Okay, let's start. Hello, everyone. Welcome to 14.02, Introduction to Macroeconomics. I won't teach today, so that's the good news.
I will start on Wednesday. So what I want to do today is essentially tell you what macro is about, macroeconomics is about, and also the rules of the game. So what a difference a single letter makes. Many of you must have taken 1401. In fact, some of you may be taking it concurrently.
It's a lecture right before mine. And, you know, that's microeconomics. 1401, this is macroeconomics, and it doesn't take a lot of imagination to realize that this course is about big things. We don't look at small things, that's what micro is about.
Micro looks at a household, at a firm, at an industry. In macro we don't do that, we look at the whole economy. We think about the US, we think about China.
We don't think about an individual price, we think about inflation, so the rate of change of all prices. We don't think about whether a particular worker is employed or unemployed. We think of whether the rate of unemployment is very high or low.
Things of that kind. OK? When we look at two countries, we look at the exchange rate, which is the relative price of two currencies, not two individual goods in two different countries, but the whole currency and so on. So that's what macro is about. Now, you could think that macro is nothing else than the sum of lots of micros.
After all, that's what an economy is made of. A population, a whole population, is made of Lots of individuals that can be analyzed with the tools of 1401 and the sequence that follows 1401. But that doesn't work. And there are parallels in physics about this and so on.
The way you want to study sort of big bodies is different from the way you want to understand the movements of small elements. And that's the case in macro. In macro, there's a big line of research that has to do with the micro foundations of macroeconomics.
But even in that case, which is very close to micro, most of the action ends up happening in the non-micro part, in the interactions and in the equilibrium aspects of the system. So it's a much more complicated object, and if you were to build it from the micro, it would be an incredibly complicated object. So one of the things we need to do in macroeconomics is take some shortcuts, and that's what makes macro a lot of an art.
It's not a science per se, it's... some sort of a science, it has the tools of a science, but it's a lot about shortcuts and tricks and so on to capture the essence of a problem that is very complex if you work to mold it in all the gory details. Okay? And in this course, we're gonna exaggerate on that sense. We're not gonna do anything complicated, I promise you that.
Some occasionally conceptually things will be complicated, but the math will not be complicated, okay? So we're gonna keep things very, very simple. I want to communicate the essence of the big macroeconomic relationships.
This is not a PhD course. If you were to take a PhD course in macro, it would be a very mathy type course. In fact, most of the people that do apply in micro in our PhD program complain against macro because they find it too mathy and so on.
But that's not going to be the case here. That's not what this course is about. My goal, so if this is a successful course, is not that you come out... being a researcher in macro of this.
Hopefully you'll have a career eventually and do all the next steps that you need to do that. But I want you to be able to do is to read something like this. This is a World Economic Outlook.
It's a publication that the IMF puts out every six months, in which it tells you how this is the world and where we're heading and so on. No equations there, lots of tables and stuff like that. I'd like you to be able to read that kind of document very clearly. I would like you to be able to read something, say, the Wall Street Journal, and read it even critically.
Sometimes disagreeing with what is in there. Financial Times, The Economist. That's the goal of this course. It's not a lot more than that. It's just that.
If you do a summer internship in Wall Street and you work in a macro hedge fund or whatever, this is going to be a good course for that. I mean, this is what traders really know. They don't know a lot more than that.
Many traders should know that. They don't. But that's a level of knowledge. I'm not...
If it gets to be very complicated, I'm failing. That's not what I want to hear. The typical lecture, again this is not a lecture, the next, the first lecture will be on Wednesday, the typical lecture and not in the first part of the course because you're not going to have the tools, the definitions and so on to do it, what I want to do is spend five to ten minutes early on, again the first part of the course we can do that because you don't have the knowledge to do that, but as we start building tools I want to be able to sort of talk about current events.
Something that is happening out there that I find interesting, or something I received that morning, even the morning of the lecture, in which I find interesting, and if I think you already have the tools to begin to understand it, I'm going to be repetitive. I'm going to sort of come back to three, four times to the same topic. Hopefully, you'll be more advanced in your knowledge in the later stages, and you'll be able to understand it more and more. Okay?
