Introduction To Macroeconomics

Introduction to Macro
Economics
Professor Walid Hejazi

Joseph L. Rotman School of Management
University of Toronto
1
SOME BIG ISSUES
Financial Crisis
Slow Growth in the US & Europe
Aggressive Monetary & Fiscal Policy
High levels of Debt: Crises in US/Europe
Surge in Money Supply (wheres the inflation?)
Shifts in the Global Economy
Is the world is flat? Or flatter?
Rise of China (and other emerging markets)
Is the US / Europe in decline?
2
Some thoughts on the
Financial Crisis
Mortgages
$500,000
R = 5%
25 Year Amortization
Payment: 2908.02 per month
Interest first year:

$25,000/ yr or 2083 / month
If pay $2083 / month: How long________?

If pay $1000 / month: How long _________?
Housing Prices Collapse
Why the 1929 Crisis led to Depression
1. Banks Failed
2. Governments balanced their books
3. Protectionism
4. Deflation
How to avert a Depression 6

The Global Recession Hit Hard: But Recovery Is here, kind of ..
Emerging and Developing Economies
World
Advanced Economies
Growth in World Output, IMF
Projections, through 2020
The G7 Economies, and China
Percentage Growth
Source: IMF, WEO Data Base, April, 2011 Update

US Monetary Base
Exploding from ~6% to 18% of GDP in less than 4 years!!!
GDP
Monetary
Base
Source: St. Louis Fed 9

Recovery no double dip
Essentially the global economy is out of recession,
and growth is gaining pace
Growth slower than expected
Financial Market Reform
Oil Prices up dramatically through 2014 but

sharply down thereafter
demand / middle east
Consumer and government debts a drain

Oil Prices: 2006 - 2015
11
Oil Prices: 1980 - 2015
12
We will consider these issues,
and more, in great detail
13
Economic Environment of Business
Macroeconomics: The study of the economy as a whole

Macroeconomic Variables:
Real Nominal
Y = Gross Domestic Product i = nominal interest rate
C = consumption P = price level
I = investment = inflation rate
G = government spending M = nominal money supply
X = net exports = exports - imports E = nominal exchange rate
r = real interest rate
ur = unemployment rate
LF = labour force
M/P = real money supply
EPc /PUS = real exchange rate
We study both the determination of equilibrium values in these

macroeconomic variables as well as their fluctuations.
14
Professor Walid Hejazi University of Toronto, Canada
Importance of Measurement
as a policy maker, must measure economic
activity precisely, and timely
must understand how monetary and fiscal
policies affect the economy
Question: when is it ideal to offset
economic shocks with monetary or fiscal
policy?
15
Important Questions
Should Canada maintain its zero inflation
policy? (or call it price stability)
Why did value of the Canadian dollar fall
significantly between 1970 and 2000, and
then rise to parity, and subsequently fall?
And fall since?
Canadian interest rates are now higher than
those in the US? Why? And does this
matter?
Should Canada adopt the US dollar? 16
Importance of Modeling
In order to answer these questions (and
many more), we need to develop a model of
the economy
The IS-LM-BP model allows us to analyze
the impact of alternative policies on several
aspects of the Canadian economy
17
The Macroeconomic Environment:
Key Concepts and Trends

Measuring Economic Activity
Broadest measure:
Gross Domestic Product
Two ways to measure GDP
(a) Incomes-based approach:
Payments to labour and capital
(b) Expenditure-based approach:
C + I + G + (X - M)
Gross domestic product, income-based
2010 2011 2012 2013 2014
$ millions
Compensation of employees 837,683 883,045 923,413 962,100 998,586 51%
Wages and salaries 727,616 766,670 799,649 828,738 859,484 44%
Employers' social contributions 110,067 116,375 123,764 133,362 139,102 7%
Gross operating surplus 449,176 497,599 495,996 511,461 543,051 28%
Net operating surplus: corporations
227,802 266,561 252,542 254,539 272,409 14%
Consumption of fixed capital: corporations
168,706 174,130 183,261 193,349 204,261 10%
Consumption of fixed capital: general
governments and non-profit institutions
serving households
52,668 56,908 60,193 63,573 66,381 3%
Gross mixed income 194,936 202,557 209,190 216,480 222,245 11%
Net mixed income 147,213 153,535 158,536 163,160 167,638 8%
Consumption of fixed capital:
unincorporated businesses 47,723 49,022 50,654 53,320 54,607 3%
Taxes less subsidies on production 71,966 73,980 76,402 80,656 83,422 4%
Taxes less subsidies on products and
imports 106,997 111,709 116,773 120,019 126,127 6%
Statistical discrepancy 1,372 1,031 1,034 1,477 -388 0%
Gross domestic product at market prices
1,662,130 1,769,921 1,822,808 1,892,193 1,973,043 100%
Source: Statistics Canada, CANSIM, table 380-0063.
Last modified: 2015-12-01.
20
Some things to note.
Wages and salaries represent the largest share of GDP

