Macroeconomics II A dynamic approach to short run economic fluctuations. The DAD/DAS model.

Transcription

1 Macroeconomics II A dynamic approach o shor run economic flucuaions. The DAD/DAS model. Par 2. The demand side of he model he dynamic aggregae demand (DAD)

2 Inflaion and dynamics in he shor run So far, o analyze he shor run we have used he IS-LM model (shows jus he demand side) and Saic AS/AD model Boh heories are silen abou Inflaion, and Dynamics Las week, we sared o develop a dynamic aggregae demand and dynamic aggregae supply (DAD-DAS) The DAD-DAS model presens a dynamic shor-run heory of oupu, inflaion, and ineres raes.

3 Inroducion The dynamic model of aggregae demand and aggregae supply (DAD-DAS) deermines boh real GDP (), and he inflaion rae (π) This heory is dynamic in he sense ha he oucome in one period affecs he oucome in he nex period

4 Inroducion Insead of represening moneary policy by an exogenous money supply, he cenral bank will now be seen as following a moneary policy rule The cenral bank s moneary policy rule adjuss ineres raes auomaically when oupu or inflaion are no where hey should be.

5 Inroducion The DAD-DAS model is buil on he following conceps: The Phillips Curve Adapive expecaions Which ogeher buil he supply side of he model - - we have done ha las week The IS curve (a negaive relaionship beween he real ineres rae and aggregae demand) The Fisher effec The moneary policy rule of he cenral bank Which ogeher buil he demand side of he model (our job for oday)

6 Keeping rack of ime The subscrip denoes a ime period, e.g. = real GDP in period 1 = real GDP in period = real GDP in period + 1 We can hink of ime periods as years. E.g., if = 2008, hen = 2008 = real GDP in = 2007 = real GDP in = 2009 = real GDP in 2009

7 The model s elemens The DAD/DAS model has five equaions and five endogenous variables: oupu, inflaion, he real ineres rae, he nominal ineres rae, and expeced inflaion. We already know he supply side equaion he Phillips curve

8 Inflaion: The Phillips Curve Recall he Phillips Curve: E ( u u ) 1 N Use he Okun s Law o ge he relaionship beween inflaion and oupu : E ( ) 1

9 Inflaion: The Phillips Curve E ( ) 1 curren inflaion previously expeced inflaion 0 indicaes how much inflaion responds when oupu flucuaes around is naural level supply shock, random and zero on average

10 Expeced Inflaion: Adapive Expecaions E 1 Assumpion: people expec prices o coninue rising a he curren inflaion rae. Examples: E 2000 π 2001 = π 2000 ; E 2013 π 2014 = π 2013 ; ec.

11 Phillips Curve E 1 A any paricular ime, inflaion would be high if people in he pas were expecing i o be high curren demand is high (relaive o naural GDP) here is a high inflaion shock. Tha is, if prices are rising rapidly for some exogenous reason such as scarciy of impored oil or drough-caused scarciy of food

12 Dynamic Aggregae Supply E E 1 1 Phillips Curve Adapive Expecaions 1 DAS Curve 1 1 E

13 The Dynamic Aggregae Supply Curve 1 1 π DAS DAS slopes upward: high levels of oupu are associaed wih high inflaion. This is because of demand-pull inflaion

14 The Dynamic Aggregae Supply Curve π 1 0 Assume 2 1 DAS =3 DAS =2 A change in previous period s inflaion shifs he DAS curve

15 The Dynamic Aggregae Supply Curve 1 π Assume ha 0 DAS =2 DAS =3 1 2 An change of he naural level of oupu will shif he DAS curve 2 3

16 The Dynamic Aggregae Supply Curve 1 0 π Assume ha DAS =3 2 1and DAS =2 A supply shock will shif he DAS curve

17 The DAS Curve: Summary The DAS curve is upward sloping When he economy is a full employmen, he heigh of he DAS curve equals inheried inflaion plus he curren supply shock When eiher he previous period s inflaion or he curren period s inflaion shock increases (decreases), he DAS curve shifs up (down) by he same amoun When naural GDP increases (decreases), he DAS curve shifs righ (lef) by he same amoun

18 DAD-DAS: 5 Equaions The supply side - DONE 1. Phillips Curve 2. Adapive Expecaions The Demand Side 3. The Demand Equaion 4. Fisher Equaion 5. Moneary Policy Rule

19 IS Curve = Demand Equaion ( r ) r r ε IS The IS curve can simply be renamed he Demand Equaion curve

20 The Demand Equaion Naural (or long-run or poenial) Real GDP Real ineres rae Naural (or long-run) Real ineres rae ( r ) Real GDP Parameer represening he response of demand o he real ineres raes Demand shock, represens changes in G, T, C 0, and I 0

21 The Demand Equaion Assumpion: ρ > 0; alhough he real ineres rae can be negaive, in he long run people will no lend heir resources o ohers wihou a posiive reurn. ( r ) α > 0 Assumpion: There is a negaive relaion beween oupu ( ) and ineres rae (r ). The jusificaion is he same as for he IS curve Posiive when C 0, I 0, or G is higher han usual or T is lower han usual.

