A FOUR MARKET MODEL Hannes Kvaran
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1 FU MKE ME Hannes Kvaran roose the macro model use four markets: roduct, credt, foregn exchange and labor. n some cases use some unusual conventons that wll now resent. 0 0 he roduct Market n ths treatment s unusual n that t uses the nflaton rate and the real G growth rate as ts deendent varables, ndcated by lower case varable names, rather than usng the rce level and real G. have wrtten n other laces n defense of ths aroach, so won t reeat my arguments here. hs treatment suoses that t makes more sense to seak of the eulbrum levels of nflaton and real growth than to seak of eulbrum levels of the rce ndex and real G. ee Fgure 1. he major shfter s nomnal G growth -- denoted by x. Fg. 1 he roduct Market w he abor Market uses the same conventon as the roduct market. he varables w and n reresent the rate of growth of (nomnal) wages and emloyment, resectvely. w 0 n 0 n n ths treatment the essental task of the labor market s consdered to be the dvdng u of sendng nto ts wage and roft comonents. Fg. 2 he abor Market Fg. 3 he Credt Market he Credt Market s resented as a cross between the market for loanable funds and an /M dagram; hence the two uantty varables n Fgure 3. You can magne z and x as actually beng measured on two arallel horzontal axes. he z s used to ndcate the (rate of growth of) credt. f one looks at z as the uantty varable, then we have a loanable funds market, wth one sgnfcant, arguable new suoston: that the nterest rates determnes not the uantty of credt, but the growth rates of B credt. hnkng of x as the uantty varable essentally yelds an /M z, x dagram, but whch also demonstrates the lnk between events n the credt market and the roduct market. n ths market, x s the result of the ostons of (endng uly) and B (Borrowng emand) whch deend sgnfcantly on monetary and fscal olces. n the roduct market x s an curve shfter. he ncluson of x as the uantty varable lnks ths market to the / dagram where x s an shfter.
2 Fg. 4 Foregn Exchange e $ =F he Foregn Exchange Market trades dollars at a rce desgnated as the exchange rate (measured as foregn currency er dollar ). he suly of dollars arses from our morts (F); the demand for dollars s buy our exorts (E) and to undertake catal nflows (K) e 0 $ 0 $ =E + K $ Fg. 5 Macro Markets he haes of Markets For the urose of ths aer, all four macro markets are assumed to aear as shown n Fgure 5. he artcular concavtes of the curves are central to the argument to be develoed. mn ca he ratonales for the assumed concavtes are: 1. uly becomes less elastc as a caacty level of outut s aroached. ubseuent ncreases of demand become rogressvely harder to meet wth ncreased outut and result nstead n rogressvely larger rce ncreases as a state of full emloyment s reached. 2. emand s nelastc at low levels of outut because buyers wll seek to mantan some necessary mnmum level of ths commodty, even at the exense of ayng hgher rces. susect the assumed shae of suly s farly standard and that of demand less so. For smlcty, each curve can be treated as f t were controlled by two arameters: the vertcal and horzontal asymtotes shown n Fgure 5. Changng ether uantty asymtote wll shft a curve horzontally sde to sde, whle changng a rce asymtote wll shft a curve vertcally u or down. he asymtotc arameters have the followng uses/nterretatons: mn -- a mnmum (erhas subsstence ) uantty of the good n ueston. ca -- caacty outut ossble from the market. s -- s changed by altered roducton costs. d -- s changed by an altered consumer reservaton rce. Fgure 6. Horzontal se of emand Fgure 7. Vertcal se of emand he number of curve shfts of suly and demand s now doubled. For examle, there are now two dstnct ways for a demand curve to ncrease: by shftng to the rght (ncreasng mn) or by rsng vertcally (rasng d). lthough the laws of suly and demand aly n both cases -- rce and uantty wll both rse -- a somewhat dfferent stuaton results n each case. Fgure 6 shows the effect of demand shftng to the rght: n ths case the nelastc ortons of the two curves ntersect. f,
3 however, demand rses vertcally Fgure 7 results: the elastc orton of the demand curve contacts the nelastc orton of the suly curve. mlar results can be had by decreasng demand horzontally or vertcally and by ncreasng or decreasng suly ether horzontally or vertcally. ut another way, ths says that we mght frutfully dvde demand ncreases nto two tyes: those n whch demand becomes less elastc as t rses and those n whch t becomes more elastc as t rses. contend that each of those has a reasonable nterretaton whch s sgnfcantly catured by the mages rovded by the changng of the four asymtotes. UE F HE ME wll conclude by resentng some uses of ths model, movng toward a system that comactly summarzes a great deal of economc common knowledge and then moves toward descrbng a taxonomy of macroeconomc tyes. he monetarst-keynesan debate Fgure 8. Keynesan Markets Fgure 9 Monetarst markets hs market set-u can ute comactly contan the essentals of the monetarst-keynesan debate. he trck s to assume that the Keynesan world (a demand-defcent economy) results from vertcal decreases of demand, whle the monetarst world (a demand-suffcent economy) results from vertcal ncrease of demand. ee Fgures 8 and 9. susect the noveltes here are two: frst, the decton of the sloe of the demand curve, and second, the resumton that all macro markets can be vewed ths way. Fgure 10 dects the monetarst and Keynesan versons of fscal and monetary exanson. he results are ute standard though a few elements (the Keynesan vew of fscal olcy, for nstance) mght reure some rethnkng. art from merely summarzng the tycal theoretcal arguments, thnk ths aroach goes a ste further, by suggestng that there s a larger frame nto whch both theores ft, that the suosedly ncomatble theores are actually comlementary, that economes have dfferent reactons deendng on the state of emloyment, that each of the theores works better when aled to the tye of economy t was devsed to exlan.
