Flashcards in Term 1 Deck (63):

1

## What are the flaws of ISLM?

###
Mixture of stock and Flow

Requires constant IR

CB cannot control money supply

CB's target inflation

IR is practised, not set

2

## What is teh Fisher Equation?

### r=i-PIe

3

## What is the equation for the IS curve?

### y=A-ar

4

## What shifts the WS (Diagonal)?

###
More benefits shifts up

More output shifts up

More unemployment shifts up

5

## What shifts the PS curve?

### Higher markup shifts down

6

## What effect will an increase in demand have on WS PS diagram?

###
Will shift output to the right temporarily, causing a new equilibrium with higher employment

The difference between the curves is the difference in real pa

7

## What is nominal rigidity of wages?

### Wages do not move in nominal, only real terms

8

## What is the equation for the linear WS?

###
W/Pe=B+Z+A(y-ye)

B is benefits

Z is other shift

Y-ye shows unemployment through output gap

9

## How do you determine unemployment?

### The point between the equilibrium and LF

10

## What is the equation for the PS curve?

###
W=P*MPL*(1/1+N)

P is prices

1/1+N is mark up based on market power

11

## Simplify the PS curve

###
w/p=(1-u)LAMDA

LAMDA = MPL

U is elasticity of demand

12

## How do you derive the IAPC using WS?

###
w/pe=B+Z+a(Y-Ye)

Take expectations

Do original-expectations

Take time derivatives and logs

dw/dt=Pit-1+a(Y-Ye)

13

## How do you derive IAPC using PS?

###
P=1(1+u)W/LAMDA

Take logs and time derivatives

Giving dp/dt=dw/dt

14

## How do you derive IAPC combining WS and PS?

###
PIt=Pit-1+a(Y-Ye)

15

## What is the banks damage loss function?

### V=(y-ye)^2+B(PI-PIT)^2

16

## Describe the inflation variable Beta?

### If bigger than one, inflation averse, targets with greater priority

17

## How do you derive the monetary rule?

###
Combine IAPC and Los function

Sub IAPC into Loss

Take derivatives of YT and solve for:

Pit-Pit-1=-1/ab(yt-ye)

18

## What is the IS equation considering time?

### (y1-ye)=-a(r0-rs)

19

## What i the IAPC equation considering time?

### Pi1=Pi0+a(Y0-Ye)

20

## What is the MR function considering time?>

### Pi2-PiT=-1/ab(y1-ye)

21

## How do you derive the taylor rule?

###
Sub Pi2 into MR

Pi+a(Y-Ye) +a(Y1-Ye)-PiT=-1/ab(y1-ye)

Factorise and solve for

r0-rs=1/[a(a/ab+a)](Pi0-PiT)+a(Y0-Ye)

r0-rs=1/2(Pi0-PiT)+1/2(Y0-Ye)

22

## What are the 3 types of supply side shock?

###
Collapsing WS

Rising PS - Change inU

Rising PS - Change in LAMDA

23

## How do you draw a positive permanent supply side shock?

###
Draw new MR outwards

Point Z new equilibrium, IAPC comes out of it

Draw A down to new IAPC (B)

Draw B across to Ye, Giving new IAPC

24

## What is a deflationary trap?

### Where IR falls below 0LB and cannot be recovered

25

## How do you calculate Rational Expectations?

###
Combine EAPC nad MR to get

PiT=PiET+a(-aB(PIt-PiT)