22 DAD-DAS: 5 Equaions Phillips Curve Adapive Expecaions Demand Equaion Fisher Equaion Moneary Policy Rule

23 The Real Ineres Rae: The Fisher Equaion ex ane (i.e. expeced) real ineres rae r i E 1 nominal ineres rae expeced inflaion rae The real ineres rae is he inflaion-adjused ineres rae. To adjus he nominal ineres rae for inflaion, one mus simply subrac he expeced inflaion rae during he duraion of he loan (he rue fuure inflaion is no known )

24 The Real Ineres Rae: The Fisher Equaion Using adapive expecaions: E 1 We ge he following relaionship: r i

25 DAD-DAS: 5 Equaions Phillips Curve Adapive Expecaions Demand Equaion Fisher Equaion Moneary Policy Rule

26 Moneary Policy Rule The fifh and final main assumpion of he DAD-DAS heory is ha The cenral bank ses he nominal ineres rae and, in seing he nominal ineres rae, he cenral bank is guided by a very specific formula called he moneary policy rule

27 The Nominal Ineres Rae: The Moneary-Policy Rule Curren inflaion rae Parameer ha measures how srongly he cenral bank responds o he inflaion gap i * Nominal ineres rae, se each period by he cenral bank Naural real ineres rae Inflaion Gap: The excess of curren inflaion over he cenral bank s inflaion arge

28 The Nominal Ineres Rae: The Moneary-Policy Rule The Cenral Bank has a desired (arge) inflaion rae I adjuss he ineres rae in such a way, as o reach his arge When curren inflaion is equal o he arge inflaion, nominal ineres rae is equal o: i *

29 The Dynamic Aggregae Demand Curve Sar wih he Demand Equaion: ( r ) r i ( i ) Fisher equaion wih adapive expecaions i moneary policy rule * ( *)

30 The Dynamic Aggregae Demand Curve ( *) A( *)

31 The Dynamic Aggregae Demand Curve π A( *) DAD slopes downward: When inflaion rises, he cenral bank raises he real ineres rae, reducing he demand for goods and services. DAD Noe ha he DAD equaion has no dynamics in i: i only shows how simulaneously measured variables are relaed o each oher

32 The Dynamic Aggregae Demand Curve * 2 * 1 π Assume: ε=0 A( *) When he cenral bank s arge inflaion rae increases (decreases) he DAD curve moves up (down) by he exac same amoun. DAD =2 DAD =1 Noe how moneary policy is described in erms of he arge inflaion rae in he DAD-DAS model

33 The Dynamic Aggregae Demand Curve * π A( *) DAD =2 When he naural rae of oupu increases (decreases) he DAD curve moves righ (lef) by he exac same amoun. When here is a posiive (negaive) demand shock he DAD curve moves righ (lef). DAD =1 1 2 A posiive demand shock could be an increase in C 0, I 0, or G, or a decrease in T.

34 The Dynamic Aggregae Demand Curve π A( *) * When here is a posiive (negaive) demand shock he DAD curve moves righ (lef). DAD =2 DAD = A posiive demand shock could be an increase in C 0, I 0, or G, or a decrease in T.

35 The Dynamic Aggregae Demand Curve π A( *) DAD 2 DAD 1 The DAD curve shifs righ (or up) if: 1. he cenral bank s arge inflaion rae goes up, 2. here is a posiive demand shock, or 3. he naural rae of oupu increases.

36 The DAD Curve: Summary The DAD curve is downward sloping When he cenral bank s arge inflaion rae increases (decreases), he DAD curve shifs up (down) by he same amoun When naural GDP increases (decreases), he DAD curve shifs righ (lef) by he same amoun When he demand shock increases (decreases), he DAD curve shifs righ (lef)

37 DAS and DAD Equaions DAS 1 DAD A( *) Noe ha here are wo endogenous variables and π in hese wo equaions Therefore, we can solve for he equilibrium values of and π

38 Soluion A A A A A A A A A A ) (1 *) ( ) (1 *) ( ) (1 * *) (

39 The model s variables and parameers Endogenous variables: E 1 r i Oupu Inflaion Real ineres rae Nominal ineres rae Expeced inflaion

40 The model s variables and parameers Exogenous variables: * Naural level of oupu Predeermined variable: Cenral bank s arge inflaion rae Demand shock Supply shock 1 Previous period s inflaion

41 The model s variables and parameers Parameers: Responsiveness of demand o he real ineres rae Naural rae of ineres Responsiveness of inflaion o oupu in he Phillips Curve Responsiveness of i o inflaion in he moneary-policy rule

42 Long-Run Equilibrium π DAS π* A DAD

43 The DAD-DAS model s long-run equilibrium The long-run equilibrium values in he DAD-DAS heory: r * * 1 E i * In he shor-run, he values of he various variables flucuae around he long-run equilibrium values.