Real Sector IPPM 2015

Real SectorFinancial Program

IPPM – May 2015

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OutlineOutline

Output Prices & Inflation Steps to FP Policy options Annex

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Output

Output is one of the most important elements of a FP

Potential vs. Real Output Factors affecting output:

Short term: Capital stock & labor Long term: TFP

Sectoral Roles: Agriculture; Public Infrastructure investment

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Output and Income

Aggregate Output and Aggregate Income (Y)• Aggregate output is the total quantity of goods and services produced (or supplied) in an economy in a given period.

• Aggregate income is the total income received by all factors of production in a given period.

• Aggregate output (income) (Y) is a combined term used to remind you of the exact equality between aggregate output and aggregate income.

• When we talk about output (Y), we mean real output, or the quantities of goods and services produced, not the dollars in circulation.

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Measures of output

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AD

SRAS

P1

Y1

The price level

The model determines the eq’m

price leveland eq’m output

(real GDP).

“Aggregate Demand”

“Short-Run

Aggregate Supply

”

P

Y

Real GDP, the

quantity of output

Aggregate Demand and Aggregate Supply

Equilibrium Output

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•planned expendituresAnother term for total demand for goods and services.•equilibrium outputThe level of GDP at which planned expenditure equals the amount that is produced.equilibrium output = planned expenditures

Some Conclusions

Over the long run, real GDP in major industrial countries (such as USA) grows (about 3% per year on average).

In the short run, GDP fluctuates around its trend. Recessions: periods of falling real incomes and rising unemployment

Depressions: severe recessions (very rare)

Short-run economic fluctuations are often called business cycles.

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Interrelations

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Basic formulations

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Accountings

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Problems in Output Measuring

Some products are not traded in the market thus no reference price: Gov’t services; charitable activities…

Quality of goods are not included GDP concept does not net out bad activities, such as crimes…

Deductions of natural resource are not accounted

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Prices & Inflations

Consumer Price Index (CPI) Wholesale Price Index (WPI) GDP Deflator

GDP Deflator = Nominal GDP*100/Real GDP

Real GDP: GDP at price of Base Year Core inflation Inflation targeting monetary policy

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Wages and Unemployment

Real wages & purchasing power Unemployment rate:

Unemployment rate = Number of employed*100/Labor force

Full Employment vs. NAIRU (Non Accelerating Inflation rate of Unemployment)

Factors of Inflation: Seasonal, Cyclical, Structural, Disguised (household working in a family-owned farm

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FP: Projecting Output

Consumption: Private and Gov’t Saving & transfers Stances in (i)Monetary, (ii)Fiscal, (iii)BOP

Investment: Private and Gov’t ICOR= Total real Investment/GDP Growth

Stances in (i)Monetary; (ii)Fiscal; (iii)BOP

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FP: Projecting Inflation

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Projecting Inflation

Factors affecting prices: Monetary Stance Fiscal Stance BOP Stance

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Policy Options

Recent trends in output growth and key driver of growth

Factors affecting medium to long term growth prospects

Trade-offs between growth & social policy objectives

General stance of economic policies

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Example

Current Situations Policy released Implications Real Sector

GDP 1Q2015 surprisingly high 6.03%

PMI 4M2015 reach new high 53.5

Policies to relax lending requirements to real estate sectors

Pushing consumer consumption by separating finance company from commercial bank

Flexible adjusting the oil&gas price in line with the world market

Large FDI projects will be accepted but delayed projects to be punished

The government chooses private consumption and net export to become driver of growth.

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VO VAN MINHNGUYEN DINH CHUC

THANK YOUTHANK YOU

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Short-Run Economic Fluctuations

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Most economists believe classical theory describes the world in the long run, but not the short run.

In the short run, changes in nominal variables (like the money supply or P ) can affect real variables (like Y or the u-rate).

To study the short run, we use a new model (the AD and AS model).

Short-Run Economic Fluctuations

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KeynesianThe General Theory of Employment, Interest, and Money, 1936Argued recessions and depressions can result from inadequate demand; policymakers should shift AD.Famous critique of classical theory:

The long run is a misleading guide to current affairs. In the long run, we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us when the storm is long past, the ocean will be flat.