So the typical lecture will have five to ten minutes in which we'll talk about some facts. something that is going on. For example, a picture like this.
This is what I received this morning. I think this came from Goldman, I think. Goldman Sachs, yes. And what you have in that picture, again, don't worry about details today, is you have two lines.
One of them is a measure of wages, wage growth, compensation to workers. And another one is a measure of inflation. Again, all the definition will come in the next lecture.
Inflation, so it's a rate at which, you know, you must have heard about inflation. It's something, prices are rising, you know, and what that picture shows you is that these two series are very highly correlated. Okay, so when wage growth is high, inflation tends to be high.
Okay, and that's a big issue on these days. There's a lot of concern about this stuff. So let me, let me try to explain a little bit what is a concern on these days.
Again, If you don't understand anything, it doesn't matter. If you don't understand anything I'm saying right now in the last lecture, then it matters. But now it doesn't matter. I'm just trying to give you a flavor of the kind of things we'll be talking about.
That picture there, again a variable that we'll define in the next lecture, not now, shows you the unemployment rate. You don't need any specific definition to know that, to feel at least, get a sense that, well, if unemployment is high, workers aren't very happy. It's not a good thing to have lots of unemployment.
And what that series shows you, the shaded areas are recessions in the U.S. What that series shows you is that typically in recessions, unemployment goes up. So that's one of the features, one of the main features of a recession is that unemployment is high. This episode here is called the Great Recession.
As a parallel for the Great Depression, the U.S. had the Great Depression in the 30s. This is the Great Recession, the biggest sort of recession outside of the Great Depression in the U.S. And it's also known as the global financial crisis because this was a recession all around the world.
And what you can see is that employment went very high, that's a very feature, a telltale sign of a big recession, and then it took a long time. This was in sort of recovering. COVID was a massive shock to the labor market, so not surprisingly the employment rate spiked there, but then it also recovered a lot faster than it recovered from that. And today we have unemployment rates that are at historically low levels. And that's a big issue.
The rate of unemployment in the U.S. is at historically low levels. Way below what is normal. Forget recessions. Obviously way below what happens in recession. But even way below what is normal, what happens during normal times.
Closely related to that is wage growth. I have just one measure of wages there. It's a series of wages that is particularly, that what I'm about to say is particularly sharp, which is the wages of in the accommodation and food service sector.
So wages have been rising very steadily and very fast recently everywhere, particularly in sectors like this, where we have some problems what we call labor supply. But I'll get back to that. Okay, so those are two facts.
We have an employment at extremely low levels. And we have wage growth at a very high, fast pace. Now that sounds wonderful, no?
I mean, what else do you want? An economy in which there's few people unemployed and the wages are growing a lot. I mean, if this was micro, this would be fantastic. Say, okay, look, a guy is employed and he's getting a high wage.
This is great. Well, not so fast for macro. Not so fast because...
I already showed you in the first picture that I showed you at the bottom, there's a connection between wage growth and inflation. And that's what we're experiencing. The normal level of inflation for an economy like the U.S. is around 2%.
That's normal. That's what central banks target in an economy like the U.S., in the euro area. Japan has been dreaming with 2%, but it hasn't been able for decades to get it, although now they are, but they weren't for a couple of decades to get to 2%. But that's about, and we'll discuss later in the course, why 2% is about right for economies of the size of the U.S. and so on. Obviously, in recessions, these things can go low, and that's why, you know, in the COVID recession, inflation went to zero, essentially.
But then it began to pick up, and it's now at levels which are unheard of in the U.S. since the 80s, okay? So depending on the particular measure you use of inflation, it's around 6.5% to 8%. That's the level of inflation we have, which is way, way above what is considered... A normal, a reasonable target for the central banks for the inflation.
Okay, so that's a problem. We have had some good news recently in that inflation clearly peaked already. Again, definition of inflation, formal definition of inflation happens in the next lecture, but it already peaked and it's declining, but it's still a very, very high level.
And that's a problem. That's a big macroeconomic problem. And one of the things we want to understand in this course is, well, what to do about it. How do you deal with that?
