Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

Macroeconomics > The IS, MP, and Phillips Curves + Derived Demand and Supply Framework > Flashcards

The IS, MP, and Phillips Curves + Derived Demand and Supply Framework Flashcards

1
Q

National Income Accounting Identity

A

Yt = Ct + It + Gt + EXt – IMt

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

Yt = Ct + It + Gt + EXt – IMt

A

National Income Accounting Identity

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

What are the 3 approaches to measuring GDP?

A
  1. Expenditure Approach - counting all purchases
  2. Production Approach (value added) - Net value of goods produced in the economy
  3. Income Approach - Income earned in the economy

Expenditure = Production = Income

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

What does the IS curve capture/show?

A

Captures negative short-run relationship between r and y
– Interest rate increase depresses investment and lower consumption
– In turn, lower investment and consumption decreases output

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

How do you derive the IS curve?

A
  1. Rewrite National Income Accounting Identity to make It the subject:
    It = Yt - Ct - Gt + IMt - EXt
  2. Add and subtract tax revenues:
    It = (Yt - Tt - Ct) + (Tt - Gt) + (IMt - EXt)
    Investment = Private Savings + Public Savings + Foreign Savings
  3. Each component is assumed to be a proportion of potential output:
    EXt = āexȲt, IMt = āimȲt, Gt = āgȲt,
    Ct = āc - bc[Rt-β]Ȳt
  4. If these components are smooth, then GDP volatility must depend on Investment:
    It/Ȳt = āi - bi(Rt - r)
    (Where Rt = Real interest rate and r = MPK)
  5. Divide national income accounting identity by Ȳt and substitute component assumptions:
    Yt/Ȳt = āc - bc[Rt-β] + āi - bi(Rt - r) + āg + āex - āim
  6. Condense all a components into a single a bar and (Yt/Ȳt) -1 becomes Ỹt:
    Ỹt = ā - bc[Rt-β] - bi(Rt - r)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What does the - bc[Rt-β] component of the IS curve represent/show?

A

Short-run output fluctuations depend negatively on the gap
between real interest rate and discount factor

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

What does the - bi(Rt - r) component of the IS curve represent/show?

A

Short-run output fluctuations depend negatively on gap between real interest rate and MPK

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

What does the a bar component of the IS curve represent/show?

A

Captures aggregate demand shocks
Changes in sensitivity of expenditure to potential output

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

Describe the IS curve

A

A downwards-sloping straight line with gradient -1/b = -1/(bc+bi)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

If b increases, what happens to the IS curve?

A
  • Higher sensitivity of It or Ct to interest rate
  • Gradient decreases in slope by pivoting about the point (0, r)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

Suppose information technology improvements create an
investment boom. What will happen to the IS curve?

A

The ai parameter increases so a overall increases. This shifts the level of output higher for any given level of R so the IS curves shifts rightwards

This is true for any shock which affects an a component

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

How do different central banks control interest rates?

A

The Bank of England sets the ‘Bank Rate’ which is the interest rate on reserve balances
The Federal Reserve sets the ‘Federal Funds Rate’, the interest rate paid on an overnight loan
The European Central Bank sets the main refinancing operations rate which is the rate on weekly ECB loans

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

Fisher Equation

A

it = Rt + πt
Nominal interest rate = Real interest rate + Inflation rate

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

it = Rt + πt

A

Fisher Equation

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

Why does the Fisher Equation show how the Central Bank controls R?

A

Rearranged to Rt = it + πt, and assuming that inflation is sticky (as in acts very slowly), changing nominal interest rates has a direct short-run effect on real interest rates

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

Describe the MP curve

A

A perfectly horizontal line which intersects the R axis at r (nominal interest rates)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

What would happen to the IS curve if there was a sharp fall in house prices and how might the central bank respond?

A

A sharp fall in prices is a negative aggregate demand shock.
The IS curve will shift leftwards, reducing Ỹ.
The central bank will respond by lowering nominal interest rates (the MP curve will shift downwards) so that the IS and MP curves again intersect at Y0

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

What equation do firms (essentially) use to set their prices?

A

πt = Etπ(t+1) + vỸt
Current Inflation = Expected inflation + Demand conditions

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

πt = Etπ(t+1) + vỸt

A

The equation which firms essentially use to set their prices

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

Backward-looking Inflationary Expectations Equation

A

Etπ(t+1) = π(t-1)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

Etπ(t+1) = π(t-1)

A

Backward-looking Inflationary Expectations Equation

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

Phillips Curve

A

πt = π(t-1) + vỸt
( Δπt = vỸt )

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

πt = π(t-1) + vỸt
( Δπt = vỸt )

A

Phillips Curve

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
24
Q

What is the NAIRU?

A

The Non-Accelerating Inflation Rate of Unemployment

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
25
Q

Okun’s Law

A

ut - ũt = - (v/α)Ỹt

Short-run output is greater when cyclical unemployment is low

26
Q

How do Okun’s Law and the concept of a NAIRU relate to the Phillips Curve?

A

Okun’s Law can be combined with Phillips Curve to integrate an ‘unemployment gap’ into the curve

πt = π(t-1) - α(ut - ũt)

27
Q

How can temporary shocks be shown on the Phillips Curve?

A

Shocks are shown as extra components which contribute negatively or positively to the rate of inflation e.g.