AD Curve

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ADP1

Y1

P2

Y2

The AD curve shows the quantity of all g&s demanded in the economy at any given price level.

P

Y

The Aggregate-Demand (AD) Curve

AS vs AD

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ADP1

Y1

the wealth effect (C falls)

P2

Y2

the interest-rate effect (I falls)

the exchange-rate effect (NX falls)

The AD Curve Slope Downward

increase in P reduces the quantity of g&s demanded because:

Shifting of the AD Curve

Changes in C Stock market boom/crash Preferences regarding consumption/saving tradeoff

Tax hikes/cuts Changes in I

Firms buy new computers, equipment, factories Expectations, optimism/pessimism Interest rates, monetary policy Investment Tax Credit or other tax incentives

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Changes in G Federal (Central) government spending, e.g., defense

State & local spending, e.g., roads, schools Changes in NX

Booms/recessions in countries that buy our exports.

Appreciation/depreciation resulting from international speculation in foreign exchange market

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Shifting of AD Curve

Aggregate-Supply (AS) Curves

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P

Y

SRAS

LRASThe AS curve shows the total quantity of g&s firms produce and sell at any given price level. AS is: upward-sloping in short run

vertical in long run

Long-Run Aggregate-Supply Curve (LRAS)

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The natural rate of output (YN) is the amount of output the economy produces when un-employment is at its natural rate. YN is also called potential output or full employment output

P

Y

LRAS

P1

P2

Change in P does not affect any of these, so it does not affect YN.

Shifting of LRAS Curve

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P

Y

LRAS1 LRAS2

YN’

Any event that changes any of the determinants of YN will shift LRAS. Example: Immigration increases L, causing YN to rise.

YN

Changes in L or natural rate of unemployment Immigration Baby-boomers retire Government policies reduce natural rate of unemployment

Changes in K or H Investment in factories, equipment More people get college degrees Factories destroyed by an earthquake

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Shifting of LRAS Curve

Why LRAS Curve Might Shift

Changes in natural resources Discovery of new mineral deposits Reduction in supply of imported oil Changing weather patterns that affect agricultural production

Changes in technology Productivity improvements from technological progress

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Short Run Aggregate Supply (SRAS)

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The SRAS curve is upward sloping: Over the period of 1-2 years, an increase in P causes an increase in the quantity of g & s supplied.

P

YY2

P1

Y1

SRAS

P2

The Slope of SRAS Matters

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AD1

SRAS

LRAS

ADlo

Y1

Plo

Ylo

Phi

Yhi

Phi

Plo

If AS is vertical, fluctuations in AD do not cause fluctuations in output or employment. If AS slopes up, then shifts in AD do affect output and employment.

P

Y

ADhi

Why SRAS slopes upward

The Misperceptions Theory

The Sticky-Wage Theory The Sticky-Price Theory

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The Misperceptions Theory Changes in the overall price level temporarily mislead suppliers about what is happening in the markets in which they sell their output:

A lower price level causes misperceptions about relative prices. These misperceptions induce suppliers to decrease the quantity of goods and services supplied.

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The Sticky-Wage Theory Nominal wages are slow to adjust, or are “sticky” in the short run: Wages do not adjust immediately to a fall in the price level.

A lower price level makes employment and production less profitable.

This induces firms to reduce the quantity of goods and services supplied.

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The Sticky-Price Theory Prices of some goods and services adjust sluggishly in response to changing economic conditions:

An unexpected fall in the price level leaves some firms with higher-than-desired prices.• This depresses sales, which induces firms to reduce the quantity of goods and services they produce.

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Common of three Theories

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In all 3 theories, Y deviates from YN when P deviates from PE.Y = YN + a (P – PE)OutputNatural rate of output (long-run)

Actual price level

a > 0, measures how much Y responds

to unexpected changes in

P

Expected price level

Common of three Theories

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SRAS

YN

When P > PE

Y > YN

When P < PE

Y < YN

PEthe

expected price level

Y = YN + a (P – PE)P

Y

SRAS and LRAS

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LRAS

SRAS

PE

Y = YN + a (P – PE)

In the long run, PE = P

and Y = YN.

P

YYN

Shifting of SRAS

Shifts arising Labor Capital Natural Resources. Technology. Expected Price Level.

