Term 2 week 7 and 8 Flashcards
What happens in short run if you decrease the money supply?
What is the relationship between money supply and interest rate?
GDP falls
Interest rate increases.
Liquidity effect
What are the potential reasons behind nominal rigidities?
Sticky wages
Long term contracts
Menu costs
Inattention
What is the bridge between the nominal and real economy?
Fisher equation
Due to nominal rigidities changes in the money supply can impact real interest rates.
What is the fisher equation?
What does it show?
Rt = it - pit+1 expected
real interest rate = nominal interest rate - expected inflation
Changes in the nominal interest rate are not matched by 1 for 1 changes in expected inflation so this causes variation in the real interest rate.
How can you graphically show, money demand, money supply and money demand
Why is it better to use interest rate as main tool for monetary policy?
Money demand shocks do not have a big impact.
What is the equation for equilibrium level of money?
M* = PY x K(i)
How do central banks choose what interest rate to check?
What is the taylor rule equation?
What values did taylor argue?
Taylor suggested that banks should choose based on:
distance from output target
Distance from inflation target.
The coefficients show how sensitive the centrla ban
What is the conclusion of moeney?
Neutral in long run
non-neutral in short run.
What is a shortcoming of the RBC model in terms of money?
RBC does not take into account the non-neutrality of money in the short run.
But monetary policy has a role to stabilise business cycles.
What is the key feature of New-Keynsian models?
Price-stickiness.
How is potential output dealt with in the Keynsian model?
What is output gap?
potential output is y bar and is exogenous to the model
The % deviation of output from potential output.
What is consumption in the Keynsian model?
Ct = (ac + act)YbarT
ac = constant share of output that goes to consumption
act = changing share of output that is caused by shocks.
What is government spending in keynsian model?
GS = (ag + agt)Ybart
a constant part of government spending and a one subject to shocks.
What is investment in the keynsian model?
it = ig + iat - b (Rt-r)Ybar
What is the Rt-R part of investment
What is the equation of the IS curve?
What is at in the keynsian model?
at = AD shock.
What is IS curve graphically?
X axis y tilda
Y Rt
IS is downward sloping
What causes shifts or movements in IS curve?
A shift is caused by anything that would change AD
A movement is a change in the real interest rate.
What specifically culd cause a shift in AD
Why is there a role for monetary policy?
Due to nominal rigidities
What is broad money?
What is cash
What is reserves?
What is central bank money
Cash and bank deposits
What is a bank deposit to the bank?
It is a liability to the bank.
What are the different type of M of money
How does the central bank conduct monetary policy?
They can change reserve requirements
How does the central bank intervene?
Impacts competition by lending
Buy or sell government bonds to remove or add amount of bonds.
How do we graphically show the IS - MP graph?
if MP is exogenous
What would happen to this graph if there was a contractionary monetary policy shock
x axis output tilda
y axis real interest
Downard sloping IS
Horizontal MP curve at R
What is contractionary and expansionary fiscal policy?
What are the advantages to central bank controlling inflation?
How do you derive the AD curve?
How is there nominal rigidities in keynsian model?
How do firms set price in keynsian models?
-Imperfect informations
-expectation on economy wide inflation rate
-demand conditions
-exogenous costs of production
What links inflation and the output gap?
How do you draw AD , AS diagram what else can you attach?
Downward sloping AD , upward sloping AS
LRAS inelastic line going through where they intersect.
What is the relationship between LRAS and prices?
LRAS and inflation are completely independent
Graphically how can you show a negative demand shock on AD/AS diagram?
What are the full dynamics
AD shifts inward
this causes negative output gap
Pi goes down
the government then takes expansionary monetary policy and R<Rt
-After this period AD goes back to normal position.
-As AS = inflation in next period = inflation in last period + fraction of output
-As lower inflation will cause AS to shift down.
-Lower prices will imply higher demand , as the negative demand shock is gone they will
-but at time 3 AS will shift up as inflation increased again and will keep doing this until it goes back to 0 output gap.
What happens if there is an increase in oil prices in AS, AD curve?
AS shifts to left at higher price level.
This causes central bank to increase interest rate.
Due to adaptive expectations, inflation is higher but demand is depressed so the AS curve will gradually move back.
-During the transition the central bank relaxes monetary policy but gradually until inflation is under control.
What does the keynsian model tell us about monetary policy?
Monetary policy
Monetary policy aims to keep inflation stable
-After negative AD shock (expansionary policies)
-After negative AS (contractionary)
-There is a tradeoff between
What is the AS equation?
piT= Piet + vYt + ot
How is fiscal policy used as stabilisation policy?
shocks to goverment purchases , shift AD, similar to monetary shocks
A positive shock generates inflation and positive short run output
-Less used as it involves lags
Plus governments with large debts are constrained
-Fiscal policy is more useful when countries are constrained by zero lower bound
What is world example of negative demand shock?
What is example of supply shock?
-demand shock - great depression
-OPEC supply shock — stagflation
What can cause AS curve to change gradient?
Nominal rigidities
