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ECON 4016 Macro Theory > 7. RBC > Flashcards

7. RBC Flashcards

1
Q

What are vector autoregressions?

A

Ways of summarising the dynamics of macro data where we are interested in obtaining the impulse response functions

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2
Q

What are impulse responses?

A

They trace out the response of current and future values of each variable to a one unit increase (or a one standard deviation increase, when scale matters) in the current value of one of the VAR errors

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3
Q

What does DSGE stand for?

A

Dynamic Stochastic General Equilibrium model

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4
Q

What is the simplest DSGE?

A
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5
Q

What is the New Keynesian model?

A

It combines DSGE structure of RBC models with assumptions that depart from classical monetary models. Features include monopolistic competition and nominal rigidities

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6
Q

What is the consequence of nominal rigidities on changes in short term interest rates?

A

They aren’t matched by one to one changes in expected inflation

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7
Q

How do financial frictions impact shocks?

A

They amplify them

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8
Q

What are business cycles?

A

Expansions and contractions that appear at the same time in different economic sectors

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9
Q

What should business cycle models be able to answer?

A

The source of cyclical fluctuations and the shock transmission mechanism

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10
Q

What second moments are we interested in?

A

Variance - volatility
Covariance, cross correlation - co-movements
Autocorrelation - degree of persistence

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11
Q

What are the two extreme cases of persistence?

A

A random walk Px=1, the series never returns to average
White noise Px=0, a transitory shock doesn’t generate any persistence

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12
Q

How persistent are most macro variables?

A

Highly persistent

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13
Q

What must be added to the Ramsey model to understand aggregate fluctuations?

A

There must be a source of disturbances. There are added in the form of fluctuation shocks- technology shocks. This is known as an RBC model

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14
Q

What is good about the RBC?

A

It provides a coherent framework that integrated growth and business cycles

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15
Q

Why is the RBC controversial?

A

Because the only fluctuations are technology shocks?

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16
Q

What is the HP filter?

A

It is a model free approach to decomposing a time series into its trend and cyclical components

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17
Q

How is the parameter lambda used in the HP filter?

A

If lambda is zero we only care about fitting and if lambda is infinity the trend value will never change from one period to the bext

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18
Q

How do we adjust lambda when the frequency of our data increases?

A

We increase lambda

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19
Q

How do empirical VARs suggest that price level and output react to an increase in interest rate?

A

The aggregate price level doesn’t respond much initially (inflection inertia) but then goes down. Output falls initially with a j shaped response and zero LR effect

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20
Q

What are the advantages of micro founded models?

A

-they are elegant
-they can be used to evaluate welfare effects of alternative policy
-we can do counterfactual experiments with them since their deep parameters are generally robust to Lucas’ critique

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21
Q

Conceptually what does the RBC highlight?

A

The efficiency of business cycles
The importance of technology shocks as a source of economic fluctuations
The limited role of monetary factors

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22
Q

Roles of money in the economy

A
  1. Medium of exchange
  2. Store of value
  3. Unit of account
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23
Q

What do we call the RBC model with money introduced?

A

The MIU model (money in utility)

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24
Q

What is the result of the MIU model?

A

It is able to generate non trivial effects to monetary shocks

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25
Q

What assumption is required for the MIU model?

A

We assume nonseperability between money and consumption

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26
Q

Keynesian features

A

Monopolistic competition
Nominal rigidities

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27
Q

What are the three components of the NK model?

A

-demand side represented by a linear approximation to the representative Euler condition for optimal consumption
-inflation adjustment is derived under the assumption of monopolistic comp yielding the New Keynesian Phillips curve
-monetary policy is represented by a rule for setting the nominal rate of interest

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28
Q

What does the credit view stress?

A

Stresses the distinct role played by financial assets and liabilities. It also stresses that some borrowers may be more vulnerable to changes in credit conditions than others

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29
Q

What is the key mechanism involved in the financial accelerator?

A

It involves the link between external finance premium and the net worth of potential borrowers

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30
Q

How can collateral constraints create financial accelerator effects?

