ECONOMICS II MACROECONOMICS

ECONOMICS IIMACROECONOMICS

BMEGT30A101BMEGT30A103

Monday: 8.15–9.45 (QA240)

Zsombor LIGETIassociate professor

Department of Economics

[email protected]

Consulting hours: Monday 10–11, QA215

2019. 04. 29. Zsombor LIGETI - Economics II 1

ECONOMIC FLUCTUATIONSCH 10–11–12

CONTENTS1. INTRODUCTION

2. SHORT-RUN vs LONG-RUN MACROECONOMICS IN A CLOSED ECONOMY

3. MODELS OF AGGREGATE DEMAND (AD) AND SUPPLY (AS)

4. SHOCKS AND STABILIZATION POLICIES – IN THE IS-LM MODEL

5. CONCLUSION


1. INTRUDUCTION



STATIC MODEL

• Assumptions —Milton Friedman’s theory of prediction: „as if”

• Efficient Market Hypothesis, EMH

INPUTS

EXOGENOUSVARIABLES

OUTPUTS

ENDOGENOUSVARIABLES

1i + 2Y = 6 (G)3i – 1Y = 4 (M)

MODEL


COMPARATIVE STATICS

• Linearization

• Multiplier – partial analysis: Δ𝑦𝑗

Δ𝑥𝑘=

𝑑𝑦𝑗

𝑑𝑥𝑘;𝑑𝑌

𝑑𝐺=?

𝑑𝑌

𝑑𝑀=?

INPUTS

EXOGENOUSVARIABLES

OUTPUTS

ENDOGENOUSVARIABLES

MODEL

1 2 6

3 1 4

i G

Y M

A y x


COMPARATIVE STATICS

• Linearization

• Multiplier – partial analysis: Δ𝑦𝑗

Δ𝑥𝑘=

𝑑𝑦𝑗

𝑑𝑥𝑘;𝑑𝑌

𝑑𝐺=?

𝑑𝑌

𝑑𝑀=?

INPUTS

EXOGENOUSVARIABLES

OUTPUTS

ENDOGENOUSVARIABLES

MODEL

1 23 −1

𝑖𝑌

=64=

𝐺𝑀

𝐴 ∙𝑦 = 𝑥

2. SHORT-RUN vs LONG-RUNMACROECONOMICS IN A CLOSED

ECONOMY


Schools of economic thoughts• Inability of firms to coordinate price changes plays a key role in

explaining price stickiness (Mankiw 2015, 292)


INPUTS

EXOGENOUSVARIABLESΔG, ΔM

ENDOGENOUSVARIABLES

Y, i, P=ഥ𝑷, L

ENDOGENOUSVARIABLES

Y=ഥ𝒀, i, P, L

Short run, sticky pricesBusiness cyclesSRAS=AD IS-LM

Long run, flexible pricesClassical dichotomyMonetary neutralityLRAS = AD=Y=MV/P

What are economic fluctuations, business cycles?

• Recession: falling output (Y=GDP) and rising unemployment (u) – At least two consecutive quarters of declining real GDP

– Okun’s Law: ΔY/Y = 3% – 2(ut – ut-1)

• Short-run fluctuations are regular but not predictable – Business cycle peak

– Business cycle trough

• What causes business cycles?

• Can policymakers avoid recession?


Business Cycle

Contraction = Slowdown + (Recession /Depression)

Growth cycle?


Economic fluctuations


Comparative dynamicsUSA (y=GDP/CAP) trend


y = 5E-10e0,016·t

R² = 0,9785

y = 1E-13e0,0202·t

R² = 0,9865

0

10000

20000

30000

40000

50000

60000

1800 1820 1840 1860 1880 1900 1920 1940 1960 1980 2000 2020

Ln(y) = 0,016·t - 21,46R² = 0,9785

Ln(y) = 0,0202·t - 29,725R² = 0,9865

7

7,5

8

8,5

9

9,5

10

10,5

11

1800 1820 1840 1860 1880 1900 1920 1940 1960 1980 2000 2020

3. MODELS OF AGGREGATE DEMAND (AD) AND SUPPLY (AS)


1. Quantity theory(Long run)

• MV =PY AD(P) = Y(P)= MV/P

• LRAS: ത𝑌 = 𝐹 ഥ𝐾, ത𝐿 – full employment or natural level of output


2. IS-LM model(Short run)

(Kenyes (1936): The General Theory of Employment, Interest, and Money. – formalized by Hicks (1937))

