GMM Final Notes

8/17/2019 GMM Final Notes

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Matt Ting | December 2014

GMM: Final Notes

Things to Remember:

• Buying back debt decreases the demand for money

• N shock !o"s through to interest rates# "hi$e mo%ement a$ong e on$y

a&ects N• 'isca$ (o$icy shifts interest rate cur%e )mo%es entire out(ut* "hi$e monetary

(o$icy shifts a$ong cur%e )so this is "hat causes a consum(tion feedbacke&ect*

• +arbon ta, that increases the (er unit (roduction cost "i$$ decrease the -.

• /ong run adustment a$"ays occurs by -. increasing or decreasing "ages

• m(ort tari& decreases the a%ai$abi$ity of the +anadian currency for other

countries and increases the e,change rate• '$e,ib$e e,change reduces the e&ect of shocks# "hi$e ,ed e,change

increases the e&ect• Must state the efects or Y, P, U

-D 3 # 5 3# 6 7Ms 3 i7# + 3# -D 38 3 N 7

-D 3 MD 3+ 3 -D 3 3 -D 39 3 -D 3

N)M* 3 -D 36+ 3 )"ages# ra" materia$s* .R-. ;

/abor 'orce 3 /R-. <5rod 3 /R-. <

Three +ur%e Mode$:

• Mono(o$y can be regu$ated by rate o return regulation and xed-price

regulation

• .hortrun !uctuations caused by shifts in -D=.R-.> Three main causes of

!uctuations:o Deand !hoc"s occur "hen there is a desired change in

consum(tion or in%estment )e>g> househo$ds sa%e income# ne" kind ofca(ita$# a"arded ?$ym(ic games*> n%estment !uctuates more thanconsum(tion

o Monetar# !hoc"s

o !uppl# !hoc"s

• -D is determined by re$ationshi( bet"een out(ut of consumers and (rice

$e%e$o n!uenced by consuption $%&, in'estent $(&, go'ernent

expenditures $G&, taxes $)&, one# suppl# $Ms&, net exports

$N*&


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o -D shifts if there is a change in desired consum(tion=in%estment at a$$

(rice $e%e$so Do"n"ard s$o(ing because of "ea$th# interest rate# $i@uidity# foreign

demand e&ect .R-. is determined by +age rate, price o interediate inputs )e>g>

energy*# expected price le'elo 6("ard s$o(ing because of sticky (rices

/R-. is Aca(acity of the economy and is determined by laour, capital,

producti'it#o /R-. re@uires the fu$$ rate of em($oyment )natura$ rate of

unem($oyment*o 6nem($oyment is caused by frictiona$ )searching*# structura$

)rea$$ocating*# institutiona$ )minimum "age*o /R-. gro"s o%er time# "hich im(acts ho" much out(ut occurs

• Di&erence bet"een actua$ out(ut and (otentia$ out(ut is out(ut ga(C (ositi%e

out(ut ga( is economic boom# negati%e out(ut ga( is recessiono f there is an out(ut ga(# the -D and .R-. "i$$ mo%e to $ongrun

e@ui$ibrium o%er timeo hen economy is not at $ongrun e@ui$ibrium )i>e> y is not at natura$

rate of em($oyment*# +ages ust adust> f there is an out(ut ga(#"ages "i$$ fa$$

o -dustment may be s$o" because of sticky (rices# beha%ioura$ )"orkers

are resistant to (ay# hurts mora$e* = informationa$ )bargaining takestime# contract negotiations*

'isca$ 5o$icy:

• 9o%ernment can a&ect aggregate demand through increasing e,(enditures

or decreasing ta,es )em($oyment insurance# (rogressi%e income ta,# ta, on(rots*• 'isca$ mu$ti($ier increases e,(enditure of 9 more than a E1 increase

• 'isca$ (o$icy may not "ork because of:o %ro+ding out )go%ernment takes on debt# "hich increases demand

for debt# increasing interest rates and decreasing in%estment* = (eo($esubstitute (ri%ate consum(tion for go%ernment consum(tion

o .ong/0ariale .ags )$ags in sca$ (o$icy can create !uctuations*o 1icardian 23ui'alence )rms recogniFe that go%ernment debt is

future ta,es and do not s(end*o )ie-4ori5on )rms ignore shortterm*o

Politicians ha'e interests outside o econo#Monetary 5o$icy:

• Money can be either s(ent or $ent

• Money demand is dri%en by intertem(ora$ (rice of moneyC if (rice of money

is $o"er# (eo($e "ou$d to borro" money


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• +entra$ bank contro$s money su(($y through o(enmarket o(erations> f the

centra$ bank (urchases bonds# the money su(($y increases> f the bank se$$sbonds# the money su(($y decreases

