Friday, April 4, 2008

Lecture 1 - Overview of US and World Economies

My notes from Lecture 1 are below. They're still in pretty raw form - as I took them during class. I brushed them up a bit and added some links that you may find helpful or interesting reading.

The lecture was (to me) a fast-paced overview of lots of economic topics. It sounds like we're going to go into more depth on each of them in future lectures.

The US Economy

US GDP growth rate has historically hovered around 3-4%. Lower than 3% generally indicates that economy is shrinking and slowing down. Over the past 3 years, GDP growth has been 3.1, 2.9 and 2.2%. Anticipated growth in 2008 is expected to be in the 1.3-2% range.

CPI inflation has also been lessening over the last 3 years. Unemployment (4.8% last month) is lower than historical average. Some ppl question whether there's a recession or not due to this.

The US govt is currently running a federal budget deficit of 3% (of GDP).

US Current account balance = trade deficit = about -6% of GDP (double the govt deficit) = about $800 billion! This is about 2/3 of combined trade deficits of all other countries. $$ are needed from foreigners to balance this deficit. Borrowing from foreigners finances the trade deficit.

In Euro Area: Real GDP growth is about 2% constant.

China: real GDP growth is 10%! By the rule of 70, this means that their GDP doubles in size every 7 years! If you do the math, the Chinese GDP will be equal to that of the US in about 2036. We can't ignore these developing nations. They have an 11% trade surplus. 2008 inflation rate is 8.7%!

US Economy - Background

When IT investment collapsed in 2000, the Fed lowered interest rates, but Greenspan kept the interest rates too low for too long. Policies caused rapid economic recovery. Increased consumption caused a huge trade deficit to develop. 6% was never heard of in the past. It was historically more like 3%. More recently, housing bubble burst, subprime loan losses and credit crisis caused economic activity to slow down because banks didn't have money to lend.

GDP growth rate per capita is relatively stable for US and W European nations. 1950-1973 saw tremendous growth as European countries rebuilt and rebounded from WWII.

Labor Productivity

How has the US economy been doing for the last 15 yrs? Living standard depends on the labor productivity. Labor productivity jumped to 2.5% (from 1.3%) beginning in 1995. Many economists called this a miracle! It was closely related to the technology revolution. Lately (since 2006), productivity growth is slowing down to 1-1.6%. The higher rate couldn't last forever.

Question: How is productivity measured?

When productivity is high, inflation tends to be low. Prof Woo will make a case for the mechanism in week 5 or 6.

Mankiw questioned how much we owe to Greenspan and how much was his luck. His answer (in an article) is that Greenspan was very fortunate and less prophetic.

Income Inequality

Bottom 99% have not gained much, while the top 1% have grown substantially. What is the cause? Which arguments have stronger evidence? Most economists believe it's due to the IT revolution, not due to international trade and job outsourcing. We'll talk about this in more detail in 2 weeks.


Global stock markets experience a "synchronization" nowadays because they aren't isolated, because there are many multinational companies and many companies are listed on several exchanges.

Some economists suggest a decoupling between US and other economies.

Since 1992, there has been a tremendous increase in foreign investment (assets and liabilities). How big? Big! We'll get back to this in week 5.

Benefits of Globalization

Everyone gains from Globalization. We achieve economies of scale due to larger markets (exports). Cheaper imports. Risk diversification through international investment. Access to international financial markets. Increased competition boosts efficiency.

Costs of Globalization

Displaced labor due to outsourcing. Greater exposure to external shocks due to financial crises in foreign markets. (Eliezer asks: Does this offset the risk diversification that is gained?)

Current Issues in the US Economy

Trade Deficit (both govt and personal)
Housing Bubble Burst

Why did we go into such a big consumption boom? Stock market and housing market were booming (until they both burst) and the Fed had a very low interest rate policy. Americans took out a lot of home equity loans based on the housing market boom and low interest rates.

Eliezer's personal take on this: I believe both technological innovation and consumerism were a major driver of the consumption boom. My observation is that there was a sudden and tremendous increase in the popularity in consumer electronics like pagers, cell phones, mp3 players, ipods, iphones, large screen tvs, cable tv, high-speed internet access, cd and dvd players, etc etc. All these items suddenly became part of the popular culture and items that every household must have - whether or not they could practically afford them or not. There was a similar change in the availability of larger automobiles. Low interest rate policy made credit card companys more liberal in their issuance of consumer credit and allowed consumers to make these "essential" purchases. Although housing costs are a large portion of household spending, the addition of these new items, some of which involve recurring monthly charges, have increased the financial burden on the average consumer.

US Trade Deficits: Unsustainable?

The current trade deficit is about $800 billion - about 6% of GDP. It's financed by borrowing from foreigners. Who are these mysterious foreigners? Primarily Middle Eastern oil (They are following the example of Norway - depositing into a national "sovereign" fund and then investing in foreign economies.)

EA Note: Congress recently held a joint subcommittee hearing on Foreign Government Investment in the US Economy and Financial Sector.

Chinese and Japanese wanted to keep their currencies cheap, so they bought a lot of US Treasury Bonds in order to keep the US$ relatively strong. But they could have made more investing outside the US. So why did they do it? We'll talk about that later in the class.

Bernanke referred to a "global saving glut" - "it's not our problem".

Subprime Loan Losses and Financial Crisis

We had strong economic growth with little risk (since Argentina 2002) and low cost of borrowing (due to Fed interest rate policy). This caused a huge credit boom.

Financial innovation

Banks didn't keep the mortgage loans. Rather, they repackaged them as CDOs which standardized all the loans together (with a wide variety of risk level) and sold the package to other financial institutions. The financial institutions only invested into these instruments because interest rates were low and they couldn't make $$ elsewhere. SIV = structured investment vehicle.

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