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Transcript of 120320
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Econ 203 Lect A, Tut C - Tutorial 9
Tutor: Vinh Nguyen1
1Concordia University
Mar 20, 2012
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Monetary Policy Targets and Instrument in Canada
• Targets:
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Monetary Policy Targets and Instrument in Canada
• Targets:• Foreign exchange rate (1960’s)
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Monetary Policy Targets and Instrument in Canada
• Targets:• Foreign exchange rate (1960’s)• Money supply (1970’s – early 1990’s)
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Monetary Policy Targets and Instrument in Canada
• Targets:• Foreign exchange rate (1960’s)• Money supply (1970’s – early 1990’s)• Inflation rate (early 1990’s – present)
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Monetary Policy Targets and Instrument in Canada
• Targets:• Foreign exchange rate (1960’s)• Money supply (1970’s – early 1990’s)• Inflation rate (early 1990’s – present)
• Instrument: interest rate. In Canada: overnight rate (the
interest rate large financial institutions receive or pay on
loans from one day until the next )
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Monetary Policy Targets and Instrument in Canada
• Targets:• Foreign exchange rate (1960’s)• Money supply (1970’s – early 1990’s)• Inflation rate (early 1990’s – present)
• Instrument: interest rate. In Canada: overnight rate (the
interest rate large financial institutions receive or pay on
loans from one day until the next )
• A relationship:
bank rate ≈ overnight rate + 0.
25%
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Monetary Policy Targets and Instrument in Canada
• Targets:• Foreign exchange rate (1960’s)• Money supply (1970’s – early 1990’s)• Inflation rate (early 1990’s – present)
• Instrument: interest rate. In Canada: overnight rate (the
interest rate large financial institutions receive or pay on
loans from one day until the next )
• A relationship:
bank rate ≈ overnight rate + 0.
25%
• Overnight rate ↓ ⇒ commercial bank lending rates ↓ ⇒
expansion in the money supply
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Taylor Rule
• Taylor Rule:
i = i 0 + a
>0
(π − π∗) + b
>0
(Y − Y p )
where π∗ is the bank’s target inflation rate and i 0 is the
target nominal interest
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Taylor Rule
• Taylor Rule:
i = i 0 + a
>0
(π − π∗) + b
>0
(Y − Y p )
where π∗ is the bank’s target inflation rate and i 0 is the
target nominal interest
• Long-run change: change in i 0
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Taylor Rule
• Taylor Rule:
i = i 0 + a
>0
(π − π∗) + b
>0
(Y − Y p )
where π∗ is the bank’s target inflation rate and i 0 is the
target nominal interest
• Long-run change: change in i 0
• Short-run change: temporarily set the nominal rate to i
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 1(i)–(iv)
• We’re given:
i = i 0 + (π − π∗) + (Y − Y p ) where π
∗ = 2%
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 1(i)–(iv)
• We’re given:
i = i 0 + (π − π∗) + (Y − Y p ) where π
∗ = 2%
• (i) With i 0 = 9%, π = π∗, Y = Y p , it must be that
i = i 0 = 9%.
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 1(i)–(iv)
• We’re given:
i = i 0 + (π − π∗) + (Y − Y p ) where π
∗ = 2%
• (i) With i 0 = 9%, π = π∗, Y = Y p , it must be that
i = i 0 = 9%.
• (ii) Now, we have Y − Y p = −5% and π = π∗. Then,
i = i 0 − 5% = 4%.
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 1(i)–(iv)
• We’re given:
i = i 0 + (π − π∗) + (Y − Y p ) where π
∗ = 2%
• (i) With i 0 = 9%, π = π∗, Y = Y p , it must be that
i = i 0 = 9%.
• (ii) Now, we have Y − Y p = −5% and π = π∗. Then,
i = i 0 − 5% = 4%.
• (iii) i dropping shifts the AD and AS curves up (seeFigure 10.8 on page 260)
( ) ( )
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 1(i)–(iv)
• We’re given:
i = i 0 + (π − π∗) + (Y − Y p ) where π
∗ = 2%
• (i) With i 0 = 9%, π = π∗, Y = Y p , it must be that
i = i 0 = 9%.
• (ii) Now, we have Y − Y p = −5% and π = π∗. Then,
i = i 0 − 5% = 4%.
