•COMPARATIVE ECONOMIC POLICIES •[Petr MACH] Every even Tuesday Room D-236 About the teacher •Ph.D. in Finance, 2001 •Advisor to the President of the Czech Republic 2001-2008 •Member of the European parliament 2014-2017 •Teacher of microeconomics, macroeconomics, monetary theory and policy, lobbying and game theory – present • •Contact: petrmach1975@gmail.com Topic 30/9 14/10 11/11 25/11 Durán de Frutos, Hugo Galvas, Matyáš García Domínguez, Jorge Iskakova, Ayana Khandro, Pema Navarro Gómez, Belén Paul, Metayer Vega Gómez, Mario Completion •Active participation recommended •Grade (A-F) based on •active participation (20%) •Student‘s presentation (20%) •Written test – calculation of exercises (60%) • Student‘s presentation •9th of December 2025 •About 15 miutes + discussion •About 8-10 slides (recommended) •Compare the taxation policy of your country and of the Czech Republic •or •Compare the monetary policy of your country and of the Czech Republic • Literature •[1] KRAFT, M. - FURLONG, S. Public Policy: Politics, Analysis, and Alternatives. CQ Press, Sixth edition, 2017. •ISBN 9781506358154 •[2] SALVATORE, D. (Ed.). National Economic Policies. North Holland, 2014. 412 pages. ISBN 978-1493304936. •[3] DODDS, A. Comparative Public Policy. 2nd Edition, Red Globe Press, 2018. 350 pages. ISBN 978-1137607041. •HANSEN, P. A Modern Migration Theory: An Alternative Economic Approach to Failed EU Policy. Agenda Publishing, 2021. ISBN 978-1788210553. •ROSSER JR., J. B., & ROSSER, M. V. Comparative Economics in a Transforming World Economy. 3rd Edition • •https://eshop.vsfs.cz/textbook-of-elementary-economics/ • • PETR MACH - Macroeconomics Textbook of Elementary Economics Only if you need to support your knowledge in economic theory The goal of the course •The course presents and analyses the reasons and effects of public policies. It deals with various arguments for and against government intervention to the market. Upon the completion of the course the students will be able to understand, challenge and evaluate various policies and their side effects. •*** •There are various arguments and motivations for various economic policies. Also, various policies have various effects and side effects. •In this course, we will describe these policies, we will present and debate various arguments for and against the application of these policies, and describe both the desired as well as the unintended effects. Content: 1. Economics and economic policy •In this lesson we will explain the scope and limitations of economics and of economic policies. •We will debate ethics behind government intervention. •You will comprehend the dispute Capitalism vs socialism / Economic liberalism vs Keynesianism / Big government vs small government. •Reading: Frédéric Bastiat: The law • Definitions •Economy •Economics •Economic policy • Economy •A set of people, firms and goods involved in production, trade, and consumption Microeconomika jako ekonomické statistiky finančních místních podniků nastiňují koncept - Bez autorských poplatků Diagramy vektorové obrázky Economics •Economics is the science which studies human behaviour as a relationship between given ends and scarce means which have alternative uses. •(Lionel Robbins) Department of Economics | Ole Miss Economic policy •A set of goals and measures through which the government tries to manage a given branch of the economy Approved stamp. wooden stamper and stamp with text approved on plakáty na zeď • plakáty | myloview.cz Economic policy •Subject •Objects •Instruments Utility maximization Lobbying Ideas - Political philosophy Preferences Corruption Voting decisions Economic policies Instruments of economic policies •Debate-voting-legislation-enforcement • •Motivation: Encourage people to do or not to do something (incentives – tax breaks, subsidies, allowances…) •Regulation: Order people to do something or ban doing something •Budget: Taxing people and spendimg money in place of them • •All based on coertion The scope of economics •Economics as a science •It can describe what people do •It can try to explain why people do what they do •It can estimate what will happen if certain actions are taken •Upon its understanding of the basic patterns of human behaviour and its limited ability to estimate the consequences of various actions, it can give some advice to policymakers •Positive vs normative statements •(how things are vs how things should be) Vektorová grafika „hand indicating or showing direction by pointing a finger vector illustration outline design“ ze služby Stock | Adobe Stock Adam Smith – Invisible hand •„ It is not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner, but from their regard to their own self interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.“ •„he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.““ Broken Window Icon Isolated Simple Cartoon 库存矢量图（免版税）1120312205 | Shutterstock What is seen and what is not seen •„Have you ever witnessed the anger of the good shopkeeper, James Goodfellow, when his careless son has happened to break a pane of glass? If you have been present at such a scene, you will most assuredly bear witness to the fact that every one of the spectators, were there even thirty of them, by common consent apparently, offered the unfortunate owner this invariable consolation—"It is an ill wind that blows nobody good. Everybody must live, and what would become of the glaziers if panes of glass were never broken?" •Now, this form of condolence contains an entire theory, which it will be well to show up in this simple case, seeing that it is precisely the same as that which, unhappily, regulates the greater part of our economical institutions.“ •„Suppose it cost six francs to repair the damage, and you say that the accident brings six francs to the glazier's trade—that it encourages that trade to the amount of six francs—I grant it; I have not a word to say against it; you reason justly. The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen. •But if, on the other hand, you come to the conclusion, as is too often the case, that it is a good thing to break windows, that it causes money to circulate, and that the encouragement of industry in general will be the result of it, you will oblige me to call out, "Stop there! Your theory is confined to that which is seen; it takes no account of that which is not seen." •It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way, which this accident has prevented.” • http://upload.wikimedia.org/wikipedia/commons/thumb/0/0a/AdamSmith.jpg/225px-AdamSmith.jpg http://spartacus-educational.com/TUkeynesP3.jpg Image result for bastiat Frédéric Bastiat 1801-1850 Karl Marx | Books, Theory, Beliefs, Children, Communism, Sociology, Religion, & Facts | Britannica Karl Marx Das Kapital 1867 Adam Smith 1776 Wealth of Nations J.M. Keynes Genaral theory, 1936 Milton Friedman 1912-2006 Interventionism vs. Economic liberalism • Bastiat – gardener example •„…socialist writers look upon people in the same manner that the gardener views his trees. Just as the gardener capriciously shapes the trees into pyramids, parasols, cubes, vases, fans, and other forms, just so does the socialist writer whimsically shape human beings into groups, series, centers, sub-centers, honeycombs, labor corps, and other variations. And just as the gardener needs axes, pruning hooks, saws, and shears to shape his trees, just so does the socialist writer need the force that he can find only in law to shape human beings. For this purpose, he devises tariff laws, tax laws, relief laws, and school laws.