KuliahImoneter Chap 2-5

© 2003 Prentice Hall Business Publishing© 2003 Prentice Hall Business Publishing Macroeconomics, 3/e Olivier Blanchard MYZ/RY Macroeconomics, 3/e Olivier Blanchard MYZ/RY 11

(2,5 HOURS = 115 SLIDES: CH.2-5)(2,5 HOURS = 115 SLIDES: CH.2-5)

Moneteryeconomics: A REVIEW OF Moneteryeconomics: A REVIEW OF THE IS-LM THE IS-LM

Prepared By Prepared By

Prof. Dr. H.M.Yunus Zain, M.A.Prof. Dr. H.M.Yunus Zain, M.A.

and and

Dr. Hj. Rahmatia Yunus,M.A.Dr. Hj. Rahmatia Yunus,M.A.

(DOSEN TETAP FE-PPS UNHAS(DOSEN TETAP FE-PPS UNHAS


Economics: State of the artsEconomics: State of the artsMicroeconomics results: partial & GE: -Consumer’s efficiency MRSij= relatif price ij-Porduction efficiency MRTSij= relative factor price ij-Exchange efficiency (market efficiency)

Two classic welfare theorem-market hold, CE is Pareto efficient-market failure, redistribution initial endowment, the CE is also Pareto optimal

Source of Market failure & government intervention

Field development:-Public Economics (Choice)-New Political Economy-Regional economics-HRE: Labor Ec.; Health Ec-others subjects

-Development Economics-International economics-monetary economics-others subjects

The state &

results of Macroeconom

ics

Four Functional Management?


New Political Economy: Toward a New Political Economy: Toward a Multidiscipline?Multidiscipline?

State of the arts and results ofSocial-political Theory (B)

State of the arts and results ofEconomic Theory (A)

New political Economy

Ekonomi politikPolitik ekonomi?

What/how (before the fact):-behavioral foundation-Rational (self-interest?)

What/how (before and after the fact):-process-institutional setting

Why (event)

A or B; or bothNew (?) Paradigm

Facts: empirical questions

science

Mat

hem

atic

s &

Phi

loso

phy:

an

AR

TS


Is the development in the fields of Economics (even as an Is the development in the fields of Economics (even as an economist) just like Ms. MADONNA? A fashion matter!economist) just like Ms. MADONNA? A fashion matter!

Mainstream economics:Mainstream economics:

-more deductive-more deductive

-abstraction: more use mathematical -abstraction: more use mathematical exposition especially in theoretical work exposition especially in theoretical work

-developed on both applied and theoretical -developed on both applied and theoretical work to explain “the stylized fact”work to explain “the stylized fact”

How about the type of Economist?How about the type of Economist?


THE STRUCTURE OF THIS LECTURETHE STRUCTURE OF THIS LECTURE

CH. 2: MACROECONOMIC INDICATORSCH. 2: MACROECONOMIC INDICATORS CH. 3: The Goods MarketCH. 3: The Goods Market CH. 4: Financial MarketsCH. 4: Financial Markets CH. 5: Goods and Financial Markets – CH. 5: Goods and Financial Markets –

The IS-LM ModelThe IS-LM Model

NEXT LECTURENEXT LECTURE DEAL ABOUT DEAL ABOUT MEDIUM MEDIUM RUN ANALYSIS (AS-AD, CH 6-9)RUN ANALYSIS (AS-AD, CH 6-9) AND AND LONG LONG RUN (CH 10-13) from Blanchard (2003)RUN (CH 10-13) from Blanchard (2003)


Goal of this lecture (ch.2)Goal of this lecture (ch.2)

Defining these indicators more precisely, Defining these indicators more precisely, Chapter 2 [Blanchard]Chapter 2 [Blanchard]

© 2003 Prentice Hall Business Publishing© 2003 Prentice Hall Business Publishing Macroeconomics, 3/eMacroeconomics, 3/e Olivier Blanchard MYZ/RY Olivier Blanchard MYZ/RY 77