• (iii) i dropping shifts the AD and AS curves up (seeFigure 10.8 on page 260)
• (iv) i was 9% and now i = 4%, so ∆i = −5%. Thus,
π = π∗ − 1.5∆i = 2% − 1.5(−5%) = 9.5%
E 203 T 9 Q ( ) ( )
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 1(v),(vi)
• Again:
i = i 0 + (π − π∗) + (Y − Y p ) where π
∗ = 2%
E 203 T t9 Q i 1( ) ( i)
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 1(v),(vi)
• Again:
i = i 0 + (π − π∗) + (Y − Y p ) where π
∗ = 2%
• (v) Now π = π∗ − 1.5∆i , so π − π
∗ = −1.5∆i . First,notice:
i new = i 0 − 1.5∆i + (Y − Y p ) = i old − 1.5∆i + (Y − Y p )
Econ203 Tut9 Q i 1( ) ( i)
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 1(v),(vi)
• Again:
i = i 0 + (π − π∗) + (Y − Y p ) where π
∗ = 2%
• (v) Now π = π∗ − 1.5∆i , so π − π
∗ = −1.5∆i . First,notice:
i new = i 0 − 1.5∆i + (Y − Y p ) = i old − 1.5∆i + (Y − Y p )
• It follows that
∆i = −1.5∆i + (Y − Y p ) ⇒ 2.5∆i = (Y − Y p )
Econ203-Tut9 Q ti 1( ) ( i)
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Econ203-Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 1(v),(vi)
• Again:
i = i 0 + (π − π∗) + (Y − Y p ) where π
∗ = 2%
• (v) Now π = π∗ − 1.5∆i , so π − π
∗ = −1.5∆i . First,notice:
i new = i 0 − 1.5∆i + (Y − Y p ) = i old − 1.5∆i + (Y − Y p )
• It follows that
∆i = −1.5∆i + (Y − Y p ) ⇒ 2.5∆i = (Y − Y p )
• With Y − Y p = −5%, it must be that ∆i = −2%. So
i new = i old + ∆i = 9% − 2% = 7%
Econ203-Tut9 Q ti 1( ) ( i)
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Econ203 Tut9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 1(v),(vi)
• Again:
i = i 0 + (π − π∗) + (Y − Y p ) where π
∗ = 2%
• (v) Now π = π∗ − 1.5∆i , so π − π
∗ = −1.5∆i . First,notice:
i new = i 0 − 1.5∆i + (Y − Y p ) = i old − 1.5∆i + (Y − Y p )
• It follows that
∆i = −1.5∆i + (Y − Y p ) ⇒ 2.5∆i = (Y − Y p )
• With Y − Y p = −5%, it must be that ∆i = −2%. So
i new = i old + ∆i = 9% − 2% = 7%
• (vi) We have π = π
∗
− 1.5∆i = 2% − 1.5(−2%) = 5%.
Econ203-Tut9 Q estion 1( ii) and MC 6 from T t 8
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03 u 9
Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 1(vii) and MC 6 from Tut 8
• (vii) Lowering interest rate creates an upward pressure on
inflation.
Econ203-Tut9 Question 1(vii) and MC 6 from Tut 8
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Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 1(vii) and MC 6 from Tut 8
• (vii) Lowering interest rate creates an upward pressure on
inflation.
• When π is taken into account, the BoC is more carefulwith lowering the interest so as to not raising π too high.Thus, i (part (v)) is higher than i (part (ii)).
Econ203-Tut9 Question 1(vii) and MC 6 from Tut 8
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Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 1(vii) and MC 6 from Tut 8
• (vii) Lowering interest rate creates an upward pressure on
inflation.
• When π is taken into account, the BoC is more carefulwith lowering the interest so as to not raising π too high.Thus, i (part (v)) is higher than i (part (ii)).
• MC 6 from Tut 8. Long term effects allude to change inpotential output, so (C) is a right choice.
Econ203-Tut9 Question 1(vii) and MC 6 from Tut 8
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Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 1(vii) and MC 6 from Tut 8
• (vii) Lowering interest rate creates an upward pressure on
inflation.
• When π is taken into account, the BoC is more carefulwith lowering the interest so as to not raising π too high.Thus, i (part (v)) is higher than i (part (ii)).
• MC 6 from Tut 8. Long term effects allude to change inpotential output, so (C) is a right choice.
• SRAS is a temporary measure to maintain the overnightrate so (A) is wrong. Correction: [I misread “SRAS” into“SPRA”] In any case, SRAS = “short-run aggregate
supply”, which has little to do with long term potentialoutput, so (A) is not the right choice.
Econ203-Tut9 Question 1(vii) and MC 6 from Tut 8
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Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 1(vii) and MC 6 from Tut 8
• (vii) Lowering interest rate creates an upward pressure on
inflation.
• When π is taken into account, the BoC is more carefulwith lowering the interest so as to not raising π too high.Thus, i (part (v)) is higher than i (part (ii)).
• MC 6 from Tut 8. Long term effects allude to change inpotential output, so (C) is a right choice.
• SRAS is a temporary measure to maintain the overnightrate so (A) is wrong. Correction: [I misread “SRAS” into“SPRA”] In any case, SRAS = “short-run aggregate
supply”, which has little to do with long term potentialoutput, so (A) is not the right choice.• AD can be shifted without any change to potential output
(see Figure 10.8, page 260). (B) is also wrong.
