Transcript Intermediate Macroeconomics - College Of Business and

An Overview of
Modern
Macroeconomics
Intermediate Macroeconomics
ECON-305 Spring 2013
Professor Dalton
Boise State University
Issues and Ideas
Macroeconomics

Study of structure, performance and
behavior of economy as a whole

Causes and impacts of short-run GDP
fluctuations
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Business (trade) cycle
Major determinants of long-run path of
GDP

Economic growth
Macroeconomics and
Politics

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Behavior of economy subject of citizen
interest
Performance and policy closely
interconnected
Post-war elections determined by
inflation, unemployment, GDP growth
Representative of ideological conflict
Macroeconomic Theory

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Set of views of how economy operates
organized into a model
Economists differ over correct model
Models have developed historically to
take account of novel facts and new
historical situations
Great Depression (1930s)
 Great Inflation (1970s)

Milton Friedman
“There is wide agreement about the major goals
of economic policy: high employment, stable
prices, and rapid growth. There is less
agreement that these goals are mutually
compatible or, among those who regard them
as incompatible, about the terms at which they
can and should be substituted for one another.
There is least agreement about the role that
various instruments of policy can and should
play in achieving the several goals.”
- “The Role of Monetary Policy,” AER, March 1968
Two Fundamental Issues


Self-adjusting properties of market
economy
Proper role of government
Government Beneficial?
NO
YES
Self-Adjusting?
YES
NO
a
b
c
d
Business Cycle
Facts
Economic Fluctuations

Pattern:
Expansion-Peak-Contraction-TroughExpansion
Trend
Correlations with GDP1
Variable
Direction
Timing
Industrial Production*
Procyclical
Coincident
Consumption**
Business Fixed Investment
Residential Investment
Inventory Investment
Government Purchases
Procyclical
Procyclical
Procyclical
Procyclical
Procyclical
Coincident
Coincident
Leading
Leading
Undesignated
Employment
Unemployment
Ave. Labor Productivity
Real Wage
Procyclical
Countercyclical
Procyclical
Procyclical
Coincident
Not clear
Leading
Undesignated
Correlations with GDP1
Variable
Direction
Timing
Money Supply
Inflation
Procyclical
Procyclical
Leading
Lagging
Stock Prices
Nominal interest rates
Real interest rates
Procyclical
Procyclical
Acyclical
Leading
Lagging
Undesignated
*durable more volatile than non-durable
** investment expenditures more volatile than consumption
expenditures
1Abel and Bernanke
Cycle Regularities2
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Output movements across sectors have high conformity
Producer and consumer durables exhibit greater amplitude
than nondurables
Production and prices of agricultural output and natural
resources have lower than average conformity
Business profits show high conformity and much greater
amplitude than other series
Prices generally procyclical
Short-term nominal interest rates procyclical, long-term
slightly so
Monetary aggregates and velocity pro-cyclical
2Lucas,
“Understanding Business Cycles”
Therefore…
 Lucas:
“Business Cycles Are All
Alike.”
- Attractive property – challenge
to theorists
- Suggests a general theory of
cycles is possible
Keynes and Cycles

Keynes and Earlier Cycle Models
- Keynesian models conform well to timeseries data, but not tied to general
economic theory that output react to
prices
- Keynesian models invariant to policy
-
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Policy changes don’t produce changes in
decision rules of agents
Earlier cycle models attempted to tie
fluctuations to general theory
Keynes and Cycles
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Keynes changed the focus of Business
Cycle economics from a consideration
of ebbs and flows of economic activity
relative to changing prices,
technology, and preferences
Keynes asked a different question…
- What determines aggregate output?
Economic Stability

