and the Financial System

Transcription

1 Macroeconomics Institutions, Instability, and the Financial System Wendy Carlin David Soskice OXPORD UNIVERSITY PRESS

2 Outline contents Reviews " Preface ix How to use the Online Resource Centre xviii Acknowledgements xx List of figures xxxi Listoftables xxxviii Abbreviations xxxix 1 The demand side 1 2 The supply side 42 3 The 3-equation model and macroeconomic policy 80 4 Expectations Money, banking and the macro-economy The financial sector and crises The global financial crisis: applying the models Growth, fluctuations and Innovation The 3-equation model in the open economy The open economy: the demand and supply sides Extending the open economy model: oil shocks and imbalances The Eurozone Monetary policy Fiscal policy Supply-side policy, Institution: and unemployment Real Business Cyde and New Keynesian models 583 Bibliography 615 Index 629

3 Contents Reviews Preface How to use the Online Resource Centre Acknowledgements List offigu res List oftabl es Abbreviations ii ix xviii xx xxxi xxxviii xxxix 1 The demand side Overview Facts about the demand side and business cycles Introducingthe IS curve Modeiiing Goods market equilibrium The multiplier The IS curve Forward-Iooking behaviour Consumption Investment Consumption, investment and the IS curve Conclusions Appendix Real and nominal interest rates and the Fisher equation Deriving the Euler equation and the PIH consumption function Questions Checklist questions Problems and questions for discussion 40 2 The supply side Overview Unemployment Why the labour market does not clear Supply side effects on unemployment Nominal rigidities and demand-side policy Facts about the supply side Modeiiing Supply side effects on unemployment Nominal rigidities, Inflation and the business cycle Applications Conclusions Appendix 74

4 xxiv CONTENTS The textbook model: competitive markets and complete contracts The mark-up and the elasticity of demand Deriving the PS curve including the tax wedge Questions Checklist questions Problems and questions for discussion 78 3 The 3-equation model and macroeconomic policy Overview The role of the central bank in stabilization Inflation and deflation Introduction to the 3-equation model Modelling The 3-equation model Using the 3-equation model Applications A temporary demand shock Forecastingand lags The deflation trap A supply shock Conclusions Appendix III The 3-equation model in more detail Questions Checklist questions Problems and questions for discussion Expectations Introduction Risk, uncertainty and expectations Risk and uncertainty Expectations formation in real-world situations The rational expectations hypothesis (REH) Phillips curves, expectations and Inflation Expectations and the 3-equation model A graphical example Comparison of adaptive and rational Inflation expectations Central bank communication and anchoring Inflation expectations The Lucas critique Expectations hypotheses, Inflation blas and time inconsistency Adaptive expections and Inflation blas Rational expectations, Inflation blas and time inconsistency Approaches to mitigate Inflation blas Conclusions Questions Checklist questions Problems and questions for discussion Money, banking and the macro-economy Introduction 149

5 CONTENTS XXV 5.2 Money and the macro-economy Money Money supply and money demand Money, banks and the 3-equation model A modern financial system The central bank sets the policy interest rate The mark-up of the lending rate over the policy rate Banks, credit constraints and collateral The role of banks in afractional reserve system Governance arrangements: banks, central bank and government The financial system and balance sheets Banks and macro stabilization Example: an Investment boom shifts the IS curve Conclusions Appendix Modeiiing the banking mark-up (r - r p ) Questions Checklist questions Problems and questions for discussion The financial sector and crises Introduction Bank behaviour, cycles and crises Bank behaviour and the macro-economy Financial crises and theircostto the economy Financial cycles and business cycles Basic mechanisms Asset price bubbles The financial accelerator The housing feedback process and the 3-equation model Credit constrained households, housing collateral and house prices A piain vanilla financial crisis Housing feedback process and the 3-equation model The bank leverage-centred feedback process Investment bank behaviour and leverage A balance sheet recession and the financial accelerator Conclusions Appendix Modeiiing the housing-centred positive feedback process A positive feedback model of Investment bank behaviour Questions Checklist questions Problems and questions for discussion The global financial crisis: applying the models Introduction Pre-crisis financial system: incentives, Instruments and actors Incentives 226

6 CONTENTS Instruments Actors The upswingof the financial cycle The crisis The scale of the crisis and nature of the post-crisis recession The credit crunch The crisis, macroeconomic policy and the 3-equation model Policy Intervention in the crisis What went wrong in the Great Depression? Monetary and fiscal policy in the crisis phase Austerity policies in the post-crisis recession Fixing banks flrst may mean less government debt later Conclusions Questions Checklist questions Problems and questions for discussion Growth, fluctuations and Innovation Introduction Short- and medium-run macro models and growth theory Growth concepts and useful tools The Solow model The model Steady State or balanced growth The Solow model and cross-country Performance Technological progress in the Solow model Technological progress and steady State growth Growth accounting: measuring the impact oftechnology Endogenous growth: the Romer model Research and development Endogenous growth and endogenous technological progress: the Romer model Schumpeterian growth: the Aghion-Howitt model Creative destruction, competition and Schumpeterian growth Schumpeterian growth and business cycle fluctuations Conclusions Questions Checklist questions Problems and questions for discussion The 3-equation model in the open economy Overview Modelling The foreign exchange market and the UIP condition Medium-run equilibrium in the open economy and the AD - ERU model ADcurve Stabilization under flexible exchange rates: 3-equation model and RX curve Inflation shock: Comparing closed and open economies Applications Demand and supply shocks: the 3-equation and AD-ERU models 330

