Midterm 2 Flashcards
IS curve
inverse relationship between output Y and real interest rate
what does equilibrium mean for the IS curve?
output = planned output (C + Ipl + G + NX)
IS curve: consumption
autonomous C
- consumer confidence
- household wealth
- expected future income
related to:
- autonomous consumption (+)
- disposable income (+)
- real interest rate (-)
IS curve: investment
autonomous I
- business confidence
- expected future profits/cash flow
- changes in technology
related to:
- autonomous investment (+)
- real interest rate (-)
IS curve: net exports
autonomous NX
- domestic preferences for foreign goods
- foreign preferences for domestic goods
- foreign trade barriers
related to:
- autonomous net exports (+)
- real interest rate (-)
Phillips curve
inverse relationship between unemployment and inflation
Okun’s law
relationship between unemployment gap and output gap
repo
short for repurchase agreement or sale and repurchase agreement
what happens in a repo?
CB borrows money by agreeing to sell bonds at t0 to p0
repurchase bonds at date t1>t0 and p1>p0
what happens in a reverse repo?
CB lends money by agreeing to purchase bonds at t0 at p0
sell bonds at date t1>t0 and p1>p0
three key equations in monetary policy response
optimal shock response
rate-rule
IS curve
how to calculate output gap?
percentage deviation of aggregate supply from potential output at a given point of time
Yt - Yp/Yp = ln(Yt) - ln(Yp)
how to calculate unemployment gap?
difference between unemployment rate and natural rate of unemployment at a given time
ut - un
how to get optimal rate rule from loss function?
sub phillips curve
minimisation for optimal path
sub dynamic is curve
isolate rt
fisher’s equation
r = i-pi
phillips’ fit to original data
wage inflation = -0.9 + 9.683u^(-1.394)
policy rate, government bond rate, lending rate
policy rate set by CB
government bond rate set by bond market
lending rate set by commercial banking system
difference between government bond rate and policy rate is the term spread
difference between lending rate and government bond rate is the credit spread
- depends on riskiness of the loan and risk tolerance of the bank
what do loops in the Phillips curve tell us?
time matters
wage inflation can depend on the rate of change of inflation and the rate of change of demand for labour (and therefore unemployment)
supply shocks
events affect inflation independent of labour market conditions and/or inflationary expectations
dual mandate of the central bank
keep inflation as close as possible to target inflation
keep output as close as possible to potential output
primary policy tool of central banks
nominal short-term interest rates (Fed Funds Rate in the US)
what is the Fed Funds Rate?
interest rate that banks lend to one another on an overnight loan of excess reserves
how does the Fed control the amount of reserves in the banking system and the Fed Funds/policy rate?
repo and reverse repo (open market operations)
how else can the central bank control the overnight rate apart from repos?
changing the reserve requirement or paying interest on reserves
what do aggregate demand shocks do?
move the IS curve
positive demand shocks cause economic output to increase
negative demand shocks cause economic output to decrease
what do aggregate supply shocks do?
change the Phillips curve or production function
positive supply shocks cause inflation to decrease
negative supply shocks cause inflation to increase
business cycles are caused by sequential shocks to:
production function (supply shock)
IS curve (demand shock)
Phillips curve (supply shock)
non-activists
wage and prices flexible so economy is self-correcting quickly
government activity to reduce high unemployment is unnecessary
classical school of thought
activists
wages and prices are sticky so slow self-correcting mechanism
government activity to reduce high unemployment is justified
keynesian school of thought
neither monetary nor fiscal policy can response immediately
data lag
recognition lag
legislative lag
implementation lag
effectiveness lag
