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Lecture 6: Macromodel Exercises
Dr. Rajeev Dhawan
Director
Given to the
EMBA 8400 Class
South Class Room #600
February 3, 2007
Policy Experiments With The Integrated
Macro Model
 Policy Experiments are comparisons of simulated time paths of all
endogenous variables to changes in the values of some of the
exogenous variables representing macroeconomic policy, such as
government spending, taxes, or money supply.
Three policy experiments are discussed in this Guide:
1. A Monetary-Stimulus (Inflation) Policy Experiment: Simulated response to
an increase in the growth of money supply from zero to a chosen rate of
inflation (1 to 20 percent range).
2. A Fiscal-Stimulus Policy Experiment: Simulated response to an increase in
real government spending by $50 billion increments without any change in
taxes.
3. A Neutral-Budget Policy Experiment: Simulated response to two
coordinated fiscal policy changes:
a. An increase in real government spending, (the same as in the second
experiment).
b. An increase in tax rates high enough to “crowd out” an exactly
offsetting amount of consumption.
1A: Monetary-Stimulus (Inflation) Experiment
Money Growth Stops in 2010
 Rate of growth of the money supply is increased from 0%
to 5% in 2006.
 This is done for 4 years from 2006 to 2009, and then money
supply growth drops to 0% in 2010 and thereafter.
Money Supply
$4,500
$4,000
$3,500
$ Billions
$3,000
$2,500
$2,000
$1,500
$1,000
$500
$-
04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31
20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20
Years
Money Supply (Simulation)
Money Supply (Base)
• Money supply growth rate is a constant 5% for four
years from 2006 – 2009
Money Supply Growth
(in Percentage %)
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Money Supply Growth (Base)
Money Supply Growth (Simulation)
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
GDP versus Potential
GDP vs GDP Potential
$7,150
$7,100
$ Billions
$7,050
$7,000
$6,950
$6,900
$6,850
$6,800
Same as
$6,750
GDP Potential in Long Run
$6,700
2031
2030
2029
2028
2027
2026
Years
GDP Potential
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
GDP
Q&A
Q: Why does GDP values fluctuate around the potential?
A: Interest Rate becomes cyclic which makes Investment
cyclical
Q: So?
A: Interest rate is cyclical because inflation rate in the model
at first is smaller than or lags the money supply growth rate,
and then later overshoots it. The important thing to note is
that if the inflation rate is equal to the money growth rate,
then there will be no dynamics!
Q: Why does Inflation lag the money growth rate initially?
A: By construction, based upon historical evidence, there is a
lag or slowness in people’s adjustment of their inflation
expectations. However, this adjustment is complete i.e.
expectations are equal to actual inflation rate in the long
run, which is equal to the growth rate of money supply.
Inflation is always a monetary phenomenon.
Inflation follows the money growth path, lagging behind at first but then overshooting on the way down. Inflation, however, is equal to the growth rate of
money supply in the long-run
Money Supply Growth Vs. Inflation
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
-1.0
2012
2011
2010
2009
2008
2007
2006
2005
2004
(in Percentage %)
•
-2.0
-3.0
Years
Inflation
Money Supply Growth
•The real interest rate becomes cyclic. At first it drops
and then rises as P overshoots M!
(In Percentage %)
Real Interest Rate
4.6
4.4
4.2
4.0
3.8
3.6
3.4
3.2
2030
2028
Real Interest Rate (Base)
2026
Real Interest Rate (Simulation)
2024
2022
2020
2018
2016
2014
2012
2010
2008
2006
2004
Years
Investment follows a cyclic path, increases in the short-run
due to a drop in the real interest rate, then drops as real
interest rate rises. In the long-run it comes back to its steady
state value
Investment
$1,040
$1,020
$1,000
$ Billions
•
$980
$960
$940
$920
Investment (Simulation)
Investment (Base)