• .udden une,(ected changes to the money mu$ti($ier a&ect the money su(($y

)e>g> bank run*•

n the $ongrun# (rices adustC $ongrun out(ut and unem($oyment are nota&ected# so you cannot articia$$y s(ur demand

• n!ation resu$ts from gro"ing (rices and can occur "hen economy is gro"ing

@uick$yo n!ation is a ta, on rea$ cash ba$ances# "hich destroys sa%ings and

,ed income instrumentso n!ation causes (rice uncertaintyo f monetary e,(ansion and in!ation are antici(ated# su(($iers "i$$

demand higher (rices and out(ut "i$$ be unchanged• Monetary (o$icy is ine&ecti%e in ,ed e,change because centra$ bank must

increase money as much as it initia$$y decreased it by to maintain e,change =

interest rates

(possile )rinit#: cannot ha%e ,ed e,change rate# inde(endent

monetary (o$icy# a$ong "ith free ca(ita$ !o"s 6sing a monetary union can circum%ent (eo($e "ho maintain (egs

o Di&ering countries and regions ha%e di&erent business cyc$es so

ha%ing di&erent monetary (o$icy is goodC e,change rate !e,ibi$ity cancushion demand shocks

o Bad because some countries do not need to trade anything

n sca$ (o$icy# -D )from in%estment and consum(tion* and N mo%e in

o((osite directions n monetary (o$icy# -D and N mo%e in same direction

Trade:

• 8,change of currencies is re@uired for internationa$ tradeC e,change rate is

the (rice of a currency re$ati%e to another• 8,(orts increase demand for +-D# im(orts increase su(($y of +-D

• +a(ita$ in!o" and foreign in%estment increase demand for +-D# +anadians

"anting to buy assets increases su(($y of +-D


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• Net e,(orts )N* is a com(onent of aggregate demand and is in%erse$y

re$ated to e,change rateo f enacting a tari N is u( because iports are do+n $N* 6

export 7 iport&

• m(osition of trade restrictions rare$y ha%e a (ositi%e e&ect on out(ut

•

f foreign country raises interest rate# suggests ca(ita$ out!o" to"ards them>f you ha%e a ,ed e,change rate# you "i$$ ha%e to decrease money su(($y tocorres(ond

8,change 5eg:

• f using (egged rate and demand is greater than su(($y# centra$ bank must

(ro%ide more money to increase su(($y )i>e> (rinting cash or buying foreignreser%es "ith o"n currency*

• f using (egged rate and demand is $ess than su(($y# centra$ bank must

(ro%ide more foreign currency )i>e> from reser%es*• Magnitude of shocks are mu$ti($ied by e,change (eg )banks stabi$iFe (eg by

increasing money su(($y# "hich $o"ers interest ratesG*• Rea$ e,change rate H nomina$ e,change rate I )domestic (rice $e%e$ = foreign

(rice $e%e$* is ters o tradeo -ccounts for (urchasing (o"er of money "hen e,changed and rate at

"hich domestic goods are e,changed for foreign goods• 8,change risks:

o Transactiona$=contractua$: agreed u(on future cash !o"so Trans$ationa$=accounting: foreign ba$ance sheet items can change %a$ueo 8conomic=o(erationa$: com(etiti%e ba$ance is a$tered by e,change rate

changes• 8$asticity of demand: sa$es dro( by the J amount , (rice

• Kedging strategies inc$ude )(roducing in country that you se$$ing in# buy (artsfrom country "ith currency risk# di&erentiate (roducts to a$ter (rice e$asticity*

5ros +ons 8$iminates irritants and uncertainties +om($ements trade agreements Reduces foreign e,change transactioncosts 5rices easier to com(are# enhancingcom(etition and eLciency

Need simi$ar economic structure 8,terna$ shocks "ou$d ha%e to be madethrough sca$ (o$icyC monetary note&ecti%e /oss of contro$# dominated by othercountry Need $arge reser%es to maintain#

(otentia$$y $eading to decit or in!ation

.u(($y .hocks

• n!ation is in%erse to unem($oyment according to 5hi$i(s +ur%e

• .u(($y shocks are sudden changes to aggregate su(($y from (rice changes

or $ongrun factors )$abour# (roducti%ity*• !tag8ation is (eriod of high in!ation and $o" economic gro"th


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• .tabi$iFation (o$icy must occur if there is a ga( bet"een .R-. = -D

intersection and /R-.C stabi$iFation does not need to occur if there is a nonrecessionary fa$$ in out(ut

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GMM Final Notes