Prepared by:Prepared by:

M. Yunus Zain & Rahmatia Yunus M. Yunus Zain & Rahmatia Yunus (FE-UNHAS)(FE-UNHAS)

C H A P T E RC H A P T E R

2. Macroeconomic indicators2. Macroeconomic indicators


Aggregate OutputAggregate Output

Measures of aggregate economic Measures of aggregate economic activity?activity? National income and product National income and product

accounts, accounts, or or GNP GNP

Measure of Measure of aggregate outputaggregate output in the in the national income accounts is national income accounts is gross gross domestic productdomestic product, or , or GDPGDP..

2-1


GDP: Production and IncomeGDP: Production and Income

There are three ways of defining GDP:There are three ways of defining GDP:1.1. GDP is the GDP is the value of the value of the finalfinal goods and services goods and services produced produced

in the economy during a given period.in the economy during a given period.

Difference between a final good and an intermediary good

Example:

- Simple economy, produce only cars:

- 10 cars, worth $21 each

- GDP = $ 210



2.2. GDP is the GDP is the sum of value addedsum of value added in the economy in the economy during a given period.during a given period.

Value added =Value added =

Value of firm’s production - Value of Value of firm’s production - Value of intermediary goodsintermediary goods

Another firm produces steel.

For each car, you need to buy for $ 10 steel ($100 in total)

Value added: Firm 1 (steel): $ 100

+ Firm 2 (cars): $ 210 - $ 100 = $ 110

Sum = $ 210



3.3. GDP is the sum of the GDP is the sum of the incomesincomes in the economy in the economy during a given period.during a given period.

PRODUCTION SIDE INCOME SIDE

Firm 1 (steel) pays workers: $ 80

$ 100 makes a profit: $ 20

Firm 2 (car) buys steel: $ 100

$ 210 pays workers: $ 70

makes a profit: $ 40

$ 210



Table 2-1 The Composition of GDP by Type of Income,1960 and 2000

(in percent) 1960 2000

Labor incomeLabor income 6666 6565

Capital incomeCapital income 2626 2828

Indirect taxesIndirect taxes 88 77


Nominal and real GDPNominal and real GDP

YearYear NumberNumber PricePrice Value in $Value in $

19901990 5 cars5 cars $ $ 100100 $ $ 500500

20002000 10 cars10 cars $ $ 200200 $ $ 2 0002 000

YearYear NumberNumber PricePrice Value in $Value in $

19901990 1 computer1 computer $ $ 100100 $ $ 100100

20002000 5 computers5 computers $ $ 120120 $ $ 600600

YearYear NominalNominal

GDP in $ of 90GDP in $ of 90

19901990 $ $ 500500 + $ + $ 100100 $ $ 600600

20002000 $ $ 2 0002 000 + $ + $ 600600 $ $ 2 6002 600


Nominal and Real GDPNominal and Real GDP

Can you think of any way of measuring the Can you think of any way of measuring the GDP in GDP in realreal terms? terms?



YearYear NumberNumber PricePrice GDP in $GDP in $

19901990 5 cars5 cars $ $ 100100 $ $ 500500

20002000 10 cars10 cars $ 200$ 200 $ 2 000$ 2 000

YearYear NumberNumber PricePrice GDP in $GDP in $

19901990 1 computer1 computer $ $ 100100 $ $ 100100

20002000 5 computers5 computers $ 120$ 120 $ 600$ 600

YearYear RealReal

GDP in $ of 90GDP in $ of 90

19901990 5 X 100 + 1 X 1005 X 100 + 1 X 100 $ $ 600600

20002000 10 X 10 X 100100 + 5 X + 5 X 100100 $ $ 15001500



Nominal and Real Nominal and Real GDP U.S. GDP, GDP U.S. GDP, 1960-20001960-2000



GDP growthGDP growth equals ( equals (please use real GDP):please use real GDP):

1

1)(

t

tt

Y

YY

expansionsexpansions recessionsrecessions


The Other MajorThe Other MajorMacroeconomic VariablesMacroeconomic Variables

UnemploymentUnemployment InflationInflation

2-2


The Unemployment and participation ratesThe Unemployment and participation rates

15-64

0-15

65+

Not

participating

Unemployed

Employed

How many people contribute to the domestic production ?


