(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 API Prof. J. Frankel, Harvard Universit 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. (RBC models.) Realistic in Long Run. p AS AD'

5 API Prof. J. Frankel Intermediate case: AS has some slope in the SR; So a monetar expansion initiall goes into both P and Y. E.g., Y > Y. Over time P responds to excess demand until Y is back at Y. What if the econom is found to be in excess 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 long painful recession. The government could expand demand to speed it up. p AD initial 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 IMF, April 2016, WORLD ECONOMIC OUTLOOK Source: IMF WEO Oct. 2015

8 Intermediate case: AS has some slope in the SR; but is vertical in the Long Run. Can be modeled via: wage W is stick, but adjusts over time. SR suppl relationship: 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 (p p e ) = σ (π π e ) where π p p -1 and π e p e p -1. Milton Friedman, the Phillips curve Over time, expectations adjust in response to actual inflation, as does W.

9 API Prof. J. Frankel Monetar expansion raises AD in the SR An increase in the current level of M shifts AD curve out (again, because M/P in the SR shifts out LM curve => i => A ). Over time: p Observed rise in P raises P e and therefore W, when contract is re negotiated after 1 st ear. p e = σ (p p e ) AS short run => AS shifts up. p e 1 -- W and P continue to adjust until, in the LR, Y is back at Y. AD initial

10 In LR, P rises in same proportion as M. STANLEY FISCHER (MIT PRESS, 2004) Neutralit of mone. API Prof. J. Frankel, Harvard Universit

11 What about an increase in expected rate of growth of M, as opposed to the level? Example: in Jan. 2013, Bank of Japan raised target to 2 % (Abenomics). An increase in the expected future rate of growth of M shifts IS out, because e => r => A. p (See next slide). AS long run 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

12 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.

13 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. 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

14 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.

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

16 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

17 Appendix 3: Japan The three arrows of Abenomics Monetar stimulus (2% inflation target + QQE) Fiscal polic (?) Structural reform (?)

18 Japan s monetar easing (QQE) raised the exchange rate (Yen/$) and stock market Nov. 2012: HR dissolved => Abenomics Jan. 2013: BoJ raised π target to 2% Outlook Recover on a shak footing, Special, Economic Research Dept., Rabobank November 13, 2013,

19 But effects on growth (& inflation) were disappointing. Because the 2 nd & 3 rd arrows weren t fired? I d sa the 2 nd was fired in the wrong direction: Abe went through with the scheduled increase in the consumption tax taking effect April 1, 2014, from 5% to 8%. As man had warned, Japan went back into recession, i.e., growth turned negative for next two quarters.

20 Abenomics seemed to boost growth, at first. But Japan went back into recession in 2014 Q2, perhaps because of a big increase in the consumption tax. Nov => Abenomics April 2014 => Consumption tax ITF220 - Professor J.Frankel