Econ203-Tut9 Question 1(vii) and MC 6 from Tut 8
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Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 1(vii) and MC 6 from Tut 8
• (vii) Lowering interest rate creates an upward pressure on
inflation.
• When π is taken into account, the BoC is more carefulwith lowering the interest so as to not raising π too high.Thus, i (part (v)) is higher than i (part (ii)).
• MC 6 from Tut 8. Long term effects allude to change inpotential output, so (C) is a right choice.
• SRAS is a temporary measure to maintain the overnightrate so (A) is wrong. Correction: [I misread “SRAS” into“SPRA”] In any case, SRAS = “short-run aggregate
supply”, which has little to do with long term potentialoutput, so (A) is not the right choice.• AD can be shifted without any change to potential output
(see Figure 10.8, page 260). (B) is also wrong.• (D) refers to temporary techniques. (D) is not correct.
Econ203-Tut9 Question 3(i)–(iv)
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Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 3(i) (iv)
• (i) At equilibrium, M s = M d so i = 0.05. As such, I = 95and Y = 1375. (Note: C = 100 + 0.8(Y − 150)).
Econ203-Tut9 Question 3(i)–(iv)
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Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 3(i) (iv)
• (i) At equilibrium, M s = M d so i = 0.05. As such, I = 95and Y = 1375. (Note: C = 100 + 0.8(Y − 150)).
• (ii) C = 1080, and S = Y − T − C = 145.
Econ203-Tut9 Question 3(i)–(iv)
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Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 3(i) (iv)
• (i) At equilibrium, M s = M d so i = 0.05. As such, I = 95and Y = 1375. (Note: C = 100 + 0.8(Y − 150)).
• (ii) C = 1080, and S = Y − T − C = 145.
• (iii) Note that
Y = C + I + G ⇒ Y − C − T − I = G − T
Note that Y − C − T = S so we have S − I = G − T .This means the government deficit can be financed by
borrowing from private savings.
Econ203-Tut9 Question 3(i)–(iv)
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Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Question 3(i) (iv)
• (i) At equilibrium, M s = M d so i = 0.05. As such, I = 95and Y = 1375. (Note: C = 100 + 0.8(Y − 150)).
• (ii) C = 1080, and S = Y − T − C = 145.
• (iii) Note that
Y = C + I + G ⇒ Y − C − T − I = G − T
Note that Y − C − T = S so we have S − I = G − T .This means the government deficit can be financed by
borrowing from private savings.• (iv) Multiplier 1
1−c = 5. So with ∆G = 50, ∆Y = 250,
thus new Y = 1375 + 250 = 1625.
Econ203-Tut9 Question 3(v)–(vii)
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Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Q ( ) ( )
• (v) Solve the system
Y = 100 + 0.8(Y − 150) + 120 − 500i + 200100 = 200 − 2000i + 0.1Y
We get i = 0.111111 and Y = 1222.22.
Econ203-Tut9 Question 3(v)–(vii)
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Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Q ( ) ( )
• (v) Solve the system
Y = 100 + 0.8(Y − 150) + 120 − 500i + 200100 = 200 − 2000i + 0.1Y
We get i = 0.111111 and Y = 1222.22.
• (vi) Solve the system
Y = 100 + 0.8(Y − 150) + 120 − 500i + 250
100 = 200 − 2000i + 0.1Y
Answers: i = 0.122222 and Y = 1444.44
Econ203-Tut9 Question 3(v)–(vii)
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Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
( ) ( )
• (v) Solve the system
Y = 100 + 0.8(Y − 150) + 120 − 500i + 200100 = 200 − 2000i + 0.1Y
We get i = 0.111111 and Y = 1222.22.
• (vi) Solve the system
Y = 100 + 0.8(Y − 150) + 120 − 500i + 250
100 = 200 − 2000i + 0.1Y
Answers: i = 0.122222 and Y = 1444.44
• (vii) Note that from (v) to (vi), i has gone up, so I hasgone down. Specifically, ∆I = −5.55. Note also thatbefore (in (iv)), ∆G = 50 leads to ∆Y = 250. Now (in(v), (vi)), ∆G = 50 leads to ∆Y = 222.22. So the fiscal
policy is now less effective in affecting Y .
Econ203-Tut9 Question 3(viii)
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Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
( )
• (viii) We have
Y = 100 + 0.8(Y − 150) + I + G = −20 + 0.8Y + I + G
Econ203-Tut9 Question 3(viii)
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Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
( )
• (viii) We have
Y = 100 + 0.8(Y − 150) + I + G = −20 + 0.8Y + I + G
• Therefore,
Y = −100 + 5(I + G ) ⇒ ∆Y = 5(∆I + ∆G )
Econ203-Tut9 References
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Vinh Nguyen
Taylor Rule
Question 3
Reference(s)
Curtis, Douglas; Irvine, Ian and Begg, David.
Macroeconomics. 2nd Canadian edition, USA: McGraw-HillRyerson, 2010.