(but at around 30 year low):
- Primary target for taxation
- big number
- easy to get to
Gross domestic product, expenditure-based
2010 2011 2012 2013 2014
$ millions
Final consumption expenditure 1,304,141 1,363,718 1,405,369 1,457,030 1,513,043
Household final consumption expenditure
923,451 963,911 995,046 1,032,863 1,079,409 55%
Goods 413,137 429,646 440,700 455,113 475,703 24%
Services 510,314 534,265 554,346 577,750 603,706 31%
Gross fixed capital formation 390,875 417,091 447,559 452,845 469,739 24%
Business gross fixed capital formation
308,033 338,157 368,695 376,938 390,007 20%
Residential structures 112,835 118,051 127,730 129,186 135,723 7%
Non-residential structures, machinery and
equipment 160,292 182,681 202,786 211,154 218,047 11%
Non-residential structures 92,462 110,954 128,492 141,461 145,311 7%
Machinery and equipment 67,830 71,727 74,294 69,693 72,736 4%
Intellectual property products 34,906 37,425 38,179 36,598 36,237 2%
General governments gross fixed capital
formation 80,481 76,529 76,141 73,060 76,688 4%
Investment in inventories 346 11,371 6,822 13,533 8,488 0%
Exports of goods and services 483,214 540,970 550,736 573,083 624,594 32%
Goods 403,968 456,613 461,512 480,280 528,850 27%
Services 79,246 84,357 89,224 92,803 95,744 5%
Less: imports of goods and services 515,074 562,198 586,644 602,822 643,209 33%
Goods 413,670 456,045 474,800 486,842 524,059 27%
Services 101,404 106,153 111,844 115,980 119,150 6%
Statistical discrepancy -1,372 -1,031 -1,034 -1,476 388 0%
Gross domestic product at market prices
1,662,130 1,769,921 1,822,808 1,892,193 1,973,043

Nominal and Real GDP
Canada, 1961 - 2012
Nominal GDP
THE BASE YEAR

2002
Real GDP
23
National Income Accounting
GDP (Gross Domestic Product): Measures the production of all goods and services in
Canada over a period of time. This includes the production (value added) with both
Canadian and foreign owned factors of production. GDP depends on location, not
ownership.
GNP (Gross National Product): Measures the production of goods and services
produced with Canadian owned factors of production. This does not include production
(value added) in Canada with foreign owned factors of production but does include
production by Canadian firms abroad. GNP depends on ownership, not location.
GDP + Profits from production abroad using Canadian

owned factors of production
- Profits form production in Canada using foreign

owned factors of production
= GNP
24
A 2 Country World
Production with USA =20 Can = 5 Production with

US owned factors Canadian owned factors
USA = 95
Can = 80
Production with Production with US

Canadian owned factors owned factors
Canada (100) USA(100)
Canadian USA
GNP = 80 + 5 GNP = 95 + 20
GDP = 80 + 20 GDP = 95 + 5
25
Portfolio Investment versus Direct Investment
Cut - off points for foreign ownership of stock in classifying FDI
flows in OECD countries.
% foreign % foreign
ownership ownership
Australia 25 Italy N/S
Austria 5 Japan 25
Belgium 10 Netherlands N/S
Canada 10 Norway 10
Denmark 10 Portugal 11
Finland 20 Spain 50
France 20 Sweden 10
FRG 25 Turkey N/S
Greece N/S UK 20
Ireland N/S USA 10
Source: OECD (1987b) and Dunning and Cantwell (1987). More recent
publications by the UN and OECD show virtually the same figures.
Walid Hejazi, Rotman School of Management, University of Toronto

