Subject) / Formulas (Lesson)

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• Human Capital skills and knowledge that accumulate over time in individuals, the labor force, and society learning acquired at school on the job training learning by doing shared social knowledge and conventions. - HK is durable and can be increased by I (education, training) - Can also depreciate - There is a strong correlation between the amount of education and the standard of living. Production Function: physical capital, human capital, and hours worked. In addition, we still have a TFP term reflecting all other influences. Shift production function upwards, so more output will be produced improvement in steady state, OECD countries can still product growth High levels of human capital can offset the impact of diminishing marginal product of capital and help explain why investment still flows into capitalrich countries. If countries differ only in their capital stocks andhave identical TFP, then diminishing marginal product of capital implies that investmentshould flow to predominantly poor countries. For instance, if the onlydifference between countries was in their capital stock, then the MPK in Indiawould be 58 times higher than in the United States.1 In response to such enormousdifferences, we would expect huge investment flows from the UnitedStates to India. However, these simply do not occur. This suggests that there areother influences on the U.S. MPK that offset the influence of diminishing returns. Government expenditure on education (% GDP, 2000). Richer countries spend a greaterproportion of GDP on education. Source: OECD In rich OECD countries, the cost of providing a year of education fora university student is around 18 times that for a year of primary school. In poor nationsthe ratio is much higher—around 89. On average most countries spend around 15–20%of average GDP per capita on each child at primary school, although this tends to behigher for the richest economies. The situation for tertiary education is very different,with poorer countries spending around 1000% of average GDP per capita on each collegestudent, compared to around 100% for richer nations
• CA (S-I ) + (T-G)  CA = X-Z + NFI
• GNI Calculation GNI = Y + NFI Y +   + profits from domestic firms foreign operations - profits made in UK from international firms + profits from interest & dividends received from foreign investments - profits from interests & dividends received from foreign investments in country + transfers from residents based overseas back home - transfers from oversea residents based in UK + grants received from foreign governments - grants paid by Government to foreign countries GNI = C + I + G + (X-M) + NFI GNI = C + I + G + CA
• Green GDP GDP - Depletion of Natrue NDP = GDP - Depletion of Nature - Depreciation of Capital Assets 
• Total Wealth W (t) = p(t) K(t) + q(t) L(t) + n(t) N(t)
• Genuine Saving = I – TD (Investment - Total Depreciation is “Genuine Investment” or “Genuine Saving”) = p(t) ∆K(t) + q(t) ∆L(t) + n(t) ∆N(t) if ∆Genuine Saving > 0 then ∆Total Wealth > 0 Y - C = Gross Investment Gross INvestment + Investment in HK (Education) - Capital Depreciation - Energy, Mineral, Forrest Depletion  - CO2 Damages = Genine Investment
• NFI Return on countires asset's - return on countir's liabilities = GDP - GNI
• KA KA = (I-S) + (T-G) KA = FDI + Portfolio Investment + Other Investment + Reserve Account
• Financial Contagion in modern, market-based financial system when financial intermediaries’ balance sheets is strong their leverage is too low they hold surplus capital and they must expand the balance sheet: Liabilities - take more short term debt Asset - find potential borrowers
• Effects of Leverage targeting by banks Targeting leverage creates a ‘multiplier’ effect: changes in asset prices cause proportionately larger changes in bank balance sheets and aggregate loans Adjustment of leverage by banks has consequences that amplify the financial cycle While at the beginning of the crisis there was divergence between sick assets (CDO) and healthy markets such as stock market, sovereign debt and high-grade corporate bonds, now all markets are affected Although direct exposure to subprime is small, anticipated losses have created large disruption
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• Vicious spiral of deleveraging Toxic assets spread around the system Shock to equity value Assets have to be sold Everyone is selling assets Price of assets drops Decline in equity value More fire sales of assets, etc... Fear of counterparty risk: interbank and money market collapse Banking crises are the costliest for the real economy and they spread out from the healthy to the unhealthy part of the financial system
• Debt Dynamics: What if r > g The only thing we care about is g and i trends in the economy The current stock of debt does not provide additional information It does not matter where you start off, but in the end the Debt level will stabilize Government could continually run deficits without seeing debt/GDP ratio increase As long as g is greater than r, and this is stationary in the long-run, the economy will generate enough income to pay off accumulated debt Therefore, country can run deficit if deficit creates an offsetting future surplus (investment where return exceeds cost, education which brings forth future revenue) Implications: Short run: Debt will accumulate Primary Deficits (~30 years) Long Run: Income sufficiently large to pay off debt even while running a primary surplus.
• What will happen to Debt if r goes up? If r increases with Debt/GDP and higher r leads to lower g, then countries can rapidly find their public finances deteriorating
• Debt Dynamics: What if g<r? Government has to run a primary surplus in order to control the debt-GDP ratio Debt level fill approach infinity in the long run. Will lead to Fiscal Policy break down. Not feasible: Government will be unable to find buyers for all Debt Stock of these bonds increases faster than income Eventually, people will fear bankruptcy and will not buy any bonds anymore Therefore, supply of bonds increases as demand falls Bond Proce will fall and interest rises High interest rates aggravates the problem Explosive Debt Dynamics
• How to Decrease Debt? Forster growth an generate Primary Surpluses Inflate Debt away (print money) Default on Debt If Deficit is just Government consumption, you can only get future surpluses if you reduce future expenditures or raise future tax revenues Run primary deficits if it creates an offsetting future surplus (i.e. investments where return > initial cost such has education, which brings forth future revenue and growth) Try boost their rating AAA ratings buy them a lot of time to adjust their primary surpluses, because their r will be lower and lower growth is needed to recoup Finance their fiscal policy with debt instead of tax cuts, as this may bring down g  
• Debt Dynamics Government Debt = Primary Budget Surplus + Interest on Historical Debt Interest on Historical Debt = (1+r) * D (1) = (1+r) * (G(1) – T(1)) Primary Budget Surplus in period 2 = G (2) – T(2) Thus D(2) = G(2) – T(2) + (1+r) * D(1) As D(2) = 0, therefore D(1) = T(2)-G(2) / (1+r) -> Government Debt = Discounted Value of future Primary Surpluses
• Taxes (1) Pigouvian Taxes - market prices are socially undesirable and need to alteed to improve outcomes, e.g. pollution externality when buying gas so impose petrol taxes (2) Ramsey Taxes - need to raise revenue to finance desired government expenditure and what to raise taxes in a wau that distorts the economy the least (T-G) Taxes are used either to correct for market failures or to raise revenue. Efficient taxes avoid taxing elastic commodities
• Rationale For Taxes 1. Collective Provision of Goods & Services: Defence Law and order Education Health Roads 2. Redistribution of Income between individuals & across time Pensions Unemployment Benefits - insurance scheme Support for families
• Can countries run deficits? Country can run deficit if deficit creates an offsetting future surplus e.g investment where return exceeds cost, education which brings forth future revenue Country cannot run deficit if deficit is just government consumption: Country can get future surplus only if reduce future expenditure or raise future taxes
• Ricardian Equivalence The way government finances its activities  does not effect Economy Government can either finance its expenditure through Current taxes or Issuing debt –> Bonds - but debt is just postponed taxes When governments cut taxes consumers are not better offThey just face a delay in when they pay taxesTherefore in response to government borrowing consumers save morePossible for multiplier to be zero

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