Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Nominal rigidity wikipedia , lookup
Long Depression wikipedia , lookup
Helicopter money wikipedia , lookup
Phillips curve wikipedia , lookup
Interest rate wikipedia , lookup
Money supply wikipedia , lookup
Monetary policy wikipedia , lookup
Ragnar Nurkse's balanced growth theory wikipedia , lookup
Business cycle wikipedia , lookup
Keynesian economics wikipedia , lookup
N. Gregory Mankiw PowerPoint® Slides by Ron Cronovich CHAPTER 11 Aggregate Demand II: Applying the IS-LM Model © 2010 Worth Publishers, all rights reserved SEVENTH EDITION MACROECONOMICS Context Chapter 9 introduced the model of aggregate demand and supply. Chapter 10 developed the IS-LM model, the basis of the aggregate demand curve. CHAPTER 11 Aggregate Demand II 1 In this chapter, you will learn: how to use the IS-LM model to analyze the effects of shocks, fiscal policy, and monetary policy how to derive the aggregate demand curve from the IS-LM model several theories about what caused the Great Depression Equilibrium in the IS -LM model The IS curve represents equilibrium in the goods market. r LM Y C (Y T ) I (r ) G The LM curve represents money market equilibrium. r1 M P L (r ,Y ) Y1 The intersection determines the unique combination of Y and r that satisfies equilibrium in both markets. CHAPTER 11 Aggregate Demand II IS Y 3 Policy analysis with the IS -LM model Y C (Y T ) I (r ) G r LM M P L (r ,Y ) We can use the IS-LM model to analyze the effects of r1 • fiscal policy: G and/or T • monetary policy: M CHAPTER 11 Aggregate Demand II IS Y1 Y 4 An increase in government purchases 1. IS curve shifts right 1 by G 1 MPC causing output & income to rise. 2. This raises money demand, causing the interest rate to rise… r 2. r2 r1 3. …which reduces investment, so the final increase in Y 1 is smaller than G 1 MPC CHAPTER 11 Aggregate Demand II LM IS2 1. IS1 Y1 Y2 Y 3. 5 A tax cut Consumers save r (1MPC) of the tax cut, so the initial boost in spending is smaller for T r2 than for an equal G… 2. r1 and the IS curve shifts by 1. 1. MPC T 1 MPC 2. …so the effects on r and Y are smaller for T than for an equal G. CHAPTER 11 LM Aggregate Demand II IS2 IS1 Y1 Y2 Y 2. 6 Monetary policy: An increase in M 1. M > 0 shifts the LM curve down (or to the right) 2. …causing the interest rate to fall 3. …which increases investment, causing output & income to rise. CHAPTER 11 Aggregate Demand II r LM1 LM2 r1 r2 IS Y1 Y2 Y 7 Interaction between monetary & fiscal policy Model: Monetary & fiscal policy variables (M, G, and T ) are exogenous. Real world: Monetary policymakers may adjust M in response to changes in fiscal policy, or vice versa. Such interaction may alter the impact of the original policy change. CHAPTER 11 Aggregate Demand II 8 The Fed’s response to G > 0 Suppose Congress increases G. Possible Fed responses: 1. hold M constant 2. hold r constant 3. hold Y constant In each case, the effects of the G are different… CHAPTER 11 Aggregate Demand II 9 Response 1: Hold M constant If Congress raises G, the IS curve shifts right. r If Fed holds M constant, then LM curve doesn’t shift. r2 r1 LM1 IS2 IS1 Results: Y Y 2 Y1 r r2 r1 CHAPTER 11 Aggregate Demand II Y1 Y2 Y 10 Response 2: Hold r constant If Congress raises G, the IS curve shifts right. To keep r constant, Fed increases M to shift LM curve right. r LM1 r2 r1 IS2 IS1 Results: Y Y 3 Y1 LM2 Y1 Y2 Y3 Y r 0 CHAPTER 11 Aggregate Demand II 11 Response 3: Hold Y constant If Congress raises G, the IS curve shifts right. To keep Y constant, Fed reduces M to shift LM curve left. LM2 LM1 r r3 r2 r1 IS2 IS1 Results: Y 0 Y1 Y2 Y r r3 r1 CHAPTER 11 Aggregate Demand II 12 Estimates of fiscal policy multipliers from the DRI macroeconometric model Assumption about monetary policy Estimated value of Y / G Estimated value of Y / T Fed holds money supply constant 0.60 0.26 Fed