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
Comparison of Inflation and Nominal Interest Rates
Nominal = Real + Inflation Rate
Inflation vs. Nominal Interest Rate
12.0
10.0
(In Percentage %)
8.0
6.0
4.0
2.0
0.0
Years
Inflation
Nominal Interest Rate
2031
2030
2029
-4.0
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
-2.0
Comparison of Real Interest Rate and Nominal
Interest Rate
Real Vs Nominal Interest Rate
12.0
(In Percentage %)
10.0
8.0
6.0
4.0
2.0
0.0
2031
2030
2029
Nominal Interest Rate
2028
Real Interest Rate
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
•As R drops it pulls down the real exchange rate
Real Exchange Rates
1.020
1.015
Real Interest Rate
1.010
1.005
(In Percentage %)
4.6
1.000
4.4
0.995
4.2
0.990
4.0
3.8
0.985
2030
2029
2028
2027
2026
2025
2024
2023
Real Interest Rate (Simulation)
2022
2021
Years
Years
Real Exchange Rates (Simulation)
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
3.6
0.980
3.4
0.975
3.2
Real Exchange Rates (Base)
Real Interest Rate (Base)
•Exports increase in the short-run due to a drop in the real exchange rate
α9 < 0
Exports Vs. Real Exchange Rate
Real Interest Rate
1.2
1.0
$1,770
4.6
$1,760
4.4
0.8
(In Percentage %)
Exports
$1,780
0.6
4.2
$1,750
4.0
$1,740
3.8
0.2
0.0
Real Interest Rate (Base)
2030
Real Interest Rate (Simulation)
Real Exchange Rate
2029
2030
2028
Exports
2027
2028
2026
Years
Years
2025
2026
2024
2023
2024
2022
2021
2022
2020
2019
2020
2018
2017
2018
2016
2016
2015
2014
2014
2013
2012
2012
2011
2010
2010
2009
2008
2008
2007
2006
2006
2005
2004
2004
2003
3.6
$1,730
3.4
$1,720
3.2
0.4
Real Exchange Rate
Billions
$1,790
•Exports increase in the short-run due to a drop in the
real exchange rate
Exports
Billions
$1,790
$1,780
Real Interest Rate
$1,770
(In Percentage %)
$1,760
4.6
4.4
$1,750
4.2
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2020
Exports (Base)
Real Interest Rate (Base)
2030
Exports (Simulation)
Real Interest Rate (Simulation)
2028
Years
Years
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
2006
2004
2004
3.4
$1,720
3.2
2003
$1,740
4.0
3.8
$1,730
3.6
•Imports also increase in the short-run even despite a drop in the
real exchange rate. Why? GDP has increased!
α12 > 0
Imports Vs. Real Exchange Rate
Billions
$2,040
1.2
Real Interest Rate
$2,030
0.8
$2,010
4.6
(In Percentage %)
Imports
$2,020
4.4
$2,000
0.6
4.2
$1,990
4.0
0.4
3.8
$1,980
0.2
3.6
$1,970
3.4
0.0
2030
2030
2029
Real Interest Rate (Base)
2028
2028
2027
Years
Years
Real Exchange Rate
2026
2026
2025
2024
2024
2023
2022
2022
2021
2020
2020
2019
2018
2018
2017
Real Interest Rate (Simulation)
2016
2016
2015
Imports
2014
2014
2013
2012
2012
2011
2010
2010
2009
2008
2008
2007
2006
2006
2005
2004
2004
2003
$1,960
3.2
Real Exchange Rate
1.0
•Imports increase in the short-run due to a rise in GDP which
overpowers the negative effect of a weak exchange rate on imports
Imports
Billions
$2,040
$2,030
Real Interest Rate
$2,020
$2,010
4.6
(In Percentage %)
$2,000
4.4
$1,990
4.2
4.0
$1,980
3.8
3.6
$1,970
Real Interest Rate (Base)
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Real Interest Rate (Simulation)
Imports (Base)
2030
Imports (Simulation)
2028
Years
Years
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
2006
2004
2003
3.4
$1,960
3.2
2031
2030
2030
2029
2029
2028
2028
2027
2027
2026
2025
2024
2024
2023
2023
2022
2022
2021
2021
2020
2020
2019
2018
2019
2016
2017
2017
2018
2015
2016
2014
2015
2013
2014
2012
2013
2011
2012
2010
2011
2009
2010
2008
2009
2007
2008
2006
2007
2005
2006
2004
2005
Trade Deficit Vs. Real Exchange Rate
Exports
$1,790
$(230)
1.2
$1,780
$(235)
1.0
$1,770
$(240)
0.8
$1,760
$(245)
0.6
$1,750
$(250)
0.4
$(255)
$1,730
0.2
$(260)
$1,720
0.0
$1,740
Years
Years
Exports (Simulation)
Trade Deficit
Exports (Base)
Exchange Rate
Exchange Rate
($ Billions)
Trade Deficit
2003
2004
Billions
2026
2025
•Trade deficit increases in the short-run because the increase in real
exports is less than the increase in real imports (based upon values of
alphas!)