What do central banks need to do in order to deal with that? Now, I've been talking about the U.S., but this is not specific to the U.S. This episode, this recovery from COVID, is incredibly common across different regions of the world. I mean, you see it everywhere, with a few exceptions, and I'm going to talk about one major exception in a minute.
But it's widespread. It's a widespread phenomenon that we had high unemployment, then we had sort of very high, well, I haven't told you that part yet, but then we had sort of low inflation, then inflation picked up enormously, and now we're all worried about these very high levels of inflation. In fact, if you look at sort of what happened between the Great Recession and the COVID recession, it was pretty normal to have 70% to 80% of the economies in the world. having inflation levels at or below 2%.
So that's the norm. If they throw you into a country, they drop you into a country, the normal thing would be, well, it's about 2%, that's the level of inflation. Obviously, if I drop you in Argentina, you're going to find a much bigger number, 10,000%, but the bulk of the countries were around 2% or so.
Today, you don't find any country with inflation below 2%, not even Japan. that for years were in deflation and trying to get sort of above zero. That's all they wanted. Not even in Japan you have inflation below 2% today. So this thing I show you, and for more or less the same reasons, is happening everywhere.
Not exactly the same factors, it's the same episode, for example, and then with differences depending on the structure of the economy or in additional shocks. In Europe, for example, they have very high inflation, but the problem is not... the origin of the problem, the bulk of the problem is the same as in the US, but at the margin they are different. In Europe, the big driver of inflation, the big recent driver of inflation, is unlike the US, which is aggregate demand, a concept you'll understand later, is essentially the war in Ukraine.
That has increased the price of energy, and the price of energy has... led to lots of inflation. So there are different reasons, but all of them are sort of different reasons that you add on top of what is a common story, which is that we overheated coming out of the COVID episode and now we're struggling with that. Now the main tool, and we're going to talk a lot about this in this course, the main tool that central banks have to deal with inflation is the interest rate.
So for reasons you'll understand later. Although you may have an intuition about some of those now, obviously when the central bank lowers the interest rates then that helps the economy to expand and when it increases interest rate then it does the opposite. Raising interest rate makes mortgages more expensive, makes everything more expensive so people tend to consume less, firms tend to invest less and so on because it's more expensive to invest, to borrow, to do something.
Okay? And there you see it. I mean, this was the level of the interest rate in the US before COVID. When COVID came, boom, they brought it all the way down.
It happens that you cannot bring the interest rate a lot lower than zero. That's the reason it stayed close to zero there. We're going to talk about that later on. But then eventually they realized they were behind the curve.
Inflation had picked up a lot, and the central banks were behind the curve. So they began to hike rates in a hurry. And that's what we have been experiencing for the last year or so.
Very fast increase in the interest rate. Now, this is, of course, about macroeconomics, but I happen to do a lot of research between macro and finance. So I'm going to put a little bit more of a component of finance. I think I'm going to do most of that in the last third of the course. But monetary policy has lots of implications for finance, for equity values, for the stock market and stuff like that.
So what you see here is the line here is the SPX 500. It's the main index of equity in the U.S. of shares. There are several indices, Nasdaq, S&P, Dow, and so on. This is the main index, the most comprehensive, the one that takes the largest companies, and so on and so forth. And when you can see what happens here is that when COVID happened, the surprise that we had really a pandemia, then the stock market crashed and declined like 30% or something like that at the time. That's interesting of assets.
I mean, that's one characteristic of... Equity that I like a lot, other risky assets as well, but they anticipate what happens. What happened there is the stock market, the shareholders realized that something big was negative and big was happening in front of us, so it was time to sell, and so the equity market collapsed. What happens next is even more interesting for a macroeconomist, which is this big boom here.
It's an enormous boom. The economy here still was at levels of activity below what it had before COVID. But the stock market, the value in the stock market had way exceeded the level we had before the pandemic.
And the main driver of that, I've shown that in some papers, the main driver of that is not, I mean, people tell lots of stories, you know, Amazon and so on, Tesla, blah, blah, blah. If you look at the aggregate, the main reason for that rise was monetary policy. You can explain all that increase in the equity value in the U.S. of the index, not individual shares, of the index by the effect of interest rates. So monetary policy plays a big role, if you care about finance, it plays a huge role in the value of assets.