7 CONTENTS xxvii Exchange rate overshooting Exchange rate volatility Conclusions Appendix Deriving the real UIP condition The 3-equation model in more detail Derivation of (1 - X) and its properties Geometry of the RX curve: varying the parameters Questions Checklist questions Problems and questions for discussion The open economy: the demand and supply sides Overview The open economy accounting framework The demand side, trade balance and the supply side Modeiiing The demand side and trade balance The supply side in the open economy The medium-run model: AD-BT-ERU Application The UK economy before the crisis Conclusions Appendix Questions Checklist questions Problems and questions for discussion Extending the open economy model: oilshocks and imbalances Overview How does a commodity price rise affect the macro-economy? Interpretingan economy's sector financial balances: does a current account im balance matter? Inflation targeting in atwo-bloc world Different medium-run 'growth' Strategie: can cause global imbalances Modeiiing Oilshocks Current account imbalances Sector financial balances Global interdependence and imbalances A 2-bloc model with inflation-targeting central banks Conclusions Appendix Dynamic adjustment to a shock in the 2-bloc model Questions Checklist questions Problems and questions for discussion The Eurozone Introduction Origins of the Eurozone and the theory of an optimal currency area 430

8 xxviii CONTENTS The Eurozone's Performance in its firstten years The Eurozone policy regime The Maastricht policy assignment Monetary policy in the Eurozone Fiscal policy in the Eurozone Stabilization in the Eurozone: common shocks Stabilization in the Eurozone: country-specific shocks ls stabilization policy necessary for country-specific shocks? The real exchange rate (competitiveness) Channel The real interest rate Channel Using fiscal policy to stabilize The real exchange rate channel-internal devaluation Conclusions about stabilization policy in the Eurozone Eurozone governance, sovereign risk and the banking system Governance arrangements: banks, governments and central bank Governance solutions Conclusions Questions Checklist questions Problems and questions for discussion Monetary policy Introduction Monetary policy and the economy's nominal anchor The classical dichotomy and the nominal anchor From theory to practice: monetary policy and Inflation in the 1970s and 1980s The Inflation target as the nominal anchor Modeiiing Active rule-based policy Central bank preferences: sacrifice ratios and costly disinflation The MR equation and Taylor rules The modern monetary policy framework practice Taylor rules in practice Monetary policy and the global financial crisis Asset price bubbles and central bank Intervention Unorthodox monetary policy in the Great Recession Post-crisis reform of financial regulation and the macro policy framework The failures of the conventional macroeconomic policy framework Post-crisis reforms for a safer financial system Conclusions Questions Checklist questions Problems and questions for discussion Fiscal policy Introduction Fiscal policy's role in stabilization The scope of fiscal policy The effects of discretionary fiscal policy The automatic stabilizers 513

9 CONTENTS xxix 14.3 Debtdynamics The government's budget identity Debtdynamics The costs of high and rising government debt Can fiscal consolidation be expansionary? The government's budget constraint and Ricardian equivalence Ricardian equivalence and the PIH Ricardian equivalence and fiscal policy effectiveness Deficit bias and the political economy of debt Causes of deficit bias Why deficit bias may vary across countries Approaches to tackle deficit bias Conclusions Questions Checklist questions Problems and questions for discussion 543 T5 Supply-side policy, institutions and unemployment Introduction Flows, matching and the Beveridge curve Unions and wage-setting arrangements Efficiency wage models A micro model of efficiency wage setting What is the empirical evidence on efficiency wages? Hysteresis and persistence in unemployment Unemployment in OECD countries Definitions: employment, unemployment and inactivity Overview Empirical studies Labour market behaviour in the crisis US unemployment during the crisis European unemployment during the crisis Conclusions Questions Checklist questions Problems and questions for discussion Real Business Cycle and New Keynesian models Introduction The real business cycle model Introduction The RBC model and business cycle facts The model and its properties Results Criticisms of the RBC model The impactof RBC modelling The New Keynesian model and stabilization policy The New Keynesian Phillips curve Stabilization bias NK DSGE modelling 606

10 XXX CONTENTS 16.4 Conclusions Questions Checklist questions Problems and questions for discussion 612 Bibliography 615 Index 629