• Real GDP shoots above the base case value, so that there
is a boom in the economy in the short-run. In the long-run,
once the prices adjust completely, the economy is back to
its potential GDP value
GDP
Real Interest Rate
$7,150
Unemployment Drops
$7,050
4.6
$7,000
4.4
(In Percentage %)
$ Billions
$7,100
$6,950
4.2
4.0
$6,900
3.8
$6,850
2030
GDP
(Simulation)
GDP (Base)
Real
Interest Rate (Base)
2030
2029
Real Interest Rate (Simulation)
2028
Years
Years
2027
2028
2026
2026
2025
2024
2024
2023
2022
2022
2021
2020
2020
2019
2018
2018
2017
2016
2016
2015
2014
2014
2013
2012
2012
2011
2010
2010
2009
2008
2008
2007
2006
2006
2005
2004
2004
2003
3.6
$6,800
3.4
$6,750
3.2
$6,700
Unemployment Rises
•Government surplus increases because GDP increases result in
increased tax collections, and government spending is assumed to be
constant.
Surplus / Deficit
Billions
Real Interest Rate
$310
$300
(In Percentage %)
$290
4.6
$280
4.4
4.2
$270
4.0
3.8
$260
3.6
$250
3.4
Real Interest Rate (Base)
2030
Real Interest Rate (Simulation)
Surplus / Deficit (Base)
2029
2030
Surplus / Deficit (Simulation)
2028
Years
Years
2027
2028
2026
2025
2026
2024
2023
2024
2022
2021
2022
2020
2019
2020
2018
2017
2018
2016
2015
2016
2014
2013
2014
2012
2011
2012
2010
2009
2010
2008
2007
2008
2006
2005
2006
2004
2003
2004
3.2
$240
•Consumption rises as GDP has risen!
Consumption
Billions
$5,600
Real Interest Rate
$5,550
$5,500
(In Percentage %)
4.6
$5,450
4.4
$5,400
4.2
4.0
$5,350
3.8
3.6
$5,300
3.4
2030
2030
2029
2028
2028
2027
Real Interest Rate (Base)
2026
2026
2025
Years
Years
Consumption (Base)
2024
2024
2023
2022
2022
2021
2020
2020
2019
2018
2018
2017
Real Interest Rate (Simulation)
2016
2016
2015
Consumption (Simulation)
2014
2014
2013
2012
2012
2011
2010
2010
2009
2008
2008
2007
2006
2006
2005
2004
2004
2003
$5,250
3.2
Comparison of Government Surplus and Nominal
Interest Rate
Surplus Vs. Nominal Interest Rate
Billions
12.0
Real
RealInterest
InterestRate
Rate
$300
10.0
$290
8.0
(In
(In Percentage
Percentage %)
%)
$280
4.6
4.6
6.0
4.4
4.4
$270
4.2
4.2
4.0
4.0
$260
3.8
3.8
4.0
3.6
3.6
$250
3.4
3.4
$240
3.2
3.2
2.0
0.0
2030
2030
2029
2030
2028
Real
RealInterest
InterestRate
Rate(Base)
(Base)
2028
2027
2028
Nominal Interest Rate
2026
2026
2025
2026
2024
2024
2023
2024
2022
2022
2021
2022
2020
Years
Years
Years
2020
2019
2020
2018
2018
2017
2018
2016
Real
RealInterest
InterestRate
Rate(Simulation)
(Simulation)
2016
2015
2016
2014
2014
2013
2014
2012
2012
2011
2012
2010
2010
2009
2010
2008
2008
2007
2008
2006
2006
2005
2006
2004
2004
2003
2004
Surplus
Nominal Interest Rates (in%)
$310
Cont…
Comparison of Government Surplus and Real Interest
Rate
Surplus Vs. Real Interest Rate
Billions
4.6
$300
4.4
Real Interest Rate
4.2
Surplus
(In Percentage %)
$290
Real Interest Rate
Real Interest Rate (Base)
2030
Surplus
Real Interest Rate (Simulation)
2030
2029
2028
Years
Years
2028
2027
2026
2026
2025
2024
2024
2023
2022
2022
2021
2020
2019
2020
3.2
2018
3.4
$240
3.2
2017
2018
2016
3.4
2015
2016
2014
$250
3.6
2013
2014
2012
3.6
2011
2012
2010
4.0
$260
3.8
2009
2010
2008
3.8
2007
2008
2006
4.4
$270
4.2
2005
2006
2004
4.0
2003
2004
$280
4.6
Real Interest Rates (in%)
$310
(Growth stops in 2009)
A Somewhat “Sequential” Working
of the Model (Monetary Policy)
 As Money Supply goes up (M↑), Inflation goes up (P↑), but not
as much which implies that Real Interest Rate falls (R↓) which
stimulates the Investment (I↑).
 Also as Real Interest Rate falls (R↓), the Real Exchange Rate
falls (EXCH↓) which boost Exports (EX↑) but hurts Imports
(IM↓)
 Rise in Investment and Exports by GDPO identity means GDP
increases (GDP↑). Consumption also rises (C↑) as GDP rises.
