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Macroeconomics Flashcards

1
Q

Overshooting assumptions

A

UIP holds at all times, sticky prices in short run but PPP in long-run, perfect capital markets, rational expectations
- i.e. in short-run wages and prices fixed. In medium run prices can adjust to DandS

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2
Q

UIP assumptions

A

Perfect capital mobility (no arbitrage costs)
Households hold 2 assets: bonds and money
Perfect substitutability between bonds - same default risk
Small country
Same constant inflation target - for real not nominal to hold
RE*
Profit maximisation by risk neutral investors*
no arbitrage costs*

  • Rogoff (2002): in practice have rigid domestic practice so doesn’t hold in practice)
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3
Q

Random walk assumptions

A

quadratic, RE, B(1+r) = 1

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4
Q

Define elasticity of inter temporal substitution.

A

Measure of responsiveness of the growth rate of consumption to the real interest rate. EIS = u’(c)/cu’‘(c). More convex –>higher u’‘(c) –> lower change in c

  • determines size of substitution effect
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5
Q

Speed of convergence. Impact of alpha.

A

speed = (1-a) (n+g+d).
Higher a = less concave pf = high MPK (less significant diminishing returns to capital) = high r = lots of incentive to invest quickly= larger change in y –> ties longer because a bigger change. Much steeper production function.

Each addition of K gives larger return so next period more S and I -> grow faster

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6
Q

Why RE so problematic for Keynesian

A

Flexible: always at medium-run employment (WS/PS intersection) so fluctuations in aggregate demand don’t affect output / employment.
- disinflation is costless

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7
Q

WS/PS what shifts if a) VAT rise b) employment benefits rise c) productivity rises d) employment protection reduced e) rise in oil price f) depreciation

A

a) PS left b) WS left c) PS right (also possible endogeneity of WS) d) WS right (closer to ES) e) PS left f) PS down (unless world pricing)

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8
Q

What impacts choice of r

A

a (size of multiplier) - semi- elasticity of expenditure w.r.t. r - large in UK - more powerful monetary transmission
alpha (steeper WS / PS)
beta
- Higher beta if history (Bundes bank) or openness to trade-finance (Swiss Bank)
- Alesina and Summers (1993): politically sensitive CB - care more about U and y
concern for future inflation
Brainard principle: conservative in the face of uncertainty
Romer (1993): openness to trade increases alpha
Fiscal policy availability
Source of shock
Transmission lag:
- inc spread between policy rates and market rates breakdown of transmission. E.g. at ZLB - inc r min.

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9
Q

Why inflation bias less of problem now

A

Control has been delegated to a central bank that cares about their professional reputation

  • Romer reputation model
  • in-office for more than one period - concern about reputation higher when less discounting of future
  • Canada and NZ took strong measures in 90s to be consistent - no major impact on output-inflation relationship - maybe not rational expectations
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10
Q

Advantages of PPT

A

r = i - Et inf t+1
- PP target inc Et for any dec in inf, reducing r now
- quick response: normal CBs are criticised for reacting to slowly, such that adverse demand multipliers set in (e.g. firms that would have stayed in business had rates and debt services costs been lowered end up bankrupt and lay off workers, who in turn cut consumption and reduce income elsewhere)
- further cuts then needed
Gasper et al (2007): Render a policy time consistent (e.g. at ZLB), makes expectations act like automatic stabilisers, ward off demand deficiency - benefits savers who have lower MPC
Removes inflation bias (Svensson 1996)

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11
Q

Disadvantages of PPT

A

Increased volatility - if not anticipated
Convex PC: smaller dec in inf for given dec in y -> limits the rise in Et inf
Stagflation: Engineering a recession in response to a cost-push shock - UK in financial crisis, inf > 2%
If not RE (adaptive) then benefits are small: more than proportionately impact as then RE revise their expectations
Hard to communicate
Makes past policy mistakes costly to unwind
If have to undershoot target then raise value of debt which can cause hysteresis

