Chapter 9 Review Questions

Transcription

1 Chapr 9 Rviw Qusions. Using h - modl, show ha if marks clar and agns hav raional xpcaions hn mporary shocks canno hav prsisn ffcs on oupu. If marks clar and agns hav raional xpcaions hn mporary produciviy shocks canno hav prsisn ffcs on oupu. Th conomy will simply swich bwn wo diffrn quilibrium posiions. P LR ( Ŷ ) LR ( Ŷ ) ( = ˆ ) P P SR b ( P ) SR = a ˆ Ŷ Suppos h conomy sars of a poin a. If marks clar, and agns hav raional xpcaions, hn following an advrs produciviy shock h conomy will mov quickly from poin a o poin b. Th ransiion is fas bcaus wags and prics ar flxibl so chang quickly in rspons o any disquilibrium, and also bcaus pric xpcaions ar updad quickly. Howvr, if h produciviy shock is mporary, onc i disappars h conomy would hn b xpcd o mov back, qually fas, o is original posiion. Thrfor, flucuaions in oupu simply follow h flucuaions in produciviy innovaions. If hs ar shor livd, hn cycls will also b qui shor. Empirical vidnc nds o suggs ha businss cycls nd o las svral yars, so mporary shocks on hir own do no gnra prsisn nough oupu movmns. A prmann produciviy shock will gnra a prsisn ffc on oupu, bu his rflcs a chang in quilibrium and wouldn xplain cyclical movmns whr h ffcs on oupu ar prsisn bu ulimaly di away.

2 . How dos ral businss cycl hory xplain flucuaions in oupu and mploymn? From qusion, mporary shocks would only xpc o hav mporary ffcs on oupu. Th challng for RBC is o xplain why mporary shocks can cra susaind oupu movmns whn prics ar flxibl and agns form xpcaions raionally. To do his, RBC horiss argu ha h ffc of a shock on h conomy is h produc of impuls and propagaion ffcs. Th impuls is h acual produciviy shock; propagaion dscribs how his hn cras a susaind movmn in oupu. A common propagaion ffc is consumpion smoohing bhaviour. Housholds which maximis lifim uiliy subjc o lifim rsourcs will nd o us saving and borrowing o smooh consumpion ovr im. Thrfor, if currn incom riss du o a posiiv produciviy shock- raional maximising consumr will sav som of h procdurs o nabl highr fuur consumpion. This can b achivd by invsing in h capial sock, which hn cras susaind oupu movmns. For xampl, suppos oupu is a funcion of produciviy and h xising capial sock: = A F ( K ) All oupu or ihr consumd or savd = C + S Savings ar rcycld by financial insiuions such as banks ino loans ha financ corpora invsmn. S = I Th fuur capial sock will hrfor b a funcion of currn invsmn dcisions. K = g ( ) + I Thrfor, oupu nx priod is a funcion of h currn lvl of invsmn, or saving: = ( ( )) or + = A+ F( g( S) ) A F g I + + I is qui asy o s how consumpion smoohing bhaviour following a on priod produciviy shock can b propagad forward.

3 Th srngh of his propagaion ffc dpnds on h srngh of consumpion smoohing bhaviour. Criics would argu ha h propagaion ffcs nd o b qui wak. Givn ha oupu and mploymn nd o mov oghr ovr h businss cycl anohr challng for RBC horiss is o xplain how mporary produciviy shocks can gnra flucuaions in mploymn. A modl by Lucas and Rapping (nild Ral wags, mploymn and inflaion and publishd in 969 in h Journal of Poliical Economy) xamins how housholds alloca im bwn work and lisur in a wo priod modl. Thy propos ha mploymn in ach priod is dscribd by h following rlaionship N N = w w θ ( ) ( + ) + r σ Whr Ni is mploymn in ach priod, wi is h ral wag in ach priod, r is h inrs ra, θ h discoun ra and σ is h lasiciy of subsiuion. This ssnially argus ha h raio of mploymn in ach priod is posiivly rlad o h prsn discound valu of ral wags in ach priod. If w assum ha h discoun ra and h inrs ra ar h sam hn his maks hings asir, as mploymn simply movs in lin wih ral wags. N N w = w σ Ral wags ar assumd o mov in lin wih produciviy (h oucom of a compiiv labour mark). Thrfor a on priod produciviy shock would s wags and mploymn incras in ha priod. Th inuiion of h modl is ha ovr im, housholds work mor in priods of high ral wags and consum mor lisur in priods of low ral wags. If wags wr o ris in boh priods hr would b no subsiuion ffc of work bwn priods. Th ky lmn o h sory is h paramr σ or h lasiciy of subsiuion. This dscribs how willing housholds ar prpard o subsiu hours of labour ovr im. If his is larg, hn small changs in ral wags can gnra larg mploymn movmns, if small hn h mploymn ffcs ar vic-vrsa. Th lasiciy of subsiuion rflcs h curvaur of h disuiliy of work funcion. If his is vry curvd, hn i signals ha h marginal disuiliy from xra work in ach