 However a rise in GDP also stimulates Imports and the neteffect is that Imports rise overall (IM↑).
 Trade Deficit (NETEX↑) increases because the rise in Imports is
greater than the rise in Exports.
 Government surplus increases because GDP increases result
in increased tax collections, and government spending is
assumed to be constant.
In the Long Run…
Inflation rate is exactly equal to
the money growth rate. This
means there is no change in the
value of real interest rate which
in turn implies no change in the
other variables of the model,
and hence no change in GDP!!
Summary of Reactions









Inflation follows the money growth path, lagging behind at first but then overshooting on the way down. Inflation, however, is equal to the growth rate of money
supply in the long-run
The real interest rate becomes cyclic. At first it drops and then rises as P overshoots
M! Investment follows a cyclic path, increases in the short-run due to a drop in the
real interest rate, then drops as real interest rate rises. In the long-run it comes back
to its steady state value
As R drops it pulls down the real exchange rate
Exports increase in the short-run due to a drop in the real exchange rate
Imports also increase in the short-run even despite a drop in the real exchange rate.
Why? GDP has increased!
Trade deficit increases in the short-run because the increase in real exports is less
than the increase in real imports (based upon values of alphas!)
Real GDP shoots above the base case value, so that there is a boom in the economy
in the short-run. In the long-run, once the prices adjust completely, the economy is
back to its potential GDP value.
Government surplus increases because GDP increases result in increased tax
collections, and government spending is assumed to be constant.
Consumption rises as GDP has risen!
1B: Monetary-Stimulus (Inflation) Experiment
When Money Growth Stops Slowly by 2013
•
e
Rate of growth of the money supply is increased from 0% to 5% in 2006, and
then kept at 5% until 2009, and then decreased slowly to 0% by 2013 (stays
at 0% afterwards)
Real Interest Rate
Money Supply
2030
2029
2028
2027
2026
2025
2030
2028
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
2006
2004
Rate
$5,000
$4,500
4.6
8.0
$4,000
4.4
$3,500
6.0
4.2
$3,000
$2,500
4.0
4.0
$2,000
3.8
2.0
$1,500
3.6
$1,000
0.0$500
3.4
$3.2
(In Percentage %)
$ Billions
10.0
Nominal Interest Rates (in%)
12.0
03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20
Years
Years
Money Supply (Simulation)
Real Interest Rate (Simulation)
Money Supply (Base)
Real Interest Rate (Base)
6.0
6.0
5.0
4.0
4.0
3.0
2.0
2.0
1.0
0.0
Money Supply Growth
10.0
Years
Years
2031
2030
2030
2029
2029
2028
2028
2027
2027
2026
2026
2025
2025
2024
2024
2023
2023
2022
2021
2022
2021
2020
2019
2020
2018
2019
Nominal Interest Rate
Real Interest Rate
Money Supply Growth (Simulation)
Money Supply Growth (Base)
2017
2018
2016
2017
2015
2016
2014
2015
2013
2014
2012
2013
2011
2012
2010
2011
2009
2010
2008
2009
2008
2007
2007
2006
2006
2005
2005
2004
2004
2003
0.0
(in Percentage %)
8.0
(In Percentage %)
Real Vs Nominal Interest Rate
12.0
Inflation follows the money growth path, lagging behind at first but then overshooting on the way down. Inflation, however, is equal to the growth rate of
money supply in the long-run
Money Supply Growth Vs. Inflation
7.0
6.0
(in Percentage %)
•
5.0
4.0
3.0
2.0
1.0
0.0
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
-1.0
-2.0
Years
Inflation
Money Supply Growth
•The real interest rate becomes cyclic. At first it drops which
helps investment and then when it rises it hurts investment.
