EC210 ~ MACRO

[e]

EC210 ~ MACRO

[e]

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[e]

Ec210 MACRO (Tom C)

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t(.)e(.)cunningham(at)lse(.)ac(.)uk

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<h2 style="margin-top: 0px;">Ec210 MACRO (Tom C)</h2>
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<ol>
<li> <a href="./?body=Home">Home</a><br />
<li> <a href="./?body=Handout">Handout</a>
<li> <a href="./?body=Notes">Economic Modelling</a>
<li> <a href="./?body=FirstTerm">First Term Summary</a>
<li> <a 
href="./?body=Definitions">Definitions</a>
<li> <a href="./?body=Models">Models</a>
<li> <a href="./?body=Issues">Issues</a>
<li> <a href="./?body=PDVs">Present Discounted Values</a>
<li> <a href="./?body=Questions">Questions</a>
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<p>Comments to:<br /> t(.)e(.)cunningham(at)lse(.)ac(<b></b>.)uk</p>

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[e]

IMPORTANT: This is not official LSE teaching material, use at your own risk!

[e]

Economic Modelling

How it works:

Macroeconomists are the doctors of the economy. They take readings of their patient's blood pressure, blood sugar, pulse, and temperature. They then make predictions about what will happen to these variables -- both in the short-term and in the long-term -- if they make some change, e.g. injecting insulin, or getting the patient to eat less salt.
There are a few statistical indicators which have become standard measures of the state of the economy, equivalent to blood pressure or pulse, thought to summarise the most important information. These include: GDP, unemployment, inflation, the exchange rate, and the interest rate. It's important to remember that there are many possible statistics we could look at, but we just focus on the ones which we think tend to be more useful.
The problem is to understand what effect a change in one variable will have on another, e.g. How will GDP respond to an increase in the interest rate?, or How will inflation respond to a decrease in unemployment?.
To answer these question you have to make some simplifying assumptions about relationships between the variables. Some typical assumptions are:
- Keynesian Consumption Function: Average Consumption = £10,000 + 0.6 * Avg. Income
- Okun's Law: % Change in GDP = 3.5 - 2 * Change in Unemployment
- Phillips Curve: Inflation Rate = 6 - Unemployment Rate
- Price Stickiness: Prices don't react to the money supply (in the short-run)
- Money Neutrality: Output is independent of the money supply (in the long run)
Each of these relationships is based on a lot of empirical and theoretical work. Each economist uses their own preferred assumptions, according to their beliefs and what they are trying to do.
[One-equation model is OK, but requires holding many things fixed // Combine equations to make something more complicated : you get a model : you can have as many endogenous variables as you have equations]
To try to get a more accurate answer you use more assumptions. The Bank of England Quarterly Model has about 160 endogenous variables (e.g. the unemployment rate), 35 exogenous variables (e.g. the income tax rate), and 90 parameters (e.g. the discount rate).
In this course you need to do three things:
- remember and understand the definitions of all the important statistics (about 20 of them);
- remember and understand the assumptions used in each of the models (about 20 of them);
- remember and understand the models, which use these assumptions (about 10 of them).
.
[[Other issues: (lags) (other variables) (let the data decide) (optimising decisions)]]

<h2>Economic Modelling</h2>

<b>How it works:</b><ol>

<li> Macroeconomists are the doctors of the economy. They take readings of their patient's blood pressure, blood sugar, pulse, and temperature. They then make predictions about what will happen to these variables -- both in the short-term and in the long-term -- if they make some change, e.g. injecting insulin, or getting the patient to eat less salt.

<li> There are a few statistical indicators which have become standard measures of the state of the economy, equivalent to blood pressure or pulse, thought to summarise the most important information. These include: GDP, unemployment, inflation, the exchange rate, and the interest rate. It's important to remember that there are many possible statistics we could look at, but we just focus on the ones which we think tend to be more useful.

<li> The problem is to understand what effect a change in one variable will have on another, e.g. <i>How will GDP respond to an increase in the interest rate?</i>, or <i>How will inflation respond to a decrease in unemployment?</i>.

<li> To answer these question you have to make some simplifying assumptions about relationships between the variables. Some typical assumptions are: <ul>
  <li> <i>Keynesian Consumption Function:</i> Average Consumption = &pound;10,000 + 0.6 * Avg. Income
  <li> <i>Okun's Law:</i> % Change in GDP = 3.5 - 2 * Change in Unemployment
  <li> <i>Phillips Curve:</i> Inflation Rate = 6 - Unemployment Rate
  <li> <i>Price Stickiness:</i> Prices don't react to the money supply (in the short-run)
  <li> <i>Money Neutrality:</i> Output is independent of the money supply (in the long run)
</ul>
Each of these relationships is based on a lot of empirical and theoretical work. Each economist uses their own preferred assumptions, according to their beliefs and what they are trying to do.

<li> [<i>One-equation model is OK, but requires holding many things fixed // Combine equations to make something more complicated : you get a model : you can have as many endogenous variables as you have equations</i>]

<li> To try to get a more accurate answer you use more assumptions. The <a href="http://www.bankofengland.co.uk/publications/other/beqm/beqmfull.pdf"> Bank of England Quarterly Model</a> has about 160 endogenous variables (e.g. the unemployment rate), 35 exogenous variables (e.g. the income tax rate), and 90 parameters (e.g. the discount rate).

<li> In this course you need to do three things:<ul>
   <li> remember and understand the definitions of all the important statistics (about 20 of them);
   <li> remember and understand the assumptions used in each of the models (about 20 of them);
   <li> remember and understand the models, which use these assumptions (about 10 of them).
  </ul>.

<li> [[<i>Other issues: (lags) (other variables) (let the data decide) (optimising decisions)</i>]]

</ol>

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