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Macro final > guest lecture > Flashcards

guest lecture Flashcards

1
Q

Real interest rate

A

=nominal interest rate minus expected inflation rate

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2
Q

monetary tightening = restrictive policy

A

requires central
banks increasing policy rates more than increases in expectedinflation.

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3
Q
  • Central banks can only determine
A

(very) short-term interest rates

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4
Q

Economic decisions are primarily affected by….

A

long-term interest rates(think of mortgages, corporate loans)

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5
Q

Long-term rates (partly) reflect

A

expected future short-term rates

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6
Q

Delay or insufficient increase in current policy rates will imply

A

bigger increasein CURRENT and future longer-term rates (due to higher inflation
expectations) which implies a sharper negative effect on economic growth

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7
Q
  • Conventional:
A

using prices (interest rates) as the primary instrument.
Works as long as interest rates are not substantially negative

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8
Q
  • Unconventional:
A

using quantities as the primary instrument:
CB transactions of financial assets, usually government bonds
* CB asset purchases are financed by liquidity that is created our of nothing (!)
* This additional liquidity greases financial markets and (hopefully) the real economy.
* It works symmetrically: CB selling gov. bonds reduces market liquidity

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9
Q

Goal monetary policy

A

price stability: inflation rate of 2% to be achieved in the medium term. CB focuses on general price level, not relative prices andignores temporary movements in general price level.

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10
Q
  • On impact, the energy price hike is a what price change
A

relative

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11
Q

In a frictionless world there is no impact on the general price level because

A

nominal prices of other products decline, leaving price level unchanged
* 𝑃 = 𝜔𝑃e + (1 − 𝜔)𝑃0

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12
Q

However, prices are sticky

A

do not adjust immediately

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13
Q

and are rigid

A

eg due tocontracts, menu/transaction costs, economic slack)

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14
Q

So a relative price change can be a

A

source of inflation (change in general pricelevel)

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15
Q

Direct effect

A

consumers of final energy products
confronted with increasing prices of energy (eg our heating bill)

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16
Q

Indirect effect=

A

: higher energy prices feed intoproduction chain: higher costs of energy as intermediate input pass
through into consumer prices of other goods and services (eg air fare).

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17
Q
  • Alternative pass through mechanism:
A

higher inflation feeds into higherwages >
wage-price spiral

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18
Q

3 types of energy price hikes

A

temp spike
perm jump
perm rise

19
Q

temp spike

A
20
Q

perm jump

A
21
Q

perm rise

A
22
Q

Alternative transmission channel of energy hike:
Wage-price spiral

A
  • When an (energy) price increase leads to higher wage demands of
    employees leading to higher wages leading to higher wage costsfirms, and (ultimately) higher prices.
  • Higher prices induce more wage hikes, leading to higher prices etc* Corporate sector confronted with erosion of profitability, erosion of
    competitiveness leading to lower investment, lower economic
    growth, unemplosyment. Example: 1980
23
Q

STAGFLATION

A

permanently higher inflation rates and lower economic
growth:
RESULT OF WAGE PRICE SPIRAL

24
Q
  • DEMAND management:
A

Influencing AD line
* Budgetary (fiscal) policy
* Monetary policy

  • Goal=influencing the business cycle: aimed at the short/medium run* Can have (perverse) long run effects.
25
Q

ECONOMIC DIAGNOSIS OF ENERGY CRISIS

A
  • Negative aggregate supply shock
  • Impact: higher prices, lower output
  • Simple textbook solution: counter negative supply shock with positiveshift in demand
26
Q

PROBLEMS WITH NEGATIVE SUPPLY SHOCK

A
  • Lower output and higher price level
  • Expansionary budgetary policy increases gdp but also prices
  • Persistent higher inflation requires restrictive monetary policy which reducesinflation and gdp
  • Either monetary policy accepts higher price level, possibly violating its
    mandate, or reacts and budgetary policy effects will be reduced (why???)
  • CB accepting higher price levels might induce more cost increases (higherwages due to higher inflation expectations) implying further negative supplyshock (wage price spiral) and permanently higher inflation
27
Q

financial stability andprice stability

A

AS: cost of (production factor) capital. AD: wealth effect, availability of credit,
housing.
* Asset prices, credit creation and balance sheets important: are financial conditionssustainable? Balance sheet recession.