Triumph of Keynes
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1946 Employment Act
Cursory investigation of time-series
data suggests post-war prosperity due
to purposeful macro policy
Cursory view also indicates economy
was more stable in the post-WW II era
Was It?
Romer: “Changes in Business Cycles:
Evidence and Explanations”
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Series of influential papers
What is evidence of changes in
fluctuations?
How measured?
 What series?
 Problems with data!
 Romer re-estimated pre-WW II data.
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Romer: “Changes in Business Cycles:
Evidence and Explanations”
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Interwar period extremely volatile
Little evidence pre-WW I period much more
volatile in US than post-WW II
Recessions less frequent and more uniform;
Expansions longer
Not much difference in average output loss
per recession
Policy dampened shocks that produced
recessions in past; however, appearance of
policy-induced recessions to fight inflation
The Great
Depression
General Features
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World-wide phenomenon
Output fell moderately in some
countries, precipitously in others
47% decline US industrial production
Nations with greater than 30%
declines: Germany, France, Italy,
Belgium, Netherlands, Czechoslovakia,
Poland, Canada
Central Questions
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How did the recession of 1929-1930,
well within historical parameters, turn
into the Great Depression of 19311933?
Why did it last so long? When did it
end?
Why was their a recession within the
Depression in the US (1937-38)?
The Causes of the Great
Depression
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Non-monetary/Non-financial
hypothesis
Monetary hypotheses
Non-monetary/financial hypothesis
Gold-Standard hypothesis
Non-monetary real business cycle
hypothesis
Eichengreen: “The origins
and nature of the Great
Slump revisited”
Bernanke: “The
Macroeconomics of the
Great Depression: A
Comparative Approach”
Structural Changes of 1920s

Changes in Composition of Production
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Minor; except consumer durables and
agricultural production in US
Changes in Flexibility of Labor Markets

Minor- high unemployment Europe, low
rates unionization, unemployment
benefits; except internal labor markets
and personnel departments US
Structural Changes of 1920s
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Changes in International Monetary
System
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Rise of foreign exchange in international
reserves made system subject to greater
destabilization (dollar and pound sterling)
Changes in Pattern of International
Settlements
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Expansion of US and Japan international
business interests during WW I; US
becomes net creditor; War reparations
Onset of Depression

Restrictive US monetary policy to
counteract stock market bubble in
1928
Rising US interest rates reduce
international credit; capital and gold
inflows
 Fed sterilization of gold inflows prevent US
prices from rising
 To maintain exchange rates foreign central
banks adopt contractionary monetary
policies
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Spread of Depression
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Eichengreen
Role of Stock Market Crash
 1930-31 Bank Runs
 Role of Gold Standard
 Was US constrained from reflating under
gold standard?
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Bernanke
Evidence
 Gold Standard and recovery
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Real Effects of Nominal Shocks
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Why did process of adjustment to
monetary shocks take so long to work
themselves out?
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Anticipated v. Unanticipated policy
Both Eichengreen and Bernanke
concentrate on two aspects
Debt-deflation process
 Nominal wage and price rigidity
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Debt-deflation
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Falling asset prices force nominal
debtors into distress sales that further
drop asset prices and increase
pressures on nominal debtors
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Counter-argument: simply a redistribution
debtors to creditors – should have no real
effects
Bernanke presents evidence that bank
panics negatively correlated with
output, employment and wages. Why?
Debt-deflation

Principal-agent literature and
imperfect information
Net worth/balance sheet plays important role
in aligning incentives of lenders and
borrowers
 Deterioration of net worth causes risk of
lending to rise, reducing lending
 World of imperfect information, some
opportunities known to some will go
unexploited due to lack of access to funds
 Sufficiently severe debt-deflation imposes
bank balance-sheet problems

Nominal Wages and Prices

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Again, Bernanke presents evidence of
nominal price and wage rigidity. Why?
Eichengreen

US
Hoover’s voluntary program
 AAA – agricultural prices
 NIRA labor and business provisions
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NLRA (Wagner Act)
England
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Unemployment benefits lagged price and
wage reductions
Monetary and Fiscal Policy

Eichengreen- international
comparisons
Monetary policy led recovery in every
instance
 No nation suffered a liquidity trap
 Fiscal policy was small and often ocunterproductive
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Hoover’s 1932 massive income tax increase
New Deal Uncertainty

Did the New Deal help the recovery
process?
New Deal instituted policies and
programs that had been “lying about” for
decades
 Uncertainty in business environment