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12
Q

ZLB stimuli

A
  • Forward guidance (since inter temporal stochastic model - Eggerston 2013 - demand depends on current and future r)
  • Commitment to irresponsibility (Eggerston 2006: if discretionary then difficult to commit - deflation bias, Krugman 1998 - Japan’s slump)
  • Fiscal - as long as ricardian equivalence doesn’t operate- credit constrained - tax cut - automatic stabilisers make initial shift in IS smaller
  • QE - investor portfolios more liquid so inc investment
  • Term funding scheme - reinforce the pass-through cut in Bank rate to r faced by households and companies
  • Bernanke (2002): CB announces low r ceiling - commitment to buy unlimited volume and that r
  • Eggerston (2008) deficit spending - govt print additional dollar of debt - incentive to inc inf
  • Svennson (2003): currency depreciation - a consequence of expected future price level - conspicuous commitment
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13
Q

Why ZLB exists

A

If negative then would cost the CB to give out loans - not sustainable. Also investors would just hoard cash.

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14
Q

Rationale for forward guidance and commitment to irresponsibility

A

Forward guidance: long rate formula - Banks often use long i as opportunity cost for mortgages and loans, and fall in opp. cost means banks are more likely to lend, which theoretically increases current demand, shifting IS (through increased investment)

Commitment to irresponsibility: increases expectations of future inflation, reduces future real purchasing power, bring consumption of durable goods forward - stronger if don’t have wage inflation but still exists as financial assets

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15
Q

Assumptions for sticky prices

A

Imperfectly competitive labour market: then output is demand determined
Elasticity of labour supply w.r.t wages is high: if menu costs higher than profit from changing prices then will change output instead to maintain profit. Changing output requires can employ more workers w/o high increase in the wage. If high wages then gains from changing prices would be so great that no menu costs would plausibly prevent them.
Real rigidities (e.g. efficiency wage, searching, contracting)) means flat LS curve
Flat WS: trading a real wage premium for real wage stability
Blinder (1994): median prices change once a year.

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16
Q

RBC contribution to sticky prices

A

Due to intertemporal substitution aggregate labour supply could be relatively elastic even if individual is very inelastic.
Hansen (1985): employment adjustments at the extensive margin (voluntary U to working) rather than then intensive margin (work more hours). Micro-macro paradox.

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17
Q

Criticisms of NKPC

A

Deflationary booms - Volker disinflation in - recession in early 1980s
Doesn’t predict inflation persistence - reality its highly autocorrelated
Countercyclical wages:
- wages sticky so a fall in prices (fall in demand) raises real value of wages and laying workers off

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18
Q

Describe reason for sticky prices

A

Calvo (1983): staggered contracts, can change prices for free at fixed intervals and all other intervals have to pay menu costs for unscheduled price changes

  • show the aggregate demand externality: harm by others not cutting their prices in face of a fall in the money supply
  • ABC (private benefit to firms) falls if flatter MC
  • Flat WS: trading real wage premium for real wage stability
  • or real rigidities so off WS: efficiency wage, contracting
  • therefore small menu costs (if have real rigidities) lead to aggregate price inertia
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19
Q

Inflation disadvantages

A

Distributional consequences: creditors to debitors - elderly have erosions of savings
Menu costs: further away from socially ideal level
BUT further away from ZLB

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20
Q

Deflation disadvantages

A

Akerlof et al (1996) - if sticky wages, inflation is only way to reduce them - cutting nominal wage is difficult - inflation allows wages to be eroded in real terms - ‘greasing the wheels of the labour market’
Deflationary spiral: ZLB
Increases real debt burdens - debt denominated in real terms (compounds issue of deflation trap)

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21
Q

Inflation bias solutions

A

Rogoff 1985 - delegation to conservative CB
- larger beta, don’t fully eliminate as then sacrifice infinite output
- Alesina and Summer (1993): some evidence that independent CB = lower inf - causation?
- whether society better off depends on discounting of the future
Walsh (1995) - incentive scheme - CB penalised for each unit inf above target - disincentive of higher inf cancels higher output
- self-funded in UK - parallel shift of MR
Svensson - lower target - can’t set negative target

Commitment to a rule would mean time consistent- PPT - as setter then can’t reoptimise.