“ The elements of garden design and basic garden patterns Pareto improvement •Vilfredo Pareto (1848-1923) • •A Pareto improvement is such a change in the allocation of resources that makes at least one individual better off without making any other individual worse off. •Pareto efficiency is a state of the allocation of resources in which it is impossible to make any single individual better off without making at least one individual worse off. • • Vilfredo Pareto.jpg A voluntary contract •By definition, a voluntary contract is a Pareto improvement • •A private theft is not •Taxation is not •Regulation is not Free Shaking Hands Cliparts, Download Free Shaking Hands Cliparts png images, Free ClipArts on Clipart Library Trade increases utility •Through exchange things find new owners to whom they will be more useful. • •U(A, Fish)=100 •U(B, Fish)=200 •U(A, Corn)=300 •U(B, Corn)=150 •A: -100+300=+200 •B: -150+200=+50 •A+B: +250 • Find the difference •Private theft •Taxation and subsidies Why don‘t most people steal? •Risk of punishment •The cost of stealing •Ethical norms Image result for bastiat •„The law perverted! And the police powers of the state perverted along with it! The law, I say, not only turned from its proper purpose but made to follow an entirely contrary purpose! The law become the weapon of every kind of greed! Instead of checking crime, the law itself guilty of the evils it is supposed to punish! •… It has converted plunder into a right, in order to protect plunder. And it has converted lawful defense into a crime, in order to punish lawful defense.“ •Frédéric Bastiat (1801-1850) •https://www.econlib.org/library/Bastiat/basLaw.html Legal plunder (=legalized looting) There is no eleventh commandment •There is „You shall not steel“ •But no „you shall not support or vote for legislation taking wealth from your neighbours in your favour“ • •Breaking „You shall not steel“ is considered a sin and leads to the twinge of remorse (conscience) •Priests preach that theft is a bad thing. Thay do not preach that the legal plunder is a bad thing •Voting for taxes, subsidies and regulation does not cause remorse • • New Catholic Bible 2. Market failure and government failure •Market Failure and Government failure. Dispersion of knowledge. Pareto efficiency. Private and Public goods. Externalities. Supply-side economics. Reading: Leonard Read • Rationale of economic policies •Market failure (to efficiently allocate resources) •Redistribution of wealth • • Market failure •The welfare cost of monopoly •The provision of public goods •The existence of externalities •The existence of the business cycle • • Government failure •It is argued that maybe the free market is not perfect but governments fail too in many aspects. •Methodological individualism •Corruption •Efficency vs equality •Supply-side economics •Index of economic freedom Monopoly à competition policies Petr Mach - Microeconomics PM MR QM D MC Q P Deadweight loss Arguments against economic policies •Government failure •Integrity of policymakers •Administrative cost •Distortion of markets •Loss of economic growth •Trade off between equality and efficiency Public goods •Some goods are called public (collective) goods and it is argued that the free market does not provide them in sufficient quantities. •It is reasoned that the government should be rsponsible for the privision of public goods. • Petr Mach - Microeconomics Two properties •Rivalry •Excludability Petr Mach - Microeconomics •Rivalry in consumption is a property of goods, whereby consumers compete one with another for the good as the consumption of the good by one consumer diminishes the quantity of the good available for others. •Excludability in consumption is a property of goods, whereby producers are able to exclude some people from consumption, typically those who do not pay for the good. • Petr Mach - Microeconomics Petr Mach - Microeconomics Lighthouse Images - Free Download on Freepik •Free riding is a phenomenon where a consumer uses a public good without paying for it. Petr Mach - Microeconomics •The tragedy of Commons is the situation where goods or natural resources are exploited or overused due to the lack of property rights or inability of the owner to exclude non-paying consumers from consumption. • Petr Mach - Microeconomics Quantity of public goods Petr Mach - Microeconomics lighthouses (Q) MR of A MR of B MR of C Together MC 1 22 8 5 35 20 2 19 5 2 26 20 3 15 2 0 17 20 4 11 0 0 11 20 Storms and solitude: the literature of lighthouses | Books | The Guardian •2.3 Externalities Petr Mach - Microeconomics •An externality is a cost or a benefit of the usage of one’s property, transferred without consent to someone else. Petr Mach - Microeconomics Petr Mach - Microeconomics Petr Mach - Microeconomics Petr Mach - Microeconomics Petr Mach - Microeconomics Redistribution of wealth •It is argued that the free market does not lead to fair distribution of wealth •„Fairness“ is not an economic term Equality •Utilitarianism •Majority rule • Trade-off Efficiency vs Equality (or rather regulation and the redistribution of wealth) •Higher equality is at the expense of efficiency and vice versa •But: Abolition of slavery in US increases both equality and efficiency Efficiency Equality 12 13.5 14 14 13 UTILITARISM •Redistribution of wealth could icrease the sum of utilities albeit it is not Pareto improvement Economics of redistribution •An attempt to end up at B leads only in I •(because of redistribution costs and iefficiencies) •Just compare North Korea and South Korea: •North Korea has higher equality than North Korea, but because of economic inefficiencies caused by government policies in the end the living standards of the poorest South Koreans are higher than the living standards of the poorest South Koreans. • •The same applied to former East Germany vs West Germany. • •Taking too much from the richer classes simply does not pay for the poorer classes. New Space Station Photos Show North Korea at Night, Cloaked in Darkness Corruption •Power tends to corrupt, and absolute power corrupts absolutely. Great men are almost always bad men. •(John Dalberg-Acton, 1834-1902) • •The bigger is the governmnet in terms of power and money it redistributes the more opportunities to corruption exist. Image result for i want to work in the organised crime Private sector or government? If you want to cut corrpution, cut government •The source of official corruption is the same everywhere: large governments with the power to dispense many goodies to different groups •Gary Becker • •(Nobel Price in economics winner) Friedman‘s 4 ways of spending money •Video: Petr Mach - Microeconomics •You spend your own money on yourself. •You spend your own money on someone else. •You spend someone else's money on yourself. •You spend someone else's money on someone else • Petr Mach - Microeconomics Petr Mach - Microeconomics The economic problem of voting •Democracy is a zero-sum game (or a negative-sum game because of the costs of redistribution) VOTER Total A B C D E Benefits from a new bus stop 6 6 6 0 0 18 Costs 5 5 5 5 5 25 Net benefit 1 1 1 -5 -5 -7 Votes: + + + - - Approved Stock ilustrace Autobusová Zastávka S Panorámem Města V Pozadí Se Znamením – stáhnout obrázek nyní - iStock Supply-side economics: Laffer curve Petr Mach - Microeconomics TAX REVENUE MAXIMISING RATE T* TAX RATE MAX TAX REVENUE Economic freedom PETR MACH - Macroeconomics http://www.youngresearch.com/wp-content/uploads/2012/12/Economic-Freedom-and-Economic-Growth.jpg Reading: •Leonard Read: I, pencil •https://fee.org/resources/i-pencil/ • 3. Taxation •Taxation. Welfare effects of taxation. Laffer Curve. Motivation and the administrative cost of government. • • •Purpose of taxes (tax policy): 1)Raise money for the state budget 2)Shape behaviour • The EU •VAT directive •Stanrad rate must not be lower than 15%. •Reduced rate must not be lower than 5% Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax EUR-Lex - 02006L0112-20240101 - EN - EUR-Lex Country Standard rate Food rate Hungary 27,0 18,0 Denmark 25,0 25,0 Croatia 25,0 13,0 Slovakia 23,0 19,0 Czechia 21,0 12,0 Netherlands 21,0 9,0 Romania 21,0 11,0 Austria 20,0 10,0 United Kingdom 20,0 0,0 France 20,0 5,5 France - Corsica 20,0 2,1 Germany 19,0 7,0 North Macedonia 18,0 5,0 Malta 18,0 0,0 Switzerland 8,1 2,6 Jersey 5,0 5,0 Guernsey 0,0 0,0 •Taxes, mandatory payments imposed on people and firms by the government, influence market demand and market supply, change the behaviour of people and affect the wealth of both sides of the market regardless of who is formally obliged to pay them. • Petr Mach - Microeconomics Two types of indirect taxes ·a specific tax (also called a per unit tax) – example: tax on fuel ·an ad valorem tax – example: VAT • Petr Mach - Microeconomics •Tax incidence or