Economic Policy and Special Topics: Real-World Applications of the Model

Transcription

1 Economic olicy and Special Topics: Real-Wold Applications of the Model Topic 8

2 Goals of Topic 8 utting ou model at wok. Go though seveal eal-wold applications: ) Analysis of aticles fom the Economist though the eyes of the model. 2) Analysis of FOMC Statements though the eyes of the model. 3) Special Topics. 2

3 Some Applications ) A thinkes guide Economist 4// & The gamble Economist 5/3/7 & Use IT o lose it Economist 5/7/7 2) Fedeal Open Maket Committee meeting statement Fed, May 9, 27 & Home tuths Economist /2/6 3) Why the wa against teo will boost the economy Business Week /5/ 4) How shocking? Economist 9/23/ & Unstoppable Economist 8/2/4 & Counting the cost Economist 8/27/5 5) When cuts aen t kind enough Economist 9/22/5 6) Squabbles ove the stimulus Economist /3/ 7) Chonic sickness Economist 6/2/ & Afte the flood Economist 3//6 3

4 Example : Housing Maket Bust and Constuction Secto Slowdown The Economist aticle Home tuths discusses the wealth effect elated to dop in house values (/2/6). When house pices ise, so does people's pospeity. In esponse to this geate affluence, they gadually incease thei spending. When house pices fall, they cut back in a simila way. The consensus is that a $ dop in wealth, ove time, educes spending by about $3-5 a yea. That suggests weakening house pices would have a faily small, gadual effect on consume spending. See pape by Atif Mian and Ami Sufi at Chicago Booth fo the wealth effect of the 2-26 housing mkt boom and the bust. The Fed has not inceased inteest ates because this aggegate demand shock is aguably deflationay and should help in keeping inflation in check. At the same time this has kept the economy out of a ecession. 4

5 Example : Housing Maket Bust and Constuction Secto Slowdown Fom an ealy FOMC statement Release Date: May 9, 27. The Fedeal Open Maket Committee decided today to keep its taget fo the fedeal funds ate at 5-/4 pecent. Economic gowth slowed in the fist pat of this yea and the adjustment in the housing secto is ongoing. Nevetheless, the economy seems likely to expand at a modeate pace ove coming quates. Coe inflation emains somewhat elevated. Although inflation pessues seem likely to modeate ove time, the high level of esouce utilization has the potential to sustain those pessues. In these cicumstances, the Committee's pedominant policy concen emains the isk that inflation will fail to modeate as expected. Futue policy adjustments will depend on the evolution of the outlook fo both inflation and economic gowth, as implied by incoming infomation. 5

6 Analyzing Housing Maket Bust and Constuction Secto Slowdown Example: 5/9/7 Fed Statement SRAS(W ) W/ N s W / AD(I ) LM( ) N* N d Assume we stat at * Assume non-icadian consumes. Cuent taxes ae unchanged but futue taxes go down. Assume thee is an income effect. N IS(I ) 6

7 Analyzing Housing Maket Bust and Constuction Secto Slowdown Example: 5/9/7 Fed Statement: Fist pat of the yea slowdown. SRAS(W ) W/ N s W / W / AD(C I ) AD(C I ) LM( ) LM( ) IS(I C ) IS(I C ) 7 N* N d Let s look hee at the end of 26-ealy 27 when investment in esidential stuctues goes down. This may induce a bief slowdown. Suppose we conside also income effects. If also people will feel pooe as VLR goes down, then aggegate consumption may dop. See eading Home Tuths /2/6 Economist. If such dop of wealth is sizable thee is also going to be a positive esponse of labo supply. This may actually incease the full-employment level of output. We disegad it hee. N

8 Analyzing Housing Maket Bust and Constuction Secto Slowdown Example: 5/9/7 Fed: cuent e-adjustment of investment and constuction. SRAS(W ) W/ N s W / W / AD(C I ) AD(C I ) LM( ) LM( ) IS(C I ) IS(C I ) 8 N* N d N Right at that point, the Fed mentioned investment in esidential stuctues was slowly moving back up. By itself this would take a while to ecove. Howeve TF was also gowing and aggegate demand was ecoveing (paticulaly consumption is still buoyant). In that osy setting we could have eveted back to the initial equilibium afte a bief stint of slowdown. Too bad it did not happen.

