Economics 302 (Sec. 001) Intermediate Macroeconomic Theory and Policy (Spring 2012) 3/26/2012. UW Madison
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1 Economcs 302 (Sec. 001) Intermedate Macroeconomc Theory and Polcy (Sprng 2012) 3/26/2012 Instructor: Prof. Menze Chnn Instructor: Prof. Menze Chnn UW Madson
2 Bond Prces and Bond Yelds The relaton between maturty and yeld s called the yeld curve, or the term structure of nterest rates. Fgure 15 1 U.S.Yeld Curves: November 1, 2000, and June 1, 2001 The yeld curve, whch was slghtly downward slopng n November 2000, was sharply upward slopng seven months later. 2of 35
3 15 1 Bond Prces and Bond Yelds The Yeld Curve and Economc Actvty Fgure 15 3 The U.S. Economy as of November 2000 In November 2000, the U.S. economy was operatng above the natural level of output. Forecasts were for a soft landng, a return of output to the natural level l of output, t and a small decrease n nterest rates. 3of 35
4 15 1 Bond Prces and Bond Yelds The Yeld Curve and Economc Actvty Fgure 15 4 The U.S. Economy from November 2000 to June 2001 From November 2000 to June 2001, an adverse shft n spendng, together wth a monetary expanson, combned to lead to a decrease n the short-term nterest rate. 4of 35
5 15 1 Bond Prces and Bond Yelds The Yeld Curve and Economc Actvty From ths fgure, you can see the two major developments: The adverse shft n spendng was stronger than had been expected. Instead of shftng from IS to IS as forecast, the IS curve shfted by much more, to IS. Realzng that the slowdown was stronger than t had antcpated, the Fed shfted n early 2001 to a polcy of monetary expanson, leadng to a downward shft n the LM curve. 5of 35
6 15 1 Bond Prces and Bond Yelds The Yeld Curve and Economc Actvty Fgure 15 5 The Expected Path of the U.S. Economy as of June 2001 In June 2001, fnancal markets expected stronger spendng and tghter monetary polcy to lead to hgher short-term nterest rates n the future. 6of 35
7 15 1 Bond Prces and Bond Yelds The Yeld Curve and Economc Actvty Fnancal markets expected two man developments: They expected a pckup n spendng a shft of the IS curve to the rght, from IS to IS. They also expected that, once the IS curve started shftng to the rght and output started to recover, the Fed would start shftng back to a tghter monetary polcy. 7of 35
8 The Yeld Curve and Recessons yr - 3 mo spread 2 3/ yr -2yr spread
9 The Yeld Curve Now (3/21/2012) center/data chart center/nterest rates/pages/hstorc Yeld Data Vsualzaton.aspx
10 15 2 The Stock Market and Movements Fgure 15 6 Modfed Standard & Poor s Composte Index, n Real Terms, snce 1970 n Stock Prces Note the sharp ncrease n stock prces n the 1990s, followed by the sharp decrease n the early 2000s. 10 of 35
11 15 2 Movements n Stock Prces The Stock Market and Economc Actvty A Monetary Expanson and the Stock Market Fgure 15 7 An Expansonary Monetary Polcy and the Stock Market A monetary expanson decreases the nterest rate and ncreases output. What t does to the stock market depends on whether fnancal markets antcpated the monetary expanson. 11 of 35
12 15 2 Movements n Stock Prces The Stock kmarket and Economc Actvty An Increase n Consumer Spendng and the Stock Market Fgure 15 8a An Increase n Consumpton Spendng and the Stock Market The ncrease n consumpton spendng leads to a hgher nterest rate and a hgher level of output. What happens to the stock market depends on the slope of the LM curve and on the Fed s behavor. 12 of 35
13 15 2 Movements n Stock Prces The Stock kmarket and Economc Actvty An Increase n Consumer Spendng and the Stock Market Fgure 15 8b An Increase n Consumpton Spendng and the Stock Market If the LM curve s steep, the nterest rate ncreases a lot, and output ncreases lttle. Stock prces go down. If the LM curve s flat, the nterest rate ncreases lttle, and output ncreases a lot. Stock prces go up. 13 of 35
14 15 2 Movements n Stock Prces The Stock kmarket and Economc Actvty An Increase n Consumer Spendng and the Stock Market Fgure 15 8c An Increase n Consumpton Spendng and the Stock Market If the Fed accommodates, the nterest rate does not ncrease, but output does. Stock prces go up. If the Fed decdes nstead to keep output constant, the nterest rate ncreases, but output does not. Stock prces go down. 14 of 35
15 Movements n House Prces 240 Case-Shller 10 cty house 200 prce ndex Nomnal 160 Real
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