cfa level i - macroeconomics2

7/27/2019 CFA Level I - Macroeconomics2

1/44

CFA Level I Macroeconomics - 2

Presented by: Aditya Ahluwaliawww.finstructor.in


2/44

UNEMPLOYMENT AND

INFLATION


3/44

Unemployment

Frictional Structural

Cyclical

Considered unemployed if actively searchingfor work

Labor force = employed + unemployed

Underemployed

Participation ratio = % working age who are

employed or seeking employment

Discouraged workers


4/44

Inflation

CPI basket


5/44


6/44


7/44

PPI , GDP deflator as measures

Headline and core inflation (excludes food and

energy)

Problems with Laspeyres index

>New goods

> Quality changes

> Substitution


8/44


9/44


10/44

Cost push inflation


11/44

Demand pull inflation


12/44

MONETARY AND FISCAL

POLICIES


13/44

Fiscal policyuse of taxation and spending toaffect economic activity

> Budget surplus or deficit

Monetary policyactions that affect quantityof money and credit in an economy in order to

influence economic activity

> Expansionary (accomodative) or contractionary(restrictive)

Aim is to keep moderate inflation and good

economic growth


14/44

Functions of money

Medium of exchange

Unit of account

Store of value


15/44

Fractional reserve banking


16/44

Narrow moneyNotes and coins incirculation, plus checkable bank deposits

Broad moneynarrow money plus money in

liquid assets


17/44

Quantity Theory of Money

> Money supply x velocity = price x real output

> MV = PY

> Velocity represents the average number of times

each unit of money is used to buy goods andservices

> Monetarists believe that velocity and the real

output change slowly, hence increase in moneysupply, will lead to a proportionate increase in

inflation

> Money neutralityreal variables are not affected

by monetary variables


18/44

Demand for money

Transaction demand: Money held to meet theneed for undertaking transactions

Precautionary demand: for unforeseen future

needs Speculative demand: to take advantage of

investment opportunities that arise in the future


19/44

Supply of money is determined by the central

bank and is independent of demand


20/44

Increase in money supply


21/44

Fischer effect

Real rates are stable, changes in interest ratesare driven by changes in expected inflation


22/44

Role of central bank

Sole supplier of currency

Banker to the government and other banks

Regulator and supervisor of payments system

Lender of last resort

Holder of gold and foreign exchange reserves

Conductor of monetary policy


23/44

Objectives of the central bank

Primary objective is to control inflation> Menu costsbusiness need to change prices

> Shoe leather costsfrequent trips to the bank to

withdraw depreciating cash

> Unexpected inflation is more costly than expected

inflation

Stability in exchange rates

Employment

Economic growth

Moderate long term rates


24/44

Monetary policy tools

Policy rate

Reserve requirements

Open market operations


25/44

Effective central banks

Independence> Operational independencecentral bank can

independently determine the policy rate

> Target independenceCentral bank defines howinflation is computed, sets the target and

determines the horizon over which it has to be

achieved

Credibility

> Should follow through on their stated intentions


26/44

Transparency> Periodic disclosure about views on inflation,

economy etc.

> Aids credibility


27/44

Transmission mechanism

Suppose economy is in a recession, steps in transmission would be as follows:


28/44


29/44

Expansionary or contractionary

policy rate > neutral ( contracionary monetary policy)

policy rate < neutral ( expansionary monetary policy)


30/44

Monetary policy limitations

Transmission may not work as expected

> Cut in rates, may increase inflationary

expectations, may increase long term rates

> Tightening may reduce growth expectations,

reducing long term rates

Liquidity trappersistent holding of cash,

such that rates dont decrease

Cannot stimulate once interest rate reacheszero

Quantitative easing may not work if perceived

credit risk is high


31/44

Additional issues in developing economies


32/44

Fiscal policy

Discretionary Automatic stabilizers

> Unemployment claims,

> Taxes

OBJECTIVES

> Influencing economic activity

> Redistributing wealth and income

> Allocation resources amongst sectors


33/44

Fiscal policy tools

Spending tools> Transfer payments

> Current spending (ongoing expenditure)

> Capital spending


34/44

Revenue tools

Revenue tools> Direct taxes

> Indirect taxes


35/44


36/44

Fiscal multiplierpotential increase inaggregate demand, resulting from an increase

in government spending


37/44

Balanced budget multiplier

If the government increases taxes to offset a$100 increase in spending, the net impact

should still be positive

100 * .8 * 2.5 = 200 250200 = 50

Ricardian equivalencepeople anticipate

future pressures from current deficits and startsaving more, hence budget deficit does not

stimulate demand


38/44

Problems with fiscal deficit


39/44

Arguments against being concerned with fiscal deficit


40/44

Difficulties in implementation

Recognition lag Action lag

Impact lag


41/44

Additional problems

Misreading statistics Crowding out

Supply shortages

Limits to deficits

Multiple targets


42/44

Fiscal policyexpansionary or contractionary> Changes in surplus or deficit

> Structural (cyclically adjusted) budget deficit

I i f d fi l li


43/44

Interaction of monetary and fiscal policy


44/44

cfa level i - macroeconomics2

Documents