A

-adjustment of asset prices following contractionary monetary policy
-borrowers are limited in the amount they can borrow by the value of their assets that can serve as collateral

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31
Q

What is calibration?

A

It is the process of researchers choosing parameter values to match unconditional model and data movements, or referencing findings in the empirical minced literature

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32
Q

Simplifying assumptions of RBC

A

Capital doesn’t depreciate
Labour is supplied inelastically
Utility is logarithmic in consumption
Technology shocks effect society’s ability to produce goods

33
Q

In the RBC what do we get when we combine the first two FOCs?

A

The Euler equation for consumption

34
Q

What does the Euler equation say in words?

A

At the margin consumers are indifferent between consuming one unit today and saving it for the future

35
Q

What is the intuition of the transversality condition?

A

Consumers don’t accumulate capital up to infinity

36
Q

What is the zero lower bound and how does it relate to the NK model?

A

The zero lower bound is the idea that policy rates can only go as lower as zero. This is ignored in the basic NK model. This has ramifications for the effects of other shocks, including fiscal policy shocks

37
Q

What is the forward guidance puzzle?

A

It is the idea that effects of a temporary 1% increase in the policy rate 100 years from now is predicted in the basic NK model to be the same as if the increase took place today

38
Q

What is the HANK model?

A

Heterogeneous Agent New Keynesian model. It assumes there are idiosyncratic shocks to households labour productivity and hence wages. This causes households to have different marginal propensities to consume

39
Q

How do low interest rates affect the asset price channel?

A

Low interest rates increase asset prices. High asset prices increase wealth for consumers and they condone more this shifts AD and inflation and output increase

40
Q

When do firms use networth as collateral for loans?

A

When there is asymmetric info

41
Q

How can the credit channel lead to output shifts?

A

Expansionary monetary policy increases with firms networth. The problem of moral hazard and adverse selection gets reduced, lending increases, investment increases further as a shift in the investment demand curve, output increases

42
Q

Following the financial crisis how did the worsening of financial frictions manifest itself?

A

Widening credit spreads, causing higher costs of credit for households and businesses and tighter lending standards. The resulting decline in lending meant that both consumption expenditure and investment fell, causing the economy to contract

43
Q

How did the crisis expose micro prudential supervision?

A

The crisis proved micro prudential supervision isn’t enough to prevent financial crises because the problems of one financial institution can harm others that are otherwise healthy

44
Q

What is micro prudential supervision?

A

Focusing on safety and soundness of individual financial institutions

45
Q

What is macroprudential supervision?

A

Focusing on the safety and soundness of the financial system as a whole

46
Q

Which aspects of the crisis in particular does the NK model not display?

A

The amplification effect attributed to the role of credit supply in the monetary transmission, since it is based on the assumption that the Modigliani- Miller theorem holds and there are no credit market imperfections

47
Q

Who are the agents in the NK model?

A

Households
Final good firms
Intermediate hood firms
Government

48
Q

What do households do in the NK model?

A

-make consumption and labour supply decisions
-demand money and bonds

49
Q

What do final good firms do in the NK model?

A

-produce homogeneous final goods Yt
-use intermediate goods Yjt to produce the final good

50
Q

What do intermediate good firms do in the NK model?

A

-use labour to produce intermediate goods Yjt
-over each of these goods they have monopoly power
-demand labour
-can set price of good Yj

51
Q

What does the government do in the NK model?

A

Runs monetary policy

52
Q

In the households maximisation problem what variables do they choose in order to maximise the equation? NK model

A

Consumption Ct, labour Lt, money Mt, nominal bonds Bt

53
Q

What does Eo denote in the household maximisation problem? NK model

A

Denotes the expectation operator conditional on time 0 info

54
Q

In the NK model what does Ft denote?

A

Lump sum dividends received from ownership of intermediate food firms

55
Q

What are total goods given by in the NK model?

A

The CES aggregator of the different quantities of intermediate goods produced

56
Q

How are the returns of the production function distributed in the NK model?