4.3
4.2
4.1
4.0
3.9
3.8
3.7
3.6
3.5
3.4
2030
Real Interest Rate (Simulation)
2028
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
2006
2004
Years
Investment
$1,040
$1,030
Real Interest Rate (Base)
$1,020
$1,010
$ Billions
(In Percentage %)
Real Interest Rate
$1,000
$990
$980
$970
$960
$950
$940
Investment (Simulation)
Investment (Base)
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
$1,785
$1,780
$1,775
0.800
$1,770
($ Billions)
0.600
0.400
0.200
$1,765
$1,760
$1,755
$1,750
$1,745
0.000
2030
2028
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
$1,735
Years
Exports (Simulation)
Real Exchange Rate (Simulation)
Real Exchange Rate (Base)
Imports
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
2006
2004
$1,740
Years
$2,040
$2,030
$2,020
$ Billions
(In Percentage %)
1.000
$2,010
$2,000
$1,990
$1,980
$1,970
Years
Imports (Simulation)
Imports (Base)
Exports (Base)
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2017
2018
2016
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
1.200
2015
Exports
Real Exchange Rate
• Real GDP shoots above the base case values, so that
there is a boom in the economy in the short-run. In the
long-run, once the prices adjust completely, the economy
is back to its potential GDP
Real Vs Nominal Interest Rate
GDP
12.0
10.0
$7,150
Unemployment Drops
(In Percentage %)
$ Billions
$7,100
8.0
$7,050
6.0
$7,000
$6,950
4.0
$6,900
Unemployment Rises
2.0
$6,850
$6,800
0.0
2030
2031
2030
2029
Nominal Interest Rate
2028
2029
2027
2028
Real Interest Rate
2026
2027
2025
2026
2024
2025
2023
2024
2022
2023
2021
2022
2020
2021
2019
2020
2018
2019
2017
2018
2016
2017
2015
2016
2014
2015
2013
2014
2012
2013
2011
2012
2010
2011
2009
2010
2008
2009
2007
2008
2006
2007
2005
2006
2004
2005
2003
2004
Years
Years GDP (Base)
GDP (Simulation)
1C: Monetary-Stimulus (Inflation) Experiment
When Money Growth Never Stops!
• Rate of growth of the money supply is increased
from 0% to 5%.
• This is done forever (till the end of simulation
period in 2030!) Real Vs Nominal Interest Rate
12.0
12.0
Nominal Interest Rates (in%)
10.0
Money Supply
$14,000
10.0
(In Percentage %)
$12,000
8.0
8.0
($ Billions)
$10,000
6.0
$8,000
6.0
4.0
$6,000
4.0
2.0
$4,000
2.0
$2,000
0.0
2030
2029
2028
2027
2026
2025
2031
2030
Nominal Interest Rate
Money Supply (Base)
2029
Real Interest Rate
Money Supply (Simulation)
2028
Years
Years
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20
2004
te
$-
0.0
• Money Supply Growth Rate is a constant 5% forever starting in
year 2005
Money Supply Growth
(in Percentage %)
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Money Supply Growth (Base)
Money Supply Growth (Simulation)
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
Inflation follows the money growth path, lagging behind at first but then
over-shooting on the way down. Inflation, however, is equal to the
growth rate of money supply in the long-run
Money Supply Growth Vs. Inflation
7.0
6.0
(in Percentage %)
•
5.0
4.0
3.0
2.0
1.0
0.0
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
Inflation
Money Supply Growth
Real Interest Rate
4.1
4.0
3.9
3.8
3.7
3.6
3.5
2030
2028
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
2006
2004
Years
Real Interest Rate (Simulation)
Real Interest Rate (Base)
Investment
$1,040
$1,030
$1,020
$ Billions
(In Percentage %)
4.2
$1,010
$1,000
$990
$980
$970
Investment (Simulation)
Investment (Base)
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
Comparison of Real and Nominal Interest Rates
Real Vs Nominal Interest Rate
12.0
(In Percentage %)
10.0
8.0
6.0
4.0
2.0
0.0
2031
2030
2029
Nominal Interest Rate
2028
Real Interest Rate
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
• Real GDP shoots above the base case values, so that
there is a boom in the economy in the short-run. In the
long-run, once the prices adjust completely, the
economy is back to the potential GDP
GDP vs GDP Potential
$7,150
$ Billions
$7,100
$7,050
$7,000
$6,950
$6,900
$6,850
2031
2030
2029
2028
2027
2026
Years
GDP Potential
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
GDP
Lessons From the Three Monetary (Inflation)
Experiments
Money Supply Growth
(in Percentage %)
6.0
5.0
1c
4.0
3.0
1b
2.0
1a
1.0
0.0
Money Supply Growth (1b)
Money Supply Growth (1a)
2031
Money Supply Growth (1c)
2030
2029
Money Supply Growth (Base)
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
Inflation Response Depends on How Long
Monetary Stimulus Lasts
Inflation
1c
6.00
4.00
1b
1a
2.00
0.00
Years
Inflation (1c)
Inflation (Base)
Inflation (1a)
Inflation (1b)
2030
-4.00
2028
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
2006
-2.00
2004
(In Percentage %)
8.00
Interest Rate Overshooting Depends on How
QUICKLY Monetary Growth Returns to Normal
Real Interest Rate
(In Percentage %)
4.6
4.4
1b
4.2
4.0
1c
3.8
1a
3.6
3.4
3.2
Real Interest Rate (1c)
Real Interest Rate (Base)
Real Interest Rate (1b)
Real Interest Rate (1a)
2030
2028
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
2006
2004
Years
Depth of the Recession Depends Upon How
Quickly the Monetary Stimulus is Withdrawn!