When monetary policy is very loose, that tends to increase the value of assets. And that's one of the mechanisms the central banks use to expand aggregate demand when they want to expand aggregate demand. They want people to feel, if you had a recession, you want people to feel richer.
So they spend more and so on and so forth. What happened here? This decline, you can also explain it fully with the hiking interest rate. Remember I showed you that the interest rate began to rise very rapidly here. Well, last year, the equity market in the US and most major equity markets around the world declined by 20% or more.
You can explain all that decline simply by increasing the interest rate. So that's another thing we need to understand is why is it that the interest rate... Why is the interest rate matter so much for something like equity? So we're going to value assets, and we're going to see what is the effect of the interest rate, and then we're going to think about, well, why would the central bank worry or not worry about these things, and so on and so forth.
But the truth is that financial markets and the central banks interact all the time. I mean, if you are, again, into Wall Street type thing, you're going to be watching every day, every time that the monetary... minutes, the minutes of the central banks are released, you're going to be watching because it has a big implication for the value of your equity.
Actually something very interesting of this nature happened last week. On Friday, last Friday, there was a release of payroll numbers, so it's an employment index, okay, employment numbers. And people expected And the payroll to increase, so to add non-farm payroll, we'll talk about these things later, by about 190,000 workers.
At 8.30, well, and this you're seeing here is the behavior of the same index I showed you before, but the futures. So it's things you can trade before the market actually opens. The market in the U.S. opens at 9.30 a.m., but you can trade futures since Asia times, okay?
Anyway, so this is the path. It's all very quiet, tranquility. Everyone is waiting the release of this news at 8.30 a.m. At 8.30 a.m., great news for the labor market.
Not only, the actual change in the payroll was not $190,000, it was over $500,000. So, enormous addition of jobs. to the economy. And look what happens to the equity market. Boom!
It imploded immediately. So this is wonderful news now for the economy. Lots of jobs. The equity market imploded as a result. Why do you think that happened?
I've already given you a little bit of the ingredients for why for an answer in the previous slides. The reason I'm showing you this is because it's a 15 minutes, it summarizes all that I was talking about in the previous 30 minutes. Why do you think that happened? This is wonderful news.
Why the stock market should crash like 2% from top to bottom as a result of that. More labor because that gives a lot more supply of that thing and thus... It increases price if there's high supply. No, but, ah, okay, that's an interesting, okay, that's an interesting explanation.
It's not the one I have in mind. It's a, the explanation says, look, that means firms hire lots of people, so the price, that means there's going to be lots of supply of whatever goods they're producing, the price of those goods is going to decline and that's going to be bad for profits. That's the story you had in mind? Yeah.
Maybe there's some of that, but I'm willing to bet that it's not the main thing. So the only clue I'll give you is that I already talked about these things five minutes ago. Employment is very closely related to inflation rates.
Yes. Up to 0.81, so this could be the result of expectations of continuing high inflation rates. Okay, you're very close.
One step more. Yes? That means that, that means that, so, okay, there you are.
So what happens? The bank, they said the shareholders wouldn't have done anything if they thought that the Fed would not be able to see this data, but they know that the Fed also sees this data. They say, whoa, these guys are gonna be worried because the economy is gonna keep overheating, they're gonna have to hike interest rates even more in order to cool down this economy, okay? I already showed you that what happens in the labor market is very connected to what happens with inflation.
The central bank knows that. And now you get this big surprise that means they're not really being able to, they're not being successful at really slowing down one of the main drivers of inflation. And so financial markets are very forward-looking.
They say, whoa, this is coming. This only means that they're not going to... Financial markets were betting that the Fed was going to begin to cut interest rates in... four months more or so. And if you look at the forwards there, so you can extract what the market thinks, right after this, it all got immediately pushed out to the end of the year.
So it's precise. It's anticipation that the central bank will have to do something. And so I thought it was very interesting from that point of view. Recessions. Well, look, and these are all very good news, but Everyone knows that the Fed needs to cool off the economy, so despite the fact that we're getting good news now, people expect, the majority of people expect a recession in the U.S. for this year.
