Zanetti Flashcards
RBC model based on 3 claims
- Efficiency of bus cycle fluctuations
- Tech shocks only ones to generate economic fluctuations
- Monetary factors unimportant (nominal rate =0 by Friedman rule)
How is unrealistic RBC used
As frictionless benchmark, hard to identify though
Optimal inflation rate
Beta
long-run equil output is
below efficient level
Commitment vs not in Barro Gordon results
Higher inflation with no commitment but same long-run output
Efficient varieties allocation without frictions
produce and consume same quantity of each good,
same amount of labour to all firms
Firms maximise profits but with frictions:
choose p facing own demand function
price adjustment costs
Inefficiency from monop. comp.
Markup leads to employment and output below optimum
Policy solution to markup problems
Employment subsidy to the firm such that 1-t=1/markup
2 staggered price setting distortions
- average markup varies over time (not the constant frictionless one)
- Prices and quantities vary across firms
Average markup
ratio of average price to average marginal cost
2 key equations in monetary policy optimal analysis
Household FOC (Euler) Firm FOC (Phillips Curve) (leads to normal IS, PC NK set up)
Why is price stability desirable even if policy maker doesn’t care directly about it
related to attainment of efficient allocation and output
Why does CB not need to worry about efficient level of output
will be obtained by successful price stabilisation
Interest rate rule has threat of strong response by CB to movement of output gap and inflation
Suffices to rule out such deviations
Able to achieve i=r natural rate with unique stable equil
Equil unique if
di/dpi>1 which is Taylor principle
Taylor type rule requires knowledge of
natural rate
comes from true model, parameter values and realised shocks
Endogenous rules fulfil
use observed variables only
don’t require parameter values knowledge
ideally approximate optimal rule
How to microfound a welfare function for mon. pol.
2nd order approx around zero inflation sty st
Marginal costs are related to output gap
output above natural requires hiring more workers requires higher real wages
Loss function increasing in effects of imperfections
elasticity of substitution for dispersion in quantity of goods
price stickiness amplifies price rigidities
in observable taylor rule
welfare losses from shocks:
increases in responsiveness to inflation or y effective in reducing welfare losses
Tech shock trade-off between stabilising and the output gap
Constant money growth rule compared to taylor
performs reasonably well but worse than aggressive taylor rule
output gap in PC vs loss function
why do frictions introduce mon. pol. trade-off
output gap in PC compared to natural level, not efficient level as in loss function
so flexible prices introduce mon. pol. trade off when frictions cause natural not to be efficient
Why is discretion a static problem in each period
no endogenous variables link periods
no debt or capital stock in equil in this model
In normal times the IS curve doesnt constrain mon. pol.
may be different under zlb
mon authority drives output below efficient level in response to +ve cost-push shock to deal with inflation
Commitment response to cost push shock
raise inflation
decrease output gap
history dependent adjustments
Commitment or discretion welfare improving?
commitment
attempt to stabilise output gap too fast in discretion
With distortion and optimal commitment
price level converges to constant
inflation bias avoided asymptotically
Where does the zlb problem come from
natural rate below 0
which is a function of unobservable shocks as well as positively depending on the discount rate
under zlb, main policy tool is
expectations which can be influenced by a commitment to hold rates low even after natural rate becomes +ve again (or change inflation target)
This still has an immediate effect even though policy is only influenced in the future
Problem with forward guidance model
not as effective as rational expectations model would predict
What can we learn from professional inflation forecaster errors
- forecast errors are serially correlated
- actual inflation tends to lead movements in expectations
- fall below 2% for some time after recession but return to 2% after
Can read in that inflation expectations are probably adaptive and anchored to some extents
What does rational expectations imply for y= eqn in NK
no discounting as households take the effect of future interest rates into general equil model
direct vs indirect effect of expected interest rates on output
direct on yt is same for all forward interest rates
indirect through impact of expected inflation
Hybrid expectations
Update forecast based on previous forecast error
Some belief of target
Suppress forward guidance impact
Stabilisation bias under discression
Attempt to stabilise the output gap faster than under commitment
Inflation bias phenomenon
CB tries to push output above natural steady state to reach efficient level, generating higher inflation
Long run output gap stays the same though so lower welfare
Solved asymptotically under commitment
Ramsey problem
Choosing optimal tax rates
taxes available are distortionary
Primal approach to Ramsey problem
find a set of taxes and prices such that allocations are PO in comp. equil.
Mirrlees approach to Ramsey problem
Focus on the best incentive vs insurance trade off
ie provide best insurance for low income whilst provide incentives to engage in production
requires mechanism design
optimal sty st capital income tax
0
to smooth distortions over time
optimal tax on K0
high as possible as inelastically supplied
If capital market imperfections, capital tax
redistributes wealth from those without credit constraints to those with
if this goes to more productive individual then would pay back with higher taxes in long run
Search friction externalities
Workers and firms bargain to split surplus
Do not internalise the effect on the unemployed who are not represented
Search: v= u= ξ= q= p= θ= δ= n= l=
v= number of vacancies u= number of unemployed ξ= contribution of unemployment to matching tech q= probability of filling vacancy p= probability of finding a job θ= v/u δ= exogenous separation rate n= number of employed l= total labour force n+u
beveridge curve u=
sep. rt/(sep. rt + p)
plot in the u,v space
η in search
fraction of total surplus going to workers
q(θ)=
p(θ)=
θ^-ξ
θ^(1-ξ)
κ=
cost per vacancy posted
output used for 2 things in search model:
consumption
cost of posting vacancies
job creation condition
marginal cost of posting an extra vacancy= marginal social benefit of posting an extra vacancy
b surplus from what?
not working
Hosios’ condition:
Job creation conditions for social planner and decentralised equil coincide (so equil is PO) if…
η = ξ
The worker’s bargaining power is equal to the elasticity of the
matching function with respect to unemployment
Search firm externality
if hiring too high, firms outside bargaining contract worse off
Worker externality
if unemployment too high, unemployed suffer from slack labour market with probability of finding job low
Duration of filling a vacancy
1/q
How to achieve socially efficient rate of unemployment
tax or subsidy on vacancies
if η < ξ:
policy needed
market wage too low, too many vacancies, too low unemployment
need tax on labour
Does the Hosios condition still apply with endogenous job separation
yes
Unemployment: causes and policy responses from classical vs NK
Classical: wages cause, employment subsidies response
NK: aggregated demand cause (so labour demand fixed maybe below equil, with higher wage), expand AD
Response to positive tech shock
Classical: increased labour productivity increases employment
NK: increases wage schedule for same reason but need fewer workers to meet demand so more unemployment, but overall effect depends on induced changes in real interest rates
