Source: US. Bureau of Economic Analysis Shaded areas indicate US recessions research.stlouisfed.org

Transcription

1 Business Cycles

2 0 Real Gross Domestic Product 18,000 16,000 (Billions of Chained 2009 Dollars) 14,000 12,000 10,000 8,000 6,000 4,000 2, Source: US. Bureau of Economic Analysis Shaded areas indicate US recessions research.stlouisfed.org

3 Real Gross Domestic Product (Percent Change from Year Ago) Source: US. Bureau of Economic Analysis research.stlouisfed.org

4 Recession Unusually low growth of output over a long period Rising unemployment

5 Recession Unusually low growth of output over a long period Rising unemployment National Bureau of Economic Research Most recent recession: 3rd quarter, nd quarter, 2009

6 Recession Unusually low growth of output over a long period Rising unemployment National Bureau of Economic Research Most recent recession: 3rd quarter, nd quarter, 2009 Note on GDP growth timing: Measure from exactly a year earlier Suppose I tell you at the end of January that GDP fell by 2% that month

7 Business Cycles

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11 Corelations with GDP growth: Consumption growth: + Investment growth: + Unemployment: Employment: + Okun s Law

12 Corelations with GDP growth: Consumption growth: + Investment growth: + Unemployment: Employment: + Okun s Law Magnitudes: % I > % C

13 Corelations with GDP growth: Consumption growth: + Investment growth: + Unemployment: Employment: + Okun s Law Magnitudes: % I > % C Major goal of theory: Secondary goal: explain observed correlations explain magnitudes

14 Okun s Law in the US Correlation: -.89 Line: % Y = 3% 2 u

15 Okun s Law in the US Correlation: -.89 Line: % Y = 3% 2 u What if u goes from 5% to 9%?

16 Aggregate Demand and Aggregate Supply

17 Simple Aggregate Demand Relationship between output demanded and aggregate price level P Y

18 Simple Aggregate Demand Relationship between output demanded and aggregate price level Simple examples: MV = P Y P ( ) M P s = ( ) M P d = L (i, Y ) Y

19 Simple Aggregate Demand Relationship between output demanded and aggregate price level Simple examples: MV = P Y P ( ) M P s = ( ) M P d = L (i, Y ) AD Y

20 Simple Aggregate Demand Relationship between output demanded and aggregate price level Simple examples: MV = P Y P ( ) M P s = ( ) M P d = L (i, Y ) Less simple example: IS-LM system AD Y

21 Why does AD slope down? Most demand curves:

22 Why does AD slope down? Most demand curves: falling marginal benefit

23 Why does AD slope down? Most demand curves: falling marginal benefit AD is different:

24 Why does AD slope down? Most demand curves: falling marginal benefit AD is different: drawn for fixed M, so if P rises, purchases must fall

25 What if M changes? ( M P ) = L (i, Y ) or P = 1 k M Y P AD 1 Y

26 What if M changes? ( M P ) = L (i, Y ) or P = 1 k M Y P AD 2 AD 1 Y

27 What if M changes? ( M P ) = L (i, Y ) or P = 1 k M Y P AD 2 AD 1 Y Note: velocity (or 1 k ) also can change

28 IS-LM gives us AD Relax the assumption of P

29 IS-LM gives us AD Relax the assumption of P Higher P reduces real money balances ( ) M P

30 IS-LM gives us AD Relax the assumption of P Higher P reduces real money balances ( ) M P

31 IS-LM AD practice Work through: 1. effect of an increase in G 2. effect of new tech that increases MPK 3. effect of an increase in M 4. effect of an increase in P 5. effect of an increase in T 6. a loss of consumer confidence ( Animal spirits )...but now finishing with AD

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34 Aggregate Demand with inflation Relationship between Y and π CB is usually increasing money supply over time When inflation is high, CB raises interest rates to fight it Higher r lowers I, lowering Y