9 Example 2: Input cost shocks (Oil) The Economist aticle How shocking? discusses the GD gowth slowdown elated to an incease in oil pices (9/23/). In 2 OECD suggested that even a $ (o oughly 5%) incease fom the level assumed in its base foecast, would educe gowth in the ich economies by aound only a quate of a pecentage point The Economist aticle Unstoppable? (8/27/5) and the aticle Counting the cost discusses ecent dynamics in oil pices (8/27/5). The cuent episodes of oil shocks have oigin in inceasing demand, notably in China, not supply disuption. In 2-5 oil pices tipled, compaable to pice jumps of , and 989-9, all of which wee followed by woldwide ecession and ising inflation. A good measue of dependence is value of oil consumed pe dolla of GD. Developed economies have become moe efficient in that but not economies in East Asia. 9

10 Oil pice shocks

11 Example: Oil shock Analyzing a emanent Incease in Oil ices SRAS(W ) W/ N s W / AD(C ) LM( ) N* N d Assume we stat at * Assume non-icadian consumes. N IS(C )

12 Analyzing a emanent Incease in Oil ices Example: Oil shock. IS-LM and AD-AS changes SRAS(W ) W/ N s W / AD(I, C ) AD(I, C ) * LM( ) LM( ) IS(I, C ) IS(I, C ) 2 N* N d The cost of poducing output fo evey pice level goes up. Hence fims can supply less output fo evey pice level. Both investment (because the MK goes down) and consumption (because VLR goes down) go down in the economy. This coesponds to a decease in aggegate demand and a shift downwads of the IS cuve. Let us assume that pices incease a bit. N

13 Analyzing a emanent Incease in Oil ices Example: Oil shock. Labo maket and SR Eq. SRAS(W ) W/ N s W / * 2 * 2 AD(I, C ) AD(I, C ) * LM( ) IS(I, C ) W / IS(I, C ) 3 2 N N* 2 N* N d The labo maket new equilibium pins down the full-employment level of labo and hence the full employment level of output, that is now lowe than at point (). The adjustment fom the SR to the LR is due to the self-coecting mechanism: wokes ae woking too little fo the wages they ae eceiving (both eal and nominal ae too high). This will bid down nominal wages to W 2 and SRAS will shift out. Long-un equilibium at (2). N

14 Example: Oil shock. LR Eq. Analyzing a emanent Incease in Oil ices SRAS(W ) W/ N s W / 2 2 * 2 2 * 2 W / AD(I, C ) W 2 / 2 AD(I, C ) * LM( ) LM( 2 ) IS(I, C ) IS(I, C ) 4 2 N N* 2 N* N d The labo maket new equilibium pins down the full-employment level of labo and hence the full employment level of output, that is now lowe than at point (). The adjustment fom the SR to the LR is due to the self-coecting mechanism: wokes ae woking too little fo the wages they ae eceiving (both eal and nominal ae too high). This will bid down nominal wages to W 2 and SRAS will shift out. Long-un equilibium at (2). N

15 Example 3: Technology Shocks The Economist aticle A Thinkes Guide discusses the supply-side issues elated to shocks to aggegate supply in 2. The Intenet will boost efficiency and gowth of fims. The economic impact of the Intenet has often been descibed as an oil shock in evese. The Intenet educes the cost of an input, infomation, and so has positive economic effects. In synthesis we can summaize the effect of Intenet on fims as a pemanent incease in A (TF incease). A study by Goldman Sachs at the time said an incease of eal GD gowth of.25% pe yea could be linked to IT evolution. (5% oveall of output; fo compaison ailways inceased GD by 2%). The Economist aticle The gamble discusses how actual highe poductivity does not necessaily tanslates (and did not tanslate) into highe pofits (in 27). It does howeve tanslate in highe pivate Investment. 5

16 Infomation Secto in the U.S. Souce: BLS. The Infomation secto includes: (a) poducing and distibuting infomation and cultual poducts, (b) poviding the means to tansmit o distibute these poducts as well as data o communications, and (c) pocessing data. Although the 2 stock maket bubble bust bought down employment in the industy substantially, houly eanings have kept a stable gowth, indicating poductivity gains as well. We have also seen in class how poductivity gowth acoss all othe industies has been substantially highe in the post-bust 2 s, indicating some evidence of an IT stuctual beak in TF. 6