The Unemployment RateThe Unemployment Rate

Unemployed

Employed

UnemployedUR =


The Unemployment RateThe Unemployment Rate

labor forcelabor force = employed + unemployed = employed + unemployed L = N + UL = N + U

Unemployment rateUnemployment rate::L

Uu

u 2 0 0 0

5 7

1 3 5 2 5 74 0 %

.

. ..


The participation rateThe participation rate

Unemployed

Employed

Not

participating

Unemployed

Employed

PR=


The Inflation RateThe Inflation Rate

InflationInflation is a sustained rise in the general is a sustained rise in the general level of prices—the price level.level of prices—the price level.

The The inflation rateinflation rate is the rate at which the is the rate at which the price level increases.price level increases.

DeflationDeflation is a sustained decline in the is a sustained decline in the price level, or a negative inflation rate.price level, or a negative inflation rate.


The GDP DeflatorThe GDP Deflator

The GDP deflatorThe GDP deflator is what is called an is what is called an index index numbernumber—set equal to 100 in the base year.—set equal to 100 in the base year.

The rate of change in the GDP deflator equals The rate of change in the GDP deflator equals the rate of inflation:the rate of inflation:

PY

Ytt

t

nom ina l G D P

rea l G D Pt

t

$

( )P P

Pt t

t

1

1

Nominal GDP is equal to the GDP deflator Nominal GDP is equal to the GDP deflator times real GDP:times real GDP: $Y P Yt t t


The Consumer Price IndexThe Consumer Price Index

GDP deflator versus GDP deflator versus consumer price indexconsumer price index (CPI) (CPI)

How do they behave?How do they behave?


The Consumer Price IndexThe Consumer Price Index

Inflation Rate, Inflation Rate, Using the CPI and Using the CPI and the GDP Deflator, the GDP Deflator, 1960-20001960-2000


How do the three variables relate to each How do the three variables relate to each other?other?

Growth rate Growth rate Unemployment rateUnemployment rate Inflation rateInflation rate


Change in the Change in the Unemployment RateUnemployment Rate Versus Versus GDP GrowthGDP Growth, United States, 1960-2000, United States, 1960-2000

Okun’s law


Change in the U.S. Change in the U.S. Inflation RateInflation Rate Versus Versus the U.S. the U.S. Unemployment RateUnemployment Rate, 1970-2000, 1970-2000

Phillips Curve


What drives the macroeconomic indicators?What drives the macroeconomic indicators?

Why do we have booms and recessions?Why do we have booms and recessions? Why do some countries grow more than Why do some countries grow more than

others?others?


A Road MapA Road Map

Output is determined by:Output is determined by: demand in the demand in the short runshort run, say, , say, a few yearsa few years,, the level of technology, the capital stock, and the the level of technology, the capital stock, and the

labor force in the labor force in the medium runmedium run, say, , say, a decade or a decade or so,so,

factors such as education, research, saving, and factors such as education, research, saving, and the quality of government in the the quality of government in the long runlong run, say, , say, a a half century or more.half century or more.

2-3


The Organization of the BookThe Organization of the Book [Blanchard, 2003)[Blanchard, 2003)

TheThe Focus of our Focus of our Lecture is here only!Lecture is here only!


ExercisesExercises

[B] Chapter 1, problems 2, 3, 5[B] Chapter 1, problems 2, 3, 5 [B] Chapter 2, problems 2, 3, 4, 5, 6, 8[B] Chapter 2, problems 2, 3, 4, 5, 6, 8





3. The Goods Market3. The Goods Market


Summary of last time ([B] ch. 2)Summary of last time ([B] ch. 2)

Definitions of:Definitions of: GDPGDP

Income Income Sum of Value addedSum of Value added ProductionProduction

Unemployment rateUnemployment rate Inflation rateInflation rate

Consumer price indexConsumer price index GDP deflatorGDP deflator


Questions? Please raise it now!Questions? Please raise it now!


