Breve corso di Economia

A. Pinto A. Pongpiriyakan

A. Sabatucci

TODAYS LECTURE
1. Market Inefficiences
2. Government Intervention 3. Market Perception of the Risk 4. Intergenerational Redistribution 5. Solow Model 6. TFP Determinants 7. The importance of International Trade

8. Leave the Euro Zone? Pro and contra.

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Market Inefficiences 1/3

An Inquiry into the Nature and Causes of the Wealth of Nations The Invisible hand : Classical Economist Model (Adam Smith, 1776):

The invisible hand is a natural phenomenon that

guides free markets and capitalism competition for scarce resources

Does it always work?

through

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Market Inefficiences 2/3

Does it always work? Long term

YES

Long term growth is more important than business cycles

It depends
Policies to avoid BC could negativly affect long term growth so should be avoided

Short term

NO
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Market Inefficiences 3/3

Business Cycles Effect during a Recession: - Unemployment rate increases - Living Standards decreases In order to minimize the negative impact of business cycles its allowed the:

Government Invervention
Ex: Great Depression of 1929
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1. Market Inefficiences
2. Government Intervention 3. Market Perception of the Risk 4. Intergenerational Redistribution 5. Solow Model 6. TFP Determinants 7. The importance of International Trade

8. Leave the Euro Zone? Pro and contra.

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Government Intervention 1/3

Keynes (1936):
The General Theory of Employment, Interest and Money
Classic Model of Smith: NeoClassic Model of Keynes:

Market restore itself after a In the Short Term the market temporary shocks is not always able to recover by iteself but it the long run it does (but in the LR we are all dead) Internvention of State to boost the ST Demand in some Key Industry.

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Government Intervention 2/3

Taxations Public Funds Collection

Current/Future Expenses Capital Expenses

Sovereign Debt Issuance

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Government Intervention 3/3

Sovereign Debt Issuance

Spread

German LT Bond

Risk Premium for a general N title

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1. Market Inefficiences
2. Government Intervention 3. Market Perception of theRisk 4. Intergenerational Redistribution 5. Solow Model 6. TFP Determinants 7. The importance of International Trade

8. Leave the Euro Zone? Pro and contra.

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Market Perception of the Risk 1/4

The interest rate for each financial product should reflect associated risk. Ex: Financial Perception of (Germany VS Italy) Italy: Long Term Stability (????) No Growth in the last 20y

Germany: Long Term Stability Sustainable Growth

The spread between the Italian and the German LT Bonds reflect the perceived default risk / capability to repay the debt.
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Market Perception of the Risk 2/4

What is Market Perception?
Its the collective view on certain assets by the market players (Banks, Private Sector)

What impact on Market Perception?

Credit Rating Agency

Credibility + other endogenous variables
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Market Perception of the Risk 3/4

Credit Ratings Agency (S&P, Moodys, Fitch) What do they do?
They collect finacial and non financial data to evaluate the performance of each financial product.

Why does the market care? The market believes that the CRA are the best available means of determing risk.
Are they always correct? No. Ex: Subprime Crisis

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Market Perception of the Risk 4/4

Credibility refers to the objective and subjective components of the believability of a source or message.
Two key components:

Trustworthiness:

The fact you follow trough your promises, without changing your mind over and over again (Berlusconi does).
The knowledge and the skills to speak about something (Grillo does not).

Expertise:

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1. Market Inefficiences
2. Government Intervention 3. Market Perception of theRisk 4. Intergenerational Redistribution 5. Solow Model 6. TFP Determinants 7. The importance of International Trade

8. Leave the Euro Zone? Pro and contra.

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Intergenerational Redistribution
Shift tax burden to future generation
When is not balanced? Today -> I borrow to satisfy my short term needs (Socialist Total Welfare) Future -> the future generations will repay my debt without receiving any benefits Why is not balanced?

Because Politicians take care only to be elected so they want to satisfy present needs of the current electoral constituency, without consindering the future impact of these decisions.

