(III) MONEY & INFLATION

Transcription

1 (III) MONEY & INFLATION LECTURE 6: AGGREGATE DEMAND & AGGREGATE SUPPLY In lectures 3-5 we saw the effects of monetar expansion, ΔM, on income, ΔY. Question 1: How do these results change when taking into account changes in the price level, P? Question 2: What are the effects on P & Y of an increase in the rate of growth of mone? Ke parameter(s) in goods market: SR elasticit of suppl,, and speed of adjustment of P over time.

2 API Prof. J. Frankel, Harvard Universit AGGREGATE DEMAND Everthing we have learned so far, about the effects of demand expansion, including monetar & fiscal polic, now goes into the AD relationship, but holds onl for a give price level P. The Aggregate Demand curve allows the price level to var.

3 Aggregate Demand Curve Slope of AD: negative P => M P => LM shifts left => Y. p AD Shift of AD: Spending increase Ā shifts AD right (b multiplier, less crowding out). p Mone increase M shifts AD up (in direction proportion to M). AD AD'

4 API Prof. J. Frankel, Harvard Universit OVERVIEW OF AGGREGATE SUPPLY Ultra-Kenesian case: AD' AS flat, at P => AD expansion goes entirel into Y. p AS Realistic in Ver Short Run. Classical case AS vertical at Y => AD expansion goes entirel into P. Then onl AS shocks move Y = Y, e.g., productivit shocks. Realistic in Long Run. p AS AD'

5 API Prof. J. Frankel OVERVIEW OF AGGREGATE SUPPLY (continued) Intermediate case: AS has some slope in the SR; So a monetar expansion initiall goes into both P and Y. But over time P responds to excess demand until Y is back at Y. What if the econom is found to be in excess p suppl: Y < Y? e.g., in the aftermath of a fall in I? Eventuall P will respond b falling enough to restore Y = Y. But that might be a AD initial long painful recession. The government could expand demand to speed it up. AS short run

6 API Prof. J. Frankel, Harvard Universit An upward-sloping suppl relationship: In response to the output fall in the great recession. Financial Times, Sept. 2015

7 inflation fell everwhere in World Bank, June 2014.Global Ec. Prospects. Exchange rate pass-through and inflation trends in developing countries, Source: IMF WEO, 2015

8 OVERVIEW OF AGGREGATE SUPPLY (continued) Intermediate case: AS has some slope in the SR; but is vertical in the Long Run. SR suppl relationship: Can be modeled via: stick wage W which adjusts over time, Y Y = ω P W σ σ elasticit of aggregate suppl (b in Romer book). E.g., wage contract W = ω P e. Y Y = P P e σ or in logs, - = σ (π π e ) Milton Friedman where π p p -1 and π e p e p -1. API Prof. J. Frankel

9 Monetar expansion raises AD in the SR An increase in the current level of M shifts LM curve out (because M/P in the SR => i ). => Y for given P => AD shifts right. An increase in the expected future rate of growth of M shifts IS out, because e AS long run => r => A. (See next slide). p AS short run Either wa, r, IS-LM shifts right => AD shifts right. p e API Prof. J. Frankel, Harvard Universit AD initial AD expanded

10 The real interest rate & the cost of capital Business investment, & other components of spending A, depend not just on the nominal interest rate i, but on the real interest rate r i - e. (To compute corporate cost of capital, it should also be long-term i, and adjusted for taxes.) This becomes important when we allow for stead-state rate of change in M & P, i.e., inflation. Generall, e is not full reflected in i in SR. So => r => A => IS shifts right => Mundell-Tobin effect.

11 Over time, P rises in response to high AD & Y. In LR, P rises in same proportion as M. Neutralit of mone. STANLEY FISCHER (MIT PRESS, 2004) API Prof. J. Frankel, Harvard Universit

12 SUMMARY OF EFFECTS OF 2 EXPERIMENTS Increase in level of M: SR: => M/P => i (liquidit effect) => r => A => Y. Increase in growth rate of M (g M in Romer book): SR: => π e => r (Mundell-Tobin effect) => A => Y. LR: M/P, i, r, A & Y back to original levels (neutralit of mone). P in proportion to M. <= P M L( i, Y) M e L( r, Y) LR: r, A & Y back to original levels (super-neutralit). i b same as π e (Fisher effect) => M/P. API Prof. J. Frankel, Harvard Universit

13 API Prof. J. Frankel, Harvard Universit Appendix 1: What lessons will monetar theor take from the 2008 global financial crisis? One is that excessive credit can show up in the form of asset price bubbles which can lead to crashes & recessions, and not necessaril alwas in the form of inflation.

14 Appendix 2 Example of overheating: China in Growth > 10% in

15 China s CPI accelerated in Inflation 1999 to 2008 Source: HKMA, Half-Yearl Monetar and Financial Stabilit Report, June 2008 API Prof. J.Frankel, Harvard