Macroeconomics Study Notes

1. What is Macroeconomics 🔗︎

The macroeconomic model describes the flow of money between housing, government, businesses, financial markets, goods and services markets, labor markets, foreign exchange markets, and the rest of the world.

• Savings and Investment:
  • Saving is managing money, while investment is putting money to use.
  • Types of Investment:
    1. PPE (Property, Plant, and Equipment): e.g., factory equipment.
    2. Inventory: A high proportion in GDP indicates low efficiency (related to the “de-stocking” part of the “three reductions” policy).
    3. Self-built housing: Houses built by individuals or businesses.
• Services:
  • e.g., service industries like healthcare and education.

2. How to Calculate GDP 🔗︎

2.1 Expenditure Approach 🔗︎

GDP = C (Consumption) + I (Investment in financial and capital markets) + G (Government spending) + Exports - Imports

2.2 Income Approach 🔗︎

GDP = Labor Income + Capital Income

2.3 The Relationship Between Savings and Investment 🔗︎

S = I (Investment by businesses in domestic financial and capital markets) + Domestic capital outflow - International capital inflow i.e., S = I + NCO (Net Capital Outflow)

2.3.1 The Role of Financial Markets 🔗︎

• Financial markets determine the interest rate (rate of return).
• Relationship between S and r: The higher the real interest rate, the more savings and the less consumption (positive correlation).
• Relationship between I and r: The higher the interest rate, the less willing businesses are to invest (negative correlation).
• Relationship between NCO and r:
  • The higher the domestic rate of return, the more negative the correlation between NCO and r.
  • The higher the foreign rate of return, the more positive the correlation between NCO and r.

2.3.2 Relationship between NX and Exchange Rate 🔗︎

NX = NCO An increase in the exchange rate leads to a decrease in net exports.

3. Loanable Funds Market and Foreign Exchange Market 🔗︎

3.1 Loanable Funds Market 🔗︎

• The interest rate is positively correlated with S and negatively correlated with I + NCO.
• The intersection determines the equilibrium of savings and investment and sets the interest rate r.

3.2 Foreign Exchange Market 🔗︎

• NX is negatively correlated with the exchange rate E.
• Case study of hedge funds attacking the Thai Baht:
  • Borrowing and selling Thai Baht, causing capital flight and a drop in the exchange rate.

4. Balance of International Payments 🔗︎

4.1 Net Exports and Net Capital Outflow 🔗︎

• NX (Net Exports) = Exports - Imports
• NCO (Net Capital Outflow) = Capital Outflow - Capital Inflow
• NX = NCO

5. Why are Foreign Exchange Reserves Increasing? 🔗︎

NX = NCO = Exports - Imports = Chinese residents + Businesses + Central Bank (ΔForeign Exchange Reserves) - Imports Central Bank (ΔForeign Exchange Reserves) = NX + Imports - (Chinese residents + Businesses)

• NX and imports are constantly increasing, while export-related investments are subject to financial controls.

6. What is the Exchange Rate? 🔗︎

e = $/¥ How many US dollars can 1 RMB be exchanged for, i.e., foreign currency / domestic currency.

7. What is Purchasing Power Parity? 🔗︎

7.1 Purchasing Power Parity Formula 🔗︎

The cost of two baskets of consumer goods:

• Production cost in China, P_China (priced in RMB)
• Production cost in the US, P_US (priced in USD) If 100/P_China > 100e/P_US, then buy goods from China and sell them in the US. Eventually, the arbitrage opportunity disappears. The exchange rate adjusts the fastest, and prices may also change. e = P_US / P_China This is purchasing power parity.

8. What is Financial Arbitrage? 🔗︎

8.1 Interest Rate Arbitrage 🔗︎

Assume r_China (China’s interest rate) > r_US (US interest rate), then borrow USD to invest in China. Current exchange rate e0, next period exchange rate e1. Investment return formula:

• Return on investment in China: e1 × (100/e0 × (1 + r_China))
• Return on investment in the US: 100 × (1 + r_US) If e1 × (100/e0 × (1 + r_China)) - 100 × (1 + r_US) > 0, the arbitrage is successful.

9. What is the Real Interest Rate? 🔗︎

Real Interest Rate = Nominal Interest Rate - Inflation Expectation E = e × CPI_domestic / CPI_foreign e = (Foreign currency 1/6.5) / (Domestic currency 1)

• The nominal exchange rate reflects current purchasing power, but the CPI (Consumer Price Index) must be considered.

10. Why Don’t Export-Oriented Enterprises Invest Abroad? 🔗︎

• Revenue (USD) - Costs (RMB)
• Real Exchange Rate E = e × CPI_domestic / CPI_foreign
  • e increases (appreciation against foreign currency), CPI_domestic increases (depreciation domestically), the real exchange rate rises.
  • With USD pricing unchanged, revenue decreases, costs increase, and gross margin falls.

