Lecture 20 The Short Run Model

Question 1

fiscal policy in the covid 19 aftermath

Answer 1

played a very active role (american rescue plan act, ARPA)
roughly 2 trillion dollars in govt support in 2021/2022- stimulus checks 5.6k for middle-income family of four, unemployment extensions, emergency aid to cover mortgage payments, increase in child tax credit (3k for family of four), emergency grants for small businesses, emergency funds for local governments: school, public workers

Question 2

supply shocks

Answer 2

labor shortages: people drop out of the workforce prior to vaccines, home schooling
covid compliance: raises costs and time for many activities
supply chain bottlenecks
trade shocks
2022 russian invasion of ukraine: rising food prices, rising energy costs

Question 3

how to model supply shocks

Answer 3

a shift in the phillips curve
ε > 0 adverse (bad) shock: inflation increases for a given level of yt
ε <0 positive (good) shock: inflation decreases for a given level of yt

Question 4

what happens when ε < 0

Answer 4

lower import tariffs, cheaper energy costs

Question 5

what happens when ε > 0

Answer 5

rising oil prices, a trade war, supply chain disruptions

Question 6

phillips curve equation

Answer 6

πt = π + νyt + ε

Question 7

simplified taxonomy

Answer 7

phase 1: plummeting economic activity, expansionary monetary policy, flat inflation, expansionary policy (arpa)
phase 2: bounce back in economic activity, expansionary then contractionary monetary policy, rising inflation, expansionary fiscal policy (arpa)
phase 3: stable and high level of economic activity, contractionary monetary policy, falling but still elevated inflation, phasing out fiscal policy but inflation reduction act still in place

Question 8

phase 1: the collapse (3/2020-12/2020)

Answer 8

negative demand shock because no one can go shopping
fiscal stimulus counteracts this demand shock partly
monetary policy bolsters demand through low interest rates
supply chain disruptions increase inflation (hence no large fall in inflation despite large recession)

Question 9

IS curve equation

Answer 9

yt = dt − β(rt − r)

Question 10

phase 2: recovery and inflationary pressure (1/2021 - 10/2022)

Answer 10

negative demand subsidies (vaccines)
fiscal stimulus is still in place
monetary policy continues to be expansionary
supply chain disruptions and the war in ukraine put additional pressure on inflation
inflation driven by supply and demand

Question 11

phase 3: the fight against inflation (10/2022 - 10/2023)

Answer 11

demand still high: stimulus runs out but households have lots of savings
monetary policy turns contractionary
supply chains unclog and energy prices come down

Question 12

monetary policy rules/taylor rules

Answer 12

fed chooses rt on a case by case basis

Question 13

fed’s dual mandate

Answer 13

1) inflation should not exceeds the fed’s inflation target
2) output gaps close to 0 to stabilize employment (you can’t have positive output gaps with stable inflation because of the phillips curve!)

Question 14

taylor rule formula

Answer 14

rt = r + μ (πt − π) + θyt
μ > 0: sensitivity of rt relative to gap between inflation and target
πbar = inflation target
θ > 0 : sensitivity of rt relative to yt

Question 15

taylor rule

Answer 15

1) if inflation is too high and the economy is in a boom: increase interest rates
2) if inflation is too low and the economy is in a recession: lower interest rates

Question 16

how to reduce inflation

Answer 16

economy had to suffer through a recession because of adaptive expectations (firms only lower prices when they saw low inflation in the past)
a cheaper way: central banks with reputation can try to reduce inflation without the pain of a recession, try to manage the publics expectations)

Question 17

a soft landing

Answer 17

when the fed reduces inflation without a recession