downward-sloping

1、Macroeconomics of Business Cyclesmacro Growth rates of real GDP, consumptionPercent change from 4 quarters earlierAverage growth rateReal GDP growth rateConsumption growth rateGrowth rates of real GDP, consumption, investmentPercent change from 4 quarters earlierInvestment growth rateReal GDP growth

2、 rateConsumption growth rateUnemploymentPercent of labor forceOkuns LawPercentage change in real GDPChange in unemployment rate19751982199120011984195119662003198720081971Facts about the business cycleGDP growth averages 33.5 percent per year over the long run with large fluctuations in the short ru

3、n.Consumption and investment fluctuate with GDP, but consumption tends to be less volatile and investment more volatile than GDP. Unemployment rises during recessions and falls during expansions. Okuns Law: the negative relationship between GDP and unemployment. Index of Leading Economic IndicatorsP

4、ublished monthly by the Conference Board.Aims to forecast changes in economic activity 6-9 months into the future. Used in planning by businesses and govt, despite not being a perfect predictor. Components of the LEI indexAverage workweek in manufacturingInitial weekly claims for unemployment insura

5、nceNew orders for consumer goods and materialsNew orders, nondefense capital goodsVendor performanceNew building permits issuedIndex of stock pricesM2Yield spread (10-year minus 3-month) on TreasuriesIndex of consumer expectationsIndex of Leading Economic IndicatorsSource: Conference Board2004 = 100

6、Time horizons in macroeconomicsLong run Prices are flexible, respond to changes in supply or demand.Short runMany prices are “sticky” at a predetermined level.The economy behaves much differently when prices are sticky.Recap of classical macro theory Output is determined by the supply side:supplies

7、of capital, labortechnologyChanges in demand for goods & services (C, I, G ) only affect prices, not quantities.Assumes complete price flexibility. Applies to the long run.When prices are stickyoutput and employment also depend on demand, which is affected by:fiscal policy (G and T )monetary policy

8、(M )other factors, like exogenous changes in C or I AD/AS ModelThe paradigm most mainstream economists and policymakers use to think about economic fluctuations and policies to stabilize the economy Shows how the price level and aggregate output are determinedShows how the economys behavior is diffe

9、rent in the short run and long runAggregate demandThe aggregate demand curve shows the relationship between the price level and the quantity of output demanded. we use a simple theory of AD based on the quantity theory of money. Recall the quantity equationM V = P Y For given values of M and V, this

10、 equation implies an inverse relationship between P and Y : Y = M V / PThe downward-sloping AD curveAn increase in the price level causes a fall in real money balances (M/P ),causing a decrease in the demand for goods & services.Y PADShifting the AD curveAn increase in the money supply shifts the AD

11、 curve to the right. Y PAD1AD2Aggregate supply in the long runRecall from Chapter 3: In the long run, output is determined by factor supplies and technologyis the full-employment or natural level of output, at which the economys resources are fully employed.“Full employment” means that unemployment

12、equals its natural rate (not zero).The long-run aggregate supply curveY PLRAS does not depend on P, so LRAS is vertical. Long-run effects of an increase in MY PAD1LRASAn increase in M shifts AD to the right. P1P2In the long run, this raises the price levelbut leaves output the same.AD2Aggregate supp

13、ly in the short runMany prices are sticky in the short run. For now we assume all prices are stuck at a predetermined level in the short run.firms are willing to sell as much at that price level as their customers are willing to buy. Therefore, the short-run aggregate supply (SRAS) curve is horizont

14、al:The short-run aggregate supply curveY PSRASThe SRAS curve is horizontal:The price level is fixed at a predetermined level, and firms sell as much as buyers demand.Short-run effects of an increase in MY PAD1In the short run when prices are sticky,causes output to rise.SRASY2Y1AD2an increase in agg

15、regate demandFrom the short run to the long runOver time, prices gradually become “unstuck.” When they do, will they rise or fall? risefallremain constantIn the short-run equilibrium, ifthen over time, P willThe adjustment of prices is what moves the economy to its long-run equilibrium.The SR & LR e

16、ffects of M 0Y PAD1LRASSRASP2Y2A = initial equilibriumABCB = new short-run eqm after Fed increases MC = long-run equilibriumAD2How shocking!shocks: exogenous changes in agg. supply or demandShocks temporarily push the economy away from full employment.Example: exogenous decrease in velocity If the m

17、oney supply is held constant, a decrease in V means people will be using their money in fewer transactions, causing a decrease in demand for goods and services.SRASLRASAD2The effects of a negative demand shockY PAD1P2Y2AD shifts left, depressing output and employment in the short run.ABCOver time, p