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22
Q

Types of menu costs

A

Physical cost of printing labels
Loss of consumer goodwill
Disruption to internal planning
Real rigidity - contract lengths
Strategic interactions - fear of sparking a price war
Kehol and Midziga (2010): find firms revert back to RRP

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23
Q

NKPC mechanism

Define stabilisation bias

A
  • NKPC: setting prices for several periods to anything that occurs in these periods but be reflected in p and inf today.
  • inc rt+1, dec y t+1, dec inf t+1, dec exp inf t+1 -> PC shifts down
    Def: CB is forced to over-stabilise the economy through raising current rates by more than optimal due to inability to commit to future interest rate outcomes
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24
Q

What is Krugman’s ‘curse of flexibility’

A

Adjustment up IS curve when have deflationary spiral is faster the more rational expectations (and steeper PC)

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25
Q

What is Pigou’s mechanism

A

Falling prices increase the real value of private sector assets -> +ve wealth effect on consumption -> shift IS right.

Debtor economies would experience rise in value of debt -> shift IS left -> toxic when combined with ZLB

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26
Q

How hysteresis happens

A

1) long-term unemployed stop seeking work (WS shift left, VPC shift left)
2) firms suspend investment & allow depreciation plus invest less in human capital, decreasing productivity (shift PS left)

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27
Q

Disadvantage of nominal GDP target

A

Observed quarterly
Measurement is subject to revision - first release, 40% of the data
GDP and CPI not perfectly correlated
- GDP excludes imports but includes exports
More complex -> more uncertainty -> progress hard to assess

If output target is erroneously set too high than the natural rate then get inflation bias

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28
Q

What is secular stagnation and its consequences

A

Lower demand, IS left, lower stabilising real rate due to debt overhang, declining population growth, rising income inequality

  • nearer ZLB
  • unconventional monetary measures likely to remain prominent
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29
Q

Adv / Disadvantage QE

A

Adv:
-targeted: spread between the market and policy rates as lender with greater risk tolerance. Buy loans sold to SMEs.
- harder to reverse so locks CB into higher inf - otherwise asset dumping and get back fraction of value. Ties hands.
Disadv:
- excessive inf
- lack of confidence - cash hoarding by banks - only increased narrow money supply
- if used to buy MBS - relax on legitimacy
- not aggressive enough - kiss goodbye to cash - Friedman helicopter drop so inc permanent money supply but reluctant as history of hyperinflation

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30
Q

Open economy 2nd stabilisation channel

A

+ve cost shock: forex market expects inc i -> return to home bonds -> depreciation -> reduces AD -> reduce inf

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31
Q

When would ERU be vertical

A

Vertical WS curve

Importers not passing relative price of imports onto consumers

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32
Q

Swan digram: a) what shifts BT b) impact of rise in oil price

A

a) rise in world output or home’s share of world output b) AD and BT left, ERU left

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33
Q

Marshall Lerner condition

A

Depreciation will improve the balance of trade (as long as demand for X & M > 1)

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34
Q

Dornbush overshooting

A

Equilibrium in financial markets in short-run. In long-run price of goods respond to these changes in financial markets

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35
Q

Competitiveness

A

Home-cost pricing
World cost pricing: no apparent loss of competitiveness even if costs rises as
Better measure: relative unit labour costs = E x ULC* / ULC

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36
Q

Why flatter BT than AD

A

Marshall Lerner condition: some income taxed or saved so net exports rise by less than the rise in AD

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37
Q

Why CA deficit isn’t sustainable

A

BP = CA + FA = 0
Accumulating foreign debt: rationed out of capital market and not able to borrow at world r
To stop inc imports want to depreciate $ - to do via UIP, raise r - pay more interest on US bonds that Chinese hold
If imports used for consumption, not investment then difficult to repay

It is possible to be in medium run eqbn with BT Deficit (-CA), as long as FA is borrowing from abroad - in the long run, it has to be at equilibrium output and balanced, (cant keep borrowing from foreign, otherwise you will be rationed out of capital
market