GDP
$7,150
1b
$7,100
$ Billions
$7,050
1c
$7,000
$6,950
$6,900
$6,850
1a
$6,800
$6,750
$6,700
GDP (1c)
GDP (Base)
GDP (1a)
GDP (1b)
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
2a. Fiscal-Stimulus Policy
Experiment
2a. Fiscal-Stimulus Policy Experiment
 In this experiment real government spending is increased in steps of
$100 billion higher from 2006 to 2009, and then spending stays
elevated at that level forever.
 NO INCREASE IN TAX RATE: A deficit-financed war provides the
historical context for large increases in government spending.
Government Spending
$1,400
$1,200
$ Billions
$1,000
$800
$600
$400
$200
$0
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
Govt. Spending (Simulation)
Govt. Spending (Base)
Government Spending and Tax Rate
$1,400
16.0%
$1,200
14.0%
12.0%
$1,000
10.0%
$800
8.0%
$600
6.0%
$400
4.0%
$200
2.0%
$-
0.0%
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
Government Spending
Tax Rate
Tax Rate
Government Spending
Government Spending vs. Tax Rate
•Higher government spending adds directly to real GDP, by the national
income accounting identity. Since prices do not adjust completely in the
first year, the full adjustment is delayed and the economy goes into a
damped oscillations but in the long run GDP comes back to steady state
$7,100
GDP
GDP
Unemployment Drops
$ Billions
$7,050
$7,000
$6,950
Unemployment Rises
$6,900
$6,850
$6,800
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
GDP (Simulation)
GDP (Base)
Inflation follows the a cyclic path. Why? Because GDP has
risen. So initially it shoots up and then drops, but eventually
settles to the steady state values
Inflation
4.00
3.00
2.00
1.00
0.00
Inflation (Simulation)
Inflation (Base)
2030
Years
2028
-2.00
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
2006
-1.00
2004
(In Percentage %)
•
 The booming economy raises the demand for money and
forces the real interest rate higher.
Real Interest Rate
(In Percentage %)
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Real Interest Rate (Base)
2030
Real Interest Rate (Simulation)
2028
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
2006
2004
Years
Rise in interest rate hurts investment
$1,020
$1,000
$980
$960
$940
$920
$900
$880
$860
$840
$820
$800
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
Investment
Real Interest Rate
Real Interest Rate
Investment
Investment Vs. Real Interest Rate
Real Exchange Rate
Real Exchange Rate
1.010
1.005
(In Percentage %)
1.000
0.995
0.990
0.985
0.980
0.975
0.970
0.965
0.960
2030
2028
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
2006
2004
Years
Real Exchange Rate (Simulation)
Real Exchange Rate (Base)
 Higher real interest rates also raise the exchange
rate relative to the domestic price level and the restof-the-world price level. That is, the real exchange
rate rises. This lowers real exports.
$1,800
($ Billions)
$1,750
$1,700
$1,650
$1,600
$1,550
$1,500
Years
Exports (Simulation)
Exports (Base)
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2017
2018
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Exports
 The imports rise as exchange rate rises.
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
Imports
$2,200
$ Billions
$2,150
$2,100
$2,050
$2,000
$1,950
$1,900
Years
Imports (Simulation)
Imports (Base)
 Higher imports and lower exports cause net exports
(trade deficit) to drop.
$-
$ Billions
$(100)
$(200)
$(300)
$(400)
$(500)
$(600)
Years
Trade Deficit (Simulation)
Trade Deficit (Base)
2031
2030
2029
2028
2027
2026
2024
2025
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2010
2011
2009
2008
2007
2006
2004
Billions
2005
Trade Deficit (Net Exports)
(in %)
 Higher real GDP and constant tax rates, raises the real
disposable income and thus also increases
consumption in the short-run, but in the long-run it
settles back to steady state values
Consumption
$5,560
$5,540
$5,520
$ Billions
$5,500
$5,480
$5,460
$5,440
$5,420
$5,400
$5,380
$5,360
2031
2030
Consumption (Base)
2029
Consumption (Simulation)
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
Comparison of Government Spending and Consumption
Govt. Spending vs. Consumption
$1,400
$5,560
$5,540
$5,520
$5,500
$800
$5,480
Consumption ($
Billions)
$1,000
$5,460
$600
$5,440
$400
$5,420
$5,400
$200
$5,380
$-
$5,360
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
Govt. Spending ($
Billions)
$1,200
Years
Govt. Spending
Consumption
 Even though the tax rate is constant, higher GDP
levels result in increased tax revenues
Tax Revenues
$1,065
$1,060
$ Billions
$1,055
$1,050
$1,045
$1,040
$1,035
$1,030
$1,025
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Tax Revenues (Simulation) Years
Tax Revenues (Base)
Government Deficit/Surplus and the Real Interest Rate
Surplus Vs. Real Interest Rate
7.0
$300
6.0
$200
5.0
$100
4.0
3.0
$$(100)
$(200)
2.0
1.0
0.0
Years
Surplus
Real Interest Rate
Real Interest Rate (in %)
8.0
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Surplus ($ Billions)
$400
A Somewhat “Sequential” Working
of the Model (Fiscal Policy)
 As Government Spending goes up (G↑), GDP goes up
(GDP↑) which causes price level to go up too (P↑).