11. The Power of Compounding 🔗︎

• At a 10% annual growth rate, it doubles in 7 years.
• At a 7% annual growth rate, it doubles in 10 years.

12. What is Financial Repression? 🔗︎

• Nothing can fully hedge against inflation.

13. Relationship between Exchange Rates and Interest Rates 🔗︎

The interest rate can be seen as the rate of return for investing in a country. When the Fed raises interest rates, r_US > r_China, capital flows to the US, and the USD appreciates.

14. What is Goods Arbitrage? 🔗︎

Assume the price of a certain commodity is P_China in China and P_US in the US. With 100 RMB:

• You can buy 100/P_China in China
• You can buy 100e/P_US in the US If 100/P_China > 100e/P_US, then buy the commodity in China and sell it in the US to earn the price difference.

15. What is Friedman’s Theory? 🔗︎

Rational income allocation: Spend future middle-age income when young, and spend middle-age savings after retirement.

16. Why are Banks so Profitable? 🔗︎

• Banks make profits through the net interest margin (about 2.5%).
• Shadow banks (like WeBank) lend without reserve requirements; enterprises borrow from shadow banks to invest.
• Bank intermediaries recommend wealth management products, earning a spread, while users earn investment returns.

17. What is M2? 🔗︎

M2: Money Supply Δm = ΔMB × MM

• Δm: Total money supply increase
• ΔMB: Money issued by the central bank (Monetary Base)
• MM: Money Multiplier

18. The Role of Issuing Currency 🔗︎

• To avoid monetary deflation, print money.
• Measures for the central bank to withdraw funds and reduce inflation:
  1. Borrowing (e.g., issuing government bonds).
  2. Increasing the reserve requirement ratio.

19. What are Surplus and Deficit? 🔗︎

• Surplus: Exports > Imports.
• Deficit: Imports > Exports.

Market Economy 🔗︎

• There’s no such thing as a free lunch This is the cornerstone of a market economy, revealing a fundamental truth:
  • Everything has a cost. Whether explicit or implicit, acquiring and using resources requires a price to be paid.

Interpretation 🔗︎

1. Resource Scarcity
   • In a market economy, resources are scarce, and every choice comes with an opportunity cost.
   • Acquiring one resource means giving up other possibilities.
2. The Relationship Between Value and Cost
   • Behind every product, service, or decision, there are hidden costs of production, time, energy, etc.
   • Things that are “free” often have indirect costs, such as through advertising or data collection.
3. Implications for Individuals and Society
   • For individuals: Make rational decisions, weigh the pros and cons, and avoid the lure of “free”.
   • For society: Understand market principles and respect the value of labor and resources.

2018 Macroeconomic Review 🔗︎

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Classic Works of Marx, Engels, Lenin, and Stalin 🔗︎

Marx 🔗︎

1. The Communist Manifesto
2. Wage Labour and Capital
3. A Contribution to the Critique of Political Economy (Preface and Introduction)
   • (Appendix: Engels’ ‘On Marx’s A Contribution to the Critique of Political Economy’)
4. The Class Struggles in France, 1848 to 1850
5. Value, Price and Profit
6. The Civil War in France
7. Critique of the Gotha Programme
8. Letters of Marx and Engels

Engels 🔗︎

9. Dialectics of Nature (Introduction, Notes, and Fragments)
10. Anti-Dühring
    • (Appendix: Introduction to the English Edition of ‘Socialism: Utopian and Scientific’)
11. Ludwig Feuerbach and the End of Classical German Philosophy
    • (Appendix: Marx’s ‘Theses on Feuerbach’)

Lenin 🔗︎

12. What Is to Be Done?
13. Two Tactics of Social-Democracy in the Democratic Revolution
14. Materialism and Empirio-criticism
15. Conspectus of Hegel’s ‘The Science of Logic’
16. Imperialism, the Highest Stage of Capitalism
17. The State and Revolution
18. The Proletarian Revolution and the Renegade Kautsky
19. ‘Left-Wing’ Communism: An Infantile Disorder
20. On Marx, Engels and Marxism
21. Three Articles on War and Peace
    • ‘Socialism and War’
    • ‘The Military Programme of the Proletarian Revolution’
    • ‘Bourgeois Pacifism and Socialist Pacifism’
22. Three Articles on the National and Colonial Questions
    • ‘The Socialist Revolution and the Right of Nations to Self-Determination’
    • ‘Draft Theses on National and Colonial Questions’
    • ‘Report of the Commission on the National and Colonial Questions at the Second Congress of the Communist International’

Stalin 🔗︎

23. On the Opposition
24. Problems of Leninism
25. History of the Communist Party of the Soviet Union (Bolsheviks): Short Course
26. Marxism and Problems of Linguistics
27. Economic Problems of Socialism in the USSR

Plekhanov 🔗︎

28. The Development of the Monist View of History
29. On the Question of the Individual’s Role in History
30. Art and Social Life (‘Letters without Address’)