holds nominal interest rate constant 1.93 1.19 CHAPTER 11 Aggregate Demand II 13 Shocks in the IS -LM model IS shocks: exogenous changes in the demand for goods & services. Examples: stock market boom or crash change in households’ wealth C change in business or consumer confidence or expectations I and/or C CHAPTER 11 Aggregate Demand II 14 Shocks in the IS -LM model LM shocks: exogenous changes in the demand for money. Examples: a wave of credit card fraud increases demand for money. more ATMs or the Internet reduce money demand. CHAPTER 11 Aggregate Demand II 15 NOW YOU TRY: Analyze shocks with the IS-LM Model Use the IS-LM model to analyze the effects of 1. a boom in the stock market that makes consumers wealthier. 2. after a wave of credit card fraud, consumers using cash more frequently in transactions. For each shock, a. use the IS-LM diagram to show the effects of the shock on Y and r. b. determine what happens to C, I, and the unemployment rate. CASE STUDY: The U.S. recession of 2001 During 2001, 2.1 million jobs lost, unemployment rose from 3.9% to 5.8%. GDP growth slowed to 0.8% (compared to 3.9% average annual growth during 1994-2000). CHAPTER 11 Aggregate Demand II 17 CASE STUDY: The U.S. recession of 2001 Index (1942 = 100) Causes: 1) Stock market decline C 1500 Standard & Poor’s 500 1200 900 600 300 1995 CHAPTER 11 1996 1997 1998 Aggregate Demand II 1999 2000 2001 2002 2003 18 CASE STUDY: The U.S. recession of 2001 Causes: 2) 9/11 increased uncertainty fall in consumer & business confidence result: lower spending, IS curve shifted left Causes: 3) Corporate accounting scandals Enron, WorldCom, etc. reduced stock prices, discouraged investment CHAPTER 11 Aggregate Demand II 19 CASE STUDY: The U.S. recession of 2001 Fiscal policy response: shifted IS curve right tax cuts in 2001 and 2003 spending increases airline industry bailout NYC reconstruction Afghanistan war CHAPTER 11 Aggregate Demand II 20 CASE STUDY: The U.S. recession of 2001 Monetary policy response: shifted LM curve right 7 Three-month T-Bill Rate 6 5 4 3 2 1 0 CHAPTER 11 Aggregate Demand II 21 What is the Fed’s policy instrument? The news media commonly report the Fed’s policy changes as interest rate changes, as if the Fed has direct control over market interest rates. In fact, the Fed targets the federal funds rate – the interest rate banks charge one another on overnight loans. The Fed changes the money supply and shifts the LM curve to achieve its target. Other short-term rates typically move with the federal funds rate. CHAPTER 11 Aggregate Demand II 22 What is the Fed’s policy instrument? Why does the Fed target interest rates instead of the money supply? 1) They are easier to measure than the money supply. 2) The Fed might believe that LM shocks are more prevalent than IS shocks. If so, then targeting the interest rate stabilizes income better than targeting the money supply. (See end-of-chapter Problem 7 on p.337.) CHAPTER 11 Aggregate Demand II 23 IS-LM and aggregate demand So far, we’ve been using the IS-LM model to analyze the short run, when the price level is assumed fixed. However, a change in P would shift LM and therefore affect Y. The aggregate demand curve (introduced in Chap. 9) captures this relationship between P and Y. CHAPTER 11 Aggregate Demand II 24 Deriving the AD curve r Intuition for slope of AD curve: P (M/P ) LM shifts left r I Y LM(P2) LM(P1) r2 r1 IS P Y2 Aggregate Demand II Y P2 P1 AD Y2 CHAPTER 11 Y1 Y1 Y 25 Monetary policy and the AD curve The Fed can increase aggregate demand: M LM shifts right r LM(M1/P1) LM(M2/P1) r1 r2 IS r I P Y at each value of P P1 Y1 Y1 CHAPTER 11 Aggregate Demand II Y2 Y2 Y AD2 AD1 Y 26 Fiscal policy and the AD curve Expansionary fiscal policy (G and/or T ) increases agg. demand: r LM r2 r1 IS2 T C IS1 IS shifts right P Y at each value of P P1 Y1 Y1 CHAPTER 11 Aggregate Demand