4 priod is vry high, and hnc workrs ar lss likly o subsiu labour ovr im so h lasiciy is low. 3. Using h - modl, xplain how h prsnc of wag and/or pric rigidiis can lad o prsisn movmns in oupu following dmand shocks. P LR SR b a ˆ c w ŵ c a b PRW b BRW u û u A poin a h conomy is on h long run aggrga supply curv and unmploymn a h NAIRU, so boh goods and labour marks ar in quilibrium. Following a dmand shock h conomy movs down h shor run supply curv o poin b, and

5 consisn wih lowr oupu unmploymn riss abov h NAIRU. Howvr, h conomy would b xpcd o quilibra hrough falling prics and rurn back o h long run aggrga supply curv (NAIRU) a poin c. Th bargaind ral wag curv (BRW) is drivd from h wag sing bhaviour of workrs W = P ( Z βu) and h pric drmind ral wag agus ha firms s prics as a mark up on coss. P = W ( + μ) LP Ths wo rlaionships dscrib how a ris in unmploymn would hn b xpcd o bring abou h fall in h pric lvl rquird o mov h conomy back o is long run quilibrium lvl of oupu, and mploymn back o h NAIRU. u W P P W P P W... Th spd a which h conomy rurns o quilibrium dpnds on how flxibl ar wags and prics, and scond how quickly pric xpcaions ar adjusd in rspons o changs in acual prics. If hr ar significan nominal rigidiis, and pric xpcaions ar adjusd slowly hn prics adjus slowly. Thrfor, following a dmand shock h conomy migh dvia from is quilibrium lvl for a susaind priod of im. 4. Explain how mor accura conomic forcasing can mak i asir for policy makrs o sabiliz h conomy. Wha ohr problms migh policy makrs fac in opraing sabilizaion policy? I is rcognisd ha hr ar significan lags in opraing monary and fiscal policis. Monary policy can b changd quickly, bu may ak up o wo yars o fully ffc h conomy. On h ohr hand, fiscal policy has a mor immdia impac bu canno b changd so quickly.

6 As a rsul, sabilisaion policy rquirs pr-mpiv acion, whr h policy is nacd o ry and offs cyclical movmns in h fuur, rahr han waiing for h cycl o happn and assuming ha policy will work o immdialy chang i. Thrfor, sabilisaion policy rquirs accura forcass of h conomy. Firs o idnify any fuur cycl or shock ha rquirs offsing, hn in formulaing h rquird sabilisaion policy. P LR 3 SR d b a 3 ˆ c For xampl, suppos h conomy is in posiion a bu a ngaiv dmand shock is prdicd in h fuur. If his shock or movmn isn prdicd, hn h conomy will mov o poin b (a rcssion) whn h shock arrivs. If forcass dc h shock, bu fail o dc is magniud hn again h policy rspons migh b oo wak o provid an ffciv sabilisaion rmdy. Alrnaivly, if h sabilisaion rmdy is oo srong hn h conomy may bounc back oo far and nd up a poin d whr inflaionary prssurs rsul. This could happn bcaus h forcas of h drop in aggrga dmand was oo pssimisic, or bcaus h forcasd rspons of h rquird policy was oo wak. If policy-makrs g i jus righ h policy rspons will offs h shock and kp h conomy a poin a. Ths xampls idnify h imporanc of forcasing in sabilisaion policy. Gnraing accura forcass hough can b a vry difficul scinc. Firs, prdicing h fuur always carris unknowns, bu prscribing h righ policy rspons is also difficul. An xac knowldg of all h ky muliplirs and lasiciis would b rquird. Also, according o h Lucas criiqu, hs in hmslvs may no b sabl across diffrn policy rgims.

7 Mor advancd problms 5. If monary shocks ar corrlad wih oupu movmns, dos his suggs ha ral businss cycl is irrlvan. On of h ky assumpions of RBC hory is ha marks clar (so wags and prics ar flxibl) and agns in h conomy ar raional and uiliy maximising (so form raional xpcaions of prics). Undr hs condiions monary shocks would b nural, bcaus xpcaions, wags and prics will adjus quickly. Th pric lvl will chang bu oupu no, all ha happns in h conomy is a movmn along h long run aggrga supply curv. RBC proagoniss argu ha hs assumpions ar valid. Prics rspond o disquilibria in marks, and housholds ar raional. Givn his dscripion of h conomy- cycls can only aris from ral shocks such as produciviy movmns or changs in h supply and fficincy of facors of producion. If monary shocks ar corrlad wih oupu movmns, hn i would imply ha h condiions RBC horiss assum migh b wrong. On possibiliy is ha if a monary shock is unanicipad, hn vn hough marks clar and agns form raional xpcaions hy may b akn by surpris. I is no conrovrsial o argu ha agns do no hav prfc informaion, and can hrfor b surprisd. In his cas, a movmn in prics may b confusd wih a produciviy shock gnraing som shor run corrlaion bwn mony on oupu. Howvr, his would only las as long as agns coninu o b surprisd. I is also worh mnioning ha vn if h assumpions in RBH hory ar no nirly sadfas; shocks may sill b gnrad by produciviy movmns.

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