18、rices fall and the economy moves down its demand curve toward full-employment.Supply shocksA supply shock alters production costs, affects the prices that firms charge. (also called price shocks)Examples of adverse supply shocks:Bad weather reduces crop yields, pushing up food prices. Workers unioni

19、ze, negotiate wage increases. New environmental regulations require firms to reduce emissions. Firms charge higher prices to help cover the costs of compliance. Favorable supply shocks lower costs and prices.CASE STUDY: The 1970s oil shocksEarly 1970s: OPEC coordinates a reduction in the supply of o

20、il.Oil prices rose11% in 1973 68% in 1974 16% in 1975Such sharp oil price increases are supply shocks because they significantly impact production costs and prices.SRAS1Y PADLRASY2CASE STUDY: The 1970s oil shocksThe oil price shock shifts SRAS up, causing output and employment to fall. ABIn absence

21、of further price shocks, prices will fall over time and economy moves back toward full employment.SRAS2ACASE STUDY: The 1970s oil shocksPredicted effects of the oil shock: inflation output unemployment and then a gradual recovery.CASE STUDY: The 1970s oil shocksLate 1970s: As economy was recovering,

22、 oil prices shot up again, causing another huge supply shock!CASE STUDY: The 1980s oil shocks1980s: A favorable supply shock-a significant fall in oil prices. As the model predicts, inflation and unemployment fell: Stabilization policydef: policy actions aimed at reducing the severity of short-run e

23、conomic fluctuations.Example: Using monetary policy to combat the effects of adverse supply shocksStabilizing output with monetary policySRAS1Y PAD1BAY2LRASThe adverse supply shock moves the economy to point B.SRAS2Stabilizing output with monetary policyY PAD1BACY2LRASBut the Fed accommodates the sh

24、ock by raising agg. demand.results: P is permanently higher, but Y remains at its full-employment level.SRAS2AD2Aggregate Demand I:The IS-LM ModelThe IS-LM model determines income and the interest rate in the short run when P is fixedThe Big PictureKeynesianCrossTheory of Liquidity PreferenceIScurve

25、LM curveIS-LMmodelAgg. demandcurveAgg. supplycurveModel of Agg. Demand and Agg. SupplyExplanation of short-run fluctuationsThe Keynesian CrossA simple closed economy model in which income is determined by expenditure. (due to J.M. Keynes)Notation: I = planned investmentPE = C + I + G = planned expen

26、ditureY = real GDP = actual expenditureDifference between actual & planned expenditure = unplanned inventory investmentElements of the Keynesian Crossconsumption function:for now, plannedinvestment is exogenous:planned expenditure:equilibrium condition:govt policy variables:actual expenditure = plan

27、ned expenditureGraphing planned expenditureincome, output, Y PEplannedexpenditurePE =C +I +G MPC1Graphing the equilibrium conditionincome, output, Y PEplannedexpenditurePE =Y 45The equilibrium value of incomeincome, output, Y PEplannedexpenditurePE =Y PE =C +I +G Equilibrium incomeAn increase in gov

28、ernment purchasesY PEPE =Y PE =C +I +G1PE1 = Y1PE =C +I +G2PE2 = Y2YAt Y1, there is now an unplanned drop in inventoryso firms increase output, and income rises toward a new equilibrium.GSolving for Yequilibrium conditionin changesbecause I exogenousbecause C = MPC Y Collect terms with Y on the left

29、 side of the equals sign:Solve for Y :The government purchases multiplierExample: If MPC = 0.8, thenDefinition: the increase in income resulting from a $1 increase in G.In this model, the govt purchases multiplier equalsAn increase in G causes income to increase 5 times as much!Why the multiplier is

30、 greater than 1Initially, the increase in G causes an equal increase in Y: Y = G.But Y C further Y further C further YSo the final impact on income is much bigger than the initial G.An increase in taxesY PEPE =Y PE =C2 +I +GPE2 = Y2PE =C1 +I +GPE1 = Y1YAt Y1, there is now an unplanned inventory buil

31、dupso firms reduce output, and income falls toward a new equilibriumC = MPC TInitially, the tax increase reduces consumption, and therefore PE:Solving for Yeqm condition in changesI and G exogenousSolving for Y :Final result:The tax multiplierdef: the change in income resulting from a $1 increase in

32、 T :If MPC = 0.8, then the tax multiplier equalsThe tax multiplieris negative: A tax increase reduces C, which reduces income.is greater than one (in absolute value): A change in taxes has a multiplier effect on income. is smaller than the govt spending multiplier: Consumers save the fraction (1 MPC

