Money and Banking - SJTU...2017/10/02 · Money and Banking Lecture IV: The Macroeconomic E ects of...
Transcript of Money and Banking - SJTU...2017/10/02 · Money and Banking Lecture IV: The Macroeconomic E ects of...
Money and Banking
Lecture IV: The Macroeconomic E↵ects of Monetary Policy: IS-LMModel
Guoxiong ZHANG, Ph.D.
Shanghai Jiao Tong University, Antai
November 1st, 2016
Keynesian Matters
Source: http://letterstomycountry.tumblr.com
Road Map
IS-LM ModelKeynesian Cross
commodity market: IS curve
money market: LM curve
IS-LM and monetary policy
Aggregate Demand and Aggregate Supplyliquidity preference and aggregate demand
long run and short run aggregate supply
AD-AS and monetary policy
Dynamic Aggregate Demand and Aggregate Supplydynamic IS curve
Philips curve
adaptive expectation
Taylor rule and Taylor principal
Keyesian Cross
Planned expenditure:consumption
planned investment
government spending
net export
Actual expenditure:consumption
investment = planned investment + unexpected inventory investment
government spending
net export
The economy is at equilibrium when planned expenditure equals actualexpenditure.
Consumption function
In Keynes’s view, consumption is determined by dispensable income:
C = C0
+mpc ⇤ Yd,
where C0
is autonomous consumption, mpc is marginal propensity toconsume, and Yd = Y � T is dispensable income.
Keynes believed that mpc must be between 0 and 1.Is it still true today?
What will happen if mpc is heterogeneous?
Multipliers
Taking the interest rates as given, multipliers that measure output’sresponse to exogenous shocks can be calculated from the Keynesian cross:
Y = C0
+mpc ⇤ (Y � T ) + I +G+NX.
private spending multiplier (C0
and I): 1
1�mpc
government spending multiplier (G): 1
1�mpc
government tax multiplier (T): � mpc1�mpc
net export multiplier (NX): 1
1�mpc
Commodity Market: IS Curve
IS curve originates from the notion that planned investment is negativelyrelated to the interest rate:
Y = C0
+mpc ⇤ (Y � T ) + I(r) +G+NX.
interest rate shifts the planned expenditure in the Keynesian cross andin turn a↵ects the aggregate output;
interest rate here is the real interest rate;
therefore we have a downward sloping IS curve
Money Market: LM Curve
LM curve originates from Keynes’ liquidity theory of money:
(MP
)d = L(Y, i).
money demand is negatively related totextcolor[rgb]1.00,0.00,0.00nominal interest rate and positively relatedto aggregate income;
therefore for a given money supply, aggregate income and nominalinterest rate are positively related;
Fisher equation:
i = r + ⇡e,
which gives a one-to-one relationship between nominal and real interestrates given economic agents’ expectation on future inflation to beconstant;
therefore we have a upward sloping LM curve
Exogenous Shocks that A↵ect IS-LM Equilibrium
Exogenous shocks that right-shift the IS curve:increase in autonomous consumption (wealth e↵ect)
increase in investment that not driven by lower interest rate (animal
spirit, technology progress)
expansionary fiscal policy shock
increase in net export (technology progress; preference shock; trade
policy shock)
Exogenous shocks that right-shift the LM curvemonetary policy shock
liquidity preference shock
Fiscal Policy vs Monetary Policy in IS-LM
When money demand is not elastic with respect to interest rate(vertical LM curve), monetary policy is e↵ective while fiscal policy isine↵ective;
When money demand is extremely elastic with respect to interest rate(liquidity trap), fiscal policy is e↵ective while monetary policy isine↵ective;
Generally the more sensitive money demand is with respect to interestrate, the more e↵ective fiscal policy is compared to monetary policy.
IS-LM and Aggregate Demand
Rising price level lowers real money supply (nominal money supply isgiven) and hence shifts the LM curve to the left;
Left-moving LM curve cause a lower equilibrium aggregate income inthe IS-LM curve;
Therefore we have an aggregate demand curve that describe a negativerelationship between price level and aggregate income;
Factors that shift the aggregate demand curve:factors that shift the IS curve shift the aggregate demand curve at the
same direction;
factors that shift the LM curve shift the aggregate demand curve
(except for the price level) shift the aggregate demand curve at the same
direction.
Aggregate Supply
Long-run aggregate supply curve is vertical (it’s determined by factorendowments and technology);
Short-run aggregate supply curve is upward sloping (wage and pricestickiness);
Factors that shift the short run aggregate supply curve:labor market friction;
financial market friction;
other production cost shocks (oil price, etc.)
Dynamic IS Curve
Similar as the IS curve, a dynamic IS curve also portraits a negativerelationship between the real interest rate and aggregate income:
Yt = Yt � ↵(rt � ⇢) + ✏t
Yt: natural output
rt: real interest rate
⇢: natural interest rate
✏t: demand shock
Fisher Equation
Fisher equation relates nominal interest rate and real interest rate:
rt = it � Et⇡t+1
rt: ex ante real interest rate
it � ⇡t+1
: ex post real interest rate
Philips Curve
Philips curve relates inflation and aggregate income:
⇡t = Et�1
⇡t + �(Yt � Yt) + ⌫t
Firms form their expectation on future inflation when setting prices;
When actual output exceeds natural output, labor market is tightened,production cost is raised, and therefore price becomes higher;
⌫t: supply shock
Adaptive Expectation
Adaptive expectation is the simplest form of expectation formation:
Et⇡t+1
= ⇡t
just simply a short-cut: in real macro we use rational expectationequilibrium (REE).
Taylor Rule and Taylor Principal
A common way to characterize monetary policy response is to use a form ofTaylor rule:
it = ⇡t + ⇢+ ✓t(⇡t � ⇡⇤t ) + ✓Y (Yt � Yt) + ut
⇡⇤t : inflation target (not exactly inflation targeting)
ut: monetary policy shock
✓t > 0, ✓Y > 0
Taylor Principle: 1 + ✓t > 1
Taylor rule: US Experience
⇢ = 2.0, ✓t = 0.5, ✓Y = 0.5, ⇡⇤t = 2.0
Dynamic AD-AS
A dynamic aggregate demand and aggregate supply model:
Yt = Yt � ↵(rt � ⇢) + ✏t
rt = it � Et⇡t+1
⇡t = Et�1
⇡t + �(Yt � Yt) + ⌫t
Et⇡t+1
= ⇡t
it = ⇡t + ⇢+ ✓t(⇡t � ⇡⇤t ) + ✓Y (Yt � Yt) + ut
After some algebra we can eliminate the expectation and solve the modelinto two equations:
dynamic aggregate supply
⇡t = ⇡t�1
+ �(Yt � Yt) + ⌫t
ut: dynamic aggregate demand
Yt = Yt �↵✓⇡
1 + ↵✓⇡(⇡t � ⇡⇤
t ) +1
1 + ↵✓⇡✏t +
↵✓⇡1 + ↵✓⇡
ut.
Long Run Economic Growth
Supply Shock
Demand Shock
Growth vs Inflation
Taylor Principal