 Real Interest Rate rises (R↑) which depresses
Investment (I↓).
 Also as Real Interest Rate rises the Real Exchange
Rate rises (EXCH↑) which hurts Exports (EX↓) but
boosts Imports (IM↑) causing the Trade Deficit to rise
(NETEX ↑).
 As GDP goes up the tax collections rise but not by as
much as the increase in government spending causing
the Government deficit to increases.
Summary of Reactions
 In this experiment real government spending is increased in steps of $100 billion
higher from 2006 to 2009, and then spending stays elevated at that level forever.
 Inflation follows the a cyclic path. Initially shoots and then drops, but eventually
settles to the steady state values
 Higher government spending adds directly to real GDP, by the national income
accounting identity. Since prices do not adjust completely in the first year, the full
adjustment is delayed and the economy goes into a damped oscillations but in the
long run GDP comes back to steady state
 The booming economy raises the demand for money and forces the real interest
rate higher.
 Higher real interest rates also raise the exchange rate relative to the domestic
price level and the rest-of-the-world price level. That is, the real exchange rate
rises. This lowers real exports and raises real Imports, causing net exports (trade
deficit) to drop for both the reasons.
 Higher real GDP and constant tax rates, raises the real disposable income and
thus also increases consumption in the short-run, but in the long-run it settles
back to steady state values
 Even though the tax rate is constant, higher GDP levels result in increased tax
revenues
Data Table 2 (a): Govt. Spending
2b: When…Govt. Spending is Reduced
to its Original Spending Value by 2013
•Government Spending increases for four years and then
gradually reduced back to the original spending by 2013
Government Spending
$1,400
$1,200
$ Billions
$1,000
$800
$600
$400
$200
$0
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
Govt. Spending (Simulation)
Govt. Spending (Base)
•Government Spending increases for four years and then
gradually reduced back to the original spending in 2012
whereas the tax rats remain constant
$1,400
16.0%
$1,200
14.0%
12.0%
$1,000
10.0%
$800
8.0%
$600
6.0%
$400
4.0%
$200
2.0%
$-
0.0%
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
Government Spending
Tax Rate
Tax Rate
Government Spending
Government Spending vs. Tax Rate
•Because the government spending is reduced and
brought back to the original level in 2012, the real
interest rates are forced to come back to the original
as the stimulus is taken away.
Real Interest Rate
(In Percentage %)
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Real Interest Rate (Base)
2030
Real Interest Rate (Simulation)
2028
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
2006
2004
Years
Inflation Behavior
Inflation
4.00
2.00
1.00
0.00
-5.00
Years
Inflation (Simulation)
Inflation (Base)
2030
-4.00
2028
-3.00
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
-2.00
2006
-1.00
2004
(In Percentage %)
3.00
•As inflation wears off and the real interest rate
returns to normal implies that the nominal interest
rate will drop
Real Vs Nominal Interest Rate
12.0
10.0
(In Percentage %)
8.0
6.0
4.0
2.0
0.0
2031
2030
Nominal Interest Rate
2029
Real Interest Rate
2028
Years
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
-2.0
Comparison of Government Spending and Consumption
$5,600
$1,200
$5,550
$1,000
$5,500
$800
$5,450
$600
$5,400
$400
$5,350
$200
$5,300
$-
$5,250
Consumption ($
Billions)
$1,400
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
Govt. Spending ($
Billions)
Govt. Spending vs. Consumption
Years
Govt. Spending
Consumption
•Higher government spending adds directly to real GDP
from the national accounting identity. Since prices do not
adjust completely in the first year, the full adjustment is
delayed and the economy goes into a damped
oscillation toward the long run steady state
GDP vs GDP Potential
$7,150
$7,100
$ Billions
$7,050
$7,000
$6,950
$6,900
$6,850
$6,800
$6,750
$6,700
2031
2030
2029
2028
2027
2026
Years
GDP Potential
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
GDP
3. Neutral-Budget Policy Experiment
– In this experiment real government spending is increased by the same
one-step increase imposed in the fiscal-stimulus experiment.
