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Презентация на тему Lecture 5. Principles of Macroeconomics

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In this Lecture:Consumer’s consumption/savings decision – responses of consumer to changes in income and interest rates.Government budget deficits and the Ricardian Equivalence Theorem.@antoniomele101
Principles of MacroeconomicsECO 1019 Lecture 5Antonio Mele meleantonio@gmail.com @antoniomele101 In this Lecture:Consumer’s consumption/savings decision – responses of consumer to changes in Intertemporal decisionsThey involve a trade off across periods of time: between current Our modelTwo period model: today and tomorrowFor simplicity: income is exogenous (no Budget ConstraintsThe consumer’s current-period budget constraint: We assume a credit market in which Budget ConstraintsThe consumer’s future-period budget constraint:Interest rate@antoniomele101 SimplifySolve the future-period budget constraint for s:@antoniomele101 Next,Substitute in the current-period budget constraint obtaining lifetime budget constraint:@antoniomele101 Consumer’s Lifetime Budget ConstraintSubstitute in the current-period budget constraint obtaining lifetime budget constraint: @antoniomele101 Simplified Lifetime Budget Constraint@antoniomele101 Simplified Lifetime Budget Constraint: Slope-Intercept@antoniomele101 Consumer’s Lifetime Budget ConstraintEndowment point: consumption bundle that consumer gets by consuming A Consumer’s Indifference Curves@antoniomele101 Sara’s Desire for Consumption Smoothing@antoniomele101 OptimizationMarginal condition that holds when the consumer is optimizing:@antoniomele101 A Consumer Who Is a Lender@antoniomele101 A Consumer Who Is a Borrower@antoniomele101 An Increase in Current Income for the ConsumerCurrent and future consumption increase.Saving The Effects of an Increase in Current Income for a Lender @antoniomele101 Observed Consumption-Smoothing BehaviorIf all consumers try to smooth consumption overtime, we should Percentage Deviations from Trend in Consumption of Durables and Real GDP@antoniomele101 Percentage Deviations from Trend in Consumption of Nondurables and Services and Real GDP@antoniomele101 An Increase in Future Income for the ConsumerCurrent and future consumption increase.Saving An Increase in Future Income @antoniomele101 Temporary and Permanent Increases in IncomeAs a permanent increase in income will Temporary Versus Permanent Increases in Income @antoniomele101 An Increase in the Real Interest Rate@antoniomele101 An Increase in the Market Real Interest RateAn increase in the market An Increase in the Real Interest Rate for a Lender@antoniomele101 Effects of an Increase in the Real Interest Rate for a Lender@antoniomele101 An Increase in the Real Interest Rate for a Borrower@antoniomele101 Effects of an Increase in the Real Interest Rate for a Borrower@antoniomele101 Introducing the governmentGovernment buys G, financed either with taxes or debt. T=Nt, Government Budget ConstraintsThe government’s current-period budget constraint:@antoniomele101 Government Budget ConstraintsThe government’s future-period budget constraint:@antoniomele101 Government Budget ConstraintsThe government’s present-value budget constraint:@antoniomele101 Competitive equilibriumEach consumer chooses current and future consumption and savings optimally given Credit Market Equilibrium ConditionTotal private savings is equal to the quantity of Credit Market Equilibrium: ImplicationsRemember:  Therefore, Or rearranging @antoniomele101 Income-Expenditure IdentityCredit market equilibrium implies that the income-expenditure identity holds.@antoniomele101 Ricardian EquivalenceThe Ricardian Equivalence Theorem states that , under some conditions, a Ricardian EquivalenceKey equation: The consumer’s lifetime tax burden is equal to the Ricardian EquivalenceThen, substitute in the consumer’s budget constraint – taxes do not Ricardian Equivalence with a Cut in Current Taxes for a Borrower @antoniomele101 Ricardian Equivalence and Credit Market Equilibrium@antoniomele101 Discussion of the assumptionsRicardian equivalence theorems says government debt represents our future ReadingsSavings are generally a good idea http://www.youtube.com/watch?v=C_8TGTKdrlYThe cost of repair http://www.economist.com/node/17173933?story_id=17173933Economists show
Слайды презентации

Слайд 2 In this Lecture:
Consumer’s consumption/savings decision – responses of

In this Lecture:Consumer’s consumption/savings decision – responses of consumer to changes

consumer to changes in income and interest rates.
Government budget

deficits and the Ricardian Equivalence Theorem.

