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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

What is the formula for the IS curve in an open economy?

y=A-art-1+bqt-1