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EC201 - MACRO TERM 2 > KEYNESIAN > Flashcards

KEYNESIAN Flashcards

1
Q

Dynamic AS/AD model incorporates features from..

A

Keynesian and new-keynesian

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2
Q

Key feature to Keynesian model

A

Frictions to adjustment of prices

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3
Q

2 positives of abandoning DSGE setting

A
  1. can represent equilibrium in as/ad diagram

2. can show BC shocks by shifts

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4
Q

AS =

A

the link between output and prices due to the price setting behaviour of firms.

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5
Q

AD =

A

the link between output and prices due to the demand behaviour of consumers and firms for the final good.

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6
Q

What 2 types of output do keynesian models distinguish between?

A

Yt bar = potential output

Yt tilda = SR output / output gap

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7
Q

Potential output =

A

level of output that prevails when FOPs are utilised at their LR level. When shocks have dissipated. Exogenous to this model.

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8
Q

Output gap formula

A

Yt tilda = Yt - Yt bar / Yt

% deviation of current output from potential output.

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9
Q

The LR =

A

the time horizon over which effects of temporary shocks have dissipated.

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10
Q

The SR -

A

the time horizon over which shocks bring the economy away from equilibrium.

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11
Q

In keynesian models, it is important to distinguish between…

A

NOMINAL AND REAL

especially for IR

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12
Q

Real IR =

A

the return in terms of the consumption good from investing 1 unit of the final good.

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13
Q

LR Real IR formula

A

R bar = MPK - d which are steady state quantities.

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14
Q

Why does R≠R bar?

A

In the SR due to monetary policy,

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15
Q

Nominal IR =

A

nominal return in terms of money of investing 1 unit of money.

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16
Q

Fisher equation

A

Rt = it - Pi t

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17
Q

National account identity

A

Yt = Ct + It + Gt

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18
Q

What does Gt refer to?

A

Gt = gov purchases

Gt ≠ government spending - it does NOT include transfers.

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19
Q

Formula for Ct

A

Ct = (ac bar + ac,t) Yt bar

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20
Q

Formula for Gt

A

Gt = (ag bar + ag,t) Yt bar

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21
Q

What is ac bar?

A

The constant LR share of potential output that goes to consumption

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22
Q

Does Ct depend on SR output? Why?

A

NO - only potential output. temporary shocks implicitly assumed to be smoothed by saving/borrowing.

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23
Q

Formula for It

A

It = (ai bar + ai,t - b(Rt - R bar)) Yt bar

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24
Q

How does It depend on real IR? explain.

A

It depends negatively on gap between real IR and R bar. If Rt > R bar, this means Rt > MPK so disincentive to invest in K, better to save retained earnings on financial market so It falls.

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25
Q

IS curve shows

A

The equilibrium relationship between SR output and the real IR, which is negative.

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26
Q

Formula for IS curve

A

Yt tilda = at - b(Rt - R bar)

where at = ac,t + ag,t + ai,t

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27
Q

ac bar + ag bar + ai bar =

A

1

28
Q

at refers to

A

An AD shock

29
Q

How can CB control the real IR?

A

They change nominal IR it by changing interbank lending rate

But since inflation is sticky, they control Rt in effect.

30
Q

4 reasons for sticky prices

A
  1. Sticky wages
  2. LR contracts between buyers and sellers
  3. Direct menu costs
  4. Inattention to monitoring demand conditions.
31
Q

MP curve shows

A

SR real IR implied by the nominal IR the CB chooses.

32
Q

MP rule formula

A

(Rt - R bar) = m(Pit - Pi bar) + €tM

33
Q

What is €tM?

A

Mean zero monetary policy shock = change in monetary policy unrelated to change in inflation.

34
Q

m bar -

A

how aggressive CB respond to inflation deviations.

35
Q

3 advantages of inflation targeting

A
  1. predictable environment for It
  2. Higher inflation distorts prices (adjust at different speeds)
  3. Direct menu costs if change prices
36
Q

AD curve is derived from

A

IS curve + MP curve

37
Q

AD curve formula

A

Yt tilda = at - bm(Pit - Pi bar) + b€tM

38
Q

What do we assume about expectations?