I'm not going to explain this graphic here, but these are forecasts, these are professional forecasts, and more than half of them, so the median of them thinks that there is a 65% probability that there is a recession in the U.S. this year. I'm a little, well, we're going to talk a lot about this, and probably we're going to be getting news about this while we're taking the course, so this is going to be a sort of picture that we're going to discuss extensively. And the reason for the recession is nothing else than the reason, if you ask this forecast, why do you think we may have a recession?
Well, because the Fed is trying to fight inflation, it's going to keep hiking interest rates, and at some point it may break something, okay? And that's... That's the reason. But we're gonna, all these things, you are gonna be able to understand very clearly hope through models. The last thing I want to say before telling you a little bit the rules of the game is that I said before that the story I told you about the US is more or less what has happened all around.
I was in Chile a month ago, I'm Chilean, and they have the same story. They start hiking interest rates a little earlier because they have more inflation. ...than the U.S., but they're going through the same cycle. There's one big economy, the second largest economy in the world, that has not been part of this. which is China.
China was very aggressive in the COVID policy, so zero COVID policy, so they really slowed down their economy. That's a consequence. They didn't want to do that, but as a result of a very strict COVID policy, they essentially shut down big parts of their economy for a long time. That, by the way, had big impact in the rest of the world through the network of production, the chains of production and stuff like that. That was inflationary in itself.
That part is dissipating. But for their own economy, for the domestic economy, that really slowed down China. An economy that grew typically at 5.5% to 6%, a lot higher 15 years ago. We're going to try to understand why later on.
But last year, I don't know, it was 3% or less. Numbers in China are difficult to figure out. They're not equally transparent to other numbers. But in any event, it's very clear that...
China slowed down a lot and that policy recently changed. The zero Covid policy changed and so there's great expectation that now there's going to be a big boom in China because they're lagging behind. I mean in the US when Covid began to dissipate we got a huge boost to growth and that's part of the reason we got all this inflation is because we had lots of growth coming out of the recession that were happening in Covid and more or less the same is expected in China. And one of the big reasons behind those big bounce-backs is, well, people are desperate. They want to spend on something.
They want to go to restaurants and cinemas and stuff like that. And the other one is they have the means to do it because they couldn't spend on anything for a while, you know? And so they can travel and stuff like that.
So people expect, and this is a very large economy that suddenly sort of wakes up. You know, that's a big thing for China, but it's also a big thing for the world. You know, what happens in China doesn't stay in China.
It's a big giant, so it moves. And for some countries, it's very, very important. This picture here shows you what is the impact on different regions of the world, on the growth rate in different regions of the world, of an increase by 1% in the rate of growth of China. One of the most... Obviously, all the neighbors benefit a lot, but Latin America benefits even more.
Why is that? Well, because... Latin America produces lots of commodities, and China consumes lots of commodities when it's building, and stuff like that. And so that's a reason, big impact on Latin America. So this is a piece of good news for the world, in the sense that activity will go up.
But it's good news on average, but it may be too much of a good thing as well. Why? Because many economies are going through what we described before.
They're trying to bring down inflation. They don't want more demand. They want less.
For now, because we're going to understand the connection later on, how demand connects to inflation, but you want less. And now you're going to get this impulse from China, which is going to fuel more inflation. It's okay for China because they don't have an inflation problem, but it may be a problem for many of the countries that are trying to undo the inflationary consequences of the previous expansion, the expansion that followed COVID. Okay, anyways, but this is the kind of things we're going to be talking about.
I said the course is not going to be mathy, but it's going to be all about models. The next lecture is the most boring lecture of the course, I tell you in advance, because it's definitions. I need to go through definitions. At least I get bored. But the rest, there's always a little model, but simple models, okay?
But the models are going to try to explain the kind of things I discussed today. So that's what this course is about. ideally, if we're successful, you're going to be able to read something like the World Economic Outlook, which will have lots of pictures like this, and you're going to be able to write a little equation, very simple on the side, to try to understand what is going on there and to catch the mistakes as well. We all have less mistakes than the Wall Street Journal, but you will catch mistakes. You'll see.
You'll be proud.