35 Long-run AS Relationship between π and Y

36 Long-run AS Relationship between π and Y Output determined by

37 Long-run AS Relationship between π and Y Output determined by Capital Labor supplied at full employment Technology

38 Long-run AS Relationship between π and Y Output determined by Capital Labor supplied at full employment Technology Not inflation

39 Long-run AS Relationship between π and Y Output determined by Capital Labor supplied at full employment Technology Not inflation π LRAS Y

40 Long-run AS Relationship between π and Y Output determined by Capital Labor supplied at full employment Technology Not inflation Terminology Natural rate of output Potential GDP Natural rate of unemployment Classical dichotomy π LRAS Y

41 Combine LRAS and AD π LRAS Y

42 Combine LRAS and AD π LRAS AD 1 Y

43 Combine LRAS and AD π LRAS Equilibrium Inflation AD 1 Y

44 Combine LRAS and AD π LRAS Equilibrium Inflation AD 2 AD 1 Y

45 Short-run AS Sticky prices: Menu costs Angry customers Some price changes are temporary Prices set by contracts Imperfect/incomplete information

46 How many times per year does your firm change prices?

47 Short-run AS Things that cause firms to raise prices:

48 Short-run AS Things that cause firms to raise prices: Expected inflation

49 Short-run AS Things that cause firms to raise prices: Expected inflation Output gap

50 Short-run AS Things that cause firms to raise prices: Expected inflation Output gap Inflation shocks

51 Short-run AS Things that cause firms to raise prices: Expected inflation Output gap Inflation shocks π SRAS = π e + γ ( Y SRAS Y P ) + ρ (1)

52 SRAS shifts π LRAS SRAS AD Y

53 SRAS shifts π LRAS SRAS AD Y Why do they cross at the same point?

54 SRAS shifts LRAS SRAS π AD Y Why do they cross at the same point? SRAS conditional on π e

55 SRAS shifts LRAS SRAS π AD Y Why do they cross at the same point? SRAS conditional on π e Every point on LRAS has a separate SRAS

56 Demand shift and transition to LR π LRAS SRAS AD Y

57 Demand shift and transition to LR π LRAS SRAS AD 2 AD 1 Y

58 Demand shift and transition to LR π LRAS SRAS 2 SRAS 1 AD 2 AD 1 Y

59 Show what will happen in our AD-AS framework in each scenario: 1. Suppose the Fed issues a press release stating that they will keep interest rates low until unemployment falls below a particular level 2. Show the effect on the US from an oil field discovery in Jordan 3. Aggregate output grows by 2 3% per year in the US 4. How will SRAS change if prices become less sticky? 5. The CB becomes more responsive to inflation 6. Access to credit cards lowers the demand for money

60 Supply shock: typical diagram π LRAS SRAS AD Y

61 Supply shock: typical diagram π LRAS SRAS 2 SRAS 1 AD 1 Y

62 Supply shock: typical diagram π LRAS SRAS 2 SRAS 1 SRAS 3 AD 1 Y

63 Long-run growth Aggregate output grows by 2 3% per year in the US

64 Long-run growth Aggregate output grows by 2 3% per year in the US LRAS 1 SRAS 1 π AD 1 Y

65 Long-run growth Aggregate output grows by 2 3% per year in the US LRAS 1 LRAS 2 SRAS 1 π SRAS 2 AD 2 AD 1 Y

66 Micro origins of upward-sloping SRAS: market power Think about an individual firm with a little market power: p s = P + a ( Y Y ) (2)

67 Micro origins of upward-sloping SRAS: market power Think about an individual firm with a little market power: p s = P + a ( Y Y ) (2) p s = P on average

68 Micro origins of upward-sloping SRAS: market power Think about an individual firm with a little market power: p s = P + a ( Y Y ) (2) p s = P on average If Y is high, MC is high, so firm charges higher price

69 Micro origins of upward-sloping SRAS: market power Think about an individual firm with a little market power: p s = P + a ( Y Y ) (2) p s = P on average If Y is high, MC is high, so firm charges higher price Suppose s proportion set price in advance (p s = EP ) 1 s proportion follow the rule in real time