A

Production function has constant returns to scale

57
Q

Characteristics of intermediate goods firms in NK model

A

Monopolistically competitive firms
Each firm faces downward sloping demand for its product
It uses labour to produce output according to the following technology Yjt= AtLjt

58
Q

Calvo pricing

A

Each producer chooses her own price Pjt
He can reset his price only when given the chance to do so, which occurs with prob 1- theta in each period

59
Q

What are the constraints of the intermediate goods firms in the NK model?

A

Production constraint
Demand curve
Prices can only be adjusted with prob 1- theta

60
Q

How do intermediate goods firms pick the optimal price when given an option to change price in the NK model?

A

The optimal price is a weighted average of current and expected future nominal marginal costs. Weights depend on expected demand in the future, and how quickly the form discounts profits

61
Q

What are fluctuations in the markup due to in the NK model?

A

Due to firms being unable to adjust prices

62
Q

What is the AD equation in the equilibrium of the NK model?

A

AD equation combines goods market clearing with the Euler equation for bonds

63
Q

How do we get the labour market equilibrium equation in the NK model?

A

Take labour demand and labour supply and impose market clearing. Then equate labour demand and labour supply so as to eliminate the real wage w from that expression

64
Q

What is the Taylor rule?

A

It is a monetary policy rule founded by Taylor. It assumed that the central bank chooses money supply so as to set the nominal interest rate to be s function of previous interest rate, current inflation, and current real marginal costs (as a fraction of the steady state value)

65
Q

What is the new Keynesian Phillips curve?

A

It is an expectations augmented Phillips curve which states that inflation rises when the real marginal costs rise. It is an aggregate supply curve for the whole economy

66
Q

Describe what happens in the NK model with sticky prices following a rise in technology

A

MC falls, since not all priced can fall immediately, markups will rise, a fraction 1- theta of flexible price firms roll lower their prices and hire more factors of production, the rest of the firms will hire less factors of production so production rises less than with flexible prices

67
Q

Describe what happens in the NK model with sticky prices following a monetary contraction

A

Drop in output, rise in nominal interest rate, fall in inflation, and rise in the output gap. These predictions which are quantitatively in line with the VAR evidence, are hard to obtain in the flexible price model

68
Q

How does the DNK model perform poorly and what techniques can alter this?

A

In its ability to match slow responses of macro variables to given shocks. Habit formation and inflation indexation

69
Q

If the central bank isn’t able to observe the output gap with certainty then how will a strong monetary response affect the economy?

A

Will result in higher inflation and output variability

70
Q

How are asset prices and interest rates related?

A

Inversely related

71
Q

How do nominal prices, real housing prices, and GDP respond to an increase in interest rates?

A

They all fall

72
Q

How do real housing prices and output respond to a positive inflation disturbance?

A

A significant fall in real housing prices and a small fall in output

73
Q

Describe the structure of the Iacovello 2005 model

A

There are 4 groups
Savers
Borrowers
Firms (intermediate/ final)
Monetary authority

74
Q

What does having savers and borrowers instead of a representative consumer allow us to do?

A

Keep track of credit

75
Q

How are borrowers constrained?

A

They face a limit on the debt they can acquire. The max amount they can borrow is proportional to the value of their collateral, in this case the stock of housing

76
Q

How does the collateral constraint effect the Euler equation of borrowers?

A

It makes them have a sun optimal Euler equation so they don’t act optimally as a result

77
Q

Explain how an increase in interest rate contracts the economy in terms of borrowers and savers

A

Savers postpone current consumption. Value of collateral for borrowers decreases since asset prices fall. This means they can borrow less and therefore consume less. Drop in consumption is larger for borrowers than savers. Output falls further than in standard model due to the financial accelerator

78
Q

How useful are DSGE models in explaining structural vs cyclical nature of fluctuations in the labour market

A

Bloody useless

79
Q

Why aren’t DSGE models designed to analyse longer term shifts in demographics, productivity, preferences, or other structural shifts?

A

Because DSGE models assume that all shocks are transitory and that the economy eventually returns to a fixed steady state

ECON 4016 Macro Theory (7 decks)

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