Macro Flashcards
IS Equation
Ye?
AEPC Equation
Ye
REPC Equation
Ya
NKPC Equation (two types)
Squ
Static MR Equation
Blo
Dynamic MR Equation
Min
What shifts WS
Changes in bargaining power
Aspirations of unions
Labour supply shifts
Why does the WS slope up and the PS down
cant remember
5 Limits to rational expectations
- How can agents (i.e normal people) be using a model for their expectations when economists cant even agree on the model
- Large firms can predict future info to inform decision making, but most agents lack information or cognitive ability to form RE.
- non-RE agents exert more than proportionate e.ect on outcomes, e.g. if 50% rational, 50% adaptive, exp inf is not simple average of inflation at t1 and πT since RE agents know πT will not be achieve, given influence of adaptive agents and so adjust exps upwards, raising aggregate exp inf
- RE equilibrium founded on beliefs about actions to be taken by others, just like Nash equilibrium in game theory. if mon pol lacks credibility, or agents uncertain whether other agents rational, then exps will not converge on πT
- Even if all agents fully rational, sticky prices and wages can prevent immediate return to point A
Why is there inflation bias
- Policy seeking efficient employment in presence of distortions from imperfect competition. Equilibrium output is determined by WS = PS, but higher output would max welfare.
- Political cycle: raising GDP to display economic competence and win votes
How to fix inflation bias (4 methods)
ind. central bank
Rogoff (1986)
Walsh (1995) - Contracts and incentives (pigovian tax on inflation).
Svensson
Why isn’t WS = PS socially optimal
MPL exceeds opportunity cost of labour. Socially optimal point would have higher output.
Rogoff
1986
Delegation to conservative central banker. I.e. Beta in MC is higher. This means a flatter MR and smaller inflation bias.
Does not eliminate bias (needs beta to be infinite for that).
Walsh
1995
Incentive scheme. CB is penalised for each unit increase of inflation above target.
Penalty either in CB dismissal or CB resources, if penalty is high enough then the disincentive of higher inflation cancels out incentive to raise output
This leads to a return to original bliss point.
Essentially a pigovian tax on inflation
Svensson ZLB
2003
The Foolproof Way
Three measures
1. Explicit CB committment to higher inflation: An upward-sloping price-level target path, starting above the current price level by a price gap
- Concrete, credible commitment: A depreciation and a crawling peg of the currency. Done by CB selling domestic currency (easy to defend a depreciation), establishing credibility for the peg.
- An exit strategy in the form of the abandonment of the peg in favor of inflation or price-level targeting when the price-level target path has been reached.
Svensson Inflation Bias
1995
Set an inflation target below πT and when bias manifests it then raises actual inflation relative to this reduced target, returning it to πT
Alesina and Summers
1993
Looked at CBs between 1950-1980. Greater central bank independence is associated with lower inflation.
Interesting to see if this still holds in new monetary policy paradigm.
How do inflation targets lead to secular demand deficits?
if debt contracts written on 2% inflation assumption but average inflation < 2% then real income transferred from borrowers to savers
Savers tend to have a lower consumption propensity and so the overall level of demand drops
Conclusions of Solow Model
- Investment in capital cannot drive long run growth in GDP per worker
- Need technological change (growth in A) to avoid diminishing returns to capital. (What does this look like in a graph). However, since technology is exogenous in Solow, need endogenous models to explain WHY technology is growing.
- Policy lesson: don’t advise poor countries to invest without due regard for technology and incentives
Solutions to Solow
- Labour growth? Nope. Why?
- Increased savings? Nope. Why?
- Technology growth! Yes! But Solow can’t explain it.
Arrow
1962
Doing more production = firms get better at production = need less inputs (factors) to produce the same output
Motivated by observation that man-hours required to produce units (e.g. US Liberty ships in WWII) declines
significantly as more units are produced
LINK TO STRATEGY
Fernald & Jones
(2014)
20% of recent US growth can be explained by a consistent increase in the number of years in education
Attribute 58% of recent US growth to rising numbers of researchers
Starting point for Arrow
1962
A = K^Beta
Starting point for Lucas
1988
L is now uhL, where u is hours working and h is human capital.
Accumulation of human capital over time (Ldot) = (1-u)h
Starting point for Romer
1968
L is now ALy, where Ly is number of workers in production.
Adot = Lr*A
Starting point for Jones
1995
Same as Romer, but Adot = Lr*A^mu
Intertemporal budget constraint
?
Core assumption for permenant income
(1+r)β=1
Government Debt Sustainability
d + ( r - g )*b
Consumer (Taxed) Budget Constraint
adfasdf
Governemnt 2 Period Budget constraint
ewer
Assumptions for Ricardian Equivalence to Hold
1) Lump-sum non-distortionary taxes
2) Consumers and government have same planning horizon
3) Consumers and government face same r→ no credit constraints
4) No uncertainty → no precautionary savings
5) Rational expectations
6) Homogeneous households
Effect of relaxing assumptions in Ricardian Equivalence
- What are the assumptions?
2. Effect of relaxing them?
DeLong and Summers (2012)
If hysteresis is occurs, fiscal stimulus can future supply potential. This increases future tax income and reduces the NPV of government borrowing. Fiscal stimulus can be self financing.
However, it depends on HYSTERISIS, FISCAL MULTIPLIER, and LR TAX RATE all being high enough
Eggertsson and Krugman (2012)
►Shock hits debt-constrained borrowers who have to cut leverage
►ZLB may well bite because large r drop needed to induce other demand to take the slack
►Price drop would worsen things
►Very ‘Keynesian’ implications – multiplier, liquidity trap, effectiveness of fiscal policy
►Underlying point: the indebted face different constraints from others, so Ricardian equivalence breaks down
Real interest rate
Nominal interest rate less EXPECTED inflation
What shifts PS curve
Degree of monopoly power exercised by firms
Alternatively, what is left over from MPL after other claims are accounted for
Population growth under the Solow model
- What happens in theory?
- What happens in the real world?
- Solow model predicts higher population means lower output per head.
- From 1960-2011, low evidence for this.
Conditional convergence in the real world
Mankiw et al. 1992: Test convergence fro 98 countries in 1985. Conditional convergence exists, but is slower than the model predicts.
They then extend the Solow model with human capital and find strong evidence for conditional convergence, and convergence rate approximates the model rate.
Absolute convergence in the real world
Very little evidence in the real world. There are isolated cases of this (South Korea) but for the most part, this is not the case.
Technology catch up equation
fasdf
Conditional convergence
- What is it?
- What does the diagram look like?
This is a plot of gk against k. For conditonal convergence, production functions are sA * f(k)/k. I.e. each country has different
Unconditional convergence
- What is it?
2. What does the diagram look like?
Starting point for Solow
?
Derive Solow steady state k*
Do it
Derive Solow steady state y*
do it
3 Open Economy assumptions
3 of them
Small
Exchange rate regime
Equal inflation targets
Condition for Solow Steady State
kdot = 0
Assumptions for Dornbusch overshooting
1976
- UIP
- Short run rigidity of price and wage levels
- Rational expecations of inflation and exchange rates
- Expectations adjust quickly but prices adjust in medium run
PS equation in open economy
wPS = lambda (1 - markup) / (1 + phi(Q-1))
Derive Consumption Euler
Max two period utility subject to budget constraint
Mankiw et al.
1992
Study of 1985.
