macro Aggregate Demand Roadmap to this lecture Equilibrium in the IS-LM Model Model An increase in government purchases A tax cut

Transcription

1 Roadmap to this lectue maco Aggegate Demand Stabilization olicy: Monetay olicy Fiscal olicy Inteaction Deiving the AD cuve fom the - slide 1 Equilibium in the - Model olicy analysis with the - Model The cuve epesents equilibium in the goods maket. = C ( T + I( + G The cuve epesents money maket equilibium. M = L(, The intesection detemines the unique combination of and that satisfies equilibium in both makets. 1 1 = C ( T + I( + G M = L(, olicymakes can affect macoeconomic vaiables with fiscal policy: G and/o T monetay policy: M We can use the - model to analyze the effects of these policies. 1 1 slide 2 slide 3 An incease in govenment puchases A tax cut 1. cuve shifts ight 1 by 1 MC G causing output & income to ise. 2. This aises money demand, causing the inteest ate to ise which educes investment, so the final incease in 1 is smalle than G 1 MC slide 4 Because consumes save (1 MC of the tax cut, the initial boost in spending is smalle fo T than fo an equal G and the cuve shifts by MC 1. 1 MC T so the effects on and ae smalle fo a T than fo an equal G slide 5 1

2 Monetay olicy: an incease in M Stuctue of the Fedeal Reseve System 1. M > 0 shifts the cuve down (o to the ight 2. causing the inteest ate to fall which inceases investment, causing output & income to ise. 1 2 slide 6 slide 7 Composition of the Fedeal Open Maket Committee Chai of the FOMC (The chai of the Fedeal Reseve Vice Chai of the FOMC (The pesident of the Fedeal Reseve Bank of New ok Othe Voting Membes of the FOMC The vice-chai of the Fedeal Reseve The othe 5 govenos of the Fedeal Reseve Eithe the pesident of the Fedeal Reseve Bank of Chicago o of Cleveland 3 of the othe 9 Fedeal Reseve Bank pesidents Othe Nonvoting Membes of the FOMC Eithe the pesident of the Fedeal Reseve Bank of Chicago o of Cleveland The emaining 6 Fedeal Reseve bank esidents Monetay olicy Institutions The FOMC changes inteest ates by caying out open-maket opeations in an expansionay open-maket opeation, the Fedeal Reseve buys govenment bonds, inceasing bank eseves, and loweing inteest ates in a contactionay open-maket opeation, the Fedeal Reseve sells govenment bonds, deceasing bank eseves, and aising inteest ates slide 8 slide 9 Monetay olicy Institutions Fiscal olicy Institutions The Fedeal Reseve can also alte inteest ates in two othe ways the Boad of Govenos can alte legally equied bank eseves the Boad of Govenos can lend money diectly to financial institutions These tools ae used vey aely Fiscal policy in the U.S. is managed by Congess the Congess ceates the tax laws that detemine the amount of taxes imposed by the fedeal govenment the Congess s spending bills detemine the level of govenment puchases Tax and spending levels ae set though a pocess called the budget cycle slide 10 slide 11 2

3 The Budget ocess Govenment Expenditues Depatments plan Continuing esolutions? Depatments negotiate with the pesident s Office of Management and Budget Congess consides and votes on spending bills esidential vetoes? esident adds his pioities and submits a budget to the Congess Congessional committees accept, amend, and eject pesidential budget poposals Govenment shutdowns? Congess passes its budget esolution Mandatoy expenditues include spending fo Social Secuity, Medicae, Medicaid, unemployment insuance, and food stamps Discetionay expenditues must be appopiated each yea by Congess these include defense spending, NASA, highway spending, education spending, and so foth slide 12 slide 13 Majo Fedeal Govenment Expenditues by Categoy, Fedeal Govenment Discetionay Spending, Excluding Defense (2000 slide 14 slide 15 Fiscal olicy Institutions Because of the way the budget pocess is set up, making fiscal policy in the U.S. is complicated and time-consuming the time between when an economic shock occus and when a policy poposal becomes effective (the inside lag can take yeas the inside lag associated with monetay policy changes can be measued in days o weeks The Histoy of Stabilization olicy The Employment Act of 1946 established Congess s Joint Economic Committee and the pesident s Council of Economic Advisos called on the pesident to estimate and foecast the cuent and futue level of economic activity in the U.S. announced that it was the esponsibility of the fedeal govenment to foste and pomote fee entepise and the geneal welfae slide 16 slide 17 3

4 The Histoy of Stabilization olicy Befoe the Geat Depession, the geneal belief was that the govenment could not stabilize the economy and should not ty to do so It was lagely due to the witings of John Maynad Keynes that economists and politicians became convinced that govenments could halt depessions and smooth out the business cycle The Histoy of Stabilization olicy Because of the low and stable inflation and unemployment ates of the 1960s, economists and politicians thought that the business cycle was dead Howeve, in the 1970s, expected inflation ose and the hillips cuve shifted up the esult was stagflation slide 18 slide 19 Inteaction between monetay & fiscal policy Model: monetay & fiscal policy vaiables (M, G and T ae exogenous Real wold: Monetay policymakes may adjust M in esponse to changes in fiscal policy, o vice vesa. Such inteaction may alte the impact of the oiginal policy change. The Fed s s esponse to G > 0 Suppose Congess inceases G. ossible Fed esponses: 1. hold M constant 2. hold constant 3. hold constant In each case, the effects of the G ae diffeent: slide 20 slide 21 Response 1: hold M constant Response 2: hold constant If Congess aises G, the cuve shifts ight 1 If Congess aises G, the cuve shifts ight 1 2 If Fed holds M constant, then cuve doesn t shift. Results: = To keep constant, Fed inceases M to shift cuve ight. Results: = = 2 1 = 0 slide 22 slide 23 4

5 Response 3: hold constant Estimates of fiscal policy multiplies If Congess aises G, the cuve shifts ight To keep constant, Fed educes M to shift cuve left. Results: = 0 = fom the DRI macoeconometic model Assumption about monetay policy Fed holds money supply constant Fed holds nominal inteest ate constant Estimated value of / G Estimated value of / T slide 24 slide 25 Monetay vesus Fiscal olicy Shocks in the - Model At the end of the Wold Wa II ea, most economists and policy makes believed that the pincipal stabilization policy tool would be fiscal policy Today, the ovewhelming consensus is that monetay policy has poven itself to be faste acting and moe eliable than discetionay fiscal policy shocks: exogenous changes in the demand fo goods & sevices. Examples: stock maket boom o cash change in households wealth C change in business o consume confidence o expectations I and/o C slide 26 slide 27 Shocks in the - Model shocks: exogenous changes in the demand fo money. Examples: a wave of cedit cad faud inceases demand fo money moe ATMs o the Intenet educe money demand EXERCE: Analyze shocks with the - model Use the - model to analyze the effects of 1. A boom in the stock maket makes consumes wealthie. 2. Afte a wave of cedit cad faud, consumes use cash moe fequently in tansactions. Fo each shock, a. use the - diagam to show the effects of the shock on and. b. detemine what happens to C, I, and the unemployment ate. slide 28 slide 29 5