70 Micro origins of upward-sloping SRAS: market power P = sep + (1 s) ( P + a [ Y Y ]) (3)

71 Micro origins of upward-sloping SRAS: market power P = sep + (1 s) ( P + a [ Y Y ]) (3) Solve for P : P = EP + 1 s a ( Y Y ) (4) s

72 Micro origins of upward-sloping SRAS: market power P = sep + (1 s) ( P + a [ Y Y ]) (3) Solve for P : P = EP + 1 s a ( Y Y ) (4) s Prices fixed in advance make EP the average

73 Micro origins of upward-sloping SRAS: market power P = sep + (1 s) ( P + a [ Y Y ]) (3) Solve for P : P = EP + 1 s a ( Y Y ) (4) s Prices fixed in advance make EP the average High Y means some firms raise their prices

74 Micro origins of upward-sloping SRAS: market power P = EP + 1 s a ( Y Y ) (5) s Y = Y + α (P EP ) (6)

75 Lucas islands model (imperfect info) No price rigidity

76 Lucas islands model (imperfect info) No price rigidity Firms

77 Lucas islands model (imperfect info) No price rigidity Firms Know their own prices

78 Lucas islands model (imperfect info) No price rigidity Firms Know their own prices Do not know many other prices

79 Lucas islands model (imperfect info) No price rigidity Firms Know their own prices Do not know many other prices Must guess whether increased willingness to pay (higher demand price) is due to inflation or to real changes (e.g. wealth, preferences, or a productivity shock in other markets)

80 Lucas islands model (imperfect info) No price rigidity Firms Know their own prices Do not know many other prices Must guess whether increased willingness to pay (higher demand price) is due to inflation or to real changes (e.g. wealth, preferences, or a productivity shock in other markets) Stable AD

81 Lucas islands model (imperfect info) No price rigidity Firms Know their own prices Do not know many other prices Must guess whether increased willingness to pay (higher demand price) is due to inflation or to real changes (e.g. wealth, preferences, or a productivity shock in other markets) Stable AD expect most changes are real

82 Lucas islands model (imperfect info) No price rigidity Firms Know their own prices Do not know many other prices Must guess whether increased willingness to pay (higher demand price) is due to inflation or to real changes (e.g. wealth, preferences, or a productivity shock in other markets) Stable AD expect most changes are real Unstable AD

83 Lucas islands model (imperfect info) No price rigidity Firms Know their own prices Do not know many other prices Must guess whether increased willingness to pay (higher demand price) is due to inflation or to real changes (e.g. wealth, preferences, or a productivity shock in other markets) Stable AD expect most changes are real Unstable AD expect most changes are due to price level fluctuations

84 Lucas islands model (imperfect info) Expectations determine α: Y = Y + α (P EP ) (7)

85 Lucas islands model (imperfect info) Expectations determine α: Y = Y + α (P EP ) (7) Stable AD Unstable AD

86 Lucas islands model (imperfect info) Expectations determine α: Y = Y + α (P EP ) (7) Stable AD high α Unstable AD

87 Lucas islands model (imperfect info) Expectations determine α: Y = Y + α (P EP ) (7) Stable AD high α Unstable AD small α

88 Lucas islands model (imperfect info) Expectations determine α: Y = Y + α (P EP ) (7) Stable AD high α Unstable AD small α Empirical claim: nations with more stable prices see bigger impacts from AD shifts (flatter SRAS)

89 Lucas islands model (imperfect info) Expectations determine α: Y = Y + α (P EP ) (7) Stable AD high α Unstable AD small α Empirical claim: nations with more stable prices see bigger impacts from AD shifts (flatter SRAS) But...