II Y2 Y2 Y AD2 AD1 Y 27 IS-LM and AD-AS in the short run & long run Recall from Chapter 9: The force that moves the economy from the short run to the long run is the gradual adjustment of prices. In the short-run equilibrium, if CHAPTER 11 then over time, the price level will Y Y rise Y Y fall Y Y remain constant Aggregate Demand II 28 The SR and LR effects of an IS shock r A negative IS shock shifts IS and AD left, causing Y to fall. LRAS LM(P ) 1 IS2 Y P SRAS1 Y Aggregate Demand II Y LRAS P1 CHAPTER 11 IS1 AD1 AD2 Y 29 The SR and LR effects of an IS shock r LRAS LM(P ) 1 In the new short-run equilibrium, Y Y IS2 Y P SRAS1 Y Aggregate Demand II Y LRAS P1 CHAPTER 11 IS1 AD1 AD2 Y 30 The SR and LR effects of an IS shock r LRAS LM(P ) 1 In the new short-run equilibrium, Y Y IS2 Over time, P gradually falls, causing • SRAS to move down • M/P to increase, Y P P1 SRAS1 Y Aggregate Demand II Y LRAS which causes LM to move down CHAPTER 11 IS1 AD1 AD2 Y 31 The SR and LR effects of an IS shock r LRAS LM(P ) 1 LM(P2) IS2 Over time, P gradually falls, causing • SRAS to move down • M/P to increase, Y P P1 SRAS1 P2 SRAS2 Y Aggregate Demand II Y LRAS which causes LM to move down CHAPTER 11 IS1 AD1 AD2 Y 32 The SR and LR effects of an IS shock r LRAS LM(P ) 1 LM(P2) This process continues until economy reaches a long-run equilibrium with Y Y IS2 Y P Aggregate Demand II Y LRAS P1 SRAS1 P2 SRAS2 Y CHAPTER 11 IS1 AD1 AD2 Y 33 NOW YOU TRY: Analyze SR & LR effects of M a. Draw the IS-LM and AD-AS r LRAS LM(M /P ) 1 1 diagrams as shown here. b. Suppose Fed increases M. IS Show the short-run effects on your graphs. Y c. Show what happens in the transition from the short run to the long run. d. How do the new long-run equilibrium values of the endogenous variables compare to their initial values? P Y LRAS P1 SRAS1 AD1 Y Y The Great Depression 30 Unemployment (right scale) 220 25 200 20 180 15 160 10 Real GNP (left scale) 140 120 1929 5 0 1931 1933 1935 1937 1939 percent of labor force billions of 1958 dollars 240 THE SPENDING HYPOTHESIS: Shocks to the IS curve asserts that the Depression was largely due to an exogenous fall in the demand for goods & services – a leftward shift of the IS curve. evidence: output and interest rates both fell, which is what a leftward IS shift would cause. CHAPTER 11 Aggregate Demand II 36 THE SPENDING HYPOTHESIS: Reasons for the IS shift Stock market crash exogenous C Oct-Dec 1929: S&P 500 fell 17% Oct 1929-Dec 1933: S&P 500 fell 71% Drop in investment “correction” after overbuilding in the 1920s widespread bank failures made it harder to obtain financing for investment Contractionary fiscal policy Politicians raised tax rates and cut spending to combat increasing deficits. CHAPTER 11 Aggregate Demand II 37 THE MONEY HYPOTHESIS: A shock to the LM curve asserts that the Depression was largely due to huge fall in the money supply. evidence: M1 fell 25% during 1929-33. But, two problems with this hypothesis: P fell even more, so M/P actually rose slightly during 1929-31. nominal interest rates fell, which is the opposite of what a leftward LM shift would cause. CHAPTER 11 Aggregate Demand II 38 THE MONEY HYPOTHESIS AGAIN: The effects of falling prices asserts that the severity of the Depression was due to a huge deflation: P fell 25% during 1929-33. This deflation was probably caused by the fall in M, so perhaps money played an important role after all. In what ways does a deflation affect the economy? CHAPTER 11 Aggregate Demand II 39 THE MONEY HYPOTHESIS AGAIN: The effects of falling prices The stabilizing effects of deflation: P (M/P ) LM shifts right Y Pigou effect: P (M/P ) consumers’ wealth C IS shifts right Y CHAPTER 11 Aggregate Demand II 40 THE MONEY HYPOTHESIS AGAIN: The effects of falling prices The destabilizing effects of expected deflation: E r for each value of i I because I = I (r ) planned