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Olivier Blanchard: The US Phillips Curve: Back to the 60s?
To your iClickers...
A. 0.02
B. 0.022
C. 0.026
B. 0.04
E. None of the above
WELL, WHAT MADE EXPECTATIONS STATIC IN THE FIRST PLACE?
To your iClickers...
A. 0.02
B. 0.022
C. 0.026
B. 0.04
E. None of the above
A. It’s OK: your estimates of the variables will still be unbiased—the missing variables go into the regression error ε, and your estimates will be less precise…
B. It’s not OK: the missing variables are highly likely to be correlated with the stuff you have on the RHS, and the computer will attribute as much of the effect of the missing variable it can to the variable it sees…
The Keynesian multiplier is:
A. A process that amplifies a shock to autonomous spending and leads it to have a multiplied effect on the level of real national income and product in the sticky-price model
B. A force that keeps national income and product equal to potential output in the flexprice model
C. The process by which a change in bank reserves produces an amplified change in the money stock
D. None of the above
The IS-Curve relationship is primarily:
A. The relationship between national income and product Y and the long-term real risky interest rate r
B. The relationship between national income and product Y and the multiplier μ
C. The relationship between national income and product Y and the marginal propensity to consume $ c_y $
D. The relationship between national income and product Y and the money stock M
E. None of the above
Paul Volcker and Alan Greenspan think inflation above 5% per year * Causes confusion… * Distracts businessmen from what it would be more productive for them to think about… * Thus slows productivity growth
Keeping rates low (2002-5) and encouraging housing and derivatives bubbles (Greenspan)
$ r = r_o + r_π(π - π^t) - r_u(u - u*) $
https://www.frbatlanta.org/cqer/research/taylor-rule.aspx
https://blogs.wsj.com/economics/2010/11/15/open-letter-to-ben-bernanke/?mg=prod/accounts-wsj
The MPRF brings together three relationships at once:
Suppose:
$ {\pi}^t = 0.02 $
$ \pi = 0.05 $
$ r_{\pi} = \frac{1}{3} $
$ r_o = .025 $
Then by the interest rate rule:
$ r = 0.025 + \frac{1}{3}(0.05 - 0.02) = 0.035 $
The central bank will conduct monetary policy so that the real interest rate is 3.5%.
Suppose further that:
$ MPE = 0.5 $
$ A_o = 2.15 $ trillion
$ I_r = 8 $
$ x_{\epsilon}{\epsilon}_r = 2 $
Then the IS Curve tells us that when the interest rate is 3.5 percent:
$ \mu = \frac{1}{1 - MPE} = 2 $
$ Y = \mu(A_o) - \mu(I_r + x_{\epsilon}{\epsilon}_r)r = 4.3 - (2)(10)(.035) = 3.6 $ trillion
Planned expenditure will equal real output and national income when they are 3.6 trillion.
Finally, supppose that:
$ u^* = 0.05 $
$ Y^* = 4 $ trillion
Then Okun's Law tells us that when output is 3.6 trillion:
$ u = 0.05 - 0.4\frac{3.6-4}{4} = 0.05 + 0.04 = 0.09 $
The unemploymente rate is then 9 percent.
When the inflation rate is 5 percent rather than the central bank's target of 2 percent, the central bank will raise the real interst rate from its normal baseline rate of 2.5 percent to 3.5 percent, which will cause output to fall to 3.6 trillion and generate an unemployment rate of 9 percent.
Nomenclature:
r :: real risky interest rate
$r^*$ :: neutral rate
$r_π$ :: reaction of central bank to higher (or lower) inflation
$π^t$ :: central bank’s inflation target
$r_u$ :: reaction of central bank to higher (or lower) unemployment
u :: unemployment rate
$u^*$ :: NAIRU: unemployment rate at which inflation equals expectations
π :: inflation
$π^e$ :: expected inflation
β :: slope of Phillips Curve: relationship of inflation to unemployment
SS :: supply shock to inflation
φ :: a combination of Okun’s Law, the multiplier, and interest sensitivity of investment and exports
δ :: demand shock
$ r_t = r^* + r_π(π_t - π^t) - r_u(u_t - u*) $
$ π_t = π^e - β(u_{t-1} - u*) + SS_t $
$ u_t = u* + φ(r_t - r*) + δ_t $
$ u_t - u^* = +{\phi}r_{\pi}(\pi_t - \pi^t) - {\phi}r_u(u_t - u*) + \delta_t $
$ (u_t - u^*) = \frac{{\phi}r_{\pi}(\pi_t - \pi^t) + \delta_t}{1 + {\phi}r_u} $
With adaptive expectations:
$ π_t = π_{t-1} - β(u_{t-1} - u*) + SS_t $
$ (π_t - π^t) = (π_{t-1} - π^t) - \beta\left(\frac{{\phi}r_{\pi}(\pi_{t-1} - \pi^t) + \delta_{t-1}}{1 + {\phi}r_u}\right) + SS_t $
$ (π_t - π^t) = \left(\frac{1 + {\phi}r_u -\beta{\phi}r_{\pi}}{1 + {\phi}r_u}\right)(\pi_{t-1} - \pi^t) - \beta\left(\frac{\delta_{t-1}}{1 + {\phi}r_u}\right) + SS_t $
$ (u_t - u^*) = {\phi}(r_t - r^*) + \delta_t $
$ π_t = π_{t-1} - β(u_{t-1} - u*) + SS_t $
$ (π_t - π^t) = (π_{t-1} - π^t) - β{\phi}(r_{t-1} - r^*) - β\delta_t + SS_t $
Try to stabilize inflation:
$ 0 = (π_{t-1} - π^t) - β{\phi}(r_{t-1} - r^*) - β\delta_t + SS_t $
$ β{\phi}(r_{t-1} - r^*) = (π_{t-1} - π^t) - β\delta_t + SS_t $
$ r_{t-1} = r^* + \frac{(π_{t-1} - π^t)}{β{\phi}} - \frac{\delta_t}{\phi} + \frac{SS_t}{β{\phi}} $
Then:
$ \pi_t = \pi^t $
The interest rate rule is:
A. A way of capturing how the Federal Reserve and other central banks typically react to the changing economic environment
B. The rule that higher interest rates reduce investment spending
C. The fact that higher interest rates make the future look “cheaper” relative to the present
D. Required by Congress that the Federal Reserve follow—or explain why it is not following
E. None of the above
The Keynesian multiplier is:
A. An amplified relationship between shifts in autonomous spending—exports, government purchases, investment, consumer confidence—and shifts in real national product
B. The fact that the money supply expands by a multiplied factor times the expansion in the monetary base
C. The fact that a sticky-price economy has multiple possible equilibrium positions for national income and product
D. The fact that investment increases when production increases because investment depends largely on business-sector cash flow
E. None of the above
Living standards were more-or-less stagnant from 5000 BC to 1800 largely because of:
A. Keynesian factors
B. Schumpeterian factors
C. Ricardian factors
D. Malthusian factors
E. None of the above
Lecture Support: http://nbviewer.jupyter.org/github/braddelong/LSF18E101B/blob/master/The_Phillips_Curve_Expectations_and_Monetary_Policy.ipynb
The Phillips Curve and Expectations, and Monetary Policy: https://www.icloud.com/keynote/0Qg3oRt5fSlNKv1hsUHb-JdVw
Expectations and Monetary Policy: https://www.icloud.com/keynote/0a3LFfOyYcAh9fqvlF-u0Jz2Q
The Monetary Policy Reaction Function: https://www.icloud.com/keynote/0E6uh3fa1_dMl4oU1f0IzFZrA