Managing Macroeconomic Fluctuations 1

Managing Economic Fluctuations

-Keynesian macro: - -term nominal interest rates. - - – . -

- .

– - -

Managing Macroeconomic Fluctuations 2

Review: New Keynesian Model

-run macroeconomics: - π = γ (Y −Y

P)+π e

+ ρ γ > 0 π

e ρ .

Y = Y d (r,...) = Y − d ⋅r r = r + λ ⋅π λ > 0 .

-run macroeconomics: -

Y = Y P

π e = π

ρ = 0 -

r = r * real rate

Y d (r,...) = Y P

- set

r = r *−λ ⋅π *

π *

-

Y P.

Managing Macroeconomic Fluctuations 3

Part 1: Disturbances and their effects:

Aggregate Demand Shock & No Response

- π↓ ↓.

- - π πe

-

logic

Managing Macroeconomic Fluctuations 4

Temporary Aggregate Supply Shock & No response

ations.

t

Managing Macroeconomic Fluctuations 5

Permanent Aggregate Supply Shock & No Response

. normal economic

-

.

Managing Macroeconomic Fluctuations 6

Part 2: Disturbances and policy responses – with focus on monetary policy:

Aggregate Demand Shock with Monetary Response

i↓ ↓ -

How does the Fed know

Managing Macroeconomic Fluctuations 7

Temporary Supply Shock: Policy Options

1. Stabilize inflation 2. Stabilize output ↑ ↑ ↓ ↓

es out.

- must - .

Managing Macroeconomic Fluctuations 8

Permanent Supply Shock: Policy Options

1. Stabilize inflation 2. Stabilize output ↑ ↑ ↓ ↓

. Accelerating inflation

- - – - Demand-Pull Inflation versus Cost-Push inflation

?

Managing Macroeconomic Fluctuations 9

Demand-Pull Inflation

.

–

Managing Macroeconomic Fluctuations 10

Cost-Push Inflation

—

Managing Macroeconomic Fluctuations 11

Why shifts in LRAS create complications:

Information: How much do we know about shocks?

π π : - π - π π

to monetary to -

s: only interest rates - ½-

- -– in

not – - From i

. - From u Disagreement about LRAS is a source of legitimate policy disputes.

Managing Macroeconomic Fluctuations 12

Output and Unemployment: Okun’s Law

-

U .

U >U ⇔Y < Y P -

Y P - :

U −U ≈ − 12 Y−Y P

Y P( ) = − 12Y P (Y −Y P )

ó

:

=> Information about potential output is quite imperfect. -

U

Y P as constants –

Managing Macroeconomic Fluctuations 13

Application: U.S. Inflation 1965-1982 - -

Question: What do we know about the

natural rate of unemployment?

Managing Macroeconomic Fluctuations 14

Updated Chart: August 2017

Managing Macroeconomic Fluctuations 15

More on: why shifts in LRAS create complications

Linkages between Supply and Demand

- insig -

-

- conomics – - - shocks - dynamic adjustment processes -run

–

-

-

-

Managing Macroeconomic Fluctuations 16

Lessons about Stabilization Policy . -

can - - lags

- -

cannot . - y- .

3 - Inflation is always and everywhere a monetary phenomenon. -

mostly metimes

When expectations matter, speculation about policy shifts can become a separate

source of shocks uncertainty

uncertainty

Managing Macroeconomic Fluctuations 17

Guide to Problem Solving – Systematic Approach

- - π

- - - .

.

1. Monetary: e.g.

Managing Macroeconomic Fluctuations 18

Examples from U.S. History:

Negative Supply Shocks: 1973-75, 1978-80 Oil Shocks

Managing Macroeconomic Fluctuations 19

Examples from U.S. History:

Paul Volcker’s Disinflation: 1980-86

Managing Macroeconomic Fluctuations 20

Examples from U.S. History #3:

Positive Supply Shocks: 1995-1999 -1994

Managing Macroeconomic Fluctuations 21

Examples from U.S. History :

Negative Demand Shocks in 2001-2004

Managing Macroeconomic Fluctuations 22

Examples from U.S. History:

Negative Shocks and the 2007-2009 Financial Crisis

Managing Macroeconomic Fluctuations 23

China in 2007-2009: Demand Shock Only

Managing Macroeconomic Fluctuations 24

The Taylor Rule

- - – - - –

–

- -

- - Keynesi