tax burden is the analysis of the effect of a tax on consumers’ and producers’ wealth. A tax does not necessarily fall only upon those who are obliged to pay it but it falls on both sides of the market, the suppliers and those who demand. • Petr Mach - Microeconomics Petr Mach - Microeconomics Specific tax Petr Mach - Microeconomics PBT SAT QAT QBT PAT D SBT Q P Ad valorem tax Petr Mach - Microeconomics PNT PBT SAT QAT QBT PAT D SBT Q P Very elastic demand Petr Mach - Microeconomics PAT PBT SAT QAT QBT D SBT Q P Very inelastic demand Petr Mach - Microeconomics QBT QAT PBT SAT PAT D SBT Q P Specific tax Petr Mach - Microeconomics QBT QAT PBT SAT PAT D SBT Q P Deadweight loss •When taxation results in a decrease in equilibrium quantity the deadweight loss is the loss in consumer surplus and producer surplus that is not compensated with additional tax revenue. • •The welfare cost of taxation consists of • the deadweigh cost • the administrative cost •These costs take the firm of a slower economic growth Petr Mach - Microeconomics • Exercise Petr Mach - Microeconomics Equilibrium Petr Mach - Microeconomics Petr Mach - Microeconomics 22 1.6 26.8 P=30-2Q Q P 4 4. Laffer curve •Taxation. Welfare effects of taxation. Tax avoidance. Tax evasion. Laffer Curve. Motivation and the administrative cost of government. • Laffer curve •Laffer curve shows the relationship between the tax revenue collected by the government and the tax rates. The increases in the tax revenues are smaller with each increase in the tax rate and from a certain point they are negative. Petr Mach - Microeconomics Adam Smith, 1776 •„High taxes, sometimes by diminishing the consumption of the taxed commodities, and sometimes by encouraging smuggling, frequently afford a smaller revenue to government than what might be drawn from more moderate taxes. When the diminution of revenue is the effect of the diminution of consumption there can be but one remedy, and that is the lowering of the tax.“ • Petr Mach - Microeconomics •Arthur Laffer, born in 1940, is an American economist. Between 1981-1989 he worked as an advisor to President Ronald Reagan. Laffer has coined the notion of the „supply-side economics“, a school of macroeconomic thought that argues that overall economic well-being is maximised by lowering the barriers to producing goods and services. It was a reaction to the Keynesian call for the stimulation of the aggregate demand by the government and the central bank activism. •„The basic idea behind the relationship between tax rates and tax revenues is that changes in tax rates have two effects on revenues: the arithmetic effect and the economic effect. The arithmetic effect is simply that if tax rates are lowered, tax revenues (per dollar of tax base) will be lowered by the amount of the decrease in the rate. The reverse is true for an increase in tax rates. The economic effect, however, recognizes the positive impact that lower tax rates have on work, output, and employment--and thereby the tax base--by providing incentives to increase these activities. Raising tax rates has the opposite economic effect by penalizing participation in the taxed activities. The arithmetic effect always works in the opposite direction from the economic effect. Therefore, when the economic and the arithmetic effects of tax-rate changes are combined, the consequences of the change in tax rates on total tax revenues are no longer quite so obvious.“ (Laffer, 2014) Petr Mach - Microeconomics TAX REVENUE MAXIMISING RATE T* TAX RATE MAX TAX REVENUE Petr Mach - Microeconomics Reasons: •1) Taxes tend to increase the prices of goods. Because of the law of demand, the quantity demanded of a good decreases with an increase in the tax. If the relative increase in the rate is lower than the relative decrease in the quantity demanded, the total of the tax revenues decreases. • •2) Taxes can be avoided or evaded. The higher the tax rate is, the higher the incentive of the taxpayer to avoid the tax is. This reduces the tax base. • •3) Taxes distort markets and thus make consumers allocate scarce means to suboptimal uses. This slows down economic growth and reduces the tax base even further. • Petr Mach - Microeconomics Find the Laffer curve Petr Mach - Microeconomics Petr Mach - Microeconomics Find its maximum using the derivative Alternative way 20 10 T MAX T∙Q 5. Price regulation •Price allocation mechanism. Alternative allocation mechanisms. Price regulation and shortages. Minimum wage. • The role of price •Price „clears“ the market • •The Price allocation mechanims (Allocation of goods (to whome) based on prices): •Those willing to pay the price or higher get the good. •Those willing to pay less than the market price do not get the good •So, obviously, some people cannot afford it (so what can economic policy do?) Market equilibrium •A voluntary contract is a Pareto improvement. It is beneficial for both contracting parties. Any government intervention (regulation) breaks this property of a contract. If a regulation forces someone or forbids someone to do something, some people will get better off and some will get worse off. • •Under regulation, some get better off, some get worse off. Arguments for government intervention •The government prefers those who would benefit at the expense of those who would be damaged • •For example, under rent control, the policy is infavour of those who actually live in the apparetments and pay the reguted price. It is at the expense of those who do not have an appartment yet. It is also at the expense of the owners of the flats. Price clears the market Petr Mach - Microeconomics QE PPE PE D S Q P excess demand (shortage) excess supply •Flexible prices •Prices clear the market •There are no shortages •Fixed /regulated prices •Shortages: • queues (lines), waiting lists, or rationing • Petr Mach - Microeconomics Price floor •A price floor is the type of price regulation under which prices below the minimum are prohibited. • • •=minimum price • • •Example: minimum wage Petr Mach - Microeconomics Price floor Petr Mach - Microeconomics Price ceiling •A price ceiling is the type of price regulation under which prices above the maximum are prohibited. • •=maximum price Petr Mach - Microeconomics Price ceiling Petr Mach - Microeconomics Intervention purchases/sales •Intervention purchase refers to the act of purchasing a commodity once its market price drops below the price set by an administrative decision (the intervention price) in order to raise the market price to the set level. Petr Mach - Microeconomics Intervention purchases Petr Mach - Microeconomics In the foreign exchange market Petr Mach - Microeconomics Capital inflow 24 S‘ D‘ Intervention purchase 25 D S EUR ER Alternative allocation •Discrimination •Bribery •Nepotism •Old first, Women first •First come, first served Petr Mach - Microeconomics •First come, first served is a principle under which scarce resources are allocated to consumers who demand them, in the order in which they expressed their demand. • •Women children first Petr Mach - Microeconomics Free goods – consider roads Petr Mach - Microeconomics QD QS P=0 PE D S Q P shortage Exercise •Assume that the demand for fuel can be described as P=30-2Q and the supply for fuel can be described as P=10+3Q. Find the equilibrium price and quantity. A price ceiling of P=20 is imposed. What will be the excess demand or supply? •Solution •First, find equilibrium: 30-2Q= 10+3Q •20=5Q, Q=4; P=30-2x4=22 •At P=20, quantity demanded will be 20=30-2Q, Q=5, and quantoty supplied will be 20=10+3Q, Q=3.33, The volume of excess demand will be the difference (5-3.33=1.666) 5. Keynesianism •Theoretical background of Keynesianism. •Business cycle •Aggregate demand, aggregate supply model •Say’s law of markets. •Phillips curve. • •John Maynard Keynes was a British economist (1883-1946). He was a proponent of the idea of stimulating aggregate demand by the government. This approach is called Keynesianism. •“I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case, the situation which it assumes being a limiting point of the possible positions of equilibrium. Moreover, the characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.” •(The General Theory of Employment, Interest and Money, 1936 Context •The Great Depression (1929–1939) was an economic shock that affected most countries across the world. It was a period of economic depression that became evident after a major fall in stock prices in the United States.