17 Example: IT evolution Analyzing a emanent Incease in oductivity SRAS(W ) W/ N s W / AD(C ) LM( ) N* N d Assume we stat at * Assume non-icadian consumes. Cuent taxes ae unchanged but futue taxes go down. Assume thee is an income effect. N IS(C ) 7

18 Analyzing a emanent Incease in oductivity Example: IT evolution. IS-LM and AD-AS changes SRAS(W ) W/ N s W / AD(I, C ) AD(I, C ) LM( ) IS(I, C ) IS(I, C ) 8 N* N d The cost of poducing output fo evey pice level goes down. Hence fims can supply moe output fo evey pice level. Both investment (because the MK goes up) and consumption (because VLR goes up) go up in the economy. This coesponds to an incease in aggegate demand and a shift outwads of the IS cuve. Let us assume that pices emain stable. N

19 Analyzing a emanent Incease in oductivity Example: IT evolution SR Eq. W/ SRAS(A, W ) 2 N s W / AD(I, C ) N d (A ) * 2 N* N* 2 N LM( ) * 2 IS(I, C ) 9 The labo maket is affected in two ways. Labo demand goes up because an incease in total facto poductivity inceases the maginal poduct of labo and hence fims want to have moe wokes. Labo supply may be cut if the income effect opeating though the pemanently highe wages of wokes is stong enough. (We assume is not a lage dop in the gaph above). Shot-un equilibium at (). N d (A ) N

20 Analyzing a emanent Incease in oductivity Example: IT evolution LR Eq. W/ SRAS(A, W 2 ) W 2 / 2 2 N s 2 2 W / AD(I, C ) N d (A ) * 2 LM( 2 ) LM( ) N* N* 2 N 2 * 2 IS(I, C ) 2 The labo maket new equilibium pins down the full-employment level of labo and hence the full employment level of output, that is now highe than at point (). The adjustment fom the SR to the LR is due to the self-coecting mechanism: wokes ae woking too much fo the wages they ae eceiving (both eal and nominal ae too low). This will bid up nominal wages to W 2 and SRAS will shift in. Long-un equilibium at (2). N d (A ) N

21 Infomation Secto in Euope The Economist aticle Use IT o lose it discusses the supply-side issues in Euope. The Euopean maket has been extemely slow in adopting IT. Hence thee poductivity gowth has been dismal. Between 97 and 995 output pe hou in Ameica gew at an aveage ate of.3% a yea. Then the pace picked up makedly, to 2.4% in While Ameica acceleated, Euope stalled: having managed 2.4% a yea in 97-95, the Euopean Union's oldest 5 membes eached only.3% in Euopeans need to make bette use of IT (adopt best pactice) to incease TF. Bloom, Sadun, and Van Reenen (27) shows that US subsidiaies in UK use IT bette than Bitish fims in the same industy. 2

22 Example 4: Why the Wa Against Teo Will Boost the Economy (R. Bao) The Business Week aticle discusses the effects on the economy of a US wa effot in Afghanistan in 2. Analyze the likely economic impact of the wa. Each $ woth of militay outlays led to a 6-7 cents incease in GD. The govenment spending had to be paid fo by deceases in othe foms of spending, especially business investment. (Note this is the same figue used in Bao s WSJ piece of 2/3/) The incease in militay spending (that is in G) would amount to about 2% of 2 GD. Bao is saying that if govenment inceases its demand of goods and sevices of.2 of GD 2 then GD 22 will be highe by.6*.2* GD 2 =.2* GD 2 This is equivalent to adding.2% to GD gowth between 2 and 22. Hence his conclusion: The cuent wa will be expansionay and will theefoe help the US economy ecove fom the cuent slowdown. 22

23 Wa against Teo olicy Analyzing how Wa Boosts the Economy SRAS(W ) W/ N s W / AD(G ) LM( ) N* N d Assume we stat at * Assume non-icadian consumes N IS(G ) 23

24 Analyzing how Wa Boosts the Economy Wa against Teo olicy - SR Eq. SRAS(W ) W/ N s W / LM( 2 ) AD(G ) W / AD(G ) LM( ) LM( ) IS(G ) IS(G ) 24 N d N* N Assume we stat at * Conside shifts of LM, shifts of the IS, shifts of the SRAS. The shot-un equilibium is detemined by the cossing between SRAS and AD. A pemanent (o long-lasting) incease in militay spending shifts the IS and AD outwads. ices adjust immediately and LM shifts a bit inwads (eal money balances dop).

