Chapter 10: Classical ISLM Flashcards
Define RBC models
Real business cycles
Define Rational Expectations
you do the best with what you got, using all information available
How can non-neutrality be preserved?
By misperceptions. Therefore, only unanticipated policy changes matter.
What is the RBC theory?
Real shocks are the primary causes of business cycles
Nominal shocks are shocks to the money supply and demand
Examples of shocks: new products, techniques, changes in availability of raw materials, weather, regulations etc.
How does non-neutrality in the ISLM model exist in the SR?
Use fiscal policy as an example.
Fiscal policy in the form of govt purchases causes the IS Curve to shift to the right (reduction in national savings). The FE line also shifts to the right to reflect an increase in labor supply caused by an expectation amongst workers of an impending increase in taxes (income effect). Real wages adjust smoothly and decrease as a result of the increase in labor supply (Classical approach). The LM Curve shifts to the left since the price level rises as a result of output exceeding its full employment level.
The resultant equilibrium is a higher real interest and higher output. Non neutrality.
Should fiscal policy be used to dampen the business cycle?
Problems with using fiscal policy:
Lags - recognition and implementation lags.
Changes in spending must be offset by changes in taxes eventually.
Does unemployment exist in the classical model?
No unemployment technically exits in the classical model as FE is always attained. The only unemployment that exists is frictional and structural unemployment caused by matching and changing skills.
Example: job destruction and job creation within an industry, which temporarily creates a mismatch of skills.
If money is neutral, why does the data show that money is a leading, procyclical variable?
Higher money growth does not necessarily correspond to an increase in output. Instead, it is the forward thinking Fed that increases the money supply to maintain stable prices, and therefore it is the expectation of higher output that drives money supply growth.
If money is non-neutral in the SR, then how should the SRAS curve be drawn?
Upward slowly curve due to misperceptions theory, which states that sometimes, producers and consumers may fail to differentiate between changes in relative prices, and changes in the general price level. When expectations change, the SRAS curve shifts along the LRAS vertical line.
Implications of the misperception theory on the non-neutrality of money in the SR on Fed desires to affect output?
The only way the Fed can affect output is through unanticipated monetary policy, and that only random outbursts will change output.