[1] The economic contagion began around September 1929 and led to the Wall Street stock market crash of October 24 (Black Thursday). It was the longest, deepest, and most widespread depression of the 20th century.[2] •Between 1929 and 1932, worldwide gross domestic product (GDP) fell by an estimated 15%. • Business cycle PETR MACH - Macroeconomics Business cycle (sometimes called the trade cycle or the economic cycle) is irregular fluctuation of the real product around its average. EXPANSION TIME Y% RECESSION Long-term average PETR MACH - Macroeconomics AD function PETR MACH - Macroeconomics Aggregate demand •M, V, P, Y • •P…dependent variable •Y…independent variable •M, V… parameters PETR MACH - Macroeconomics PETR MACH - Macroeconomics AD M∙V Y P Aggregate supply •Unlike in microeconomics: • •No substitution effect • •AS is perfectly inelastic • •AS is a vertical line • •Y is independent of the P PETR MACH - Macroeconomics PETR MACH - Macroeconomics AS YA Y P Demand-pulled inflation PETR MACH - Macroeconomics AS AD M∙V Y P P0 P1 YA PETR MACH - Macroeconomics AS YA Y P M∙V=MB∙m∙V ΔMB P0 P1 CENTRAL BANK Supply-pushed inflation PETR MACH - Macroeconomics AS AD M∙V Y P P0 P1 YA •Demand-pulled inflation is an increase in the price level caused by an increase in aggregate demand. • • •Supply-pushed inflation is an increase in the price level caused by a decrease in aggregate supply. • PETR MACH - Macroeconomics Why recessions take place? PETR MACH - Macroeconomics SRAS AD Y P P0 P1 Y0 Y1 Classical economics PETR MACH - Macroeconomics Keynesian economics PETR MACH - Macroeconomics Paradox of Thrift 1)Thrift is a good thing (from the individual point of view): 2) •Thrift was considered a virtue. • •2) Thrift is a bad thing (from the macroeconomic point of view): •If people save cash, they reduce spending (consumption), which decreases AD, which in turn can cause recession. PETR MACH - Macroeconomics Motives to hold cash •Transaction motive •Precautionary motive •Speculative motive • •This leads to the definition of the function of the demand for cash balances PETR MACH - Macroeconomics Preference of liquidity •Liquidity = cash • •Normaly people tend to keep their wealth in the form of cash (=they prefer liquidity). They will buy other assets (bonds) only if they receive a compensation (interest) PETR MACH - Macroeconomics Demand for cash holdings PETR MACH - Macroeconomics DH H IR •Interest rate is a crucial variable in Keynesian economics PETR MACH - Macroeconomics Keynes’s consumption function PETR MACH - Macroeconomics Aggregate expenditure PETR MACH - Macroeconomics Y AE Keynes believed: 1)Spending is determined by C=Ca+cY 2)Unemployment is caused by LOW spending 3)Government can increase spending • (Gov can compensate a decrease in C by an increase in G) 1) •4) Increased spending leads to increased output and lower unemployment 1) •If any of these assumptions is wrong the Keynesian policy will not work PETR MACH - Macroeconomics What can the government do? •Taxes? (only if it does not reduce private spending) •Encourage people to spend more •The government can borrow money from the people. •The government can print up some money •Spending a cash reserve PETR MACH - Macroeconomics Exercise PETR MACH - Macroeconomics Exercise PETR MACH - Macroeconomics Exercise PETR MACH - Macroeconomics Exercise PETR MACH - Macroeconomics Exercise PETR MACH - Macroeconomics 6. Fiscal policy •Debt and deficit •Crowding-out effect •Ricardian Equivalence •Stabilisation policy Fiscal policy •Policy of the government regarding the size of its revenues and expenditures, the balance of which is supposed to influence aggregate expenditure, (in order to influence macroeconomic variables such as P, Y, U…) •Expansionary fiscal policy – running or increasing budget deficits through either decreasing taxes or increasing government purchases of goods •Restrictive fiscal policy – running or increasing budget surpluses through either increasing taxes or decreasing the government purchases of good • •AE=C+I+G+NX PETR MACH - Macroeconomics Mechanism of fiscal policy PETR MACH - Macroeconomics SRAS AD: AE=C+I+G+NX Y P P0 P1 Y0 Y1 AE=C+I+G+NX PETR MACH - Macroeconomics SRAS AD Y P P0 P1 Y0 Y1 • •Expenditures > Revenues => Budget Deficit •Revenues > Expenditures => Budget Surplus •Expenditures=Revenues => Deficit=0 (balanced budget) • PETR MACH - Macroeconomics Public debt •The total volume of money that the government owes to someone. • •It can be expressed in absolute terms; per capita, as % of GDP • •The government pays interest on the debt • • PETR MACH - Macroeconomics Debt-to-GDP ratio PETR MACH - Macroeconomics Debt and deficit PETR MACH - Macroeconomics Deficit and debt (2022) PETR MACH - Macroeconomics Deficit/surplus Public debt Argentina -3,9 % 84,5 % Czech Rep. -3,6 % 42,3 % Germany -2,6 % 66,5 % China -7,5 % 77,1 % Russia -2,2 % 19,6 % Turkye -1,6 % 31,2 % USA -5,5 % 121,6 % Venezuela -6,0 % 157,8 % Czech Rep. Celkem za 4 roky: -1142 mld https://www.psp.cz/sqw/text/orig2.sqw?idd=235995 Czech public debt Debt is an alternative to taxes •Advantages •Disadvantages Problems associated with debt •Interest payments •Crowding-out effect •Ricardian Equivalence •Risk of default PETR MACH - Macroeconomics Debt and interest •The government must pay interest on its debt. •Annual interest expenditures of the government=DEBT x average interest rate • •Example: •Assume that in 2019 the public debt is 2050 bn CZK and the average interest rate is 3%. What is the annual interest expenditure? •=2050 x 0,03=61,5 bn CZK • PETR MACH - Macroeconomics Czech government interest expenditure Crowding-out effect •Is an effect of budget deficit on aggregate expenditures • •Loans market: •Savings=Borrowings • •Private consumption spending (C)=disposable income – savings (S) • •Borrowings=State budget deficit+ investments • •Addintional spending by the governemnt (D) is AT THE EXPENSE of private spending (C, I) •Defict= D =-(∆C+ ∆I) • •AE=C+I+G+NX PETR MACH - Macroeconomics Crowding out PETR MACH - Macroeconomics E1 E0 0 C B SLOANS A DLOANS LOANS IR DEFICIT DECREASE IN PRIVATE INVESTMENTS DECREASE IN PRIVATE CONSUMPTION INVESTMENTS Stabilisation policy •Policy of increasing the demand to prevent recession or of restricting the demand to prevent „overheating“ PETR MACH - Macroeconomics Default •Inability of the government to pay its debts • •Risk of default grows with DEBT/GDP ratio PETR MACH - Macroeconomics Policy lags •Lag=delay • •Recognition lag •Decision lag •Take-effect lag PETR MACH - Macroeconomics Stabilisation policy PETR MACH - Macroeconomics OPTIMAL TIMING TIME Y% NO ACTION FISCAL EXPANSION FISCAL RESTRICTION PETR MACH - Macroeconomics Exercise •Calculate the deficit (in absolute terms; per capita, as % of GDP). Expenditures are 1050 bn CZK, revenues are 1000 bn CZK, Nominal GDP is 4000 bn CZK. Population is 10 million people. •In absolute terms: D=1050-1000=50 bn CZK •Per person: D/N=50,000,000,000/10,000,000=5000 CZK •As % of GDP: D/GDP=50/4000=1.25% PETR MACH - Macroeconomics Exercise •Calculate the deficit (in absolute terms; per capita, as % of GDP). Expenditures are 1000 bn CZK, revenues are 920 bn CZK, Nominal GDP is 3500 bn CZK. Population is 10.5 million people. •D=1000-920=80bn •D/GDP=80/3500 D=2.28%of GDP •80,000/10.5=7619 • •Calculate the public debt (per capita; as % of GDP). The debt is 2000 bn CZK. Nominal GDP is 3500 bn CZK. Population is 10.5 million people PETR MACH - Macroeconomics Example •Assume that in 2018 the public debt was 2000 and nominal GDP was 4000. Assume that in 2019 there is no deficit, the real growth Y%=6% and inflation is P%=3% •debt(2018)=2000/4000=50% •Debt(2019)=2000/(4000)(1.03)(1.06)=45.8% • •In 2018 the debt was 1500 and nom.GDP was 2800. In 2019 there was no deficit, inflation was 5% and economic growth was 2%. Calculate DEBT/GDP ratio in 2018 and in 2019. PETR MACH - Macroeconomics •Assume that the