• Keynes: the problem is inadequate spending –underutilized resources

• IS curve (Investment = Saving) Keynesian cross– The slope of IS

– Shifts of the IS

• LM curve (Liquidity = Money) real money balances (E 𝜋 ≗ 𝜋𝑒=0) i=r

– The slope of LM

– Shits of the LM


Elements of IS curve 1Consumption (C, G)

𝐶 𝑌𝐷𝐼 = 𝐶0 + Ƹ𝑐 𝑌 − 𝑇 + 𝑇𝑅

• 𝑀𝑃𝐶 ≐ Ƹ𝑐 =𝑑𝐶 𝑌𝐷𝐼

𝑑𝑌𝐷𝐼marginal propensity to consume

• C0 = autonomous consumption

• T = tax; TR = transfer

• YDI = disposable income

• G = government-purchases


Elements of IS curve 2Investment (I)

• I(r, η)= I0–ar, (a>0), r = real interest rate = i–πe

(E 𝜋 = 𝜋𝑒=0) i=r

• η: profit optimism (η>0) and pessimism (η<0)


Market equilibrium– Keynesian cross –

F(K,L) = Y = E = C0 + (Y – T + TR) + I0 – a·i + G


c

0 0 0 0

1ˆ ˆ

ˆ1Y C I G cT cTR ai

c

SUPPLYDEMAND

IS curve

• IS (Investment=Saving): Each point on the IS curve represents equilibrium in the goods market

• The slope of IS:


ˆ10

di c

dY a

LM curve

• LM (Liquidity=Money): Each point on the LM curve represents equilibrium in the money market real money balances

•𝑀𝑆

𝑃= 𝑀𝐷 𝑌, 𝑖, 𝜋𝑒 = 𝐿 𝑌, 𝑖, 𝜋𝑒 = 𝑚𝑌 − 𝑘𝑖

• The slope of LM:

• Theory of Liquidity Preference– Transaction– Safety– Speculation

• Monetary transmission mechanism– Monetary transmission mechanism: how a monetary expansion induces

greater spending on goods and services (Mankiw 2015, 341)


0di m

dY k

The multipliers

• INVESTMENT, CONSUMPTION

• FISCAL

– Government-purchases multiplier

– Tax multiplier

• MONETARY

– Money multiplier


Simple (goods-market’s) multipliers(interest rate is constant)

• Government-purchases:

• Consumption:

• Tax/Transfer:

• Investment:


0

10

ˆ1

dY

dG c

0

ˆ0

ˆ1

dY c

dT c

0

10

ˆ1

dY

dI c

0

10

ˆ1

dY

dC c

0

ˆ0

ˆ1

dY c

dTR c

Special cases

• Liquidity trap – LM horizontal

• Investment trap – IS vertical


IS-LM and AD=Y(P)


• AD(P)=Y(P) IS-LM system’s equilibrium

• IS:

• LM:

0 0 0 0

1ˆ ˆ

ˆ1Y C I G cT cTR ai

c

1 Sm Mi Y

k k P

4. SHOCKS AND STABILIZATION POLICIES – IN THE IS-LM MODEL


• Stabilization policy refer to policy actions aimed at reducing the severity of short-run economic fluctuations, keeping output end employment as close to their natural levels as possible

• Government is acting as the demander of last resort


The potential effects of falling prices

• Keynesian Effect: P↓M/P↑ Y ↑

• Pigou effect: P↓ C(YDI, A/P)↑ Y ↑

• Debt-deflation theory: unexpected P↓Y↓

– Redistribute wealth

– Debtors have higher propensities to spend than creditors: MPCDeptors > MPCCreditors

• Expected deflation: P ↓= πe<0 I(i –πe) Y↓


5. CONCLUSION

• IS-LM AD are the main functions of economic policies

• Short-run (if P is sticky) AD determines Y


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ECONOMICS II MACROECONOMICS