AGEC 340 – International Economic DevelopmentCourse slides for week 14 (April 13 & 15)

Macroeconomic Policy*

• Exchange rates and inflation• Monetary and fiscal policy

* If you are following the textbook, this is chapter 18.

The U.S. economy

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Real U.S. GDP per year, 1947-2008(trillions of 2000 dollars, seasonally adjusted quarterly data )

Note: Trend line shown is a rough estimate of "potential" GDP.Source: U.S. Bureau of Economic Analysis (www.bea.gov/national)

Dividing the pie: How is it used? How is it made? How is it earned?

US data on incomeUS data on demand US data on supplyClick here for the latest figures:

How does macroeconomics matter for trade?

• What is “macroeconomics”, anyway?

• How would it enter our diagrams?

Our country (US) Rest of the world (ROW)Int’l. Trade

Q(tons)

Sexports

Dimports

Q(tons)

Q(thou. tons)

From week 3, the three-panel diagram…What if our currency falls in value? (e.g. more US$ per foreign currency)

More simply, from week 4’s “small country diagrams”, When our currency falls in value…

Pt

SDPrice($/unit) Pt

SD

An importable good An exportable good

How does agriculture fit in?

• “Devaluation” or “depreciation” of the currency helps producers of any tradable, whether exported or imported

• Agriculture is a major producer of tradables, using non-tradable land and labor; a low value of the currency helps farmers!

• But note that currency depreciation hurts most consumers, who are net buyers of tradable goods, and net sellers of non-tradables…

How has the U.S. exchange rate moved?

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The Real Exchange Rate Facing U.S. Agriculture, 1970-2008

Note: Left scale is inverted, so a rise in the solid line is a decline in the value of the U.S. dollar. Source: Calculated from ERS/USDA data (www.ers.ursda.gov/data/macroeconomics;.

Real

Exch

ange

Rat

e (2

005=

100)

[fo

reig

n cu

rren

cy p

er U

S do

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reve

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The exchange rate and farm income

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Real Exch. Rate (left scale, 2005=100)

Net Farm Income (right scale, 2000 US$)

The Real Exchange Rate and Net Farm Income in the United States, 1970-2008

Note: Left scale is inverted, so a rise in the solid line is a decline in the value of the U.S. dollar. Source: Calculated from ERS/USDA data (www.ers.ursda.gov/data/macroeconomics; www.ers.usda.giv/data/farmincome.

Real

Exch

ange

Rat

e (2

005=

100)

[fo

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n cu

rren

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S do

llar,

reve

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Real

Net

Far

m In

com

e (b

illio

ns o

f 200

0 US

$)

Qty. of ag goods

Qty of other goods

We can think of this using a PPF and indifference curves

Foreigners are trading with us along the dashed line, at price = Pag/Pother

QsQdexports

Gains from trade

Qty. of all tradable goods(e.g. farm products)

Qty of other goods (all non-tradables, e.g. most services)

Adding up all tradable goods on the X axis…

If total exports = imports (exactly balanced trade), then the slope of the “price line” here would be Pt/Pother

Qty. of all tradable goods(e.g. farm products)

Qty of other goods (all non-tradables, e.g. most services)

Now we can see effects of macro policy:What if our country (e.g. the U.S.) borrows

money from the rest of the world?Then we have “capital inflows” and a matching “trade deficit”; we consume more tradables than we produce: Pt/Pother is lower than if we did not borrow.

Qs Qd

Gains from borrowing (but note losses if/when we have to pay back!)

…but now back to the textbook!

What does the U.S government actually do?

• The U.S. Government Printing Office publishes all our official documents, – e.g. for the budget, historical data is here:

http://www.gpoaccess.gov/usbudget/fy11/

note especially:Receipts and Outlays as Percentages of GDP: 1930–2015Receipts by Source as Percentages of GDP: 1934–2015Outlays by Function and Subfunction: 1962–2015

Some conclusions from macroeconomics

• A key function of government is to stabilize the economy over time, by borrowing more in bad times and saving more during boom periods.

• A key “macroeconomic” variable is the international exchange rate, which determines the prices of all internationally-traded goods relative to domestic ones.

• To maximize long-run national income, governments should pursue freer international trade, and focus its interventions remedies for market failure.

• Next week: foreign investment, migration and aid