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38
Q

Solow: inc in g

A
  • ln(y/l) grows at steeper line but kink due to short-term drag on growth due to lower productivity per effective labour as capital per effective worker decrease in SR 0 higher alpha amplifies this
  • Y/AL - falls- by more the larger alpha
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39
Q

Solow: inc in n

A
  • n lowers living standards through thinning out of capital per worker
  • augmented: lowers ln(Y/L) only if g < a x change in n
  • assumes n doesn’t impact other factor, inc n could increase s if immigrants save more or inc A if more skills
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40
Q

Why swiggly savings line

A

savings is a luxury good that rises with income - utility discount rate falls with income

  • due to subsistence income needs can’t expand capital stock
  • only rich can afford capital stock
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41
Q

Factors impacting achieving Solow steady state

A

Savings efficiently converted into capital - depends on the loanable funds market
Quality of financial institutions matter
Need to utilise common global tech - educate workers

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42
Q

Human capital theory of growth

A

Mechanism: Growth depends on empowering labour to produce more through training
Rationale: dynamic feedback from education -> leads to be more kinds of learning w/o diminishing returns
Policy: subsidise training / education
Evidence: +ve corr(edu, GDP) -> reverse causality?
Criticism: Mankiw (1992) estimates the returns to human capital in cross-country panel data and finds less than linear - i.e. not constant returns to scale - doubt the model

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43
Q

Knowledge externalities theory of growth

A

Mechanism: Tech depends on the level of capital in the economy. Inc capital, inc tech -> increasing returns
Higher n -> needs more capital -> leads to more tech
Rationale: Growth comes from tech which comes from capital accumulation -> A now endogenous
- Externalities from capital accumulation: private sector don’t produce social optimum.
Individuals face diminishing returns to K but social is increasing.
Policy: subsides investment

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44
Q

Ideas theory of growth

A

Mechanism: ideas for non-rivalrous, subsequent produce with CRS
Rationale: Romer - partially non-excludable so firms can earn quasi-rents
Shaw (1992): trade & eco integration helps as higher returns
Easterly (2001): firms respond to incentives so inc these returns to RandD
Policy: stimulate R&D
Criticism: Jones 1995- world research effort inc a lot over last 140 years - GDP did not grow rapidly
Phi: extent to which the fertility of ideas profits from existing knowledge base in the economy

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45
Q

Evidence against neutrality

A

Euroscelerosis: high unemployment but table wage moderation (K vs L)
Rising income inequality: skill premium Acemoglu (2002)

46
Q

Definiton of neutrality

A

An invention which raises the marginal productivity of labour & capital in same proportion

47
Q

Facts of leader-follower model of convergence

A

Convergence in growth rates but not levels
Existence of convergence clubs (whether innovate to take adv of tech transfer - IP protection) -e.g. US states
Grossman and Helpman (2015): integration of people and cultures facilitate the flow of knowledge
Allen (2012): why don’t all adopt common tech: culture, institutions, nature of change (directed)
Acemoglu and Robinson (2012): role of institutions in economic prosperity - inclusive - democratic & high incentives - e.g. North and South Korea dividend in 1953.
Fall behind -> high growth rate e.g. Post War
Barry (2004): evidence for conditional convergence - middle income trap, coordination failure, poverty trap
Less advanced: most to gain from international trade as draw on existing knowledge
Limited no. of observation on what consider the long-run

48
Q

Evidence against Solow convergence

A

Lucas 1990: r= ak^a-1. US 15x richer than India, a = 0.4. rI / rUS = 58 -> nonsense.
Grossman & Helpman (1991): add in difference in human capital. r/r = 5
Add in externalities from human capital r/r = 1.4. Private returns from human capital are much lower than 40%.

