Presentation14 Monetary Policy - Drexeljpd48/Presentation14_Monetary_Policy.pdf ·...
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Macroeconomics Monetary Policy ECON 321
Transcript of Presentation14 Monetary Policy - Drexeljpd48/Presentation14_Monetary_Policy.pdf ·...
Macroeconomics+Monetary+Policy+
ECON+321+
Monetary+Policy+
€
MS = MD = PYη (r +π e )λ
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Y = income.i = r +π e, where π e is expected inflation.λ (empirically ≈ -.1) and η are parameterssuch that :dMD
di< o
dMD
dY> o
Monetary+Policy+
€
MS = MD = PYη (r +π e )λ
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ln(MD ) = ln(P) +ηln(Y ) + λ ln(r +π e )d ln(MD )
dt=d ln(P)dt
+ηd ln(Y )dt
+ λd ln(r +π e )
dt
gµ = π +ηgY + λgr + λΔπ e
π e (remember λ < 0)
gr = 0
gµ = µ = π +ηgY + λΔπ e
π e
Where we can see now that :η = elascticity of MD with respect to income.λ = elasticity of MD with respect to nominal interest rates.
Monetary+Policy+
€
gµ = µ = π +ηgY + λΔπ e
π e (remember λ < 0)
Δπ e
π e ≡is+the+percentage+change+in+infla;on+expecta;ons.++As+you+expect+infla;on+to+increase,+you+demand+less+money+because+you+expect+the+money+to+lose+value.+
Now+Suppose+the+change+in+expected+infla;on+is+0.+
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π = µ −ηgYThere+is+a+very+;ght+link+between+money+supply+and+infla;on.+
Money+Supply+and+Infla;on+
Money+Supply+and+Infla;on+
© 2007 Thomson South-Western
Figure 4 Money and Prices During Four Hyperinflations
(a) Austria (b) Hungary
Money supply
Price level
Index(Jan. 1921 = 100)
Index(July 1921 = 100)
Price level
100,000
10,000
1,000
10019251924192319221921
Money supply
100,000
10,000
1,000
10019251924192319221921
Money+Supply+and+Infla;on+
© 2007 Thomson South-Western
Figure 4 Money and Prices During Four Hyperinflations
(c) Germany
1
Index(Jan. 1921 = 100)
(d) Poland
100,000,000,000,000
1,000,000
10,000,000,0001,000,000,000,000
100,000,000
10,000100
Moneysupply
Price level
19251924192319221921
Price levelMoneysupply
Index(Jan. 1921 = 100)
100
10,000,000
100,000
1,000,000
10,000
1,000
19251924192319221921
German+HyperLInfla;on+
German+HyperLInfla;on+
German+HyperLInfla;on+
Zimbabwe+HyperLInfla;on+
Zimbabwe+HyperLInfla;on+
Zimbabwe+HyperLInfla;on+
Keynes+vs+Lucas+and+Friedman+• Ra;onal+Expecta;ons:+The+viewpoint+that+individuals+(consumers+or+firms)+make+es;mates+of+unknown+variables+u;lizing+all+available+informa;on.+
• Keynesian+Economics:+didn’t+put+much+stock+in+ra;onal+expecta;ons.++There+were+big+sets+of+equa;ons+without+individual+consumer+or+firm+reac;ons.++It+lacked+Micro+first+principals.+They+thought+they+could+eradicate+business+cycles.+
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i.e. C = αY + βr + γΠ
Keynes+vs+Lucas+and+Friedman+• Lucas+and+Friedman+came+along+and+said+hey+this+doesn’t+make+sense,+we+need+to+include+consumer+and+firm+reac;ons+in+these+models+because+people+will+start+to+figure+out+the+game.+