25 Wa against Teo olicy Analyzing how Wa Boosts the Economy SRAS(W ) W/ N s AD(G ) * LM( ) LM( ) Change in spending Change in output W / AD(G ) W / IS(G ) IS(G ) 25 N d N* N Notice that the change in spending is lage than the change in equilibium output in the shot un. This is what Bao says. The highe eal ates misplace investment. To see this ecall that the IS can be witten as = C() + G + I() + NX.

26 Analyzing how Wa Boosts the Economy Wa against Teo olicy - LR Eq. SRAS(W 2 ) SRAS(W ) W/ N s 2 2 W 2 / 2 =W / 2 LM( 2 ) 2 AD(G ) W / AD(G ) LM( ) LM( ) IS(G ) IS(G ) 26 N* N N d Self-Coecting mechanism to get to LR: point at (2) = (). eople ae demanding highe nominal wages at the shot-un equilibium in point (). Changes in nominal wages move the SRAS in. Changes in pices move the LM cuve inwads. Now the pice level is highe and nominal wages ae highe. Real wages ae back to thei pevious level

27 Example 5: emanent Cut in esonal Income Tax ate The Economist aticle When cuts aen't kind enough Sep 22nd 25 discusses the effects on the economy of a cut in income tax ates. Fance s pesident, Jacques Chiac, took powe in 22 on a pledge to cut income taxes by a thid; up to 25, he had timmed them by just %. Dominique de Villepin, his pime ministe, simplified Fance's tax bands and chopped the top ate fom 48% to 4%. As ecently as 2, it was 54%. 27

28 Tax Rates in Euope 28

29 Analyzing a emanent Cut in Income Tax Rate Example: Chiac s Fiscal olicy SRAS(W ) W/ N s W / AD(C ) LM( ) N* N d Assume we stat at * Assume non-icadian consumes. Cuent taxes ae unchanged but futue taxes go down. Assume thee is a lage income effect. N IS(C ) 29

30 Analyzing a emanent Cut in Income Tax Rate Example: Chiac s Fiscal olicy - SR Eq. SRAS(W ) W/ N s W / LM( 2 ) AD(C ) W / AD(C ) LM( ) LM( ) IS(C ) IS(C ) 3 N d N* N Assume we stat at * Conside shifts of LM, shifts of the IS, shifts of the SRAS. The shot-un equilibium is detemined by the cossing between SRAS and AD. A pemanent dop in taxes inceases VLR which influences positively cuent consumption and shifts the IS and AD outwads. ices adjust immediately and LM shifts a bit inwads (eal money balances dop). N

31 Analyzing a emanent Cut in Income Tax Rate Example: Chiac s Fiscal olicy SRAS(W ) W/ N s N s AD(C ) * 2 N* LM( 2 ) LM( ) * 2 IS(C ) W / AD(C ) W / IS(C ) 3 N* N N d Now look at what happens to Labo supply and labo demand. The labo demand is unaffected by VLR, but wokes ae now iche, want to consume moe leisue, and wok less. Hence N s shifts in. Conside then whee is the new long-un equilibium. (oint 2 in the next slide). Note that thee is disageement on how big income effects may be in the labo maket. N

32 Analyzing a emanent Cut in Income Tax Rate Example: Chiac s Fiscal olicy - LR Eq SRAS(W 2 ) SRAS(W ) AD(C ) * * 2 N* LM( 2 ) LM( ) LM( 2 ) AD(C ) IS(C ) W/ W 2 / 2 W / IS(C ) 2 N* N N s N s N d Self-Coecting mechanism to get to LR. New point at (2). eople ae demanding highe nominal wages at the shot-un equilibium in point (). Changes in nominal wages move the SRAS back in. Changes in pices move the LM cuve back in. N * 2 32