49
Q

RBC assumptions

A

Many households living forever
Constant returns to scale
Agents perceiving temporary shocks
Factor returns responding quickly

50
Q

Facts of RBC

A

Intertemporal labour supply mechanism: strong response of labour supply - make hay whilst the sun rises (i.e. high elasticity). Substitution effect dominates income effect with a temporary wage change so labour supply increases.
Need capital accumulation so effects of inc A can be transferred to next period.
More persistence: less inter temporal substitution
Monetary policy is irrelevant

51
Q

RBC prediction of prices, consumption, wages and unemployment to a rise in output

A

Prices: fluctuations through AS shifting right -> fall in wages -> negative correlation. Empirics: positive correlation

Consumption: rise in interest rate so more working and saving today - -ve corr. Empirics: positive correlation. If shocks large enough to impact all periods then can fit data but then inconvenient for labour supply mechanism.

Wages: predicts highly pro-cyclical wage as rise in factor payment. Empirics: at best acyclical. To fit, add in wage smooting as contract lengths.

Employment: wages & employment move together -> need super elastic supply to have small change in wages. Hansen-Wright (1992): simulation - explains less than half variation in employment. Excessive vs intensive margin. Still implies U is voluntary.

52
Q

Evidence against random walk

A

Johnson et al (2006): US households spent 20-40% predictable tax rebate when received rather than announced - 2001

Excess smoothness: var(cons growth) / var (income growth) = 0.6. Not enough reaction to news

  • Deaton’s paradox 1987.
  • credit constraints (build buffer in case bind in the future)
  • Precautionary savings: uncertainty over y2 - MU / y graph (not quadratic utility)
  • permanent shocks should be reflected in permanent consumption: don’t spend as much as resources permit (defo permanent?)

Excess sensitivity: of consumption to past information

  • Flavin 1983
  • Zeldes (1989) find sensitivity for credit constrained but not others
  • uncertainty: present known income worth more than future so excess sensitivity
53
Q

Ricardian Equivalence assumptions

A 
Lump-sum
Same planning horizons
- Barro (1974): wish to leave bequests. 
No credit constraints
No uncertainty
RE
Homogenous households
54
Q

Ricardian equivalence equation

A

C = p (E + PV(Y-G))

  • Crowding out: c falls by permanent increase in G
  • p is impatience
55
Q

Explain normative theories of public debt

A

Barro (1979): tax smoothing
Govt minimises PV of distortions.
DWL correspond to loss triangles in PS and CS - assumes no Ponzi games: can’t have debt inc indefinitely by using more debt to pay of existing
- approx quadratic in the tax rate
- t=(r-y)(PV(g) +b)
- assumes bust followed by boom
- doesn’t explain tendency towards a deficit

56
Q

Explain positive theories of debt

A

Positive: collective vs individual

Present-in office bias: B = (b-1)G/(1+b) > 0

  • voters have info constraints
  • T1 = 2a G/(1+a)(1+b)

Weak minister of finance: Persson and Tabellini (2002)

  • common pool problem. cooperative b = 0.
  • Rogoff (1985): conservative minister of finance
  • benefit concentrated (decentralised) whilst social cost is spread (not fully internalised)

Partisian/ strategic debt accumulation

  • Level: Persson and Svenson (1989). Liberal should run surpluses.
  • Composition: Alesina and Tabellini 1990
    - military vs social - both run deficits
  • assumes exogenous limit on level of national debt e.g. US state govt, EU
  • b increase in probability of other party being in govt
  • tying hands theory: to restrain successor’s spending
  • due to inability to set binding commitments about how would set policy in period 2
  • Debt bias is bigger if chance of being kicked out of office is high, G is high, and H and the weight given to the primary spending target a are low

Delayed stabilisation: Alesina and Drazen 1991

  • disagreement on how to divide burden
  • war of attrition
  • evidence against unconditional aid
  • consensus to change an unsustainable status quo is not found
  • doesn’t explain bias but why it then persists
57
Q

Empirics of fiscal policy

A

Ireland b = 25% in 2007 -> 108% in 2011

Romer (2012): Debt issue correlative with no. of coalition partners & no. of spending ministers e.g. Belgium & Italy

FT (2019): Congressman Ben McAdams: politicians take course with less resistance - in their case deficit spending’

Hyperinflation after WWI - labour or capital - delayed stabilisation

Netherlands and Belgium 50% gap in b ratios.

Less evidence for strategic debt acc

Reagan left a lot of debt to restrain future Democratic spending?

