Tutorium 5 Flashcards
Definition: Quantitative Easing
The central bank targets longer-term interest rates, bc. short term interest have hit the zero lower bound.
Possibilities:
• Buy long-term securities to increase their price (or decrease their yields) —> banks sell them —> new money for loans
• Promise to keep the short-term rate low for an extended period
—> more trust in the financial system —> consumption
How to test the effectiveness of quantitative easing
• Identify key components related to QE
• Compare the yields (and volume) of bonds before the announcement (of the Central bank) and after the ann.
—> the lower the yield drops, the more effective the policy
future short-term interest rates —> long-term interest rates
long-term interest rate depends on:
• current short-term rate
• future expected short-term rate
—> central bank can announce that it will keep short-term rates low in the future, to influence current long-term rates
True?
Quantitative easing can lower interest rates, bc. it lowers the probability of companies to default
If QE is exp. to be successfull in stimulating economy
—> fewer companies go bankrupt and companies will have to pay less to borrow
—> yield on corporate bonds goes down (especially for riskier companies) and the premium of CDS goes down
inflation expectations —> interest rates
quantitative easing successfull —> higher demand
—> higher prices —> higher exp. inflation
—> decreases real interest rate
(bc. real = nominal - exp. inflation)
tax cuts —> economy
Stimulate the economy:
• hh. have more disposable income —> consumption
• firms expect higher profits —> invest more
—> aggregate demand goes up
Decreasing economy:
• gov‘t has to borrow to finance tax cuts
—> higher demand for credits —> interest rates up
—> crowds out investment
• hh. and firms expect taxes to increase in the future
—> encourages saving money today
—> overall effect is ambigous
Reasons for the gov‘t to cut taxes
- gov‘t has a budget surplus / lower gov‘t spending
- please the rich
- reduce the size of the gov‘t (political reason)
- stimulate the economy in a recession
Why is it misleading to look at the change of the economy after a tax cut?
• tax cuts may be correlated with other factors that affect the economy as well
e.g. gov‘t cuts taxes in a recession
—> the factor that led the economy into the recession still affects the economy
—> only looking at the change of the economy after a tax cut would underestimate the pure effect of the tax cut
How to:
Measure the influence of a tax cut to the economy
• identify tax cuts, that are implemented independent from the current economic conditions —> exogenous tax cuts
e.g. by studying policy speeches or reports, in which the tax cuts were announced
—> study the economy after these „exogenous“ tax cuts
Romer and Romer:
How big is the effect of a tax increase of 1% on GDP?
Decreases the GDP by up to 3%
Which components of aggregate demand are most sensitive to tax changes?
Investment and durable goods (durable = haltbar)
How do tax changes influence the equilibrium?
Are changes positive or negative?
the overall effect is very limited.
gov‘t borrows money to cut taxes —> interest rate increases
—> but: in reality, investment actually increases after tax cut
—> the stimulating effect of the tax cut is bigger, than the crowding out effect, but the effect is very small (or ambigous)