6 CASE STUD The U.S. economic slowdown of 2001 ~What happened~ 1. Real GD gowth ate : 3.9% (aveage annual 2001: 0.8% fo the yea, Mach 2001 detemined to be the end of the longest expansion on ecod. 2. Unemployment ate Dec 2000: 3.9% Dec 2001: 5.8% The numbe of unemployed people ose by 2.1 million duing 2001! CASE STUD The U.S. economic slowdown of 2001 ~Shocks that contibuted to the slowdown~ 1. Falling stock pices Fom Aug 2000 to Aug 2001: -25% Week afte 9/11: -12% 2. The teoist attacks on 9/11 inceased uncetainty fall in consume & business confidence Both shocks educed spending and shifted the cuve left. slide 30 slide 31 CASE STUD The U.S. economic slowdown of 2001 ~The policy esponse~ 1. Fiscal policy lage long-tem tax cut, immediate $300 ebate checks spending inceases: aid to New ok City & the ailine industy, wa on teoism 2. Monetay policy Fed loweed its Fed Funds ate taget 11 times duing 2001, fom 6.5% to 1.75% Money gowth inceased, inteest ates fell slide 32 CASE STUD The U.S. economic slowdown of 2001 ~The ecovey~ The ecession officially ended in Novembe Real GD ecoveed, gowing 2.3% in 2002 and 4.4% in The unemployment ate lagged: 5.8% in 2002, 6.0% in The Fed cut inteest ates in 11/02 and 6/03. Unemployment finally appeas to be esponding: 4.8% in Febuay slide 33 - and Aggegate Demand Deiving the AD cuve So fa, we ve been using the - model to analyze the shot un, when the pice level is assumed fixed. Howeve, a change in would shift the cuve and theefoe affect. The aggegate demand cuve captues this elationship between and. Recall, last time we deived AD fom the QTM Intuition fo slope of AD cuve: (M/ shifts left I ( 2 ( 1 AD slide 34 slide 35 6

7 Monetay policy and the AD cuve Fiscal policy and the AD cuve The Fed can incease aggegate demand: M shifts ight I at each value of (M 1 / 1 (M 2 / 1 2 Expansionay fiscal policy ( G and/o T inceases agg. demand: T C shifts ight at each value of slide 36 slide 37 - and AD-AS AS in the shot un & long un Recall : The foce that moves the economy fom the shot un to the long un is the gadual adjustment of pices. In the shot-un equilibium, if > < = then ove time, the pice level will ise fall emain constant slide 38 The SR and LR effects of an shock A negative shock shifts and AD left, causing to fall. 1 ( 1 slide 39 The SR and LR effects of an shock The SR and LR effects of an shock ( 1 ( 1 In the new shot-un equilibium, < In the new shot-un equilibium, < 1 slide 40 Ove time, gadually falls, which causes SRAS to move down M/ to incease, which causes to move down 1 slide 41 7

8 The SR and LR effects of an shock The SR and LR effects of an shock Ove time, gadually falls, which causes SRAS to move down M/ to incease, which causes to move down 1 2 ( 1 ( 2 SRAS 2 slide 42 This pocess continues until economy eaches a long-un equilibium with = 1 2 ( 1 ( 2 SRAS 2 slide 43 A Mathematical Example A Mathematical Example Goods Maket: = a + b( T + δ d+ G C = a + b( T b = a bt + δ d+ G I = δ -d Hence, the cuve is: T T G G a 1 G b T 1 b 1 b 1 b Can you find the multiplies? d 1 b Recall: = C + I + G Can you descibe which ae the endogenous/exogenous vaiables? slide 44 slide 45 A Mathematical Example The AD cuve fom - Money Maket: M d e f M s M M s e f Cuve a 1 b 1 1 b G Cuve b T 1 b d 1 b Hence, the cuve is: Define: slide 46 slide 47 8

9 The AD Cuve Then, the AD cuve is: a G b T 1 b 1 b 1 b Equilibium combinations of and d M s f 1 b Fiscal multiplies ae smalle since γ < 1 olicy Effectiveness When is fiscal policy moe effective? is flat: i.e. f (the sensitivity of money demand to inteest ates is lage, hence γ is close to 1. The esponse of inteest ates is smalle and thee is less cowding-out. is steep: d (investment demand sensitivity to inteest ates is small, hence γ is close to 1. Investment is insensitive to inteest ates so the multiplie effect is little affected slide 48 slide 49 When is Monetay olicy moe Effective? Show to youself this happens when: is flat: (when is the flat? is steep (when is the steep? slide 50 9