Macro - Week 2 Flashcards
RBC model, economic fluctuations. Price/wage rigidities, output-inflation trade-off, Phillips curve, monopolistic competition
1
Q
Business cycle characteristics
A
- vary in length
- occur infrequently
- occur vary in severity
2
Q
From RCK to RBC model
A
Uncertainty
- Introduce fluctuations via technology
At+1 = ρAAt + εA,t
- and government spending
Gt+1 = ρGGt + εG,t
Labor supply
- Consumers also choose labour supply and maximise expected utility
3
Q
Consumer: intratemporal trade-off - consumption vs. leisure
A
- The total time endowment (standardised to 1) can be used for work or leisure (Equation 1)
- Working more gives you a wage, w, which increases utility w/C
- I But working more costs you leisure which you value at b/(1 − Lt)
- I Optimisation requires that marginal gains equal marginal losses (Equation 2)
- Rewriting gives the equation above
4
Q
Consumer: intertemporal trade-off
A
8
Q
Possible solution to RCB: Nominal rigidities
A
- Constructing the canonical IS-LM model from first principles
- Assumptions: Economy
- Labour is only production factor, Y = F(L), F′(L) > 0, F′′ (L) < 0
- All production is consumed (no government/investments): C = Y
- Two assets: money (no interest) and risk free bonds (interest i): At+1 = Mt + (1 + it)(At + WtLt − PtCt − Mt)
- Assumptions: Households: see attachment
9
Q
The new Keynesian IS curve
A
10
Q
The new LM curve
A
11
Q
IS-LM 2.0
A
- Downward sloping IS curve (lower interest rate stimulates current consumption, thus requires higher production)
- Upward sloping LM curve (higher interest rate lower money demand. To maintain equilibrium production must increase)
12
Q
Expansionary monetary policy (IS-LM model)
A
- Question: Will firms supply the additional output (that is the result of expansionary monetary policy, see attachment) at the fixed price?
- If market for labour is perfectly competitive, than wages must go up to hire additional labour (otherwise households do not supply this labour)
- But if goods market is perfectly competitive, firms’ prices equal marginal costs. Hiring more labour lowers labour productivity, so firms are only willing to hire more labour if wages go down.
- Conclusion: In the standard setting, a monetary stimulus results in rationing on the goods market, not extra production! …Unless there are additional distortions.
13
Q
Possible solutions for RBC
A
- Log-linearise and find an analytical solution to this linearised model (well-documented in the book, try it yourself, tedious but straightforward)
- Numerically solve using a computer (nowadays easy with software like Dynare)
14
Q
Calibration vs estimation
A
- Estimation
- Search for parameter values that result in a model that fits the data best (according to some criteria in some dimension). Tricky because definition of a ‘best match’ drives all results.
- Calibration
- Pick the values of the parameters based on other (often microeconomic) evidence and compare model-generated variances and covariances to the data.
- Researchers often combine both methods and estimate the parameters we cannot measure directly.
15
Q
Problems with RCB model
A
- Monetary neutrality: Monetary policy (and money) has no real effects according to the RBC model. This is contradicted by most research, especially on business cycle frequencies.
- Technology shocks: Technology shocks must occur very often to explain observed fluctuations in output and have to be big and persistent.
- Labour market effects: The model predicts that employment and labour productivity move closely together. In reality, these are essentially uncorrelated.
- Model Assumptions: The standard RBC model assumes instantaneous market clearing. The 2008 crisis shows us that not even financial markets clear immediately. Moreover, many prices appear to be ‘sticky’ and unemployment is not a choice!
16
Q
Case 2: Sticky Prices, Flexible Wages, and a Competitive Labour Market
A
- Mechanism: Higher demand for products increases labour demand. Wages must increase to lure people to supply more labour. Markups (price minus marginal costs) go down and are countercyclical (as in the data).
- Unemployment: There is no unemployment (not working is voluntary). Labour input does decrease during a recession.
- Real Wage: During a boom, labour demand increases, so nominal (and real!) wages increase until households supply enough labour to produce new product demand. If labour supply is relatively unresponsive to the real wage, then real wages are very procyclical (not moderately).
18
Q
Case 3: Sticky Prices, Flexible Wages, and Real Labour Market Imperfections
A
- Unemployment: The non-market clearing wage generates unemployment. Labour input increases during a boom. Effect on unemployment depends on slope of labour supply (typically steep) and real wage function.
- Real Wage: During a boom, labour demand increases. This increases the real wage according to the real wage function (by assumption). Real wages are procyclical. Size of the effect depends on the steepness of the real wage function.
19
Q
Case 4: Sticky Wages, Flexible Prices, and Imperfect Competition
A
- Unemployment: The non-market clearing wage assumes unemployment. Labour input increases during a boom.
- Real Wage: Effect of demand shocks on the real wage depend on the markup function.
- If markup is procyclical, the real wage is countercyclical.
- If markup is moderately countercyclical, real wage is sticky/constant.
- If markup is sufficiently countercyclical, then this markup dominates diminishing marginal product of labour and real wage is also procyclical (but what about cyclicality of prices??)
21
Q
Phillips Curve
A
22
Q
Expectations-augmented Phillips Curve
A
why mismatch between theory (relationship bw unemployment and inflation) and reality?
24
Q
imperfect competition - households
A
25
Q
imperfect competition - firms
A