4 Fgure 10. Keynesan heory Fscal Exanson Monetary Exanson Credt Market roduct Market Credt Market roduct Market B 0 B 1 Fgure 11. Monetarst heory Fscal Exanson Monetary Exanson Credt Market roduct Market Credt Market roduct Market z, B B1 B0 1 0 B 1 0 ynamcs n abdng stereotye of monetarst and Keynesan thnkng s that the former s long run and that the latter s short run. Usng those characterzatons, we may develo ctures of the dynamc reactons of economes. Fgures 12 and 13 show the resultng analyss. et me ont two artcularly aealng eces of analyss. he frst s the sense of the lags nherent n monetary olcy, gven the number of stes that nterose between monetary exanson and subseuent nflaton. he second s the mage that the rmary evl of exansonary fscal olcy s not that t s nflatonary, but recsely that t s unable to move aggregate demand at all, mlyng that crowdng out must be occurrng. Fgure 12. Fscal Exanson Fgure 13. Monetary Exanson Credt Market roduct Market Credt Market roduct Market B 1 B B B 1 0
5 taxonomy beyond eturnng to the dea that suly and demand curves can each shft n four ossble ways, we can construct eght market tyes based on the redomnant curve shft. Monetarsm and Keynesansm have accounted for two. he other sx all seem to have reasonable nterretatons, abetted by the stores suggested by the asymtotes of the macro markets. ee Fgure 14. et me resent examles of the two contrastng tyes of suly decreases: ost-war Germany had suffered a decrease of ts catal stock -- a leftward shft of -- resultng n a hghly nflatonary stuaton. ny further curve shfts would have serous mact on the nflaton rate. he suly decrease n the U n the 1970s was of a dfferent tye. sng factor costs lfted the suly curve vertcally, takng the economy further from caacty outut. Based on ths observaton, let me make a testable redcton, n a strange sense of the word. earler suggested that what ass for facts n economcs are only consensus onons. o submt a redcton to see f t suares wth the facts. My logc leads to the followng concluson: an aggregate demand ncrease n the 1970s, nduced by exansonary monetary olcy for nstance, should not have been hghly nflatonary, snce t would have been ushng aganst a farly elastc, underutlzed suly sde. uly sde nflaton -- such as the uward ressure on factor costs nduced by nflatonary exectatons -- would be exected to be sgnfcant. (f true, there s a consderable rony here: monetary olcy would have been nflatonary not because t was nherently so, but merely because the unwarranted exectaton of monetary-nduced nflaton roduced a truly nflatonary suly-sde wage ush.) oes that ft the facts? Fnally, wll menton that there actually far more than merely eght macroeconomc states, because there are four markets, each of whch can have eght states. nterestngly, n the monetarst and Keynesan cases, t seems as f all markets tend to assume the same shaes but ths need not be so. Conseuently, wth four markets and eght ossble states we 8 4 = 4096 ossble economes. et s get started!
6 BE. Notaton conventons and suggestons. evel ate of Change Varable ymbol Varable ymbol rce evel nflaton eal G real growth (Nomnal) ncome Y nomnal ncome growth y (Nomnal) Exendtures () X nomnal sendng growth x (Nomnal) Money uly M money growth rate m Velocty of Money V growth of velocty v (Nomnal) Wage rate W (nomnal) wage rate growth w Emloyment N emloyment growth n Credt used Z growth of credt use z ome other notaton suggestons Borrowng/Credt emand B endng/credt uly Nomnal nterest rate real nterest rate r Exchange rate e Foregn Catal Flows K Exorts E morts F V E C Fgure 14. Eght ossble states of a macro market emand ncrease emand ecrease H Z N
7 V E C H Z N uly ncrease uly ecrease
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