33、) of a tax cut, so the initial boost in spending from a tax cut is smaller than from an equal increase in G. The IS curvedef: a graph of all combinations of r and Y that result in goods market equilibrium i.e. actual output = planned expenditureThe equation for the IS curve is:J.R. HicksY2Y1Y2Y1Deri

34、ving the IS curver IY PErY PE =C +I (r1 )+G PE =C +I (r2 )+G r1r2PE =YIS I PE YWhy the IS curve is negatively slopedA fall in the interest rate motivates firms to increase investment spending, which drives up total planned spending (PE ). To restore equilibrium in the goods market, output (a.k.a. ac

35、tual expenditure, Y ) must increase. Fiscal Policy and the IS curveWe can use the IS-LM model to see how fiscal policy (G and T ) affects aggregate demand and output. Lets start by using the Keynesian cross to see how fiscal policy shifts the IS curveY2Y1Y2Y1Shifting the IS curve: GAt any value of r

36、, G PE YY PErY PE =C +I (r1 )+G1 PE =C +I (r1 )+G2 r1PE =YIS1The horizontal distance of the IS shift equals IS2so the IS curve shifts to the right.YNOW YOU TRY: Shifting the IS curve: TUse the diagram of the Keynesian cross or loanable funds model to show how an increase in taxes shifts the IS curve

37、.The Theory of Liquidity PreferenceDue to John Maynard Keynes.A simple theory in which the interest rate is determined by money supply and money demand. EquilibriumThe interest rate adjusts to equate the supply and demand for money:M/P real money balancesrinterestrateL (r ) r1How the Fed raises the

38、interest rateTo increase r, Fed reduces MM/P real money balancesrinterestrateL (r ) r1r2The LM curveNow lets put Y back into the money demand function:The LM curve is a graph of all combinations of r and Y that equate the supply and demand for real money balances.The equation for the LM curve is:Der

39、iving the LM curveM/P rL (r , Y1 ) r1r2rYY1r1L (r , Y2 ) r2Y2LM(a)The market for real money balances(b) The LM curveWhy the LM curve is upward slopingAn increase in income raises money demand. Since the supply of real balances is fixed, there is now excess demand in the money market at the initial i

40、nterest rate. The interest rate must rise to restore equilibrium in the money market.How M shifts the LM curveM/P rL (r , Y1 ) r1r2rYY1r1r2LM1(a)The market for real money balances(b) The LM curveLM2The short-run equilibriumThe short-run equilibrium is the combination of r and Y that simultaneously s

41、atisfies the equilibrium conditions in the goods & money markets: Y rISLMEquilibriuminterestrateEquilibriumlevel ofincomePolicy analysis with the IS -LM modelWe can use the IS-LM model to analyze the effects offiscal policy: G and/or Tmonetary policy: MISY rLMr1Y1causing output & income to rise. IS1

42、An increase in government purchases1. IS curve shifts right Y rLMr1Y1IS2Y2r21.2. This raises money demand, causing the interest rate to rise2.3. which reduces investment, so the final increase in Y3.IS11.A tax cutY rLMr1Y1IS2Y2r2Consumers save (1MPC) of the tax cut, so the initial boost in spending

43、is smaller for T than for an equal G and the IS curve shifts by1.2.2.so the effects on r and Y are smaller for T than for an equal G. 2.2.causing the interest rate to fall ISMonetary policy: An increase in M1. M 0 shifts the LM curve down(or to the right)Y rLM1r1Y1Y2r2LM23.which increases investment

44、, causing output & income to rise. The Feds response to G 0Suppose Congress increases G.Possible Fed responses:1. hold M constant2. hold r constant3. hold Y constantIn each case, the effects of the G are different If Congress raises G, the IS curve shifts right.IS1Response 1: Hold M constantY rLM1r1

45、Y1IS2Y2r2If Fed holds M constant, then LM curve doesnt shift.Results:If Congress raises G, the IS curve shifts right.IS1Response 2: Hold r constantY rLM1r1Y1IS2Y2r2To keep r constant, Fed increases M to shift LM curve right.LM2Y3Results:IS1Response 3: Hold Y constantY rLM1r1IS2Y2r2To keep Y constant

46、, Fed reduces M to shift LM curve left.LM2Results:Y1r3If Congress raises G, the IS curve shifts right.Estimates of fiscal policy multipliersfrom the DRI macroeconometric modelAssumption about monetary policyEstimated value of Y / G Fed holds nominal interest rate constantFed holds money supply const

47、ant1.930.60Estimated value of Y / T 1.190.26Shocks in the IS -LM modelIS shocks: exogenous changes in the demand for goods & services. Examples: stock market boom or crash change in households wealth C change in business or consumer confidence or expectations I and/or CShocks in the IS -LM modelLM s