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1. Market Inefficiences
2. Government Intervention 3. Market Perception of theRisk 4. Intergenerational Redistribution 5. Solow Model 6. TFP Determinants 7. The importance of International Trade

8. Leave the Euro Zone? Pro and contra.

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Solow Model 1/6

The Solow Model (also known as Exogenous Growth Model), is a simple economic model of long-run economic growth.

The key variables:

1. K = Capital (amount of tangible/intangible assets) 2. L = Labour (amount of total hours in the market)
NB because the Unemployment Rate in the long run is fixed, L doesnt really affects long run growth

3. A = Residual Factor called Total Factor Productivity (TFP)

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Solow Model 2/6

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Solow Model 3/6

Steady State

K has diminishing returns to scale

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Solow Model 4/6

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Solow Model 5/6

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Solow Model 6/6

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1. Market Inefficiences
2. Government Intervention 3. Market Perception of theRisk 4. Intergenerational Redistribution 5. Solow Model 6. TFP Determinants 7. The importance of International Trade

8. Leave the Euro Zone? Pro and contra.

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TFP Determinants 1/2

Productivity of L :
i. ii. iii. Knoledge, Education & Training Health Competition, Social Dimension & Environment Institutions

Productivity of K :
i. ii. Innovation of Product Innovation of Process

iii. Infrastructure
iv. Structural change and resource reallocation v. Financial system vi. Integration (trade) vii. Geography

iv.

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TFP Determinants 2/2

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1. Market Inefficiences
2. Government Intervention 3. Market Perception of theRisk 4. Intergenerational Redistribution 5. Solow Model 6. TFP Determinants 7. The importance of International Trade

8. Leave the Euro Zone? Pro and contra.

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The importance of International Trade 1/7

Why is International Trade Important?
1.

Because economic integration worths more than sum of its parts. Specialisation of production (Comparative and Absolute advantages). Variety of goods in the market (car industry example) These are some of the ideas that gave birth to the European Union!

2.

3. 4.

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The importance of International Trade 2/7

Comparative & Absolute Advantage

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The importance of International Trade 3/7

Comparative & Absolute Advantage

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The importance of International Trade 4/7

Comparative & Absolute Advantage

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The importance of International Trade 5/7

Comparative & Absolute Advantage

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The importance of International Trade 6/7

Globalisation
When countries trade, they become more connected.
Economy of one country also effects its trading partner. This is the global trend. WTO is founded in 1995, now with 159 member countries Its objective is to encourage trade by eliminating barriers (tariff and non-tariff measures)

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The importance of International Trade 7/7

Is it always good?
Not for everyone!
When a country opens its border to trade, some industry could suffer from foreign competition. To decide, we need to compare cost with benefits: 1. Poverty reduction: WTO cites trade lifted more than 500 million people from poverty 2. Trade offers new markets to sell goods and services 3. Many industries that are hurt are inefficient Survival of the fittest? (BRICs Ex) 4. Is manufacturing and skills concentration a bad thing?

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1. Market Inefficiences
2. Government Intervention 3. Market Perception of theRisk 4. Intergenerational Redistribution 5. Solow Model 6. TFP Determinants 7. The importance of International Trade

8. Leave the Euro Zone? Pro and contra.

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To Leave or not to Leave EuroZone? 1/4

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To Leave or not to Leave EuroZone? 2/4

PROs:
1. Monetary policy independence:

This means allowing each country to manage its own currency

2. Higher Responsiveness: a. Recession in Spain and Greece could be better responded

b. Each Eurozone country has different economic cycle

c. The fact is the Eurozone has strong north-south divide

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To Leave or not to Leave EuroZone? 3/4

CONs:
1. No Exit:

No legal and logistical possibility

2. Even if this happens, there will be chaos!

a. Capital flight

b. External debt restructuring/default?

c. UBS estimated that if Greece leaves the Euro, Greek economy will shrink by 50 per cent!

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To Leave or not to Leave EuroZone? 4/4

Conclusions:

No guarantee EuroZone exit would lead to better management of economy.

Critics argue that good governance is needed, not a currency exit. Euro breakup leads to currency fluctuation. This is actually one original reason Euro was founded!

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Thank You

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