Oil price shock raises oil prices –>
Δπt = vỸt + ot
Here the Phillips Curve shifts vertically upwards

28
Q

Generalised Consumption Equation

A

Ct = (āc - bc[Rt-β])Ȳt + ꭓ(Yt - Ȳt)
Where ꭓ ∈ (0,1)

Normal consumption plus some multiple (ꭓ) of the output gap

29
Q

Ct = (āc - bc[Rt-β])Ȳt + ꭓ(Yt - Ȳt)

A

Generalised Consumption Equation

30
Q

IS Curve with Multiplier

A

Ỹt = (1/(1-ꭓ)){Ỹt = ā - bi(Rt - r) - bc[Rt-β] }
Condensed into…
Ỹt = â - b̂i(Rt - r) - b̂c[Rt-β]
Where â ≡ ā/(1-ꭓ) and similarly for bi and bc

31
Q

IS Curve

A

Ỹt = ā - bi(Rt - r) - bc[Rt-β]

32
Q

Ỹt = ā - bi(Rt - r) - bc[Rt-β]

A

IS Curve

33
Q

Ỹt = â - b̂i(Rt - r) - b̂c[Rt-β]

A

IS Curve with Multiplier

34
Q

How do the two rounds of a shock work with the multiplier?

A

Positive demand shock
1st round effect - Increase short-run output for a given value of Ct
2nd round effect - Consumption increases because Ct depends on Ỹt (which has increased)

Result: Ỹt increases by more than the initial shock

35
Q

What were the trade offs of Volcker’s disinflation push in the late 1970s?

A
  • Economy fell into recession
  • Unemployment increased
  • Reduced output
    BUT
    + Much less costly than expected
    + Brought inflation under control
36
Q

LM (liquidity money) Curve

A

Mt/Pt = L(Ỹt,Rt)

Real balances depend positively on
short-run output and negatively on real interest rate

37
Q

Mt/Pt = L(Ỹt,Rt)

A

LM (liquidity money) Curve

38
Q

Describe the LM Curve

A

A straight line which slopes upwards from left to right in Ỹt,Rt space

39
Q

Why have central banks chosen to control it instead of Mt?

A

Money demand is subject to volatility many shocks and nominal interest rates are easier to control
When CB targets it, Mt absorbs money demand shocks which leads to less macroeconomic instability

40
Q

What is the Taylor Principle?

A

Monetary policy is stabilizing when the nominal interest rate is higher than the increase in inflation

it = Φπt where Φ > 1 (nominal interest rule)

41
Q

Combined Fisher and Nominal Interest Rule Equation

A

Rt = (Φ-1)πt

If Φ < 1, monetary policy response is destabilised

42
Q

Rt = (Φ-1)πt

A

Combined Fisher and Nominal Interest Rule Equation

43
Q

Inflation-Targeting MPR

A

Rt - r̄ = ψ(πt - π bar) where ψ>0

Coefficient ψ controls CB’s response to inflation deviations

If πt > π bar, then set Rt > r̄ (and vice versa)

44
Q

Rt - r̄ = ψ(πt - π bar)

A

Inflation-Targeting MPR

45
Q

How is the AD curve derived form the IS and Inflation-Targeting MPR curves?

A

Using the Inflation-Targeting MPR curve, substitute Rt - r̄ into the IS curve Ỹt = ā - b(Rt - r̄) [assuming that r̄ = β]
AD: Ỹt = ā - bψ(πt - π bar)

46
Q

Ỹt = ā - bψ(πt - π bar)

A

AD Curve (derived from IS and MP curves)

47
Q

Taylor Rule Equation

A

it = ī + (1+ψ)(πt - π bar) + ΦỸt

BoE and Fed set bank rate and FFR using this equation

48
Q

it = ī + (1+ψ)(πt - π bar) + ΦỸt

A

Taylor Rule Equation

49
Q

Dual-Mandate MPR

A

Rt - r̄ = ψ(πt - π bar) + ΦỸt

50
Q

Rt - r̄ = ψ(πt - π bar) + ΦỸt

A

Dual-Mandate MPR

51
Q

How is the AD curve derived form the IS and Dual-Mandate MPR curves?

A

Using the Dual_Mandate MPR curve, substitute Rt - r̄ into the IS curve Ỹt = ā - b(Rt - r̄) [assuming that r̄ = β]
AD: Ỹt = ā/(1+bΦ) - (bψ/1+bΦ)(πt - π bar)
Ỹt = ǎ - b̂ψ(πt - π bar)

52
Q

Describe the behaviour of the dual-mandate AD curve

A

If b̂ < b, the dual mandate AD curve has a steeper gradient than the inflation-targeting curve (and vice versa)

53
Q

How is the AS curve constructed in the AS-AD framework?

A

The Phillips Curve (with a cost-push shock +ot) is representative of the AS curve

πt = πt-1 + vỸt + ot

54
Q

Short-run equilibrium is found where the AS and AD curves are equal. What are

A

Ỹt = â - b̂ψ(πt-1 - π bar + ot)
And
πt - π bar = vâ + (1 - vb̂ψ)(πt-1 - π bar + ot)
Where
â ≡ ā/(1+bψv) and b̂ ≡ b/(1+bψv)

55
Q

Adaptive Expectations Equation

A

Et[πt+1] = πt-1
Motivated by inflation sluggishness

56
Q

Et[πt+1] = πt-1

A

Adaptive Expectations Equation

57
Q

Rational Expectations Equation

A

πt = Et[πt+1] + vỸt

58
Q

πt = Et[πt+1] + vỸt

A

Rational Expectations Equation

59
Q

If the central bank announces a lower inflation target, what will expected inflation be with rational expectations?

A

Et[πt+1] = π^1 < π^0

60
Q

What are rational expectations and what is beneficial about them?

A

With rational expectations, the private sector uses all available information to best forecast all variables of interest

It’s beneficial because you get costless disinflation (without output downturn and higher unemployment)

Macroeconomics (4 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions