Post on 09-Jun-2020
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Macroeconomics IILecture 3: Intro to Economic Fluctuations
Tomas Lichard
IES (Summer 2017/2018)
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Long run vs. short run
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Long run vs. short run
When we talk about long run and short run inmacroeconomics, we usually don’t refer to a precise timelength
They differ in the behavior of pricesin the long run:
prices are flexible and nominal variables (inflation, nominalinterest rate) do not affect real variables (RGDP, real interestrate)money supply is irrelevant when determining real variables(monetary neutrality)
in the short run:
nominal variables matter, because prices are not flexiblee.g. reduction in money supply leads to decrease in RGDPgrowth and higher unemployment
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
GDP & Unemployment Rate
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
GDP & Unemployment Rate II
Okun’s law - relationship between GDP growth rate andchange in unemployment rate:
-4-2
02
4g_
RG
DP
-1 0 1 2d_UR
n = 279 RMSE = .6995406
g_RGDP = .78427 - 1.6643 d_UR R2 = 45.9%
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Okun’s law in CR
1994
1995
1996
19971998
1999
2000
2001
2002
2003
2004
20052006
2007
2008
2009
20102011
2012
−5
05
10
Gro
wth
of R
GD
P (
%)
−2 −1 0 1 2Change in unemployment rate (pp)
n = 19 RMSE = 2.2520943
growth_GDP = 2.9424 − 1.817 dUR R2 = 44.4%
CSO data
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
International comparisonNote: Authors here use the inverse relationship! (dUR on the left, dRGDP on the right)
Source: Ball et al. (2013)
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Consumption & investment
-30
-20
-10
0
10
20
30
40
50
60
70
1950 1960 1970 1980 1990 2000 2010
ShadedareasindicateUSrecessions-2015research.stlouisfed.org
RealGrossPrivateDomesticInvestmentGrossDomesticProductbyExpenditureinConstantPrices:PrivateFinalConsumptionExpenditurefortheUnitedStates©
(PercentChangefrom
QuarterOneYearAgo),
(PercentChangefrom
YearAgo)
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Leading economic indicators
Wall Street indexes predicted nine out of the last fiverecessions
– Paul Samuelson
Policy-makers like to know in advance if a recession is coming,so they try to look for signs of a future GDP downturn inother data:
Average workweek of production workers in manufacturing;Average initial weekly claims for unemployment insurance;New orders for consumer goods and materials, adjusted forinflation;New orders for nondefense capital goods;Index of supplier deliveries;
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Leading economic indicators
Wall Street indexes predicted nine out of the last fiverecessions
– Paul Samuelson
Policy-makers like to know in advance if a recession is coming,so they try to look for signs of a future GDP downturn inother data:
New building permits issued;Index of stock prices;Money supply (M2), adjusted for inflation;Interest rate spread, yield curves;Index of consumer expectations.
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Yield curve
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Leading economic indicators — CR
Source: OECD Composite Leading Indicators, Country reviews
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Why are prices sticky?
Some causes of sticky prices (Percentage of managers whoagree with the explanation according to Blinder, 1994)
Coordination failure: firms wait for other firms to increaseprices (60.6%);Lags with cost-based pricing (55.5%);Delivery lags (54.8%);Implicit contracts (50.4%);Nominal contracts (35.7%);Cost of price adjustment (30%);Procyclical elasticity (29.7%).
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
What is AD?
Relationship between the quantity of output demanded andthe aggregate price level;
It is not analogous to demand for single good!
In the short run, it influences production;
Recall the quantity equation:
MV = PY ,
orM
P=
(M
P
)d
= kY ,
leading to a downward sloping AD curve
Economic intuition?
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
What is AS
Relationship between the quantity of goods and servicessupplied and the price level
Recall that in the long run output does not depend on theprice level, it is determined by amount of labor, capital andtechnology:
Y = F(K , L
)= Y
However, in the short run it depends on the price level
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Demand shocks
Shocks: exogenous events shifting AD or AS
Example of a demand shock: expansion of credit cards
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Supply shocks
They alter the costs for firms, and by that prices - price shocks
e.g. drought, oil cartels, unions, environmental laws areexamples of what can cause a price shock
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Accommodating a shock
Imagine an adverse supply shock, how can a CB react?
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Case study: oil shocks
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Case study: Velde (2009)
Francois R. Velde: “Chronicles of a Deflation Unforetold,”.(JPE 2009)
In 18th century, French government assigned nominal value toeach coin by a decree (coins were without markings)
In 1724, French government/king probably wanted todecrease prices in the economy, it lowered each coin’s value by45% (in three steps)
this was effectively a decrease in money supply
In 1726 the policy was reversed and coins were declared tohave 25% more value
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Case study: Velde (2009)
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Case study: Velde (2009)
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Case study: Velde (2009)
In conclusion, prices took very long to fall, and they did notfall by the full 45%
the only market that adapted quickly was the foreign exchangemarket
Nominal wages did not react at all =⇒ real wages increased
Interest rate increased,
Industrial output dropped by 30%
After the reversal of the policy, prices and output reboundedrelatively quickly
Tomas Lichard Macroeconomics II
Empirics of business cyclesAggregate Demand
Aggregate SupplyStabilization Policy
Conclusion
Recall that...
1 We covered introduction to business cycles: they arefluctuations of the economy around long-term trend
2 In the short run, prices are sticky
3 Aggregate demand is a relationship between demanded outputand the price level
it is influenced by money velocityin the short run, AD may influence aggregate output
4 Aggregate supply is a relationship between supplied outputand the price level
5 Shocks are exogenous shifting of AD (demand shock) or AS(supply/price shock) curve
Tomas Lichard Macroeconomics II