A

Adaptive expectations
Pi t E = Pi t-1
backwards looking behaviour

39
Q

SRAS/Phillips curve formula

A

Pi t = Pit-1 + vYt tilda + Oc

40
Q

v bar -

A

sensitivity of prices to change in demand conditions.

41
Q

Oc =

A

exogenous shocks to costs of production e.g. oil shock, strikes, weather

42
Q

How does higher expected inflation lead to higher actual inflation?

A

Higher expected = workers demand higher wages = higher production costs for firms = it’s optimal for them to raise their prices.

43
Q

LRAS is given by

A

Vertical line at Yt tilda = 0

44
Q

Business cycles for keynesian mean…

A

Yt tilda ≠ 0

45
Q

Can we do quantitative analysis with keynesian?

A

NO - can’t do calibration

46
Q

If a demand shock at time t+1 is temporary, what does this mean?

A

At time t+2, ADt+2 = ADt

AD curve back to its original position.

47
Q

How do CB react to negative demand shock?

A

Rt+1 < R bar

48
Q

At time t+2, is the economy now back to its equilibrium?

A

NO - AD back to normal, but because inflation fell last period, not inflationary expectations have fallen = AS curve shifts down under AE.

49
Q

How does AS respond from t+3 onwards to the negative demand shock?

A

Since AS falls at t+2, but inflation higher than in t+1 since AD back to normal = inflation expectations increase relative to t+1 = AS gradually shifts back up to its original.

50
Q

How to CB respond to negative demand shock in t+2 onwards?

A

Since the shift in ASt+2 causes positive output gap, CB gradually increase IR back to R bar and cause demand to contract.

51
Q

Therefore, if a BC is demand driven, inflation is…

A

PRO-CYCLICAL

52
Q

Effects of negative demand shock on output

A

Recession first

Then small expansion before back to equilibrium.

53
Q

If we have a negative supply shock, how does AS change over the periods?

A 
t+1 = AS shifts left and up
t+2 = shock gone but since inflation risen, inflationary expectations rise relative to t, so AS above ASt still. Eventually goes back to ASt.
54
Q

How to CB respond to negative supply shock over the periods?

A

Initially increase Rt to curb inflation
But this causes a recession
Gradually reduce Rt back to R bar

55
Q

Therefore, if a BC is supply driven, inflation is…

A

COUNTER-CYCLICAL

56
Q

was the great depression consistent with the model?

A

YES - demand driven recession and deflation

57
Q

were the 1970s oil price shocks model consistent?

A

YES - stagflation

58
Q

What’s the missing deflation puzzle?

A

Financial crisis: huge fall in AD, but not many countries experienced deflation.

59
Q

Possible explanations for missing deflation puzzle.

A
  1. AS shifted up at same time

2. Flatter slope of AS

60
Q

3 reasons why AS may have shifted up

A
  1. higher oil prices
  2. higher inflationary expectations
  3. higher production costs due to wage rigidity.
61
Q

3 reasons why slope of AS may have become flatter.

A
  1. Higher costs of changing prices
  2. Increased market power = prices less responsive to demand
  3. More international trade = prices less responsive to national demand conditions.
62
Q

If AD falls but AS is very flat, impact on inflation and output

A

Large fall in output

Very little fall in inflation

63
Q

What do Coibion & Gorodnichenko (2015) say about deflation puzzle?

A

Caused by high inflationary expectations

Survey from uni of Michigan: how expect prices to change over next 12 months.

64
Q

Why were inflationary expectations so high?

A

expectations reacted strongly to rise in global oil prices. Gasoline prices very salient and frequently observed = disproportionate effect on expectations even though small part of consumption basket. Also rise in production costs due to higher oil prices. So AS shifts up.

65
Q

Why don’t CB just stimulate the economy forever?

A

€tM < 0 means Rt falls so expansionary.
AE assumes agents are surprised by shocks.
But if monetary shocks frequent, agents will expect them = inflationary expectations rise = output falls - opposite of intended effect.

66
Q

2 weaknesses of fiscal policy

A
  1. Implementation lags due to gov legislation

2. Large public debts = constrained

67
Q

benefit of fiscal policy

A

Useful when MP constrained by ZLB on it.

EC201 - MACRO TERM 2 (10 decks)

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