90 Lucas islands model (imperfect info) Expectations determine α: Y = Y + α (P EP ) (7) Stable AD high α Unstable AD small α Empirical claim: nations with more stable prices see bigger impacts from AD shifts (flatter SRAS) But... firms in nations with highly variable inflation will not set prices beforehand, so sticky price models predict the same empirical facts

91 Phillips Curve

92 Phillips Curve?

93 Deriving the Phillips Curve P = EP + ( ) 1 (Y ) Y + ν (8) α

94 Deriving the Phillips Curve ( ) 1 (Y ) P = EP + Y + ν α (8) ( ) 1 (Y ) P P 1 = EP P 1 + Y + ν α (9)

95 Deriving the Phillips Curve ( ) 1 (Y ) P = EP + Y + ν α (8) ( ) 1 (Y ) P P 1 = EP P 1 + Y + ν α (9) ( ) 1 (Y ) π = Eπ + Y + ν α (10)

96 Deriving the Phillips Curve ( ) 1 (Y ) P = EP + Y + ν α (8) ( ) 1 (Y ) P P 1 = EP P 1 + Y + ν α (9) ( ) 1 (Y ) π = Eπ + Y + ν α (10) Okun s Law: ( ) 1 (Y ) ( Y = β u u N ) α

97 Deriving the Phillips Curve ( ) 1 (Y ) P = EP + Y + ν α (8) ( ) 1 (Y ) P P 1 = EP P 1 + Y + ν α (9) ( ) 1 (Y ) π = Eπ + Y + ν α (10) Okun s Law: ( ) 1 (Y ) ( Y = β u u N ) α π = Eπ + β ( u u N) + ν (11)

98 Phillips Curve observations π = Eπ + β ( u u N) + ν

99 Phillips Curve observations π = Eπ + β ( u u N) + ν It is a representation of the same facts that build AS

100 Phillips Curve observations π = Eπ + β ( u u N) + ν It is a representation of the same facts that build AS Theory implies the curve is real

101 Phillips Curve observations π = Eπ + β ( u u N) + ν It is a representation of the same facts that build AS Theory implies the curve is real Includes expected inflation

102 π = Eπ + β ( u u N) + ν (12)

103 π = Eπ + β ( u u N) + ν (12) When will policy manipulations of this relationship stop working?

104 π = Eπ + β ( u u N) + ν (13)

105 Phillips Curve? π = Eπ + β ( u u N) + ν

106 Phillips Curve? π = Eπ + β ( u u N) + ν Only a short-run relationship

107 The Phillips Curve is clockwise

108 What determines Eπ? Adaptive expectations: π = π 1

109 What determines Eπ? Adaptive expectations: π = π 1 π = π 1 β ( u u N) + ν

110 What determines Eπ? Adaptive expectations: π = π 1 π = π 1 β ( u u N) + ν u N : non-accelerating inflation rate of unemployment

111 What determines Eπ? Adaptive expectations: π = π 1 π = π 1 β ( u u N) + ν u N : non-accelerating inflation rate of unemployment Idea: if prices have risen quickly in the past, the SRAS will shift up quickly

112 What determines Eπ? Adaptive expectations: π = π 1 π = π 1 β ( u u N) + ν u N : non-accelerating inflation rate of unemployment Idea: if prices have risen quickly in the past, the SRAS will shift up quickly What is going on with AD, though?

113 What determines Eπ? Adaptive expectations: π = π 1 π = π 1 β ( u u N) + ν u N : non-accelerating inflation rate of unemployment Idea: if prices have risen quickly in the past, the SRAS will shift up quickly What is going on with AD, though? AD must be rising for u = u N at π = π 1

114 What determines Eπ? Adaptive expectations: π = π 1 π = π 1 β ( u u N) + ν u N : non-accelerating inflation rate of unemployment Idea: if prices have risen quickly in the past, the SRAS will shift up quickly What is going on with AD, though? AD must be rising for u = u N at π = π 1 AD rising for same reason that people expect Eπ = π 1 : money growth

115 What determines Eπ? Adaptive expectations: π = π 1 π = π 1 β ( u u N) + ν u N : non-accelerating inflation rate of unemployment Idea: if prices have risen quickly in the past, the SRAS will shift up quickly What is going on with AD, though? AD must be rising for u = u N at π = π 1 AD rising for same reason that people expect Eπ = π 1 : money growth Is this model of expectations consistent with real behavior?