– Instead of running a deficit, the government raises the tax rate high
enough to crowd out the exact amount of increase in government
spending by reducing consumption.
Billions
Government Spending vs. Tax Rate
$880
(in %)
17.0%
$860
$820
16.0%
$800
15.5%
$780
$760
15.0%
$740
14.5%
$720
$700
14.0%
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
Government Spending
Tax Rate
Tax Rate
Government Spending
16.5%
$840
Tax Revenues
Billions
$1,180
$1,160
$1,140
$ Billions
$1,120
$1,100
$1,080
$1,060
$1,040
$1,020
$1,000
$980
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Tax Revenues (Simulation) Years
Tax Revenues (Base)
•Higher taxes via higher tax rate leads to drop in
consumption
Consumption
Billions
$5,500
$5,480
$5,460
$ Billions
$5,440
$5,420
$5,400
$5,380
$5,360
$5,340
$5,320
2031
2030
Consumption (Base)
2029
Consumption (Simulation)
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
Government Spending vs. Consumption
$5,500
$860
$5,480
$840
$5,460
$820
$5,440
$800
$5,420
$780
$5,400
$760
$5,380
$740
$5,360
$720
$5,340
$700
$5,320
Years
Govt. Spending
Consumption
Consumption ($
Billions)
$880
20
200 4
200 5
200 6
200 7
200 8
200 9
201 0
201 1
201 2
201 3
201 4
201 5
201 6
201 7
201 8
201 9
202 0
202 1
202 2
202 3
202 4
202 5
202 6
202 7
202 8
202 9
203 0
31
Govt. Spending ($
Billions)
Govt. Spending vs. Consumption
No Change in Interest Rate!
Real Interest Rate
(In Percentage %)
5.0
4.0
3.0
2.0
1.0
0.0
Real Interest Rate (Base)
2030
Real Interest Rate (Simulation)
2028
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
2006
2004
Years
Increased G and Decreased C => Constant GDP
GDP
Billions
$8,000
$ Billions
$7,000
$6,000
$5,000
$4,000
$3,000
$2,000
$1,000
$-
GDP (Base)
2031
2030
2029
GDP (Simulation)
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
Second half of the data Neutral Experiment Table
4: Stop and Go Experiment
Money Supply Growth
(in Percentage %)
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Money Supply Growth (Base)
Money Supply Growth (Simulation)
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
4.0
2.0
0.0
Money Supply Growth
Inflation
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
-2.0
2012
2011
2010
2009
2008
2007
2006
2005
2004
(in Percentage %)
Money Supply Growth Vs. Inflation
8.0
6.0
-4.0
Years
20
0
20 4
0
20 5
0
20 6
0
20 7
0
20 8
0
20 9
1
20 0
1
20 1
1
20 2
1
20 3
1
20 4
1
20 5
1
20 6
1
20 7
1
20 8
1
20 9
2
20 0
2
20 1
2
20 2
2
20 3
2
20 4
2
20 5
2
20 6
2
20 7
2
20 8
2
20 9
3
20 0
31
$ Billions
Money Supply
$6,000
$5,000
$4,000
$3,000
$2,000
$1,000
$-
Years
Money Supply (Simulation)
Money Supply (Base)
Real Interest Rate
(In Percentage %)
4.6
4.4
4.2
4.0
3.8
3.6
3.4
Real Interest Rate (Base)
2030
Real Interest Rate (Simulation)
2028
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
2006
2004
Years
8.0
6.0
4.0
(In Percentage %)
Real Vs Nominal Interest Rate
12.0
10.0
2.0
0.0
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
Nominal Interest Rate
Real Interest Rate
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
$980
$ Billions
Investment
$1,040
$1,020
$1,000
$960
$940
$920
2031
2030
2029
2028
2027
2026
2025
2024
Investment (Base)
Investment (Simulation)
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
$310
4.6
$300
4.4
$290
4.2
$280
4.0
$270
3.8
$260
$250
3.6
$240
3.4
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years
Surplus
Real Interest Rate
Real Interest Rate (in %)
Surplus ($ Billions)
Surplus Vs. Real Interest Rate
$7,150
$7,100
$7,050
$7,000
$6,950
$6,900
$6,850
$6,800
$6,750
$6,700
$ Billions
GDP
2031
2030
2029
2028
2027
2026
2025
2024
2023
GDP (Base)
GDP (Simulation)
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
Years