@antoniomele101

Слайд 3 Intertemporal decisions
They involve a trade off across periods

Intertemporal decisionsThey involve a trade off across periods of time: between

of time: between current and future consumption, between current

and future taxes, etc.
In Solow model: arbitrary intertemporal decision rule, constant saving rate
We use microeconomic principles to have a more detailed analysis

@antoniomele101

Слайд 4 Our model
Two period model: today and tomorrow
For simplicity:

Our modelTwo period model: today and tomorrowFor simplicity: income is exogenous

income is exogenous (no work/leisure decision). This helps us

focus on the consumption-savings decision
Lump sum taxes


@antoniomele101

Слайд 5 Budget Constraints
The consumer’s current-period budget constraint:


 
We assume a

Budget ConstraintsThe consumer’s current-period budget constraint: We assume a credit market in

credit market in which we trade a bond issued

either by the consumers or the government

@antoniomele101

Слайд 6 Budget Constraints
The consumer’s future-period budget constraint:


Interest rate
@antoniomele101

Budget ConstraintsThe consumer’s future-period budget constraint:Interest rate@antoniomele101

Слайд 7 Simplify
Solve the future-period budget constraint for s:


@antoniomele101

SimplifySolve the future-period budget constraint for s:@antoniomele101

Слайд 8 Next,
Substitute in the current-period budget constraint obtaining lifetime

Next,Substitute in the current-period budget constraint obtaining lifetime budget constraint:@antoniomele101

budget constraint:


@antoniomele101

Слайд 9 Consumer’s Lifetime Budget Constraint
Substitute in the current-period budget

Consumer’s Lifetime Budget ConstraintSubstitute in the current-period budget constraint obtaining lifetime budget constraint: @antoniomele101

constraint obtaining lifetime budget constraint:



 
@antoniomele101

Слайд 10 Simplified Lifetime Budget Constraint


@antoniomele101

Simplified Lifetime Budget Constraint@antoniomele101

Слайд 11 Simplified Lifetime Budget Constraint: Slope-Intercept


@antoniomele101

Simplified Lifetime Budget Constraint: Slope-Intercept@antoniomele101

Слайд 12 Consumer’s Lifetime Budget Constraint
Endowment point: consumption bundle that

Consumer’s Lifetime Budget ConstraintEndowment point: consumption bundle that consumer gets by

consumer gets by consuming disposable income in current and

future period

@antoniomele101

Слайд 13 A Consumer’s Indifference Curves
@antoniomele101

A Consumer’s Indifference Curves@antoniomele101

Слайд 14 Sara’s Desire for Consumption Smoothing
@antoniomele101

Sara’s Desire for Consumption Smoothing@antoniomele101

Слайд 15 Optimization


Marginal condition that holds when the consumer is

OptimizationMarginal condition that holds when the consumer is optimizing:@antoniomele101

optimizing:


@antoniomele101

Слайд 16 A Consumer Who Is a Lender
@antoniomele101

A Consumer Who Is a Lender@antoniomele101

Слайд 17 A Consumer Who Is a Borrower
@antoniomele101

A Consumer Who Is a Borrower@antoniomele101

Слайд 18 An Increase in Current Income for the Consumer


Current

An Increase in Current Income for the ConsumerCurrent and future consumption

and future consumption increase.
Saving increases.
The consumer acts to smooth

consumption over time.


@antoniomele101

Слайд 19 The Effects of an Increase in Current Income

The Effects of an Increase in Current Income for a Lender @antoniomele101

for a Lender
 
@antoniomele101

Слайд 20 Observed Consumption-Smoothing Behavior


If all consumers try to smooth

Observed Consumption-Smoothing BehaviorIf all consumers try to smooth consumption overtime, we

consumption overtime, we should observe that aggregate consumption is

smoother than aggregate income
Aggregate consumption of non-durables and services is smooth relative to aggregate income, but the consumption of durables is more volatile than income.
This is because durables consumption is economically more like investment than consumption.


@antoniomele101

Слайд 21 Percentage Deviations from Trend in Consumption of Durables

Percentage Deviations from Trend in Consumption of Durables and Real GDP@antoniomele101

and Real GDP
@antoniomele101

Слайд 22 Percentage Deviations from Trend in Consumption of Nondurables

Percentage Deviations from Trend in Consumption of Nondurables and Services and Real GDP@antoniomele101

and Services and Real GDP
@antoniomele101

Слайд 23 An Increase in Future Income for the Consumer


Current

An Increase in Future Income for the ConsumerCurrent and future consumption

and future consumption increase.
Saving decreases.
The consumer acts to smooth

consumption over time.



@antoniomele101

Слайд 24 An Increase in Future Income
 
@antoniomele101

An Increase in Future Income @antoniomele101

Слайд 25 Temporary and Permanent Increases in Income


As a permanent

Temporary and Permanent Increases in IncomeAs a permanent increase in income

increase in income will have a larger effect on

lifetime wealth than a temporary increase, there will be a larger effect on current consumption.
A consumer will tend to save most of a purely temporary income increase.
This is the permanent income hypothesis by Milton Friedman


@antoniomele101

Слайд 26 Temporary Versus Permanent Increases in Income
 
@antoniomele101

Temporary Versus Permanent Increases in Income @antoniomele101

Слайд 27 An Increase in the Real Interest Rate
@antoniomele101

An Increase in the Real Interest Rate@antoniomele101

Слайд 28 An Increase in the Market Real Interest Rate


An

An Increase in the Market Real Interest RateAn increase in the

increase in the market real interest rate decreases the

relative price of future consumption goods in terms of current consumption goods – this has income and substitution effects for the consumer.