Take expectations

PIET=PIT

26

## What is the LUCAS supply surprise function?

###
y=ybar+O(Pi-Pie)

Shows how the government can cheat and boost output

27

## What happens if people believe the governments promises?

### The economy resides at A, the time inconsistent commitment equilibrium

28

## What happens if people believe the government but they do not deliver?

### Gov sets at point B

29

## How do you determin point B?

###
Put SAS0 into Loss function

Diff with respect to Pi

Solve for Pi

Pi=Pi*+(k-1)/(1+O^2)OYbar

30

## What happends if the people do not believe the Gov?

### End up at C, time consistent discretionary equilbrium

31

## How do you calculate point C?

###
Sub SAS into Loss function

Diff for Pi

Solve for Pi

PiE=Pi*+(k-1)OYbar

Take expectations

Pi=Pi*+(k-1)OYbar

32

## How can the Gov get people to trust them?

### Delegate responsibility to CB

33

## How can you build a CB Reputation?

###
Use an ERM

Euro

New Zeeland

34

## How would an ERM build trust?

###
A currency board allows a exchange rate by law

If Gov tries to cheat, all money converted

35

##
How would the Euro Build Trust

### After using an ERM for several years, can convert to shared currency to lock in trust

36

## What is the new zeeland method?

###
Delgate responsibility to CB

Known as walsh contracts

37

## What are the 3 possible stages of the financial crisis?

###
Collapse of subprime mortgages

Drying up of liquidity in the market

Leamon Brothers

38

## Discuss the collapse of sub prime mortgages?

### CDS and transferred risk creates a moral hazard

39

## Discuss teh drying up of liquidity in the interbank market

### When the liquidity between banks ran out, northen rock collapsed

40

## Discuss the Leamon Brothers

###
The CB could not support every bank due to moral hazard

By letting it crash, many other parties where harmed

41

## Discuss liquidity problems

###
Do not have the cash to meet short term obligations

Are okay in the long run

Can be fixed by CB loans

42

## Discuss solvency problems

### Cannot meet long or short term obligations

43

## How did we learn from the past to fix the crash?

###
Dont raise IR

Liquidate banks

Dont use tariffs

Dont contract fiscal policy

Give each problem an instrument

Monetary = Inflation

Deficit = Fiscal

Use fiscal to help monetary due to 0lB

44

## How can the Gov fix the 0LB?

### Use fiscal to shift IS outwards

45

## Why cant we rely solely on fiscal policy?

###
Open economy means multiplier is reduced

Currency movements

Debts and deficits

46

## What is the deficit debt equation?

###
Db=(g-t)+(r-y)b

Deficit = Positive Intercept

47

## What does the diagram look like if r

###
Slope is negative

Will always tend back to x-axis intercept

Dynamic stability

48

## What does the diagram look life if r>y?

###
Positive slope

If running a surplus

To right of x-axis intercept, will increase indefinitely

To left, is okay

This is unstable

49

## How do you calculate b?

###
Diff with despect to t and solve

b=g-t/y-r

50

## Why is settting a target for b difficult?

###
Both variables are effected by output

If recession, G will increase and t will fall automatically

51

## What must a country do if it has a positive slope (r>y)?

### It must run a surplus

52

## Modify the debt equation to include risk

### db=(g-t)+(r+p-y)b

53

## What happens if a country risk increases?

### Slope becomes steeper, will need to run a greater surplus

54

## How do you calculate the value of a bond?

### YTM-CP/CP

55

## Why would somebody purchase a negative bond?

### They do not trust the others

56

## Discuss automatic stabalisers

###
Taxes and expenditure automatically adjust to reduce the effect of recessions/booms

The bigger the gov, the bigger the stabilisers

57

## How do you calculate the levels of G and T without stablisers?

### G(Ye)-T(YE)/PYe

58

## Discuss Ricardian Equivalence?

###
If a Gov issues bonds, households will save more as they are a promise of higher taxwes

Will therefore have greater investment

Unlikley

59

## What is the formula for RUIP?

### Rt-r*=QeT-1-qT

60

## Combine AD and RUIP?

###
Y=A-ar*+bq

b is due to the Marshall Lerner condition

61

## What effect does a positive demand shock have on an ERU AD diagram?

###
Positive demand shock therefore AD shiftts right

This causes a real appreaciation

62

## What effect does a positive supply shock have on an ERU and AD diagram?

### Shift PS curve upwards, causing a depreciation

63