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Transcript
Capital Markets:II
Capital Markets and the Business
Cycle
Analysis of Capital Markets
Aggregate Savings
Aggregate Investment
Analysis of Capital Markets
Aggregate Savings
• Households take wealth and
interest rates as given and
maximize utility through their
choice of consumption
(Savings = Income – Cons.)
Aggregate Investment
Analysis of Capital Markets
Aggregate Savings
• Households take wealth and
interest rates as given and
maximize utility through their
choice of consumption
(Savings = Income – Cons.)
• Rising (falling) interest rates
induce a dominant substitution
effect which causes current
consumption to fall (rise) – that
is, savings rises (falls).
Aggregate Investment
Analysis of Capital Markets
Aggregate Savings
Aggregate Investment
• Households take wealth and
interest rates as given and
maximize utility through their
choice of consumption
(Savings = Income – Cons.)
• Rising (falling) interest rates
induce a dominant substitution
effect which causes current
consumption to fall (rise) – that
is, savings rises (falls).
• Firms take technology,
employment, and interest rates
as given and choose capital to
maximize firm value.
Analysis of Capital Markets
Aggregate Savings
Aggregate Investment
• Households take wealth and
interest rates as given and
maximize utility through their
choice of consumption
(Savings = Income – Cons.)
• Rising (falling) interest rates
induce a dominant substitution
effect which causes current
consumption to fall (rise) – that
is, savings rises (falls).
• Firms take technology,
employment, and interest rates
as given and choose capital to
maximize firm value.
• Decreasing MPK insures that
rising interest rates will lower
demand for capital.
Analysis of Capital Markets
Aggregate Savings
Aggregate Investment
• Savings is used to smooth
consumption in the face of
variable income.
Therefore, a perceived rise
(fall) in income will cause
savings to decrease
(increase)
• An increase (decrease) in
productivity increases
(decreases) investment
demand, but the lag
between purchase and
installation of capital must
be considered.
A Temporary Drop in
Productivity
20
16
12
8
4
0
0
100
200
300
400
500
A Temporary Drop in
Productivity
• If the productivity decline
is short-lived enough,
investment decisions are
unaffected.
20
16
12
8
4
0
0
100
200
300
400
500
A Temporary Drop in
Productivity
• If the productivity decline
is short-lived enough,
investment decisions are
unaffected.
• However, the temporary
decline in income lowers
aggregate savings
20
16
12
8
4
0
0
100
200
300
400
500
A Temporary Drop in
Productivity
• If the productivity decline
is short-lived enough,
investment decisions are
unaffected.
• However, the temporary
decline in income lowers
aggregate savings
• Interest rates rise while
savings and investment
fall
20
16
12
8
4
0
0
100
200
300
400
500
A Permanent Drop in
Productivity
• A long lived productivity
decline impacts the
demand for capital.
20
16
12
8
4
0
0
100
200
300
400
500
A Permanent Drop in
Productivity
• A long lived productivity
decline impacts the
demand for capital.
• Income is now
permanently lower –
savings stays the same,
but consumption drops
20
16
12
8
4
0
0
100
200
300
400
500
A Permanent Drop in
Productivity
• A long lived productivity
decline impacts the
demand for capital.
• Income is now
permanently lower –
savings stays the same,
but consumption drops
• Interest rates, investment,
savings, and consumption
all decline
20
16
12
8
4
0
0
100
200
300
400
500
Example: Oil Price Shocks
• A rise in energy prices is considered to be a drop
in productivity (think of MPL and MPK as net of
energy costs)
Example: Oil Price Shocks
• A rise in energy prices is considered to be a drop
in productivity (think of MPL and MPK as net of
energy costs)
• The 1970’s saw two major oil price increases:
Example: Oil Price Shocks
• A rise in energy prices is considered to be a drop
in productivity (think of MPL and MPK as net of
energy costs)
• The 1970’s saw two major oil price increases:
– 73-’74: OPEC oil embargo raises oil prices from $4 to
$10 a barrel
– -’78-’79: Iranian Revolution temporarily disrupts oil
production: oil prices rise from $15 to $30 a barrel.
• The first shock was perceived as permanent while
the second was perceived as temporary
J80
J80
J79
J79
J78
J78
J77
J77
J76
J76
J75
J75
J74
J74
J73
J73
J72
J72
Interest Rates: 1972-1980
16
14
12
10
8
6
4
2
0
Business Cycle Characteristics
• Can our model of capital markets replicate
the relevant business cycle facts?
Business Cycle Characteristics
• Can our model of capital markets replicate
the relevant business cycle facts?
• Correlation
• Volatility
• Timing
-2
-4
-6
1/1/00
1/1/98
1/1/96
1/1/94
1/1/92
1/1/90
1/1/88
1/1/86
1/1/84
1/1/82
GDP
6
4
2
0
GDP
-2
-4
-6
1/1/00
1/1/98
1/1/96
1/1/94
1/1/92
1/1/90
1/1/88
1/1/86
1/1/84
1/1/82
GDP & Consumption
6
4
2
0
GDP
Consumption
0
-5
-10
-15
-20
-25
1/1/00
1/1/98
1/1/96
1/1/94
1/1/92
1/1/90
1/1/88
1/1/86
1/1/84
1/1/82
GDP & Investment
25
20
15
10
5
GDP
Investment
1/1/00
1/1/98
1/1/96
1/1/94
1/1/92
1/1/90
1/1/88
1/1/86
1/1/84
1/1/82
GDP & Gross Savings
GDP
Saving
0
-1
-2
-3
-4
-5
1/1/00
1/1/98
1/1/96
1/1/94
1/1/92
1/1/90
1/1/88
1/1/86
1/1/84
1/1/82
GDP & Interest Rates
5
14
4
3
12
2
1
10
8
6
4
2
0
GDP
Interest
Capital Market Facts
Variable
Direction
Timing
Consumption
Procyclical
Coincident
Investment
Procyclical
Coincident/Leading
Savings
???
???
Interest Rates
Procyclical
Lagging
Can our capital market model explain these
facts?
20
16
12
8
4
0
0
100
200
300
400
500
Can our capital market model explain these
facts?
• As with labor markets, the key
is the price/output correlation.
Specifically, remember that the
interest rate is procyclical.
20
16
12
8
4
0
0
100
200
300
400
500
Can our capital market model explain these
facts?
• As with labor markets, the key
is the price/output correlation.
Specifically, remember that the
interest rate is procyclical.
• This suggests that supply side
factors (ie, productivity) are
behind changes in investment,
savings, and interest rates.
24
20
16
12
8
4
0
0
100
200
300
400
500
Can our capital market model explain these
facts?
• As with labor markets, the key
is the price/output correlation.
Specifically, remember that the
interest rate is procyclical.
• This suggests that supply side
factors (ie, productivity) are
behind changes in investment,
savings, and interest rates.
• Further, because investment
drives the results, most shocks
must be perceived as
permanent.
24
20
16
12
8
4
0
0
100
200
300
400
500