• This+has+major+implica;ons+for+policy+implica;ons.++For+instance+the+Phillips+Curve.+€
i.e. Δπe
π e
Phillips+Curve:+U=ŪLa(πLπ(E))+
.+π+
U++Ū+
π+>+π(E)+
π+=+π(E)+
π+<+π(E)+
Expecta;ons+aren’t+changing+here.++The+Fed+can+affect+unemployment+rates.+
S;cky+Prices+and+Unemployment+
P+
Y+
AD’+
SRAS+
LRAS=Y=AF(K,L,H,R)+
Y*+
AD+
Suppose+we+have+an+expansionary+monetary+policy.+++
If+WR+(real+wage)+=+WN/P+
So+as+prices+rise,+the+real+wage+will+fall,+and+there+will+be+a+reduc;on+in+unemployment+as+firms+hire+people.+Then+there+will+be+a+slow+adjustment+as+firms+and+workers+adjust+nominal+wages+and+we+will+see+the+SRAS+curve+shig+to+the+leg.++Eventually+we+will+be+at+a+higher+price+level+and+the+same+unemployment.+
If+people+expect+the+expansionary+monetary+policy+and+adjust+wages+immediately,+there+will+be+no+effects+on+unemployment.+
SRAS’+
A+B+
C+
Phillips+Curve+Performance+
Phillips+Curve+Performance:+50’s+and+60’s+
Phillips+Curve+Performance:+70’s+
Augmented+Phillips+Curve:+U=ŪLa(πLπ(E))+
.+π+
U++Ū+
π+=+π(E)+
π+=+π(E)+
The+curve+will+shig+now+shig+out+with+increases+in+expected+infla;on,+which+will+take+away+the+ability+of+the+Fed+to+affect+unemployment.+
Money+and+Infla;on+
ln(MD)+
ln(P)+slope+=+
€
gµ
slope+=+π+
ln(L(i,Y)))
ln(MD),+ln(P)+
;me+
Unexpected+Increase+In+Money+Supply+
ln(MD)+
ln(P)+
ln(L(i,Y)))
ln(MD),+ln(P)+
;me+
Unexpected+Increase+In+Growth+Rate+of+Money+Supply+
ln(MD)+
ln(P)+
ln(L(i,Y)))
ln(MD),+ln(P)+
;me+
€
Δπ e
π e = 0
Fed+Announces+at+(t0)+a+Future+Increase++in+Money+Supply+at+(t1)+
ln(MD)+
ln(P)+
ln(L(i,Y)))
ln(MD),+ln(P)+
;me+
€
Δπ e
π e ≠ 0
t1++++++++++++++++++t0+
Federal+Government+Budget+Constraint+
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Gt +Vt + rBt−1g =
Mt −Mt−1
Pt+ Bt
g − Bt−1g +Tt
Gt = Government ExpenditureVt = Government TransferBtg = Government Bonds
r = real interest rateTt = TaxesMt = Money SupplyPt = Price Level
++++resources++++++++spending+
Federal+Government+Budget+Constraint+
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Mt −Mt−1
Pt: acts like a tax.
C1
P1
+C2
(1+ r)P2
=Y1
P1
+Y2
(1+ r)P2
an ↑MS ⇒↑π ⇒↑P2 ⇒↓real future income Y2
(1+ r)P2
Inflation tax from ↑Mt −Mt−1
Pt
Federal+Government+Budget+Constraint+
€
Gt +Vt + rBt−1g =
Mt −Mt−1
Pt+ Bt
g − Bt−1g +Tt
Now+Suppose+a+government+is+in+terrible+debt.++Assume++++++++++gets+very+high+so+that+the+bond+market+thinks+the+debt+becomes+very+risky.++This+will+cause:++
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Btg
€
↑i⇒↓PB (which is the price the issuer gets.)So+the+bond+market+can+shut+down,+but+the+government+s;ll+has+to+pay++
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Gt +Vt + rBt−1g
So+there+are+two+not+so+fun+choices:+
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1) ↑Tt ⇒ Not so popular.2) ↑Mt ⇒ print money, but get rapid inflation.