GDP versus GNP at Market Prices

Canada, 1961 - 2009
1,800,000,000,000
1,600,000,000,000
1,400,000,000,000
1,200,000,000,000
1,000,000,000,000
Nominal GNP
800,000,000,000
Nominal GDP
600,000,000,000
400,000,000,000
200,000,000,000
0
1992-09
2001-09
1961-03
1962-09
1964-03
1965-09
1967-03
1968-09
1970-03
1971-09
1973-03
1974-09
1976-03
1977-09
1979-03
1980-09
1982-03
1983-09
1985-03
1986-09
1988-03
1989-09
1991-03
1994-03
1995-09
1997-03
1998-09
2000-03
2003-03
2004-09
2006-03
2007-09
2009-03
28
0.94
0.95
0.96
0.97
0.98
0.99
1.01
0.93
1
1961-03
1962-03
1963-03
1964-03
1965-03
1966-03
1967-03
1968-03
1969-03
1970-03
1971-03
1972-03
1973-03
1974-03
1975-03
1976-03
1977-03
1978-03
1979-03
1980-03
1981-03
1982-03
1983-03
1984-03
1985-03
1986-03
1987-03
GNP/GDP
1988-03
1989-03
What does this mean?
1990-03
1991-03
1992-03
1993-03
1994-03
1995-03
1996-03
1997-03
1998-03
1999-03
2000-03
2001-03
2002-03
2003-03
2004-03
2005-03
2006-03
2007-03
2008-03
2009-03
29
Canadian outward investment also improves
our living standards.
*Annual income from interest, dividends and reinvested earnings on Canadian direct investment
abroad. Millions of Canadian Dollars 30
Receipts are Now Greater than Payments
31
Canadas Openness to
International Trade and FDI
Canadas Exports, Imports, & GDP
Canadian Dollars
33
Canadas Trade, relative to GDP
Percent, relative to GDP
34
Percent of Canadas total exports
Distribution of Canadas Exports

Distribution of Canadas Imports
Percent of Canadas total imports
36
The Exchange Rate
E = US / CAN = the number of US dollars one obtains per Canadian
If E increases, Canadian dollar appreciates.
If E decreases, Canadian dollar depreciates.
Any transaction between Canada and the rest of the world involves the exchange rate.
Natural Question: should we have maintained a fixed E with US?

Surge in the Exchange Rate
Is a low currency good?

Canadians do well in world export markets because of a
low currency
Low incentive to be innovative
Contributes to poor productivity performance
Is the surge in the currency good?

Exporters
Importers
Implications for productivity
Canada changing FDI patterns
Foreign Direct Investment

In Canada
Foreign companies operating in Canada
Abroad
Canadian companies operating abroad
Portfolio Investment versus Direct Investment
Cut - off points for foreign ownership of stock in classifying FDI
flows in OECD countries.
% foreign % foreign
ownership ownership
Australia 25 Italy N/S
Austria 5 Japan 25
Belgium 10 Netherlands N/S
Canada 10 Norway 10
Denmark 10 Portugal 11
Finland 20 Spain 50
France 20 Sweden 10
FRG 25 Turkey N/S
Greece N/S UK 20
Ireland N/S USA 10
Source: OECD (1987b) and Dunning and Cantwell (1987). More recent
publications by the UN and OECD show virtually the same figures.

Percent of GDP
Canadas Share of Inward FDI
(Shares of World, Developed Countries, G20 and North American FDI)
70%
60%
50%
World
40% Dev Econ
NAFTA
30% G20
United States
Canada + US
20%
10%
0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
42
Distribution of FDI within the G7
(Shares of FDI within the G7)
43
Distribution of Developed World FDI
(Shares of FDI within the Developed World)
44
Foreign Ownership of the Canadian economy
Percent of Total
7
Are these Changes Good?
High Outward
Depends on whether the outward is
Moving abroad because of a poor competitive environment
domestically
Moving abroad reflecting the competitive advantage because of
domestic firms
High Inward
Inward FDI brings with it many benefits, in terms of technology,
new management techniques, high paying jobs, exports, increased
competition
There are some reservations about the economic and social impact
of MNEs however all countries are trying to attract such firms,
subject to some conditions
Sector GDP* (millions of chained 2002 dollars) CAGR** % Change
2001 2010
2001 2010 shares shares 2001-2010 2009-2010
Agriculture, Forestry, Fishing and
Hunting
Mining and Oil and Gas Extraction
Utilities
24,674
51,236
27,384
`
26,357
53,930
29,845
2%
5%
3%
2%
4%
2%
0.70%
0.50%
0.90%
0.30%
4.80%
-0.20%
Construction 55,542 73,856 5% 6% 2.90% 6.60%
Manufacturing 181,084 159,740 17% 13% -1.20% 5.70%
Goods Producing Industries 339,779 347,710 33% 28% 0.30% 4.90%
Wholesale Trade 53,438 69,513 5% 6% 2.70% 5.30%