33 Example 6: emanent Cut in Income and Investment Tax ate The Economist aticle Squabbles Ove the Stimulus Oct st 2 discusses the composition of Bush s initial fiscal stimulus: cuts in income tax ates and investment taxes. his stimulus is to be divided between fou main tax cuts. Two ae to boost consumption. M. Bush wants a one-time tax ebate fo pooe Ameicans who pay taxes but who didn't ean enough to get a full ebate ealie this yea. He also wants to acceleate some (o all) of the cuts in maginal income-tax ates aleady slated fo 24 and, possibly, those due in 26. To help businesses, the White House poposes abolishing the copoate altenative minimum tax. This tax, which affects a tiny faction of companies, is designed to ensue that fims do not avoid paying taxes by claiming excessive deductions. Lastly, M. Bush wants to intoduce some pemanent incentives to boost investment. 33

34 Analyzing a emanent Cut in Income and Investment Tax ate Example: Bush s Fiscal olicy SRAS(W ) W/ N s W / AD(C ) LM( ) N* N d Assume we stat at * Assume non-icadian consumes Assume lage Income effects. N IS(C ) 34

35 Analyzing a emanent Cut in Income and Investment Tax ate Example: Bush s Fiscal olicy - SR Eq. SRAS(W ) W/ N s W / LM( 2 ) AD(C ) AD(C ) LM( ) LM( ) IS(C ) IS(C ) 35 N* N d Assume we stat at * Conside shifts of LM, shifts of the IS, shifts of the SRAS. The shot-un equilibium is detemined by the cossing between SRAS and AD. A pemanent dop in taxes inceases VLR which influences positively cuent consumption and shifts the IS and AD outwads. ices adjust immediately and LM shifts a bit inwads (eal money balances dop). N

36 Analyzing a emanent Cut in Income and Investment Tax ate Example: Bush s Fiscal olicy SRAS(W ) W/ N s N s * 2 * 2 W / AD(C ) W / AD(C ) LM( ) LM( ) IS(C ) IS(C ) 36 N* 2 N* N d Now look at what happens to Labo supply and labo demand. The labo demand is unaffected by VLR, but wokes ae now iche, want to consume moe leisue, and wok less. Hence N s shifts in. Fims have a lowe use cost of capital and invest moe. Moeove thei MN goes up in the long un. Conside then whee is the new long-un equilibium. (oint 2 in the next slide) N

37 Example: Bush s Fiscal olicy LR Eq. Analyzing a emanent Cut in Income and Investment Tax ate SRAS(W SRAS(W ) 2 ) W 2 / * 2 * 2 AD(C ) LM( ) LM( ) IS(C ) W / AD(C ) W / IS(C ) 37 2 N s N s N* N d 2 N* Self-Coecting mechanism to get to LR. New point at (2). eople ae demanding highe nominal wages at the shot-un equilibium in point (). Changes in nominal wages move the SRAS back in. Changes in pices move the LM cuve back in. N

38 Example 7: Japan s Economy The Economist aticle Chonic Sickness discusses the demand-side issues elated to Japan s ecession and deflation in 2 Analyze the likely causes of the slow gowth and ecessions of Japan in the 993 and ealy 2 s. Incease in the maginal popensity to save and dop in investment oppotunities. The Economist aticle Afte the Flood discusses the monetay policy issues elated to estoing Japan s inflation afte the dop in pices due to negative demand shocks and expanding demand in 26 (5 yeas late!) In 26 The Bank of Japan (BoJ) declaed that the days of its ultaloose monetay policy wee ove and that it was winding down its unothodox pactice, begun five yeas ago, of flooding the banking system with fee money (giving out fee eseves). Chaiman Fukui howeve stated aising ates again (to.5% July 26). See aticle Saving Gace (Economist 5/5/7) 38

39 Japan s Economy Index of Industial oduction Gowth 39

40 Japan s Economy Recessions 4

41 Japan s Economy Chonic Sickness Consume Confidence Falls By a Lot in Japan SRAS(W ) Assume we stat at * Assume consumes ae standad IH (i.e., non-liquidity constained, non-icadian). Assume no income effect on labo supply. AD(C ) LM( ) IS(C ) 4