116 Disinflation Adaptive (or naive) expectations recession from disinflation (See Phillips Curve and AD-AS)

117 Disinflation Adaptive (or naive) expectations recession from disinflation (See Phillips Curve and AD-AS) How can we get disinflation with no problems?

118 Disinflation Adaptive (or naive) expectations recession from disinflation (See Phillips Curve and AD-AS) How can we get disinflation with no problems? Rational

119 Disinflation Adaptive (or naive) expectations recession from disinflation (See Phillips Curve and AD-AS) How can we get disinflation with no problems? Rational Truth is probably somewhere between the extremes

120 What is the sacrifice ratio? How much GDP do we have to give up to bring down inflation by 1%?

121 What is the sacrifice ratio? How much GDP do we have to give up to bring down inflation by 1%? Usually 5%

122 What is the sacrifice ratio? How much GDP do we have to give up to bring down inflation by 1%? Usually 5% Okun s Law: 1% higher u (over a year) 2% lower GDP

123 What is the sacrifice ratio? How much GDP do we have to give up to bring down inflation by 1%? Usually 5% Okun s Law: 1% higher u (over a year) 2% lower GDP How much more u do we need to reduce π by 1%?

124 What is the sacrifice ratio? How much GDP do we have to give up to bring down inflation by 1%? Usually 5% Okun s Law: 1% higher u (over a year) 2% lower GDP How much more u do we need to reduce π by 1%? 2.5%

125 Sacrifice ratio What if we want to reduce inflation from 9.7% to 3% over 4 years?

126 Sacrifice ratio What if we want to reduce inflation from 9.7% to 3% over 4 years? 3.5% + 3.5% + 1.4%1.1% = 9.5% unemployment years

127 Sacrifice ratio What if we want to reduce inflation from 9.7% to 3% over 4 years? 3.5% + 3.5% + 1.4%1.1% = 9.5% unemployment years 9.5%u GDP loss

128 Sacrifice ratio What if we want to reduce inflation from 9.7% to 3% over 4 years? 3.5% + 3.5% + 1.4%1.1% = 9.5% unemployment years 9.5%u 19% GDP loss

129 Sacrifice ratio What if we want to reduce inflation from 9.7% to 3% over 4 years? 3.5% + 3.5% + 1.4%1.1% = 9.5% unemployment years 9.5%u 19% GDP loss Sacrifice ratio in the Volcker recession:

130 Sacrifice ratio What if we want to reduce inflation from 9.7% to 3% over 4 years? 3.5% + 3.5% + 1.4%1.1% = 9.5% unemployment years 9.5%u 19% GDP loss Sacrifice ratio in the Volcker recession: = 2.8

131 Faster disinflations have lower sacrifice ratios Sacrifice ratio What if we want to reduce inflation from 9.7% to 3% over 4 years? 3.5% + 3.5% + 1.4%1.1% = 9.5% unemployment years 9.5%u 19% GDP loss Sacrifice ratio in the Volcker recession: = 2.8

132 What is u N? Staiger, Stock, and Watson: 95% confidence interval lower bound (1990): 95% confidence interval upper bound (1990):

133 What is u N? Staiger, Stock, and Watson: 95% confidence interval lower bound (1990): 5.1% 95% confidence interval upper bound (1990): 7.7%

134 What is u N? Staiger, Stock, and Watson: 95% confidence interval lower bound (1990): 5.1% 95% confidence interval upper bound (1990): 7.7% 6.2% is their best estimate for 1990

135 Hysteresis Unemployment can be persistent

136 Hysteresis Unemployment can be persistent Unemployed people lose skills, contacts, etc.

137 Hysteresis Unemployment can be persistent Unemployed people lose skills, contacts, etc. Unemployed people lose insider status