Retail Trade 55,234 76,319 5% 6% 3.30% 3.80%
Transportation and Warehousing 50,176 58,439 5% 5% 1.50% 4.30%
Information and Cultural Industries 36,498 45,634 4% 4% 2.30% 0.70%
Finance and Insurance, Real Estate and
Leasing and Management of
Companies and Enterprises 196,769 257,454 19% 21% 2.70% 2.60%
Professional, Scientific, and Technical
Services 47,453 60,804 5% 5% 2.50% 0.60%
Administrative and Support, Waste
Management and Remediation
Services 22,820 30,566 2% 2% 3.00% 1.60%
Educational Services 50,675 62,626 5% 5% 2.10% 2.20%
Health Care and Social Assistance 67,198 82,962 6% 7% 2.10% 2.30%
Arts, Entertainment and Recreation 10,142 11,265 1% 1% 1.10% 0.90%
Accommodation and Food Services 24,950 27,410 2% 2% 0.90% 2.60%
Other Services (except Public
Administration) 26,101 32,483 3% 3% 2.20% 1.60%
Public Administration 59,705 74,892 6% 6% 2.30% 2.30%
Services-Producing Industries 701,115 890,219 67% 72% 2.70% 2.60%
47
http://www.ic.gc.ca/eic/site/cis-sic.nsf/eng/h_00013.html#vla2b
Canada Fiscal and Debt
http://www.fin.gc.ca/afr-
rfa/2013/report-rapport-eng.asp
48
G7 Government Net Debt, Relative to GDP, 2012
49
Government Budget Balance, Relative to GDP
50
Government Debt, Billions of Dollars and Relative to GDP
51
Government Debt Charges, percent of Total Revenues
52
Government Net Debt Ratio, relative to GDP
53
Government Revenue, Relative to GDP
54
Composition of Government Revenue
55
Composition of Government Revenue, 1966 - 2013
56
Should Canada pay off the debt?
What is the optimal debt to GDP ratio?
It is some positive number (say 5%), but not 70%
In 1992, the deficit was $43 billion (that is, the addition
to the debt in one year)
Debt to GDP ratio in 1992 was about 70%
If deficit disappears, growth in debt stops
As GDP rises, debt to GDP ratio falls
Assume that GDP growth averages 4%
Growth in the debt is zero
How long would it take for debt to GDP ratio to
reach its optimal of say 5%? Answer???
Highlights importance of debt repayment
Significant progress has been made in this respect
Savings and Investment
58
GDP = Y = C + I + G + X where X = exports - imports
GDP is a measure of economic activity: the distinction between C, I, G, and X is based on

the type of purchase rather than the type of product being purchased
Example: a car purchased by...
Households for their personal use enters the NIAs as C

Businesses to undertake business activity enters the NIAs as I
Government enters the NIAs as G
Produced here and sold abroad enters the NIAs as exports
Produced abroad and used here enters the NIAs as imports
Question: Suppose a car is imported from Japan: how does this affect GDP?
Later, we ask how such a transaction would affect the Balance of Payments.
59
Notation
Y = GDP
J = net investment received from foreigners
= investment income received - investment income paid
F = transfers from government to the private sector
N = interest paid on government debt
T = taxes
G = government spending
C = consumption
X = net exports = exports - imports
60
Savings and Investment

Savings of the private sector:
Sp = Y + J + (F + N - T) - C
= GDP + J + (Impact of Government) - C
Savings of the government:
Sg = (T - F - N) - G
Savings of the Rest of the World:

Sr = - (X + J) (X+J) = Current account
Example: assume X > 0 and J = 0

This implies that Sr < 0 ie. Canadian are lending abroad
S = Sp + Sg + Sr
= Y + J + (F + N - T) - C + (T - F - N) - G + - (X + J)
=Y-C-G-X
The National Income Identity: Y = C + I + G + X
This implies therefore that S=I(Savings = Investment)
61
In a closed economy, Domestic Savings = Domestic Investment
What are the gains from global capital markets?
In the absence of global capital markets, the only way to finance domestic investment is
have domestic savings.
Think of developing countries with tremendous investment opportunities: cannot

realistically ask developing countries to increase domestic savings.
Similarly, the US has record capital inflows to finance investment in the US: the productive
investment opportunities in the US are being exploited (financed) by both US and global
investors
Who benefits from records on US markets?
Of course, global capital flows come at some risk: herding behaviour that led to the East
Asian Financial Crisis
62
The Labour Market:
Key Concepts and Trends

Unemployment
In order to be classified as unemployed in Canada, an individual of working age (16 years
and older) must be:
1. Available for work

2. Looking for work
3. Unable to find work
The Labour force is defined as the number of people who are either employed or
unemployed:
Unemployment rate = (Number of people unemployed) / (Labour force)
The labour force participation rate is the percentage of the adult population that is in the
labour force:
Labour force participation rate = (Labour force) / (working age population)
Discouraged workers are people who drop out of the labour force.
Question: why doesnt Flaherty, Canadas Finance Minister, simply earmark $5 billion for
job creation? Wouldnt this reduce the unemployment rate? 64
Natural Rate of Unemployment
The natural rate of unemployment that would obtain in normal times. It reflects:
Labour mobility
Changing jobs/industries
Leaving and re-entering the labour force
Immigration
There is always some unemployment. The natural rate of unemployment is

the average level around which the unemployment rate fluctuates. Usually
this is estimated for a particular year by averaging all the unemployment rates
from 10 years earlier and 10 years later.
65
An Example Canadian Labour Force Statistics

Population: 28,314,700 (15 years and older)
Employed
Not in Labour Force
Unemployed
POP (15 +) 28,314,700

LF 18,876,100
E 17,507,700
U 1,368,400
LFPR 67%
UR 7.2%
66
Some Labour Market Concepts
POPULATION = Not in Labour Force + Labour Force
Labour Force = Employed + Unemployed
LFParticipation Rate = LF / POP
Unemployment Rate = U / LF
Data for Canada (December 2012)
POP = 28,314,700 (working age)

LF = 18,876,100
E = 17,507,700
U = 1,368,400
LFPR = 66.7%
UR = 7.2%
Canadas Labour Market
Labour force characteristics
2009 2010 2011 2012 2013
thousands
Population 15 years and
over 27,298.2 27,658.5 27,987.3 28,314.7 28,673.2
Labour force 18,329.0 18,525.1 18,699.4 18,876.1 19,079.4
Employed 16,813.1 17,041.0 17,306.2 17,507.7 17,731.2
Full time 13,578.9 13,736.7 13,995.0 14,212.9 14,380.2
Part time 3,234.2 3,304.4 3,311.2 3,294.8 3,351.0
Unemployed 1,516.0 1,484.1 1,393.1 1,368.4 1,348.2
Not in the labour force
8,969.2 9,133.4 9,287.9 9,438.6 9,593.8
Actual hours worked
541,209.1 555,643.2 567,127.1 577,063.2 581,451.2
%
Employment to population
ratio 61.6 61.6 61.8 61.8 61.8
Participation rate 67.1 67.0 66.8 66.7 66.5
Unemployment rate 8.3 8.0 7.4 7.2 7.1
Source: Statistics Canada, CANSIM, tables 282-0002 and 282-0022.
http://www40.statcan.gc.ca/l01/cst01/ECON10-eng.htm
Canadian Unemployment Rate
1982 Recession
1992 Recession
2008 Period
70
US Unemployment Rate
1982 Recession 2008 Period
1992 Recession
US Labour Force Participation Rate
72
Differences in Definition of
Unemployment
Differences in the way unemployment is measured account
for about 0.8 to 0.9 percentage points of the unemployment
rate gap
In the U.S. a "passive" job searcher is not counted as an