58
Q

Implications of tax smoothing

A

Run deficit if temporary dec in g

  • tax follows a random walk
  • deficit determined by temporary changes in g only
  • Golden Rule: govt can make public investment that earns market r then nattered out of budget and doesn’t impact t
  • no need to pay off existing debt more rapidly
  • Fiscal spending is less effective if open and Mundell Fleming says is ineffective if floating FX
59
Q

Why fiscal policy not delegated

A

Govt role more complicated:

  • market failure
  • public goods
  • redistributive role
60
Q

Role of independent fiscal council

A

Beestma & Lebrun (2018):

  • watch-dog: ensure fiscal policy is sustainable over the long-run - guard against deficit bias
  • impatience, lack of commitment
  • constraining discretion - rules - trilemma (simple, flexible, enforceable - Debrun 2017)
  • ameliorate coordination failures -> facilitating role of strong minister of finance
    • must have some veto power
  • Provide targets (e.g. Osborne optimistic so 3 years late)
  • info asymmetries: govt can undermine role of don’t give probate info or administrative obstacles
61
Q

Costs of debt

A
  • if borrow in own currency then curb default risk as don’t worry about what market thinks - e.g. why debt crisis located in Eurozone
  • small prob default requires risk premium -> raise cost of debt -> default more likely
  • strategic default: if debt owned overseas then small political costs from holders < political costs of high taxes / low spending
  • forced default: can’t roll over debt
  • less likely to default of have marketable asset )e.g. oil, infrastructure, equity holdings
62
Q

What makes MR horizontal

A

a or b at infinity

a: rises in r and falls in y become perfect tools for achieving an inflation target
b: inflation nutter

63
Q

RBC: What determines the extent to which shocks propagate?

A
  • degree of inter temporal substitution
  • i.e. response of labour and savings
  • arguments based on transitory shocks so negatively related to persistence of shocks
  • shocks most be perceived as temporary and returns impacted quickly
64
Q

Why don’t see output target

A
  • in equilibrium output equals the unique natural rate so isn’t a choice variable
65
Q

What is excess sensitivity of consumption

A

Failure of unpredictability of consumption changes

66
Q

How test excess sensitivity (and issue) and excess smoothness

A
  • changes in consumption = yX + e
  • y=0 then not excess
  • could be spurious correlation if use aggregate data (mean income rises but consumption constant)
  • changes c = Be, if have B < 1 then smoothness
67
Q

How overshooting can be avoided

A

If fiscal and monetary policy tools kept r constant

68
Q

Why steeper PC: inflation bias smaller

A
  • bigger alpha = flatter MR = less change in inflation for a given change in output because prices are more flexible - larger MC of deviation from A to B
  • as prices more reactive, CB reacts more aggressively so smaller bias
69
Q

Beta convergence

Sigma convergence

A

beta: Negative relation between level of GDP and growth at start of observation period

Signma: reduction in dispersion levels

70
Q

If productivity decline: what happens in PC-MR model

A
  • shift VPC left, on new SRPC at old y so inflation rises
71
Q

Does govt setting plans only to end of tax year matter?

A

No as presume next govt have to fund the liability. May be uncertainty over whether debt is to be repaid via future tax rises or future government spending cuts and that this distinction matters for current expenditure and its response to the tax cut.

72
Q

UK 2011: high inflation 4.5% but recession

A

Stagflation: unsure on policy response

- i.e. possible oil price shock

73
Q

Discussion of RBC and recent financial crisis

A
  • unemployment: mass decision to go on holiday

- result from technology shock in the financial sector?

74
Q

Issue with deflation

A
  • likely to delay spending through raising the ex ante real interest rate
  • i.e. small subset of prices changing isn’t so much of a problem
75
Q 
How monetary policy responds to fall in oil price for oil-importing country: 
All 3 shift right
- ERU shift as PS shift 
- BT as lower oil imports
- AD as boost in net trade
A

Monetary policy should be loosened to support the adjustment to a higher medium-run output.