28
Q

Financial conditions make economies more

A

procyclical

29
Q

procyclical

A

more intensive
booms, but also more intensive busts.

30
Q
  • Higher inflationary pressures alongside elevated financial vulnerabilities,
    specifically high indebtedness and surging house prices
A

s= risky: output costof tighter financial conditions could be larger than in the past

31
Q

The funding of expansionary budgetary policy might create financial instability in the form of

A

Tax hikes, expenditure cutbacks, debt issuance

32
Q

Recent example UK: Financial vs Price stability

A
  • High indebtedness consumers, firms and governments makes market liquidityvery important (determines ability to refinance debt)
  • BoE (as most CBs) in tightening mode, selling government bonds and reducingliquidity in the market in order to combat inflation
  • Reduced market liquidity implies larger volatility and more impact of fire sales* UK: fiscal plans Tuss government reduced market confidence in government bonds: decrease in price and sharp increase bond yields
  • Liability driven investment strategy UK pension funds caused huge losses on theirderivative positions, eliciting large margin calls and dash for cash, leading to firesales
  • Downward spiral. Risk to FS
  • BoE forced to intervene: buying bonds, providing market liquidity
  • This contradicts its tightening mode: inflation requires less liquidity
33
Q

Role of monetary policy (in general)

A
  • CB’s mandate is to deliver low and stable inflation. This enables people todistinguish between general and relative price changes (improving allocation)
  • But also responsibility for economic growth (although in varying degrees)
34
Q

why is monetary policy on the lookout for signs of second roundeffects:

A

: higher energy prices becoming engrained in the behaviour of economic agents leading to (cost increases and) persistently higherinflation expectations.

35
Q

example of second round effects

A

indexation

36
Q

what do second round effects imply

A

unhinged inflation expectations and thiswill elicit a tightening of monetary policy

37
Q

The problem with supply shock: monetaryfiscal policy mix

A

Fiscal expansion and monetary tightening tension
* Pressure on central banks to delay tightening
* But delay might imply higher long-term rates (why?) and more output loss
* And higher long-term rates reduce the effects of fiscal expansion* Correct diagnosis in real time of type of price shock crucial but
difficult
* Incorrect diagnosis has serious macroeconomic consequences

38
Q

covid

A

Exogenous shock
* Loss of lives
* Loss of productive capacity
* Breakdown of global value chains
* Both demand and supply negatively affected (why??)
* Substantial income support by governments
* On top of secular demographic developments (ageing)
*  economies operating at capacity.

39
Q

Energy crisis (2022-?)

A
  • Political origin: reaction to Putin’s invasion of Ukraine
  • Putin uses natural resources (oil and LNG) as a political weapon.
  • This crisis came at a time we were still recuperating from earlier
    problems (see earlier slides)
  • This has a bearing on resilience and (in some countries) availablepolicy space (room to maneuvre)
  • Massive income support by government impacted public finances
  • Massive monetary support from unconventional policies led to loose financial conditions (low rates, massive liquidity, high indebtedness)
  • Economies were operating at capacity
40
Q

Policymakers should constantly assess their policy measures along three dimensions:

A

Necessity
effectiveness
side effects

41
Q

Necessity

A
  • Monetary policy tightening required by mandate because of evidence of second round effect of energy price hike on costs and inflation (see graphs)
  • Necessity expansionary budgetary policy depends on objective policy (income support, energy transition, …)
  • Expansionary budgetary policy may be required for supporting some consumers and firms (micro economic perspective)
42
Q

effectiveness

A
  • History: Restrictive monetary policy is effective in combatting inflation. Macro-economic instrument for a macro-economic
    problem. Clear mandate of CB.
  • Budgetary policy can be effective if directed towards targeted groups. Is however difficult to make operational and politically sensitive.
  • Multiple objectives of budgetary policy reduce its effectiveness:
    Supply side strengthening?
  • The tension between expansionary budgetary policy and restrictivepolicy implies reduced effectiveness of both types of policy. Need forpolicy consistency. IMF (2022).
43
Q

side effects

A

Monetary policy: can contribute to financial instability. Current financial
fragility makes it difficult to fine-tune the output effects of monetarytightening.
* Expansionary budgetary policy may shield the economy from the relativeprice change that is crucial for transitioning to a less energy intensive
economy
* Expansionary budgetary policy reduces the public funds available tocounter longer term challenges such as sustainability (greening) anddemography

Macro final (9 decks)

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