unemployed person
In the US the age of the sample commences at 16 years

whereas in Statistics Canadas Labour Force Survey, it is
15 years of age
Differences in Definition of
Unemployment
In Canada, reserves are not measured
In both countries, institutionalized persons

not covered (ie. prisoners)
Canadas UR Persistently Higher
than US
Canada
US
Why is the unemployment rate higher in
Canada than in the U.S.?
Measurement issues:
More likely to be classified as NLF in U.S.
Sociological issues:
Canadians are more likely to say they are U
Incarceration rate is much higher in the U.S.
Why is the unemployment rate higher in
Canada than in the U.S.?
Unionization rate higher in Canada:
30% versus 10%
EI rules
More likely to receive benefit in Canada; for longer
Regional differentiation in eligibility
Whats been happening to
Labour force participation?
Labour force participation rates of men and

women have almost converged
Participation rates of women have increased
Participation rates of men have fallen (esp. 55+)
Retirement ages are falling:
Men: 60.5
Women: 58.5
Labour force and participation rates
2008 2009 2010 2011 2012
thousands
Labour Force 18,203.90 18,329.00 18,525.10 18,699.40 18,876.10
Males 9,644.40 9,671.30 9,763.30 9,858.90 9,950.10
Females 8,559.50 8,657.80 8,761.80 8,840.50 8,926.00
%
15 years and older 67.7 67.1 67 66.8 66.7
Males 72.8 71.9 71.7 71.5 71.3
Females 62.7 62.5 62.4 62.3 62.2
15 to 24 years 67.5 65.5 64.5 64.6 63.6
Males 68 65.7 64.4 64.7 63.5
Females 67 65.2 64.6 64.4 63.6
79
Labour force and participation rates
2008 2009 2010 2011 2012
25 to 44 years 87.2 86.9 86.8 86.7 87.1
Males 92.4 91.4 91.3 91.3 92
Females 82.1 82.3 82.3 82.1 82.2
45 years and older 54.3 54.5 54.8 54.7 54.6
Males 60.5 60.5 60.7 60.5 60.1
Females 48.5 48.9 49.3 49.3 49.4
65 years and older 10.1 10.5 11.4 11.9 12.6
Males 14.2 15.1 16.2 16.5 17.1
Females 6.8 6.7 7.5 8.1 8.8
80
Labour force participation rates, men
and women aged 25 to 64, 1976 to 2009
http://www.statcan.gc.ca/pub/81-004-x/2010001/article/11151-eng.htm
Questions
What is the unemployment rate?

Unemployment rate(UR) = Unemployed(U)/Labour force
= 1.56/(1.56+12.38) = 11.19%
What is the Labour force participation rate(LFPR)?

LFPR = LF/Qualified population
= (1.56+12.38)/21.38 = 65.2%
If 1 million jobs are created, what is the highest and lowest possible unemployment rates
that can result?
If there is no entry into the Labour force: UR = (1.56-1)/13.94 = 4%

If there is maximum entry into the Labour force: UR = (1.56-1+7.44)/(13.94+7.44) = 37.4%
What will happen to the unemployment rate if each new job creates 1 new entry? Why?
82
Inflation
83
Inflation
CPI inflation
A measure of price movements, produced by Statistics Canada and obtained
by comparing the retail prices of a representative "shopping basket" of goods
and services at two different points in time.
Core inflation
Year-over-year growth in a variant of the CPI that excludes the eight most
volatile components which account for 19 per cent of the CPI basket
(fruit, vegetables, gasoline, fuel oil, natural gas, mortgage interest, intercity
transportation, and tobacco products) as well as the effect of changes in
indirect taxes on the remaining components.
84
85
86
Why do we measure inflation?

In order to distinguish between nominal and real variables.
Suppose that average incomes in Canada over the past year increased by 3%, but prices
increased by...
a) 1%, then real incomes grew by 2%
Yt = 100, Pt = 1
Yt+1 = 103, Pt+1 = 1.01
The number of dollars you earn (the nominal income) increased by... 3%
The number of goods you earn (the real income) increased by...
(103)/(1.01) = 101.98 = 102, or 2%
b) 3%, then real incomes grew by ..
c) 5%, then real incomes grew by ..
87
Question: Would agents in the economy sign contracts that resulted in real wage
reductions? ==> costs of unanticipated inflation
We calculate the inflation rate based on the GDP deflator because:
GDP grows for two reasons:

1) prices went up
2) actual output increased
We obviously care about measuring the real growth in our economy, and hence need to
calculate the inflation rate.
Question: If measured inflation is 3%, then what is true inflation. For example, the Bank of
Canada has a zero inflation policy in effect. Their inflation rate is 1 to 3%. Why?
88
Full Employment
Y* & UR*
89
Some Definitions:
Y* is the potential of the economy: The amount the economy would produce if all labour
and capital are utilized optimally.
UR* is the optimal level of unemployment

UR* should be positive
Prime Minister (governing party) argues that UR* is 9%

(official opposition) argues UR* is 6%
Who is right? Explain
90
Okuns Law
For each percentage point that UR rises above UR*, Y falls below Y* by 2%.
(Y - Y*) / Y* = -2 (UR - UR*)
Question: If Y = 105, Y* = 100, and UR* = 10%

Answer: UR = 7.5% ie. UR< UR* by 2.5% implies Y>Y* by 5%
91
The Balance of Payments
92
Determination of the Exchange Rate
Exports
Imports
Demand Supply
Investment Demand Market for Supply Investment

Income Canadian Income Paid
Received Dollars
Demand Supply
Capital Capital
Inflows Outflows
Forces of Supply and Demand interact to determine the equilibrium exchange rate
93
The Balance of Payments

The Balance of Payments summarizes Canadas transactions with the rest of the world, and
hence summarizes transactions that involve the exchange rate.
BP = Current Account + Capital Account = Change in FX
Current Account = X + J
Capital Account
1. Capital Inflows - Capital Outflows
2. International borrowing - International lending
3. The Capital Account increases when Canadians sell more assets (claims) to foreigners
than Canadians buy from foreigners
Portfolio Investment - purchase a claim on a real asset

Direct Investment - purchase real assets (ie. Plant and equipment)
When does portfolio investment become direct investment?
FX = foreign exchange reserves held domestically

94
The Exchange Rate

E = US / CAN = the number of US dollars one obtains per Canadian dollar = 67 cents.
If E increases, Canadian dollar appreciates.
If E decreases, Canadian dollar depreciates.
Any transaction between Canada and the rest of the world involves the exchange rate.
95
96
20.000
40.000
60.000
80.000
100.000
120.000
140.000
160.000
0.000
01/01/1970
01/01/1972
01/01/1974
01/01/1976
01/01/1978
01/01/1980
01/01/1982
Increase in
Significant
01/01/1984
01/01/1986
The price of Oil

01/01/1988
01/01/1990
01/01/1992
01/01/1994
01/01/1996
Oil Prices: Price per barrerl, US dollars
01/01/1998
01/01/2000
01/01/2002
01/01/2004
01/01/2006
01/01/2008
1
0.5
0.6
0.7
0.8
0.9
1.1
1970M01
1971M08
1973M03
1974M10
1976M05
1977M12
1979M07
Spot Oil Price (WTI)
1981M02
1982M09
And when Oil Prices Collapse, the Canadian Dollars Follows

1984M04
Increase in
Significant
1985M11
1987M06
1989M01
1990M08
1992M03
1993M10
1995M05
Canada heavily dependent on Oil
1996M12
1998M07
Value of Canadian Dollar
2000M02
2001M09
US dollars, per Canadian
2003M04
2004M11
2006M06
2008M01
20.00
40.00
60.00
80.00
0.00
100.00
120.00
140.00
160.00
2000-01-01
2000-11-01
2001-09-01
2002-07-01
2003-05-01
2004-03-01
2005-01-01
2005-11-01
2006-09-01
2007-07-01
Correlation: 0.93
2008-05-01
2009-03-01
OIL PRICES
2010-01-01
2010-11-01
2011-09-01
2012-07-01
2013-05-01
2014-03-01
2015-01-01
2015-11-01
0.2
0.4
0.6
0.8
1.2
0
1
2000-01
2000-09
2001-05
2002-01
2002-09
2003-05
2004-01
2004-09
2005-05
2006-01
Petro Currency?
2006-09
2007-05
2008-01
2008-09
2009-05
2010-01
2010-09
2011-05
2012-01
2012-09
Canada US Exchange Rate
2013-05
2014-01
2014-09
2015-05
98
Saudi Arabia 18%
Venezuela 14%
Canada 12%
Iran 9%
Iraq 8%
Kuwait 7%
United Arab 7%
Russia 4%
Libya 3% The Worlds proven
Nigeria 3% oil reserves
Kazakhstan 2%
Qatar 2%
United States 1%
China 1%
Brazil 1%
Algeria 1%
Mexico 1%
0 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16 0.18 0.2
The Balance of Payments summarizes a countrys transactions with the rest of the world
The Balance of Payments summarizes the supply and demand forces for the Canadian dollar
To understand what happens to the exchange rate,