76
Q

Talk about mechanism for overshooting with cost shock

A

inf shock -> C raise r -> forex market anticipate rise in r so immediate appreciation -> output and inf fall -> CB gradually reduces r and have gradual depreciation

77
Q

Talk about mechanism for overshooting with permanent demand shock

A

medium run q changes -> get new PC from inf at B -> CB set lower r which causes an appreciation -> them combined cause C of higher output -> transition

  • fall in demand offset by higher net exports due to depreciation
78
Q

Example of FX overshooting

A 
In 1979 (Thatcher era), mon pol tightened. Didn't lead to immediate fall in inf but to appreciation of the £ which hurt the manufacturing sector 
- didn't anticipate impact of FX
79
Q

What slope of RX relies on

A

Interest and FX sensitivity of aggregate demands, CB preferences and slope of PC
Flatter RX:
- Flatter IS: the higher b and a - greater AD response to change in r then need to change r by less ceteris paribus
- Steeper MR (lower alpha or beta): if less hard-nosed then return to equilibrium will be slower and therefore raise r by less

80
Q

Issue with fixed FX

A

Results in large domestic (short-term) interest rate fluctuations which can have negative effects on banking sector, investments, unemployment, inequality, govt budget

81
Q

Talk about directed technical change

A

Acemoglu model (2002):

  • elasticity = 1/1-p
  • skill premium w= (H/ L ) ^ sigma - 2
  • Market for innovation: price and market effect both attract more innovation.
82
Q

What is time inconsistency

A

forward guidance is not a credible commitment as CB has incentive to renege on their promise, as it is not optimal in the future to incur such welfare problems

  • benefit in past, cost present so optimal to deviate
  • w/o credibility: outcome replicates RE
83
Q

Should time inconsistency be a problem?

A
  • Maybe CB can bypass credibility problem by tying their hands w/ integrity
  • whilst CB may be trusted to not renege, loose monetary policy is detrimental to other interest groups, such as savers or fixed income earners (pensioners), that lose on higher inflation rates, and can force the hand of CB (many have attributed this to cause of prolonged impact of economic downturns after Great Depression and Japan’s Lost Decade. Also right-wing economists say low rates can keep ‘zombie firms’ alive and cause asset price bubbles (maybe like the one we have now)
84
Q

Why inflation bias occurs

A

1) uninetnioanl -> failure to account for lower productivity e.g. Orphanides account of mon pol in 1970s - UK peaked over 20% per annum (new VPC)
2) seeking Es = Ed -> efficient employment
3) Political cycle: inc GDP seen as sign of economic competence

85
Q

Why WS curve exists

A

Efficiency wage: cannot observe effort so got to incentivise high effort, higher opportunity cost of leaving e.g. Ford $5 / day

Union wage setting

86
Q

What makes PS curve flat

A

Constant mark-up and constant MPL

87
Q

What beta represents

A

Inflation aversion: the willingness to trade off a longer period of inflation deviation to reduce impact on unemployment

88
Q

Current account and balance of payments account

A 
CA = (S-I) + (T - G 
BP = CA + FA = 0
89
Q

What is BT curve

A

the combinations of real exchange rate q and the level of output y at which trade is balanced (X=M

90
Q

How debt-income varies

A

If r > y then unless running a surplus, the debt income ratio will grow, because interest payments are rising faster than the GDP
If y > r govt can still run primary deficit and
have a shrinking debt income ratio, because GDP is growing at a faster rate than the govt must pay out interest payments, so they are paying off debt

91
Q

Why high debt matters if intertemporal BC is satisfied

- cost of sustainable deficit

A

1) Crowding out - rising govt debt increases r so lower output - matters if Ricardian equivalence doesn’t hold i.e. that people don’t save enough for future taxes
2) Inter-generational distribution
3) Distortionary - high debt requires high taxes and if not lump-sum then reduces output and consumption
- Reinhart and Rogoff (2010): if b > 0.9 then 1% lower g but likely reverse causality

92
Q

Why strategic default

A

Political cost of high taxes/low spending exceed political costs from debt holders + costs of not being able to borrow again for some time. Political cost from debt holders smaller if a large proportion of debt is owned overseas

93
Q

Relationship with ricardian equivalence and debt bias

A

If RE holds then consumers will have saved to repay the current tax cuts in the future so no risk of default or bias.