@antoniomele101

Слайд 29 An Increase in the Real Interest Rate for

An Increase in the Real Interest Rate for a Lender@antoniomele101

a Lender
@antoniomele101

Слайд 30 Effects of an Increase in the Real Interest

Effects of an Increase in the Real Interest Rate for a Lender@antoniomele101

Rate for a Lender
@antoniomele101

Слайд 31 An Increase in the Real Interest Rate for

An Increase in the Real Interest Rate for a Borrower@antoniomele101

a Borrower
@antoniomele101

Слайд 32 Effects of an Increase in the Real Interest

Effects of an Increase in the Real Interest Rate for a Borrower@antoniomele101

Rate for a Borrower
@antoniomele101

Слайд 33 Introducing the government
Government buys G, financed either with

Introducing the governmentGovernment buys G, financed either with taxes or debt.

taxes or debt.
T=Nt, T’=Nt’
Private and government bonds are

indistinguishable, have same interest rate r

@antoniomele101

Слайд 34 Government Budget Constraints


The government’s current-period budget constraint:




@antoniomele101

Government Budget ConstraintsThe government’s current-period budget constraint:@antoniomele101

Слайд 35 Government Budget Constraints


The government’s future-period budget constraint:




@antoniomele101

Government Budget ConstraintsThe government’s future-period budget constraint:@antoniomele101

Слайд 36 Government Budget Constraints


The government’s present-value budget constraint:




@antoniomele101

Government Budget ConstraintsThe government’s present-value budget constraint:@antoniomele101

Слайд 37 Competitive equilibrium
Each consumer chooses current and future consumption

Competitive equilibriumEach consumer chooses current and future consumption and savings optimally

and savings optimally given interest rate r
The government present-value

budget constraint holds
The credit market clears

@antoniomele101

Слайд 38 Credit Market Equilibrium Condition


Total private savings is equal

Credit Market Equilibrium ConditionTotal private savings is equal to the quantity

to the quantity of government bonds issued in the

current period.


@antoniomele101

Слайд 39 Credit Market Equilibrium: Implications


Remember:
 
Therefore,
Or rearranging
@antoniomele101

Credit Market Equilibrium: ImplicationsRemember:  Therefore, Or rearranging @antoniomele101

Слайд 40 Income-Expenditure Identity


Credit market equilibrium implies that the income-expenditure

Income-Expenditure IdentityCredit market equilibrium implies that the income-expenditure identity holds.@antoniomele101

identity holds.




@antoniomele101

Слайд 41 Ricardian Equivalence


The Ricardian Equivalence Theorem states that ,

Ricardian EquivalenceThe Ricardian Equivalence Theorem states that , under some conditions,

under some conditions, a change in the timing of

taxes is neutral, i.e. has no effect on the interest rate and on current and future consumption



@antoniomele101

Слайд 42 Ricardian Equivalence


Key equation: The consumer’s lifetime tax burden

Ricardian EquivalenceKey equation: The consumer’s lifetime tax burden is equal to

is equal to the consumer’s share of the present

value of government spending – the timing of taxation does not matter for the consumer.



implies

@antoniomele101

Слайд 43 Ricardian Equivalence


Then, substitute in the consumer’s budget constraint

Ricardian EquivalenceThen, substitute in the consumer’s budget constraint – taxes do

– taxes do not matter in equilibrium for the

consumer’s lifetime wealth, just the present value of government spending.




@antoniomele101

Слайд 44 Ricardian Equivalence with a Cut in Current Taxes

Ricardian Equivalence with a Cut in Current Taxes for a Borrower @antoniomele101

for a Borrower
 
@antoniomele101

Слайд 45 Ricardian Equivalence and Credit Market Equilibrium
@antoniomele101

Ricardian Equivalence and Credit Market Equilibrium@antoniomele101

Слайд 46 Discussion of the assumptions
Ricardian equivalence theorems says government

Discussion of the assumptionsRicardian equivalence theorems says government debt represents our

debt represents our future liabilities as a nation, must

be paid by taxing citizens in the future.
It’s a good benchmark to start thinking about government debt, however some of the assumptions are very strong!
Situations in which it might not hold:
Heterogeneity: different taxes for different people
Finite lifetimes
Distortionary taxes
Imperfections in the credit markets

@antoniomele101

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