Академический Документы
Профессиональный Документы
Культура Документы
038
Advanced macroeconomics MJRI.10.042
I.e. other than the intertemporal-substitution and capital-accumulation mechanisms of basic real-business-cycle
models.
The IS Curve shows the combinations of output and the interest rate such
that planned and actual expenditures on output are equal.
Alternative (but not accurate) explanation: AD shows alternative equilibrium
points in the goods market.
Planned real expenditure function (general formulation) (eq. 5.1):
= (, , , ),
= ( | ) +
The LM Curve shows the combinations of output and the interest rate that
lead to equilibrium in the money market for a given price level.
The condition for supply and demand of real balance to be equal at a give
price level (eq. 5.7):
= (, ),
< 0,
> 0
| = >0
- LM is upward-sloping
- LM is steeper if income elasticity of money demand ( ) is higher and/or
interest elasticity ( ) is lower
Additional remarks about the IS-LM model:
- All assets other than money are treated as perfect substitutes
- Total wealth in the economy equals to the total value of all assets
- Total value of any individuals asset holdings must equal his or her total
wealth
- If the market for every asset but one clears, the market for the remaining
asset must also clear
- As in the IS-LM model are only two assets (money and everything else), only
one asset-market equilibrium is needed we look only at money market!
The AD Curve
The intersection of the IS and LM curves shows the values of i and Y such that
money market clears and actual and planned expenditures are equal (for any
given levels of , , , , ).
Next we derive the relationship between P and Y. Consider the effect in
increase in P (i.e. inflation):
- Since P does not enter in (), the IS curve is unaffected
- M/P decreases higher interest rate is needed to clear the money market
for a given level of Y LM curve shifts up
- As a result, i raises and Y falls (see Fig. 5.4) the level of output at the
intersection of IS and LM curves is a decreasing function of P.
To find the slope of the AD curve, differentiate (5.4) and (5.7) with respect
to P . This yields two equations in two unknowns (eq. 5.9 and 5.10):
| =
| +
|
|
|
Solving these equations gives (eq. 5.11), which shows the determinants of
the slope of AD curve:
2
<0
| =
[(1 ) ] +
domestic goods).
Higher real exchange rate implies that foreign goods are now more expensive
relative to domestic goods, so everyone (both domestically and abroad) wants
to by domestic goods planned expenditure rises.
Real exchange rate and planned expenditures move in the same direction!
Eq. (5.4) becomes (5.12):
= (, , , ,
)
() is increasing in
= ( , )
= (, , , ,
)
Vertical LM means that output for a given price level (i.e. the position of AD
curve) is determined entirely in the money market.
Example: if , then IS* shifts right appreciation of domestic currency ( ),
but no effect on output AD curve is unaffected (see Figure5.7).
In case of fixed exchange rate there are 2 changes in the model:
1) the exchange rate is pegged at some level (eq. 5.16): =
2) money supply becomes endogenous
3) AD is now determined by equations (5.7), (5.12), (5.13) and (5.16).
LM* equation can be neglected (determines only the M), so the model is
reduced to (i) upward-sloping IS* curve and (ii) horizontal line for = (Fig.5.8)
Changes in E now affect AD. If , then IS* shifts right and output increases
(for any P). Disturbances in the money market have no effect on Y.
()
Derivatives of both sides with respect to are equal (eq. 5.18):
=
[( + )]
[( + )]
+
()
()
i.e. risks are not covered, but investors are assumed to be risk-neutral.
8
() > 0
+ (, , , ,
)=0
(,
0 < < 1,
, , ) + (, , , ,
)
< 0,
> 0,
< 0
We can use (5.21) to substitute for net exports and thereby eliminate the
exchange rate from the model (eq. 5.23 and fig. 5.9):
= (, , , ) ( )
Note: exchange rate is implicitly changing as we move along the IS** curve.
Interest rate has double effect on Y and IS** is therefore flatter:
a) Direct effect on domestic demand
b) Indirect effect through the change in exchange rate and NX
() > 0,
() < 0
Firms are competitive. They hire labor up to the point where the marginal
product of labor equals the real wage (eq. 5.26):
() =
= ( ),
() > 0
Implications:
- Horisontal AS; fluctuations in AD cause firms to change E and Y until .
- Until and / (), labor demand curve is vertical (respective
E is called effective labor demand). Workers are on their curve and there
is no unemployment (see Fig. 5.13, point E).
- This model implies procyclical real wage and countercyclical markup (ratio
of price to marginal cost)
Case 3: Sticky Prices, Flexible Wages, and Real Labor Market Imperfections
Assume that firms have some real-wage function (eq. 5.29):
= (),
() 0
11
()
5.30):
= ()
12
()
>0
() > 0,
(eq. 5.31)
() < 0
(eq. 5.32)
(eq. 5.33)
AS0 and AS0 are initially steady, but then policymakers use fiscal or monetary
policy in period 1 to shift AD0 curve out to AD1. As a result, price level rises to
P1 and output rises to Y1 (see Figure 5.16, p. 244). The wage is adjusted to
previous periods inflation, by factor 1 0 (eq. 5.34):
2 1 1
=
=
1 0 0
If there is no further inflation, i.e. 2 = 1 , then the real wage is 1 1 = ,
which is equal to the real wage in period 0. Thus AS2 goes through the point
(Y0, P1) -> employment and output would be the same as in period 0.
This process can continue indefinitely: if policymakers follow expansionary
policies, they can keep output (and employment) at higher level at the cost of
inflation.
Phillips curve (Phillips 1958)
But this pattern started to disappear in the late 1960s and early 1970s
(see Figure 5.17)
WHY?
13
14
>0
or (eq. 5.36):
= + (ln ln ) +
Core or underlying inflation, equals the previous periods actual inflation
(eq. 5.37):
= 1
Replacing core inflation in (5.36) with expected inflation (eq. 5.38):
= + (ln ln ) +
We get the short-run aggregate supply curve in inflation-output space (eq.
5.39):
= + (1 )1 + (ln ln ) + ,
01
Implications:
- The core inflation is a weighted average of past inflation and expected future
inflation
- Core inflation is not just mechanical function of past inflation, but still there is
some link between these two
- No general model of aggregate supply
15