Economic Growth and the Financial system

Economic Growth, the Financial System, and Business Cycles Business cycle: Alternating periods of economic expansion and economic recession.

Long-Run Economic Growth Long-run economic growth: The process by which rising productivity increases the average standard of living. The Growth in Real GDP per Capita, 1900–2010 Measured in 2005 dollars, real GDP per capita in the United States grew from about $5,600 in 1900 to about $42,200 in 2010. The average American in the year 2010 could buy nearly eight times as many goods and services as the average American in the year 1900.

The Connection between Economic Prosperity and Health

Long-Run Economic Growth Calculating Growth Rates and the Rule of 70 What Determines the Rate of Long-Run Growth? Labor productivity: The quantity of goods and services that can be produced by one worker or by one hour of work. Labor productivity affected by technology

Long-Run Economic Growth What Determines the Rate of Long-Run Growth? Increases in Capital per Hour Worked Capital Manufactured goods that are used to produce other goods and services. Technological Change Economic growth depends more on technological change than on increases in capital per hour worked. Technological change is an increase in the quantity of output firms can produce using a given quantity of inputs.

Saving, Investment, and the Financial System Financial system: The system of financial markets and financial intermediaries through which firms acquire funds from households.

Saving, Investment, and the Financial System The Macroeconomics of Saving and Investment Y = C + I + G + NX Y = C + I + G I = Y − C − G = Y + TR − C − T = T − G − TR

Saving, Investment, and the Financial System The Macroeconomics of Saving and Investment S = + or S = (Y + TR − C − T) + (T − G − TR) or S = Y − C − G Examples from old notes! So, we can conclude that total saving must equal total investment: S = I

Market for loanable funds: The interaction of borrowers and lenders that determines the market interest rate and the quantity of loanable funds exchanged.

The Market for Loanable Funds Demand and Supply in the Loanable Funds Market The Market for Loanable Funds

Equilibrium in Loanable Funds At the equilibrium interest rate, the quantity of loanable funds supplied equals the quantity of loanable funds demanded. Here the equilibrium interest rate is 8%, with $300 billion of funds lent and borrowed. Investment spending projects with a rate of return of 8% or higher receive financing; those with a lower rate of return do not. Lenders who demand an interest rate of 8% or lower have their offers of loans accepted; those who demand a higher interest rate do not.

The Market for Loanable Funds Explaining Movements in Saving, Investment, and Interest Rates An Increase in the Demand for Loanable Funds

Crowding out: A decline in private expenditures as a result of an increase in government purchases. The Effect of a Budget Deficit on the Market for Loanable Funds

Who sets the interest rate? Central Banks? - Kind of.

ANY good tradesman will tell you the importance of the bits of a house that you cannot see. Never mind the new kitchen: what about the rafters, the wiring and the pipes? So it is with financial markets. The stockmarkets are the most visible: as they soar or swoon, the headline-writers get to work. The money markets, however, are the plumbing of the system. Normally, they function efficiently and unseen, allowing investment institutions, companies and banks to lend and borrow trillions of dollars for up to a year at a time. They are only noticed when they go wrong. And, like plumbing, when they do get blocked, they make an almighty stink. (Source: Blocked Pipes, The Economist, Oct 2nd 2008)

Business cycle

The Business Cycle Some Basic Business Cycle Definitions Panel (a) shows an idealized business cycle, with real GDP increasing smoothly in an expansion to a business cycle peak and then decreasing smoothly in a recession to a business cycle trough, which is followed by another expansion. The periods of expansion are shown in green, and the period of recession is shown in red Panel (b) shows the actual movements in real GDP for 1999 to 2002. Real GDP fluctuates during the period around the business cycle peak of March 2001. The following recession was fairly short, and a business cycle trough was reached in November 2001, when the next expansion began. The Business Cycle

What Happens during a Business Cycle? The Effect of the Business Cycle on Boeing The Effect of the Business Cycle on Boeing Panel (a) shows movements in real GDP for each quarter from the beginning of 1990 through the end of 2008. Panel (b) shows movements in the number of passenger aircraft shipped by Boeing for the same years. In panel (b), the effects of the recessions on Boeing are more dramatic than the effects on the economy as a whole.

What Happens during a Business Cycle? The Effect of the Business Cycle on the Inflation Rate Toward the end of a typical expansion, the inflation rate begins to rise. Recessions, marked by the shaded vertical bars, cause the inflation rate to fall. By the end of a recession, the inflation rate is significantly below what it had been at the beginning of the recession.

What Happens during a Business Cycle? The Effect of the Business Cycle on the Inflation Rate The Impact of Recessions on the Inflation Rate Don’t Let This Happen to YOU! Don’t Confuse the Price Level and the Inflation Rate

What Happens during a Business Cycle? The Effect of the Business Cycle on the Unemployment Rate How the Recession of 2001 Affected the Unemployment Rate

What Happens during a Business Cycle? The Effect of the Business Cycle on the Unemployment Rate How Recessions Affect the Unemployment Rate Unemployment rises during recessions and falls during expansions. The reluctance of firms to hire new employees during the early stages of a recovery means that the unemployment rate usually continues to rise even after the recession has ended.

What Happens during a Business Cycle? The Effect of the Business Cycle on the Unemployment Rate The Impact of Recessions on the Unemployment Rate

What Happens during a Business Cycle? Recessions Have Been Milder and the Economy Has Been More Stable Since 1950 Fluctuations in Real GDP, 1900–2008 Fluctuations in real GDP were greater before 1950 than they have been since 1950.

Why Is the Economy More Stable? • The increasing importance of services and the declining importance of goods. • The establishment of unemployment insurance and other government transfer programs that provide funds to the unemployed. • Active federal government policies to stabilize the economy.