US Holding of NYSE and NASDAQ equities

I just wanted to point out that most of the $14 trillion that we talked about in the NYSE and NASDAQ market values is held by US households (as opposed to internationally), either directly or indirectly. (Households can own equities directly by buying a mutual fund or depositing in a money market account, or buying stock of one company that has stock of another company on its books.)

Savings Institutions

When we talked about savings institutions (financial intermediaries) in class, I kept using banks as an example. This is not the only example of a financial intermediary- there are Savings and Loan companies, credit unions (I believe that Harvard employees have a credit union) and finance companies (such as GM's loan arm, GMAC). For our purposes, these instituions basically function the same as banks. Furthermore, banks are the most important (i.e. widely used) financial intermediary. The 15% figure I gave in class would be for all financial intermediaries, but banks make up the vast majority of that number.

Supplying Saving vs. Supplying Securities

I wanted to make an important distinction that I feel was not entirely clear in class. I will use an example with bonds, but you can replace stocks with bonds here and everything would still be correct. First, if you are SUPPLYING saving, you are actually demanding bonds. If you are supplying (also referred to as issuing or selling) bonds, you are DEMANDING saving, i.e. borrowing. Notice that the roles are reversed in depending on whether you are talking about loanable funds or financial instruments. I mention this because understanding the concept of selling vs. buying bonds will be very important later.

Convergence

In response to a student question from Barro's lecture:

There are actually two concepts in growth economics- absolute convergence and conditional convergence. The idea of absolute convergence is that there is one value of per capita GDP that all countries are growing toward (an equilibrium level if you will). Alternatively, you can think of this as poorer countries growing faster than richer countries no matter what, so that eventually they will all come to the same steady state level. Conditional convergence, on the other hand, postulates that there is a unique steady state level for each country. This level depends on things like natural resources, institutions and government frameworks in place, etc. If these are not present to a sufficient degree, the country will have a very low steady state and/or may not converge at all. Alternatively, you can think about convergence to steady state (and catching up to rich countries) is conditional on these things being present. With absolute convergence, a country with a lower GDP would be growing faster, since it has further to go to achieve steady state. With conditional convergence, a country that it further from its own steady state would be growing faster, and it slows down as it approaches this steady state. I don't know that the distinction between absolute and conditional convergence was explicitly made in lecture. The point is that being further away from steady state implies faster growth.

There are a lot of analogies that I could make here. My current favorite is Newton's law of cooling. My physics is a bit (read, very) rusty, but I seem to remember that if you take an object of one temperature and drop it into a substance of another temperature, it heats/cools quickly at first, since the temperature differential between the two substances is high, and then as the substance gets closer in temperature to that of its surroundings, it heats/cools more slowly. The process is described by a differential equation of the form dT/dt = k(T-T*) or something similar (again, rusty), which looks not too different from what you saw in lecture.

Definitions From Barro Lecture

I noticed in Prof. Barro's lecture that there were several acronyms that he used without (in my opinion) adequately explaining. So I will add some information here.

PPP: stands for Purchasing Power Parity. In context, Barro said that the Summers dataset for GDP adjusted for PPP. Let me give you an example of why this is useful. Normally, you could compare GDPs across countries by just using exchange rates to convert everything to US dollars. However, if you just do this you might notice strange things like the fact that a Big Mac would cost $10 in some countries and 15 cents in others. In other words, the purcahsing power of US dollars is very different in the two countries. The PPP just adjusts such that, at least on an aggregate level, the amount of stuff you could buy with a given number of US dollars would be the same for each country. It's a bit of an oversimplification, but you get the idea.

OECD: stands for Organization for Economic Cooperation and Development. I think I explained this very briefly last semester. Basically, a bunch of countries (mainly developed countries) realized that it would be helpful to understand the macroeconomies of other countries, so they formed this organization to share information and whatnot. You can learn more at www.oecd.org. This is relevant to you guys for now mainly because a lot of the cross country data that economists look at comes from here.

A Nasty Whiff of Inflation

I welcome you to ask questions about the above article from the first section. As Simon pointed out, the article can be confusing to you- I read it over again and realized that it talks a lot about concepts (monetary policy and interest rates for example) that you haven't learned anything about yet. I think the main gist of what you are supposed to be getting from this article is an example of what would cause inflation, or an increase in the CPI. The parts about loose monetary policy and such are still a little over your heads at this point, but not to worry!

Growth Rate Form of Production Function

Recall that in class I gave you the production function Y=Af(K,L), and then a couple of minutes later I gave you an equivalent equation in growth rates form, given by:

%chgY = %chgA + a%chgK + (1-a)%chgL

(I apologize for the abuse of notation, I'm somewhat limited in the characters I can use!) Some of you are likely wondering how on earth we can go from one of these to the other. So I will try to explain. Last semester I explained that a change in a variable (change in total cost for example) could be represented by the derivative of the variable (eg. marginal cost is the derivative of total cost). Now, a question for you: what is the derivative of ln(x)? It's dx/x, right? Or alternatively, the change in x divided by x. This is the definition of percent change, is it not? Thus, (instantaneous) percent change in a variable is the derivative of the natural log of the variable. Now, why is this useful?

In our discussion, we are assuming a particular functional form for the f function given above. Specifically, we are assuming what is called a Cobb-Douglas production function. This function is f(K,L)=(K^a)*(L^(1-a)) for some a between 0 and 1. So now you have Y=A*(K^a)*(L^(1-a)). To get the percent changes, take the natual log of both sides and then the derivative:

lnY = ln(A*(K^a)*(L^(1-a)))

lnY = lnA + ln(K^a) + ln(L^(1-a))

lnY = lnA + alnK + (1-a)lnL

dy/y = dA/A + adK/K +(1-a)dL/L (this is the total derivative since the terms are separable)

%chgY = %chgA + a%chgK + (1-a)%chgL

I hope that makes sense!