expenditure & agg. demand income & output CHAPTER 11 Aggregate Demand II 41 THE MONEY HYPOTHESIS AGAIN: The effects of falling prices The destabilizing effects of unexpected deflation: debt-deflation theory P (if unexpected) transfers purchasing power from borrowers to lenders borrowers spend less, lenders spend more if borrowers’ propensity to spend is larger than lenders’, then aggregate spending falls, the IS curve shifts left, and Y falls CHAPTER 11 Aggregate Demand II 42 Why another Depression is unlikely Policymakers (or their advisors) now know much more about macroeconomics: The Fed knows better than to let M fall so much, especially during a contraction. Fiscal policymakers know better than to raise taxes or cut spending during a contraction. Federal deposit insurance makes widespread bank failures very unlikely. Automatic stabilizers make fiscal policy expansionary during an economic downturn. CHAPTER 11 Aggregate Demand II 43 CASE STUDY The 2008-09 Financial Crisis & Recession 2009: Real GDP fell, u-rate approached 10% Important factors in the crisis: early 2000s Federal Reserve interest rate policy sub-prime mortgage crisis bursting of house price bubble, rising foreclosure rates falling stock prices failing financial institutions declining consumer confidence, drop in spending on consumer durables and investment goods CHAPTER 11 Aggregate Demand II 44 Interest rates and house prices 9 8 170 interest rate (%) 7 6 150 5 130 4 110 3 90 2 70 1 0 2000 2001 2002 2003 2004 50 2005 House price index, 2000=100 Federal Funds rate 30-year mortgage rate 190 Case-Shiller 20-city composite house price index Change in U.S. house price index and rate of new foreclosures, 1999-2009 14% 1.4 10% 1.2 8% 1.0 6% 0.8 4% 2% 0.6 0% 0.4 -2% 0.2 -4% -6% 1999 0.0 2001 2003 2005 2007 2009 New foreclosure starts (% of total mortgages) Percent change in house prices (from 4 quarters earlier) 12% US house price index New foreclosures House price change and new foreclosures, 2006:Q3 – 2009Q1 20% 18% Nevada Florida Illinois New foreclosures, % of all mortgages 16% 14% Michigan Ohio California Georgia 12% 10% 8% Colorado Arizona Rhode Island New Jersey Texas 6% S. Dakota Hawaii 4% Oregon Alaska 2% 0% -40% -30% -20% -10% 0% Wyoming N. Dakota 10% Cumulative change in house price index 20% U.S. bank failures by year, 2000-2009 Number of bank failures 70 60 50 40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009* * as of July 24, 2009. 100% 7/20/2009 120% 11/11/2008 140% 3/5/2008 (% change from 52 weeks earlier) 6/28/2007 10/20/2006 2/11/2006 6/5/2005 9/27/2004 1/20/2004 5/14/2003 9/5/2002 12/28/2001 4/21/2001 8/13/2000 12/6/1999 Major U.S. stock indexes DJIA S&P 500 NASDAQ 80% 60% 40% 20% 0% -20% -40% -60% -80% Consumer sentiment and growth in consumer durables and investment spending 110 15% 10% 100 5% 90 0% 80 -5% -10% 70 -15% Durables -20% Investment 60 UM Consumer Sentiment Index -25% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 50 Consumer Sentiment Index, 1966=100 % change from four quarters earlier 20% Real GDP growth and Unemployment 10% 10 Real GDP growth rate (left scale) Unemployment rate (right scale) 8 6% 7 6 4% 5 2% 4 3 0% 2 -2% 1 -4% 1995 0 1997 1999 2001 2003 2005 2007 2009 % of labor force % change from 4 quaters earlier 8% 9 Chapter Summary 1. IS-LM model a theory of aggregate demand exogenous: M, G, T, P exogenous in short run, Y in long run endogenous: r, Y endogenous in short run, P in long run IS curve: goods market equilibrium LM curve: money market equilibrium Chapter Summary 2. AD curve shows relation between P and the IS-LM model’s equilibrium Y. negative slope because P (M/P ) r I Y expansionary fiscal policy shifts IS curve right, raises income, and shifts AD curve right. expansionary monetary policy shifts LM curve right, raises income, and shifts AD curve right. IS or LM shocks shift the AD curve.