48、hocks: exogenous changes in the demand for money. Examples:a wave of credit card fraud increases demand for money.more ATMs or the Internet reduce money demand.NOW YOU TRY: Analyze shocks with the IS-LM ModelUse the IS-LM model to analyze the effects of1.a boom in the stock market that makes consume

49、rs wealthier.2.after a wave of credit card fraud, consumers using cash more frequently in transactions.For each shock, a.use the IS-LM diagram to show the effects of the shock on Y and r.b.determine what happens to C, I, and the unemployment rate.CASE STUDY: The U.S. recession of 2001During 2001, 2.

50、1 million jobs lost, unemployment rose from 3.9% to 5.8%.GDP growth slowed to 0.8% (compared to 3.9% average annual growth during 1994-2000). CASE STUDY: The U.S. recession of 2001Causes: 1) Stock market decline C30060090012001500199519961997199819992000200120022003Index (1942 = 100)S&P 500CASE STUD

51、Y: The U.S. recession of 2001Causes: 2) 9/11increased uncertaintyfall in consumer & business confidenceresult: lower spending, IS curve shifted leftCauses: 3) Corporate accounting scandalsEnron, WorldCom, etc. reduced stock prices, discouraged investmentCASE STUDY: The U.S. recession of 2001Fiscal p

52、olicy response: shifted IS curve righttax cuts in 2001 and 2003spending increasesairline industry bailoutNYC reconstruction Afghanistan warCASE STUDY: The U.S. recession of 2001Monetary policy response: shifted LM curve rightThree-month T-Bill Rate0123456701/01/200004/02/200007/03/200010/03/200001/0

53、3/200104/05/200107/06/200110/06/200101/06/200204/08/200207/09/200210/09/200201/09/200304/11/2003IS-LM and aggregate demandSo far, weve been using the IS-LM model to analyze the short run, when the price level is assumed fixed. However, a change in P would shift LM and therefore affect Y. The aggrega

54、te demand curve (introduced in Chap. 9) captures this relationship between P and Y.Y1Y2Deriving the AD curveY rY PISLM(P1)LM(P2)ADP1P2Y2Y1r2r1Intuition for slope of AD curve:P (M/P ) LM shifts left r I Y Monetary policy and the AD curveY PISLM(M2/P1)LM(M1/P1)AD1P1Y1Y1Y2Y2r1r2The Fed can increase agg

55、regate demand:M LM shifts rightAD2Y r r I Y at each value of PY2Y2r2Y1Y1r1Fiscal policy and the AD curveY rY PIS1LMAD1P1Expansionary fiscal policy (G and/or T ) increases agg. demand:T C IS shifts right Y at each value of PAD2IS2IS-LM and AD-AS in the short run & long runRecall from Chapter 9: The f

56、orce that moves the economy from the short run to the long run is the gradual adjustment of prices.risefallremain constantIn the short-run equilibrium, ifthen over time, the price level willThe SR and LR effects of an IS shockA negative IS shock shifts IS and AD left, causing Y to fall. Y rY PLRASLR

57、ASIS1SRAS1P1LM(P1)IS2AD2AD1The SR and LR effects of an IS shockY rY PLRASLRASIS1SRAS1P1LM(P1)IS2AD2AD1In the new short-run equilibrium, The SR and LR effects of an IS shockY rY PLRASLRASIS1SRAS1P1LM(P1)IS2AD2AD1In the new short-run equilibrium, Over time, P gradually falls, causingSRAS to move downM

58、/P to increase, which causes LM to move down AD2The SR and LR effects of an IS shockY rY PLRASLRASIS1SRAS1P1LM(P1)IS2AD1SRAS2P2LM(P2)Over time, P gradually falls, causingSRAS to move downM/P to increase, which causes LM to move down AD2SRAS2P2LM(P2)The SR and LR effects of an IS shockY rY PLRASLRASI

59、S1SRAS1P1LM(P1)IS2AD1This process continues until economy reaches a long-run equilibrium with NOW YOU TRY: Analyze SR & LR effects of MDraw the IS-LM and AD-AS diagrams as shown here. Suppose Fed increases M. Show the short-run effects on your graphs. Show what happens in the transition from the sho

60、rt run to the long run. How do the new long-run equilibrium values of the endogenous variables compare to their initial values? Y rY PLRASLRASISSRAS1P1LM(M1/P1)AD1The Great DepressionUnemployment (right scale)Real GNP(left scale)120140160180200220240192919311933193519371939billions of 1958 dollars05