public debt is 3000 in 2018, the nom. GDP is 5000 in 2018. The deficit in 2019 is 150, inflation is 2%, economic growth is -1%. Calculate DEBT/GDP ratio in 2018 and 2019. • •2018: 3000/5000=60% •2019 3150/(5000x1.02x0.99)=62.3% PETR MACH - Macroeconomics •Debt is 3000, nom GDP is 7000 in 2019. In 2020 the deficit is 100, there is no economic growth and inflation is 20%. Calculate the DEBT/GDP in 2019 and 2020. • •2019: DEBT/GDP=3000/7000=42.85% •2020: 3100/(7000x1.2)=36.9% PETR MACH - Macroeconomics •DEBT is 3000 and GDP 6000 in 2019. In 2020 there is a surplus of 200, economic growth of 8% and inflation of 2%. Calculate DEBT/GDP in 2019 and 2020. • •2800/(6000x1.08x1.02) • •Calculate surp./GDP in 2020 •200/(6000x1.08x1.02)=3% PETR MACH - Macroeconomics Example •Assume that the public debt was 2000 bn CZK in the year 2018. The deficit in 2019 is 50 bn CZK. What will be the public debt in 2019? • •DEBT (2019)=DEBT (2018)+Deficit (2019) •=2000+50 • •Nominal GDP is 4000 bn CZK. Population is 10 million people. •Debt per head: 2,050,000,000,000/10,000,000=205,000 CZK •Debt as % of GDP: 2050/4000=51.25% PETR MACH - Macroeconomics •In 2017 the Nominal GDP was 4000 and the Public Debt was 2000. In 2018 the nominal GDP increased to 4400 and the budget deficit was 2% GDP. What was the Debt to GDP ratio in 2018? •(2000+88)/4400 PETR MACH - Macroeconomics •Nominal GDP is CZK 4500 billion and public debt is CZK 1500 billion. Next year the growth of the real GDP will be 3% and the inflation rate will be 2%. What must be the deficit so that the debt to GDP ratio remains constant? •1500/4500=0.333=(1500+def)/(4500x1.03x1.02) • •1500+def=0.3333x(4727.7)=1575.9 •Def=1575.9-1500=75.9 PETR MACH - Macroeconomics •Assume that this year the public debt is CZK 1000 billion and the nominal GDP is CZK 4000 billion. Next year the growth of the nominal GDP will be 10%. What must be the deficit next year so that the debt to GDP ratio remains constant? • •1000/4000=0.25=(1000+def)/(4000x1.1) •0.25x4400-1000=def=100 PETR MACH - Macroeconomics Exercise – crowding out effect •The government runs a deficit of 60 (bn CZK) •This leads to an increase of the interest rate from 1.5% to 1.8%, which increases total savings from 600 to 620 (bn CZK). Calculate the volume of the Crowding-out on Consumption and on Investments. • •The government revenue is 600 and expenditures 650. To pay for the deficit the government issues bonds. The interest rate grows from 2% to 3% and the volume of savings from 400 to 440. Calculate the volume of the Crowding-out on Consumption and on Investments. • PETR MACH - Macroeconomics Exercise – Public Debt •In 2017 the Nominal GDP was 4000 and the Public Debt was 2000. In 2018 the rate of inflation is 2% and the real economic growth is 3%. The government runs a deficit of 40. What was the Debt to GDP ratio in 2017? What was the Debt to GDP ratio in 2018? PETR MACH - Macroeconomics •Assume that last year the debt was 2000 and nominal GDP was 4000. This year the rate of inflation P%=3% and real growth is Y%=7%. • •What must be the deficit so that the DEBT/GDP ration remains constant? •(2000+Def)/(4000x1.03x1.07)=2000/4000=0.5 PETR MACH - Macroeconomics 7. Monetary policy •Monetary policy – objectives and instruments. •Inflation and deflation. •Theoretical basis. •Instruments of monetary policy • • • •Monetary policy is the set of procedures by which the monetary authority of a country, usually the central bank, controls the supply of money through intervening into the exchange rate or in the rate of interest, or through the sale or purchase of assets, in order to control objectives such as the inflation rate or the exchange rate. • •Compare: fiscal and monetary policies • PETR MACH - Macroeconomics Long run – The quantity theory of money AS YA Y P M∙V=MB∙m∙V ΔMB P0 P1 Central bank Short run – positively sloped AS PETR MACH - Macroeconomics LRAS AD1 SRAS AD0 Y P Central banks objectives •„The Czech National Bank shall be the state central bank. Its primary purpose shall be to maintain price stability.“ •Article 98, Constitution of the Czech Republic • •„The primary objective of the European System of Central Banks (hereinafter referred to as "the ESCB") shall be to maintain price stability.“ •Artile 127, Treaty on Functioning of the European Union • PETR MACH - Macroeconomics Bank of England •In relation to monetary policy, the objectives of the Bank of England shall be – (a)to maintain price stability, and (b)subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment (c) •https://www.bankofengland.co.uk/-/media/boe/files/about/legislation/1998-act.pdf People‘s bank of China •Article 3 The objective of monetary policy is to maintain the stability of the value of the currency and thereby promote economic growth. • •http://www.pbc.gov.cn/english/130733/2941519/2015082610501049304.pdf •The target of monetary policy is the nominal value of the objective of the central bank, for instance, a given rate of inflation. PETR MACH - Macroeconomics Objective x Target •Objective is a macroeconomic variable the Central bank wants to control • •Target is the desired nominal value of the objective the Central bank wants to achieve PETR MACH - Macroeconomics Meaning of price stability? Meaning of price stability •ECB, October 1998 • •Price stability is „a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%” • •ECB May 2005 • •„…below but close to 2% over the medium term“ • •https://www.ecb.europa.eu/ecb/educational/shared/img/MP_0806_300dpi-textsheet.en.pdf •„Despite the valiant attempts of our statisticians to correct observed prices for changes in the quality and availability of goods and services, there is no doubt that some aspects of both are ignored by these calculations. Estimates for the United States suggest that the inability to adjust fully for quality changes may have added around 1.5 % a year to the growth of consumer durables prices between 1947 and 1983.“ • •https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/1992/the-case-for-price-stabi lity.pdf?la=en&hash=D4AAD904AF413E48ECD112F4C7FE7323D6D1C90E Possible objectives: •Exchange rate •Price level •Monetary aggregates •GDP Trade-off in moentary policy •„you cannot catch two rabbits“ Proverb-Those that chase the two rabbits can't get anything - 79448632 Methods •Moentary expansion •=acceleration • •Monetary restriction •=stepping on the brake • •As you accelerate or slow down a car, monetary expansion and restriction accelerates or slows down monetary aggregates , inflation (or GDP) •Neutral MP •=no changes in M, M%, P, P% • • Tachometr MMB 80 mm | Motohanz Harley-Davidson a choppery Recall the equation of Exchange: PETR MACH - Macroeconomics •Let •M% be the percentage change in M (the money stock) •V% be the percentage change in V (the velocity of circulation) •P% be the rate of inflation = percentage change in P (the price level) •Y% be the economic grpwth = percentage change in Y (output=GDP) • • PETR MACH - Macroeconomics Exercise PETR MACH - Macroeconomics Exercise PETR MACH - Macroeconomics Exercise PETR MACH - Macroeconomics Exercise PETR MACH - Macroeconomics Exercise PETR MACH - Macroeconomics Exercise PETR MACH - Macroeconomics • 8. Monetary policy 2 • Main instruments •Exchange rate interventions •„Open market operations“ – selling and buying bonds •Interest rate (at which comercial banks can borrow money from the Central bank) • PETR MACH - Macroeconomics Transmission mechanism •Instruments→MB→M→P PETR MACH - Macroeconomics Transmission mechanism Transmission mechanism of ECB Stylised illustration of the transmission mechanism from interest rates to prices https://www.ecb.europa.eu/mopo/intro/transmission/html/index.en.html Restrictive vs Expansionary •Restrictive: decreasing money stock, inflation •Instruments: •Raising rates, selling bonds and foreign currencies • •Expansionary: increasing money stock, inflation •Instruments: •Cutting interest rates, buying bonds and currencies • •Neutral policy (no change in the money stock) • • PETR MACH - Macroeconomics ER as an objective •Instrument: •Purchases and sales of foreign currencies PETR MACH - Macroeconomics Intervention against apreciation PETR MACH - Macroeconomics DEUR SEUR EUR ER Intervention against depreciation PETR MACH - Macroeconomics DEUR SEUR EUR ER Effects of ER interventions: •Intervention to depreciate its currency •(buying foreign currencies) •Foreign Exchange reserves go up •M goes up •P goes up • •Intervention to appreciate its currency •(selling foreign currencies) •Foreign Exchange reserves go down •M goes down •P goes down • PETR MACH - Macroeconomics Interest rates PETR MACH - Macroeconomics PB SBONDS DBONDS SLOANS DLOANS BONDS LOANS IR M as an objective •Central banks can directly control MB •(and let P fluctuate) • •It would be better to have a fixed rate [of growth in the money stock] that would on the average produce moderate inflation or moderate deflation, provided it was steady, than to suffer wide and erratic perturbations. •Milton Friedman • • • PETR MACH - Macroeconomics P or P% as an objective •Instruments: •Purchases and sales of bonds •Increases and cuts in the interest rate PETR MACH - Macroeconomics Inflation targeting • Target and reality https://www.cnb.cz/cs/menova-politika/zpravy-o-inflaci/Zprava-o-inflaci-IV-2020/?tab=tabgraph 2-week repo rate Exercise •The Monetary base MB= 200 bn CZK. The money multiplier is constant m=4. Velocity of circulation of money is constant at V=7. The real GDP is assumed to grow by Y%=6%. The inflation target is P%=5%. How much assets should the central bank buy or sell? PETR MACH - Macroeconomics Exercise •The Monetary base MB= 250 bn CZK. The money multiplier is constant m=5. Velocity of circulation of money is constant at V=10. The real GDP is assumed to grow by Y%=4%. The inflation target is P%=2%. How much assets should the central bank buy or sell? PETR MACH - Macroeconomics Exercise •The Monetary base MB= 250 bn CZK. The money multiplier is constant m=4. Velocity of circulation of money is constant at V=5. The real GDP is assumed to decrease by Y%=-2%. The inflation target is P%=2%. The Exchange rate is 25 CZK per 1 EUR. How much euros should the central bank buy or sell? PETR MACH - Macroeconomics Exercise •The central bank expcets real GDP to decrease by 2%. It wants to have inflation of 3%. It expects the velocoty of money to increase by 1%. What should be the change in the money stock? Exercise •The money stock increases by 27%, GDP grows by -2%, the velocity of money increases by 10% . What will be the rate of inflation? 9. Welfare •Social security •Education •Healthcare… • •Justification and instruments Merit Goods •Economist Richard Musgrave (in 1950s) coined the term „merit goods“ as a justification of some welfare economic policies. •According to Musgrave a merit good is a good that tends to be underconsumed or underproduced if it was left to the free markets •Therefore, the government should step in and provide the good, support its consumption or production or make it mandatory to buy it Why underconsumed •Because of having a positive externality •Because it is believed that consumers may tend to be „short-term“ utility maximisers (not being responsible enough) Petr Mach - Microeconomics Petr Mach - Microeconomics „Demerit“ goods •Similarly we can define „demerit“ goods •Goods that tend to be overconsumed because of negative externalities •A justification for the government to prohibit or demotivate the consumption or production of goods •Examples: •Smoking cigarettes •Driving cars •Taking drugs Petr Mach - Microeconomics Petr Mach - Microeconomics Instruments of welfare policy •Mandatory goods (basic education, social security…) •Tax allowances (charity gifts, mortgage interest…) •Social benefits and subsidies (housing benefits, food stamps…) •Public services (libraries, parks, elementary schools) •Other (Deterring images, campaigns) Examples of obligatory merit goods •Elementary education •Vaccination •Mandatory car insurance •Health insurance •Pension insurance /security •Unemployment insurance •Sickness insurance • • • Exercise - allowances •A person has a taxable income of 800,000. The tax rate is 15%. He paid 170,000 on mortgage interest and 30,000 to charities (expenditures eligible for tax allowance). How much will he pay on taxes? How much will he save on taxes due to his payments? •He will save 15%x(170,000+30,000)=30,000 •He will pay 15%x(800,000-170,000-30,000)=90,000 Pension system •Pay-as-you-go •Funded system •Supported saving/investment • •The problem of population ageing Problem of population ageing •Increase in life expectancy •Lower fertility rates •Benefits and costs • •Problems for pay-as-you-go systems Balance of the pension system •Three parametres: •Retirement age •Social security/contribution rate •Pension/wage ratio •Possible solutions: •Migration •Fertility increase / Population growth 10. Trade policy and integration •Trade and Foreign Investment. Economic integration and disintegration. Comparative advantage.Protectionism. Sanctions. Migration. Levels of international economic integration ·Free trade area ·Customs union ·Common market ·Monetary union ·Fiscal union •(ranked from weakest to strongest) • Protectionism Petr Mach - Microeconomics Protectionism is a policy that imposes various barriers to trade, such as tariffs, import quotas, and certification in order to protect domestic producers from foreign competition. This policy favours domestic producers at the expense of the consumers. The opposite is called free trade Free trade vs protectionism •The core of the debate is based on the theory of comparative advantage •David Ricardo (1772-1823) •The theory implies that both parties can gain from free trade and GDP will grow after trade liberalisation and decrease when trade barriers are raised •On the other hand, theory of infant industries implies that domestic production should be protected from foreign competition Comparative advantage workers needed to produce a unit of Cloth Wine England 100 120 Portugal 90 80 •Without trade England could have 1 t of cloth and 1 t of wine for which it needed 220 workers. Portugal can have 1 t of cloth and 1 t of wine with 170 workers. •If both countries trade, England can produce 2 t of cloth with 200 dělníků and Portugal 2 t of wine with 160 workers. Ten they can trade 1 t of cloth for 1 t of wine. •In the end they can have 1t of cloth and 1 t of wine with a smaller number of workers. •The saved 20 workers in England and 10 workres in Portugal can produce more things. •GDP would grow in both countries thanks to free trade. Who benefits from tariffs Petr Mach - Microeconomics Assume that under free trade any quantzity can be imported at Pglobal. Quantity demanded will be Q2 of which Q1 will be supplied by domestic producers and Q2-Q1 will be imported. If a tarfiff is imposed, price of imported apples increases to Pglobal+tariff. Quantity demanded decreases to Q4 of which Q3 will be supplied by domestic priducers and Q4-Q3 will be imported. The government gains the blue areaa. Domestic producers gain the yellow area. Further integration •Customs union •Free trade areas often create a customs area. By charging equal tariffs on goods imported from third countries they prevent distortions of reimports from low-tariff countries. •Common market •Common marketes means that countries have agreed to allow to the market goods certified for entry to the market in any of the involved countries. EEA is an example of a common market •Currency union either means the creation of a system of fixed Exchange rate between currencies or a single currency Number of currencies in Europe A decrease in the number of currencies referes to monetary integration, an increase refers to monetary disintegration Robert Mundell •17 arguments against joining a currency area •17 arguments for joining a currency area • •Lets discuss some of them •A currency area in economics is a territory where a single currency is used or a territory where multiple currencies connected through fixed exchange rates are used. •A currency area can be a country or a group of countries. • •A currency union is a currency area made up upon a treaty between countries with rights and obligations for the member countries. • PETR MACH - Macroeconomics Optimum currency area •Thare are some macroeconomics conditions •In an „optimum currency area“ there are not regional differencies in the rate of inflation and economic growth •In a currency area that is not „an optimum currency area“ sharing a single currency leads to regional differencies in the rate of inflation and output PETR MACH - Macroeconomics Benefits of sharing a currency with others •Benefits •You save on fees on changing currencies •You get rid of the currency risk of changing the exchange rate •… •Costs of sharing a currency •Your country does not control the money stock any more, you cannot influence the rate of inflation any more •Your currency cannot depreciate any more •… PETR MACH - Macroeconomics Optimum – where marginal benefits equal marginal cost PETR MACH - Macroeconomics MB QOPTIMAL MC Q As a currency area enlarges additional benefits tend to be smaller and smaller and additional costs bigger and bigger. At a point where MB=MC the size Q of the currency area (in terms of countries, regionas or people involved) is optimal. With labour mobility having a currency area does not cause problems •Labour mobility is the degree to which people are able and willing to move from one region to another to find new jobs. PETR MACH - Macroeconomics Arguments against •You want your own inflation rate •You want to manipulate the ER •You want to be able to print money for budget •You do not want to sacrifice seigniorage due to international usage of your money •You want to control your own denomination •You want to keep control in case of war or default •You do not want to pay for the others •… PETR MACH - Macroeconomics Arguments for joining currency •You want to take the inflation from abroad •You want to reduce transaction costs •You want to eliminate costs of money issue •You want to remove discretion from your own authorities •You want to get ER rid of manipulation •You want to provide catalyst for furher integration •… • PETR MACH - Macroeconomics •The central bank prints additional 50 billion this year so that it inreases the monetary base to 300 billion. The money multiplier and the velocity of circulation of money are constant. Economic growth is 2%. What will be the rate of inflation? •(1+P%)(1+Y%)=(1+V%)(1+M%) •M=m MB •Now: M(1)=m 300 •Before: M(0)=m 250 •M%=300/250 – 1 or 50/250 M%=20% •P%=1.2/1.02 – 1=17.65% PETR MACH - Macroeconomics •Assume that the central bank prints additional 35 billion this year so that it increases the monetary base to 235. There is no change in the money multiplier and the velocity of money. The economy grows at 5%. What will be the rate of inflation? •(1+P%)(1+Y%)=(1+V%)(1+M%) • PETR MACH - Macroeconomics PETR MACH - Macroeconomics •Assume that you live in Montenegro or Andorra. You use the euro. Assume that the rate of inflation of the euro is 2%. Assume that you hold 100,000 euros in cash. What is the change in the value of your savings? What is the decrease in the purchasing power of money that you suffer? • PETR MACH - Macroeconomics •Assume that your central bank wants to increase exports and GDP by the intervention in the foreign Exchange market. Should it appreciate or depreciate its currency? How should it do? PETR MACH - Macroeconomics •Assume that Czech central bank wants to help the economy (exporters) by intervening into the Exchange rate. Should it appreciate or depreciate its currency? What should the CNB do? • •EX, IM, NX depend on the Exchange rate •NX is part of GDP •Let‘s say that the current ER is 26 CZK per EUR •Depreciation of the currency increases NX PETR MACH - Macroeconomics PETR MACH - Macroeconomics 10. Public choice theory •Economics of politics. Median voter theorem. Hoteling model. Constitutional economics. Utility maximization Lobbying Ideas - Political philosophy Preferences Corruption Voting decisions Economic policies •Public choice theory deals with the decision-making process in politics where people elect their representatives who then make decisions on public spending, taxes, and regulation in the government and the parliament. • •Whereas in the market competing firms offer various goods and consumers pay with money, in the political market politicians sell promises and ideas, and voters pay with their votes. • Petr Mach - Microeconomics Utility functions •Voters •UV=f(taxes, benefits, security….) • •Politicians •UP=f(power, salaries, fame…) •they behave so that they get re-elected…. • •Bureaucracy •UB=f(power, salaries, size of agancies….) • •Interest groups (size of the rent, lobbying expenditure, probability of success) • Petr Mach - Microeconomics Example •A voter considers two parties, A nd B. Party A promises low taxes and some expenditure cuts so that the voter would benefit 20,000 when realised. However in a voting intention survey its odds are low and potential partners are not likely to support the policy. The voter beleives there is a 5% probability the policy is realised if he votes for it. Party B promises no tax changes and promises buliding a new highway and cuts in expenditures from which the voter has no utility. The voter‘s utility of such a highway is valued as 12,000. The probability it is going to be realised is 15%. Which party is the voter going to vote for? •The principle of minimum differentiation states that there is a tendency for competing political parties to maintain similar opinions, in the same way as there is a tendency of two shops in the street to occupy positions in the middle of the street to attract most customers. Petr Mach - Microeconomics Petr Mach - Microeconomics Political spectrum •A political spectrum is a range of political positions. A typical political spectrum ranks voters from left to right, where the left represents the preference of highest taxes, expenditures and regulation, whereas the right represents the preference of lowest taxes, expenditures and regulation. Petr Mach - Microeconomics Petr Mach - Microeconomics 61st 101st Party B 81st 1st Party A 40th 40 20 20 21 Median voter theorem •The median voter theorem states that political parties tend to promote policies that are favourable for the voter whose opinions are in the middle of the political spectrum. • Petr Mach - Microeconomics 11. Lobbying •Rent-seeking and lobbying. Reading: Bastiat: The Petition of candle makers • Lobbying •A lobby or an interest group is an organised group of people whose interest is to promote a public policy. • •They influence the public or the government in order to promote their goals. Petr Mach - Microeconomics Result of a smart plan or lobbying? •Economic policies may be devised and perfectly calculated by smart policymakers •or •Economic policies can be pushed through by various interest groups and lobbyists 83% perceive lobbying negativly •77 % obyvatel EU myslí, že „lobbing a komerční zájmy můžou vyústit v politiku, která je v rozporu s veřejným zájmem“. V České republice si to podle průzkumu myslí dokonce 83 % respondentů. 73 % respondentů v EU „se obává, že lobbisti zastupující komerční sektor mají na utváření politiky EU příliš velký vliv“ • •(EU Citizen’s Opinion Poll on transparency, ethics, and lobbying in the EU, 2013, s. 4-5) • •(https://www.access-info.org/wp-content/uploads/Infographics_EU_citizens_Opinion_Poll_ENGLISH_ONLI NE.pdf). • • Cynical view •Lobbying is the continuation of market competition with other means. • •Paraphrase to • •„War is the continuation of politics with other means“ •Carl von Clausewitz (Prussian general and war theorist 1780-1831) Expected profit / Expected return Exercise Lobbyists „buying“ legislators Petr Mach - Microeconomics TC TR R 51 Q Lobbying does not make sense Petr Mach - Microeconomics MINIMUM LOSS TC TR R 51 Q 0 •Agreements between lobbyists and legislators are informal and cannot be enforced by law •They are secret and often illegal •Game theory can help explain the behaviour •Risk, probability and „expected“ revenue must be taken into account Petr Mach - Microeconomics Lobby or not to lobby, that‘s the question A; B Not to lobby Lobby Not to lobby 0; 0 -1.25; 0.5 Lobby 0.5; -1.25 -0.5; -0.5 Petr Mach - Microeconomics Two interest groups, considering whether to lobby or not to lobby for special favourable tax breaks. Assume lobbying costs 0,25 million and is always successful. Successful lobbying gains the lobbyist additional 1 million and this gain is paid by the other firm in some other way. If any tax break is enacted, each firm must pay additional 0.25 million on tax advisors and accountants Game theory – prisoner‘s dilemma A; B B cooperates (stays silent) B defects (betrays) A cooperates (stays silent) -1; -1 -5; 0 A defects (betrays) 0; -5 -3; -3 the number of years in prison, a minus indicates that it is a negative payoff (a loss) What Prisoner‘s dilemma is Player B cooperates Player B defects Player A cooperates c; c a; d Player A defects d; a b; b Prisoner’s dilemma is a situation described in game theory, in which two rational players tend to choose non-cooperation even though cooperation would give a better outcome. Election campaing game •Election campaings are costly. Two main political parties make an agreement on spending reduction (to 10 million) •If they comply, their campains will offset and each gain 1 mil votes and CZK 100 per vote •If one party does not comply while the other complies, the first gains 1.5 mil votes, the other 0.5 mil votes • • Petr Mach - Microeconomics A; B Comply (spend 10 mil.) Not to comply (spend 50 mil.) Comply (spend 10 mil.) 90; 90 40; 100 Not to comply (spend50 mil.) 100; 40 50; 50 Pork-barrel politics A; B Not lobbying Lobbying Not lobbying 50; 50 10; 65 Lobbying 65; 10 25; 25 Consider a limited budget of 200 million to be distributed by MPs. The will decide among two projects – a highway of 200 million or the launch of a space rocket of 200 million. Only one project can win. The construction lobby considers to lobby for the highway and the technological lobby considers lobbying for the rocket. Because winning the contract would bring the firm a profit of 100 million. Neither of the firms knows whether the other lobbies or not. If neither firm lobbied each would win the contract with a probability of 50% without any additional lobbying expenses. If both lobby, each can also win with a probability of 50% but with a lobbying cost of 25 million (in line with the Tullock model) and the expected profit of each would be 25 million. If one lobbies and the other does not, the lobbying firm would spend 25 million on lobbying and would gain the contract with a high probability of 90% and the net expected profit is 65 million. Rent-seeking •Rent-seeking is the practice of manipulating public policy to increase profits of a firm or an industry at the expense of the consumers or taxpayers. • Petr Mach - Microeconomics Petr Mach - Microeconomics Petr Mach - Microeconomics Lobbying •Expected revenue •Lobbying investment Petr Mach - Microeconomics Rent-seeking game Petr Mach - Microeconomics Petr Mach - Microeconomics Rule for quotient derivatives Petr Mach - Microeconomics Petr Mach - Microeconomics Rent-seeking game A 0 1 4 9 16 25 36 49 64 81 100 B 0 9 16 21 24 25 24 21 16 9 0 Petr Mach - Microeconomics Petr Mach - Microeconomics •If each firm invests ¼ of the rent, two firms together invets ½ of the rent. This represents a „transaction cost“ or a deadweight cost of rent-seeking. Petr Mach - Microeconomics Application of Game theory •Paraphrase William Shakespeare from Hamlet: • •„To lobby or not to lobby……that is the question“ • •(dilemma) Tax exemptions A; B Not lobbying Lobbying Not lobbying 0; 0 -1,25; 0,5 Lobbying 0,5; -1,25 -0,5; -0,5 Consider two firms, A and B, each seeking a specific tax exemption worth CZK 1 million. The government needs to collect a given amount of money so if one firms lobbies an exemption the governemnt somehow takes the missing money from the other firm. The cost of lobbying is 0,25 million and we assume that lobbying is always successfull. The cost of additional tax advisors and accountants if there is at least one exemption are ionu a 0,25 million. Pork-barrel politics A; B Not lobbying Lobbying Not lobbying 50; 50 10; 65 Lobbying 65; 10 25; 25 Consider a limited budget of 200 million to be distributed by MPs. The will decide among two projects – a highway of 200 million or the launch of a space rocket of 200 million. Only one project can win. The construction lobby considers to lobby for the highway and the technological lobby considers lobbying for the rocket. Because winning the contract would bring the firm a profit of 100 million. Neither of the firms knows whether the other lobbies or not. If neither firm lobbied each would win the contract with a probability of 50% without any additional lobbying expenses. If both lobby, each can also win with a probability of 50% but with a lobbying cost of 25 million (in line with the Tullock model) and the expected profit of each would be 25 million. If one lobbies and the other does not, the lobbying firm would spend 25 million on lobbying and would gain the contract with a high probability of 90% and the net expected profit is 65 million. • 12. Constitutional economics •Leviathan. Democracy. Constitutional restrictions to power. • •Leviathan in political economy is a description of the government that tends to maximise its benefits, that is tax revenues. Thomas Hobbes, an English philosopher of the 17th century published a book named “Leviathan” in which he linked the state to Leviathan, a biblical sea monster. James Buchanan, following Hobbes, used the term Leviathan to describe his pessimist assumption of the state. Petr Mach - Microeconomics Thomas Hobbes (1651): LEVIATHAN Petr Mach - Microeconomics Image result for thomas hobbes leviathan Image result for leviathan Ways to raise money •Taxes •Running deficits •Inflation (printing money) Petr Mach - Microeconomics Laffer curve – Leviathan government TAX REVENUE MAXIMISING RATE T* TAX RATE MAX TAX REVENUE •„Art 98. The Czech National Bank shall be the state central bank. Its primary purpose shall be to maintain price stability“ Petr Mach - Microeconomics Image result for czech flag •„The Confederation shall maintain its income and expenditure in balance over time.“ • •„The Confederation may levy a direct tax: •a) of a maximum of 11.5 per cent on the income of private individuals; •b) of a maximum of 8.5 per cent of the net profit of legal entities;“ • •„The Confederation may levy value added tax on the supply of goods, on services, including goods and services for personal use, and on imports, at a standard rate of a maximum of 6.5 per cent and at a reduced rate of at least 2.0 per cent.“ • •„The Confederation shall maintain its income and expenditure in balance over time.“ • Petr Mach - Microeconomics Image result for swiss flag •„The Hong Kong Special Administrative Region shall follow the principle of keeping the expenditure within the limits of revenues in drawing up its budget, and strive to achieve a fiscal balance, avoid deficits and keep the budget commensurate with the growth rate of its gross domestic product.“ • Petr Mach - Microeconomics Image result for hong kong flag •„The budgets of the Federation and the Länder shall, in principle, be balanced without revenue from credits. The Federation and Länder may introduce rules intended to take into account, symmetrically in times of upswing and downswing, the effects of market developments that deviate from normal conditions, as well as exceptions for natural disasters or unusual emergency situations beyond governmental control and substantially harmful to the state’s financial capacity. For such exceptional regimes, a corresponding amortisation plan must be adopted. Details for the budget of the Federation shall be governed by Article 115 with the proviso that the first sentence shall be deemed to be satisfied if revenue from credits does not exceed 0.35 per cent in relation to the nominal gross domestic product.“ • Petr Mach - Microeconomics Image result for germany flag Poland •„It shall be neither permissible to contract loans nor provide guarantees and financial sureties which would engender a national public debt exceeding three-fifths of the value of the annual gross domestic product. The method for calculating the value of the annual gross domestic product and national public debt shall be specified by statute.“ • • •This can be changed only with a qualified majority of 66.7% votes in the Chamber of Deputies. (Art. 235/4) • Petr Mach - Microeconomics Image result for poland flag