Congress pass general law and Roosevelt and
agencies sort out details
 FDR sign executive order and Congress would
later ratify
 Businessmen’s correspondence
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Development of
Modern
Macroeconomics
Keynes

General Theory of Employment,
Interest and Money (1936)
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Treatise on Money (1930)
Fundamental flaw in operation of
market as coordinating device
Fundamental misunderstanding of
economists
Keynes
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Major discovery: Principle of Effective
Demand
Rejection of “laissez-faire”
New Deal and Keynesianism
Post WW II commitment to Activist
policy
Macroeconomics Develops

Orthodox Keynesianism
Hicks, “Mr. Keynes and the Classics”
(1937)
 Modigliani, “Liquidity Preference and the
Theory of Interest and Money” (1944)
 IS-LM Model
 Theoretical Schizophrenia
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Macroeconomics Develops
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Monetarist Response and Neoclassical
Synthesis
Friedman, “The Quantity Theory of
Money: A Restatment” (1956)
 Patinkin, Money, Interest and Prices
(1956)

Macroeconomics Develops
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Phillips Curve
Phillips, “The Relation Between
Unemployment and the Rate of Change of
Money Wage Rates in the Untied Kingdom,
1861-1957” (1958)
 Samuelson and Solow, “Analytical Aspects
of Anti-Inflationary Policy” (1960)
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Macroeconomics Develops
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Orthodox Monetarism
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Friedman and Scwartz, A Monetary
History of the United States, 1867-1960
(1963)
Natural Rate Hypothesis
Phelps, “Phillips Curves, Expectations of
Inflation and Optimal Unemployment over
Time” (1967)
 Friedman, “The Role of Monetary Policy”
(1968)
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Macroeconomics Develops
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Rational Expectations and New
Classical Economics
Lucas, “Some International Evidence on
Output-Inflation Tradeoffs” (1973)
 Lucas, “An Equilibrium Model of the
Business Cycle” (1975)
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Real Business Cycle Theory
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Kydland and Prescott, “Time to Build and
Aggregate Fluctuations” (1982)
Macroeconomics Develops

New Keynesian Response
Mankiw, “Small Menu Costs and Large
Business Cycles: A Macroeconomic Model
of Monopoly” (1985)
 Akerlof and Yellen, “A Near-rational
Model of the Business Cycle, with Wage
and Price Inertia” (1985)
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Growth Economics
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Endogenous growth theory
MACRO
SCHOOLS
Dominant
source of
instability
PostKeynesian
Fluctuations in
Autonomous
Expenditures
Expectations
Price
Adjustment
Market
Adjustment
Very weak
Loanable
Funds
Market
Notion of
Equilibrium
Dominant
Time Frame
Rules v.
Discretion
Role of Incomes
Policy
No joint
State of rest
probably
below full
employment
Short
Discretion
Essential and
beneficial
Predominantly short
No clear
consensus
Predominately
against
Reasonable
Sticky
New
Keynesian
Demand and
supply shocks
(eclectic)
Rational
Emphasis
on Price
Rigidities
Slow
No clear
consensus
Consistent
with
involuntary
unemployment
Orthodox
Keynesian
Fluctuations in
Autonomous
Expenditures
Adaptive
Inflexible
below Full
employment
Weak
No joint
State of rest
probably
below full
employment
Short run
Discretion
Some support
Austrian
Monetary
Disturbances
Reasonable
Flexible
Strong
Loose
joint
Tendency
towards
market
clearing
Short and
Long
Rules
Harmful and
distorting
Orthodox
Monetarist
Monetary
Disturbances
Adaptive
Flexible
Strong
Tight
joint
Market
clearing at
natural rate
Short and
Long
Rules
Irrelevant and
distorting
New
Classical
Monetary
Disturbances
Rational
Extremely
Flexible
Very strong
Tight
joint
Market
clearing at
natural rate
Long = short
Rules
Irrelevant and
distorting
Real
Business
Cycle
Supply shocks
(mainly
technological)
Rational
Extremely
Flexible
Very strong
Tight
joint
Market
clearing at
moving
natural rate
Long = short
Rules
Irrelevant and
distorting