one must understand what happens to the Balance of payments.
Question: why has the value of the Canadian dollar fallen over the past 30 years from par
with the US dollar to less than 70 cents?
Question: Is a depreciating dollar good for Canadians? Exports increase and imports fall,
thus increasing GDP and employment.
100
Example: Suppose we import a car from Europe
How does this affect the NIAs?
1. AD = Y = C + I + G + X
one of C, I or G increases
imports increase, and X falls (X = exports - imports)
Therefore, level of AD is unaffected, but its composition changes.
2. BP = Current Account + Capital Account = change in FX

a) current account falls
b) the second entry depends on method of payment
i) cash, then Change in FX falls
ii) bank account, then Capital Account up (ie. At the beginning of the transaction,
a Canadian owned that account, and at the end, a foreign owns that account. Equivalent to a
Canadian that has a Canadian claim on real assets to a foreigner)
101
What are the future implications:
a) If paid for in cash, then no future implications
b) if paid for using a bank account at CIBC, then next period Canadians pay interest to
foreigners J falls, and either
i ) Capital Account up
ii) FX falls
102

Introduction To Macroeconomics

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Introduction To Macroeconomics

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Introduction to Macro

Professor Walid Hejazi

Interest first year:

If pay $2083 / month: How long________?

How to avert a Depression 6

Emerging and Developing Economies

Source: IMF, WEO Data Base, April, 2011 Update

Source: St. Louis Fed 9

Growth slower than expected

Financial Market Reform

Oil Prices up dramatically through 2014 but

Consumer and government debts a drain

Macroeconomics: The study of the economy as a whole

We study both the determination of equilibrium values in these

Key Concepts and Trends

Wages and salaries represent the largest share of GDP

Source: Statistics Canada, CANSIM, table 380-0064.

THE BASE YEAR

National Income Accounting

GDP + Profits from production abroad using Canadian

- Profits form production in Canada using foreign

Production with USA =20 Can = 5 Production with

Production with Production with US

Walid Hejazi, Rotman School of Management, University of Toronto

GDP versus GNP at Market Prices

Distribution of Canadas Exports

Natural Question: should we have maintained a fixed E with US?

Is a low currency good?

Is the surge in the currency good?

Foreign Direct Investment

Walid Hejazi, Rotman School of Management, University of Toronto

Wholesale Trade 53,438 69,513 5% 6% 2.70% 5.30%

GDP = Y = C + I + G + X where X = exports - imports

GDP is a measure of economic activity: the distinction between C, I, G, and X is based on

Example: a car purchased by...

Households for their personal use enters the NIAs as C

Savings and Investment

Savings of the Rest of the World:

Example: assume X > 0 and J = 0

In a closed economy, Domestic Savings = Domestic Investment

What are the gains from global capital markets?

Think of developing countries with tremendous investment opportunities: cannot

Key Concepts and Trends

1. Available for work

Natural Rate of Unemployment

There is always some unemployment. The natural rate of unemployment is

An Example Canadian Labour Force Statistics

POP (15 +) 28,314,700

POPULATION = Not in Labour Force + Labour Force

Labour Force = Employed + Unemployed

LFParticipation Rate = LF / POP

POP = 28,314,700 (working age)

In the U.S. a "passive" job searcher is not counted as an

In the US the age of the sample commences at 16 years

In both countries, institutionalized persons

Labour force participation rates of men and

What is the unemployment rate?

What is the Labour force participation rate(LFPR)?

If there is no entry into the Labour force: UR = (1.56-1)/13.94 = 4%

Why do we measure inflation?

b) 3%, then real incomes grew by ..

c) 5%, then real incomes grew by ..

We calculate the inflation rate based on the GDP deflator because:

(Y - Y) / Y = -2 (UR - UR*)