94
Q

Why even if CB cares about the future wouldn’t deviate to C’

A

1) Hysteresis

2) Convex PC: to marginally decrease inf, big decrease in y

95
Q

Would PPT or nominal GDP inc or dec volatility

A

Volatility, depends on the source of the shock.
With GDP, if have perfect data, less volatility but
unlikely so actually more volatile. Supply side shock with PPT is volatile but with demand side it is less volatile

96
Q

Should central banks announce their expected medium term path for policy interest rates as well as the current policy interest rate?

A

If at ZLB then yes

No: run risk of loosing credibility
- When Mark carney was at BoC: promised overshoot but reached bliss point quickly

97
Q

Reasons for expected q to inc a lot

A

Expected depreciation:

  • Brexit
  • financial crisis
  • the UK left the ERM (fixed exchange rate to basket of Euro countries) and BoE had a high interest rate but people thought couldn’t sustain so heavily depreciated
98
Q

Trilemma

A

Fixed ER, capital mobility, independent MP

- if have fixed q then by UIP condition change in i has to be zero so loose mon pol independence.

99
Q

How explain low r and high savings in crisis

A
  • Precautionary savings: fear of credit rationing as banks in trouble
  • Ricardian equivalence: increased govt spending then save more
  • if deemed permanent then reduce income 1-1
  • asset prices fall (defined contribution pensions are linked to asst prices so they fall too) - feed into permanent income - so start saving - higher mortgage value to service if house price falls
100
Q

Why convex PC

A

Trade unions are resistant to wage cuts

101
Q

Definition of QE

A

creation of electronic money to purchase assets such as bonds to boost the money supply

102
Q

Talk about a in IS curve

A

Semi-elasticity of expenditure w.r.t r.

  • determines transmission mechanism speed
  • influenced by no. of floating rate mortgages
  • UK: 85%, US 93% fixed 30 years

Also depends on CB nominal interest rate being proportional to rate offered by commercial banks to households/firms

103
Q

Explain UIP equation and why it shifts

A
  • RHS: expected depreciation of the log real FX rate between today and tomorrow
  • r = r* if q in equilibrium and not expected to be knocked out of equilibrium between today and tomorrow
  • Shift: Any change in the money supply.
104
Q

How dec n impacts Romer model of growth

A
  • Decreases no. of workers in RandD -> reduces level of A -> permanently reduces steady-state growth rate since constant returns to labour in RandD lead to a growth effect of scale
  • size of effect depends on assumption regarding returns to scale in RandD

Jones: dec n -> decrease in growth rate of labour in RandD

105
Q

Why golden rule of capital exists

A
  • Diminshing marginal returns to capital but constant depreciation
  • It is where consumption is maximised
  • s* = alpha
  • k = (d/a)^1/1-a
106
Q

Do impatient consumers invalidate RE?

A

Ricardian equivalence is about timing of taxes leaving discounted lifetime utility unchanged, whereas impatience is about how quickly that lifetime income is spent

107
Q

Implementing the golden rule

A
  • if k > k* : optimal to implement, the foregone capital we have scrapped was less than the output cost we pay to maintain it against depreciation so inc welfare at all horizons
  • if k < k* then need to invest to accumulate more capitals. If there’s an infinite discount rate on future utility then don’t implement
108
Q

Impact of inc in G with ricardian equivalence

A
  • Debt taken on to finance so inc future taxes so dec c by fixed amount from t onwards.
  • if perfect substitutes e.g. healthcare, education, housing then dec 1-1 in that period
109
Q

Explain how openness to trade impacts alpha

A

if inc r -> immediate appreciation -> impact import prices immediately -> steeper PC
- import price = world price * nominal FX

110
Q

Why raise r by more than MR

A
  • Dynamic loss
  • leads to a more favourable constraint tomorrow
  • balance MC - MB = MBt+1 - MCt+1
111
Q

2 situations where r stabalise

A
  • Fixed FX so not own MP

- ZLB

FHS (8 decks)

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