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Shifting of SRAS

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Everything that shifts LRAS shifts SRAS, too. Also, PE (expected price level) shifts SRAS:If PE rises, workers & firms set higher wages. At each P, production is less profitable, Y falls, SRAS shifts left.

LRASP

Y

PE

SRAS

PE

SRAS

YN

Supply Side Economics

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Managing the economy

Aimed to increase the country’s AS and shift the LRAS to the right;

Combined with AD policies, they aim to meet government macroeconomic targets;

Supply side policies can be private or public sector, e.g. improvements in productivity in the private sector.

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Supply Side Economics

Supply Side Policies

1. Labor market measures – improving education and training, reducing trade union powers, profit-related and performance related pay, encouraging more flexible pension arrangements

2. Tax reforms – reducing the tax burden and replacing direct with indirect taxes

3. Welfare reform – reducing state benefits to encourage employment rather than benefits and reducing the unemployment trap

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Supply Side Policies

4. Industrial and competition policy – privatisation, deregulation, contracting out

5. State Owned Enterprises (SOE) (for Vietnam?)

6. Financial and capital market measures – deregulating financial markets, greater competition amongst banks and building societies, encouraging saving and share ownership, promoting entrepreneurship

Overall, supply side can be categorised into policies focused on the labour market or product market

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What factors affect supply?

Supply side policies seek to increase long run aggregate supply and so increase the productive potential of the economy.

They aim to do this by increasing the quantity and quality of resources

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2 main approaches to SS policy Free market approach (new classical) – by raising work incentives, removing restrictions on firms and increasing competitive pressures

Interventionist approach (Keynesian) – seeks to shift the LRAS curve to the right through government intervention in markets to correct market failure

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Work debate

How has the government encouraged people into work?

How could this be extended? What are economic restructuring policies being designed and implemented in Vietnam?

Can we clasify Enterprises Law as a supply side policy?

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Free market SS policies

Reducing direct taxes e.g. income and corporation tax – encourages increases in quality and quantity of labor and capital. Lower tax encourages more working and training to gain higher paid jobs. Should encourage those out of work to seek work if it is beneficial to them. Corporation tax reduction will increase the funds that firms have available to spend on R&D and new capital, thereby increasing LRAS.

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• Cutting benefits – if benefits are cut, together with a decrease in income tax, then this should encourage more people to move into the job market, by making it more financially attractive to work

• Paying benefits for ‘job seeking’. Some people argue that tying benefits to actually seeking employment will in turn lead to more people joining the labor market

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• Reforming trade unions – some unions act as a monopoly to the management, a de facto monopsony, could also be achieved if the union represents all workers. This can push wage rates about the equilibrium level.

• Free market economists argue that union power should be reduced to stop people being priced out of the market (Thatcher in 1980s)

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• Privatisation – in the 1990s the government of Vietnam has stated privatisation policies (equitization in Vietnamese jargon). Free market economists believe that firms work better in the private sector and more competition leads to increased supply.

• Deregulation – removing laws and regulations to restrict competition

• Competition policy – to make markets more economically efficient

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Interventionist supply side policies

Education and training – greater quantity and quality of education should raise labor productivity and mobility. If the government does not intervene in education then not enough resources will be used and it will be underused and underprovided (merit good with positive externalities)

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Interventionist supply side policies

Investment grants – profit incentive by firms might mean that in the short term firms do not invest. These grants aim to increase the quantity and quality of investment

Regional policy – aims to regenerate areas of deprivation and increase infrastructure, schools, hospitals and housing where there is a shortage

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• If a country becomes capable of producing at a lower costs then the BOP position should improve

• Trend growth rate should rise• Unemployment should be lower as labor is more flexible

• Increasing productive capacity should also reduce the risk of inflation – the output can rise without causing a rise in the price level

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Effectiveness of SS policies

• Can be influenced by other factors;• Takes time to have effect (education)• Expensive (education, training, healthcare?)• Workers and producers may respond in an unintended ways e.g. Firms > more dividends than investment, workers> reduce hours after income tax is cut

• No guarantee they will work: Education – does not always lead to higher standards; privatisation does not always lead to increased competition

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Effectiveness of SS policies

Real Sector IPPM 2015

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