138 Hysteresis Unemployment can be persistent Unemployed people lose skills, contacts, etc. Unemployed people lose insider status Affect public policies

139 Hysteresis Unemployment can be persistent Unemployed people lose skills, contacts, etc. Unemployed people lose insider status Affect public policies Leads to more rent-seeking

140 Hysteresis Unemployment can be persistent Unemployed people lose skills, contacts, etc. Unemployed people lose insider status Affect public policies Leads to more rent-seeking Increases the cost of disinflation

141 Business cycle terminology Shocks: exogenous events that shift AD or AS Demand shock Supply shock

142 Practice with AD/AS shocks Work through each of the numbered scenarios with our simple AS-AD model.

143 Practice with AD/AS shocks Work through each of the numbered scenarios with our simple AS-AD model. Things on axes do not shift curves

144 Practice with AD/AS shocks Work through each of the numbered scenarios with our simple AS-AD model. Things on axes do not shift curves

145 Practice with AD/AS shocks Work through each of the numbered scenarios with our simple AS-AD model. Things on axes do not shift curves Which curve shifts initially and why?

146 Practice with AD/AS shocks Work through each of the numbered scenarios with our simple AS-AD model. Things on axes do not shift curves Which curve shifts initially and why? What is going on in the SR (equilibrium)

147 Practice with AD/AS shocks Work through each of the numbered scenarios with our simple AS-AD model. Things on axes do not shift curves Which curve shifts initially and why? What is going on in the SR (equilibrium) What happens in the LR (eq. and transition mechanism)?

148 Practice with AD/AS shocks Work through each of the numbered scenarios with our simple AS-AD model. Things on axes do not shift curves Which curve shifts initially and why? What is going on in the SR (equilibrium) What happens in the LR (eq. and transition mechanism)? What could/would a central bank do in response?

149 Practice with AD/AS shocks Work through each of the numbered scenarios with our simple AS-AD model. Things on axes do not shift curves Which curve shifts initially and why? What is going on in the SR (equilibrium) What happens in the LR (eq. and transition mechanism)? What could/would a central bank do in response? 1. Banks become more confident and loan out more 2. Credit cards and ATMs become more available 3. The central bank increases the money base 4. OPEC temporarily colludes to raise the price of oil 5. Unions succeed at raising wages temporarily 6. New technology increases MPK 7. Government buys more stuff 8. Government raises taxes T 9. Loss of consumer confidence ( Animal spirits )

150 Demand shock Suppose banks become more confident and loan out more

151 Demand shock Suppose banks become more confident and loan out more What happens to money supply?

152 Demand shock Suppose banks become more confident and loan out more What happens to money supply? What happens to AD, AS?

153 Demand shock Suppose banks become more confident and loan out more What happens to money supply? What happens to AD, AS?

154 Demand shock Suppose credit cards become more available

155 Demand shock Suppose credit cards become more available What happens to the velocity of money?

156 Demand shock Suppose credit cards become more available What happens to the velocity of money? M P = ky = Y V

157 Demand shock Suppose credit cards become more available What happens to the velocity of money? M P = ky = Y V

158 Supply shock (price shock) OPEC raises the price of oil or unions succeed at raising wages

159 Supply shock (price shock) OPEC raises the price of oil or unions succeed at raising wages How can the Fed respond to this stagflation?

160 Supply shock (price shock) OPEC raises the price of oil or unions succeed at raising wages How can the Fed respond to this stagflation? Do nothing

161 Supply shock (price shock) OPEC raises the price of oil or unions succeed at raising wages How can the Fed respond to this stagflation? Do nothing Raise money supply

162 Fed response to supply shock If Fed raises money supply:

163 Keynesian theory in algebraic terms Y = C(Y T ) + I(r) + G M P = L(r, Y ) P SR = P Y LR = Y

164