42 Japan s Economy Chonic Sickness Consume Confidence Falls By a Lot in Japan SRAS(W ) Same dop in consume confidence as we see in Example Topic 7. e s AD(C ) AD(C ) LM( ) LM(M, ) The economy will eventually coect itself and bing us back to *. The dawback is that the selfcoecting mechanism woks slowly when < (it takes time to cut nominal wages). Let s pause fo a moment think about how the Fed could bing us back to. IS(C ) e s 42 IS(C )

43 Japan s Economy Flooding the Economy with The BoJ inceases money supply to stabilize the economy. e s e s 43 AD(C ) SRAS(W ) AD(C ) LM( ) LM(M, ) LM(M, ) IS(C ) IS(C ) As Money supply inceases, I inceases and the AD cuve shifts back out. Notice (this is subtle) when I inceased between the shot un and the long un when the economy coected itself, the AD cuve did not shift! The eason? I inceased as fell and M/ inceased. The esponse of changing on Investment (and as a esult ) is why the AD cuve slopes down. In the case of the selfcoecting mechanism, we just move along the AD cuve when the economy coects itself (because of the pice effect on M/). When M changes the AD cuve shifts. It says that at evey given, highe M is highe M/ esulting in lowe inteest ates and highe investment and highe. That means, at evey given an incease in M leads to highe ( a ightwad shift in the AD cuve).

44 Special Topic : China The Economist aticle Fom T-shits to T-bonds discusses the intenational ole of China and its economic consequences woldwide (7/3/5). China has been gowing fo the past ten yeas in double digits. Due to the elative abundance of labo and the scacity of fixed capital China has been specializing in elatively low value added sectos and light manufactuing in geneal. In many accounts in the media China has been accused to foste its gowth to an atificially undevalued cuency in ode to make its poduct cheape vis-à-vis the est of the wold. This has detemined an incease of Chinese expots. By many in the US this has been viewed as cheating in tems of selling its poducts to low. Moeove, this has been linked to the even faste decline in employment in manufactuing in the US. What ae the meits of these aguments? What ae the consequences on aggegate economic outcomes in the US? 44

45 China s effects on the demand side Thee ae seveal issues these aguments disegad on the demand side: ) Chinese poducts ae cheape, that is why they ae bought. This implies that consumes ae benefiting fom low pices. The Economist cites souces that estimates its gains in 7 $billions pe yea. 2) These low pices have helped maintaining pice low and inflation unde contol. 3) China is expoting almost as much as it is impoting fom the US, so it is not the main souce of tade deficit fo the US (i.e. a negative NX tem). otentially the US is gaining fom a Chinese expansion. The only solid agument fo an appeciation of the Chinese cuency is that the US could sell moe to China. 45

46 China s effects on the supply side Thee ae seveal issues these aguments disegad in tems of labo supply: ) The injection in the wold economy of seveal million of Chinese wokes has necessaily poduced an incease in potential output woldwide (N has gone up al lot). 2) Howeve, China has begun exeting substantial effects on pices of aw mateials. Oil pices have been inceasing ecently because of inceased demand fom China moe than disuption in oil poducing counties o OEC decisions. The fact howeve that pices of goods have been declining because of cheap expots has balanced those inflationay pessues linked to the negative supply shock in OECD counties and the US especially. 46

47 China s effects on the labo maket Thee ae seveal issues these aguments disegad in the labo maket: ) The injection in the wold economy of seveal million of Chinese wokes has necessaily poduced a decease in the etun to labo as a facto of poduction. Real wages have emained substantially low. At the same time the scace facto, capital, has been ewaded with highe etuns. 2) But can we say that wokes have been suffeing and Copoate Ameica (though highe pofits and etun on capital) has been gaining? Only if we assume that wokes ae homogenous. 3) Chinese wokes ae elatively unskilled. This implies that in eality only eal wages of unskilled wokes have been declining. Skilled wokes howeve have become moe scace and in fact they have been expeiencing highe etuns. 47

48 Additional Topics Open economy maco. See intenational finance. We can allow ou model to incopoate tade with othe economies. Moe discussion of China and its effect on the US macoeconomy. Intoduction to intenational finance. 48