Goals of this chapter 3 (lecture)Goals of this chapter 3 (lecture)

Describe the composition of the GDPDescribe the composition of the GDP See how the equilibrium output is determined See how the equilibrium output is determined

in the short runin the short run


The Composition of GDPThe Composition of GDP3-1

Table 3-1 The Composition of U.S. GDP, 2001

Billions of dollars

Percent of GDP

GDP (Y)GDP (Y) 10,20810,208 100100

1.1. Consumption (Consumption (CC) ) 7,0647,064 6969

2.2. Investment (Investment (II)) 1,6921,692 1717

NonresidentialNonresidential 1,2461,246 1212

ResidentialResidential 446446 55

3.3. Government spending (Government spending (GG)) 1,8391,839 1818

4.4. Net exports = X - MNet exports = X - M 329329 33

Exports (Exports (XX)) 1,0971,097 1111

Imports (Imports (IMIM)) 1,4681,468 1414

5.5. Inventory investmentInventory investment 5858 11


The Demand for GoodsThe Demand for Goods

The total demand for goods (aggregate The total demand for goods (aggregate demand, AD) is written as:demand, AD) is written as:

3-2

Z C I G X IM The symbol “The symbol “” means that this equation is an ” means that this equation is an

identityidentity, or definition., or definition. Under the assumption that the economy is Under the assumption that the economy is

closedclosed, , X = IMX = IM = 0, then: = 0, then:

Z C I G


Consumption (Consumption (CC))

Disposable income:Disposable income:

C C YD ( )( )

The function The function CC((YYDD) is the ) is the consumption consumption

function (behavioral equation).function (behavioral equation).

Y Y TD



A more specific form of the consumption A more specific form of the consumption function is this function is this linear relationlinear relation::

C c c YD 0 1

This function has two This function has two parametersparameters, , cc00 and and cc11::

cc11 (marginal) (marginal) propensity to consumepropensity to consume

cc00 is the intercept of the consumption is the intercept of the consumption

function.function.



Consumption and Consumption and Disposable IncomeDisposable Income

C C YD ( )

Y Y TD

C c c Y T 0 1 ( )


Investment (Investment (II): assumed autonomous or ): assumed autonomous or exogenousexogenous

Note: Distinction Note: Distinction ExogenousExogenous - - EndogenousEndogenous

I I


Government Spending (Government Spending (GG))

Government spending, Government spending, GG, together with taxes, , together with taxes, TT, describes , describes fiscal policyfiscal policy—the choice of taxes —the choice of taxes and spending by the government.and spending by the government.

We shall assumeWe shall assume that that GG and and TT are also are also exogenousexogenous..


The Determination ofThe Determination ofEquilibrium OutputEquilibrium Output

Equilibrium in the goods marketEquilibrium in the goods market requires requires that production, that production, YY, be equal to the demand for , be equal to the demand for goods, goods, ZZ::

3-3

Y c c Y T I G 0 1 ( )

Y ZThen:Then:

The The equilibrium conditionequilibrium condition is that, is that, production = income =production = income =YY = demand (Z). = demand (Z). Demand (Demand (Z) Z) depends on depends on YY..


Demand, production and incomeDemand, production and income

Production

IncomeDemand


Using AlgebraUsing Algebra

The equilibrium equation can be manipulated to derive The equilibrium equation can be manipulated to derive some important terms:some important terms: Autonomous spending and the multiplierAutonomous spending and the multiplier::

GITYccY )(10

( )1 1 0 1 1 c Y c c I G c T

Yc

c I G c T

1

1 10 1[ ]

multiplier autonomous spending

GITcYccY 110


Using a GraphUsing a Graph

Equilibrium in the Goods Equilibrium in the Goods MarketMarket

Z c I G c T c Y ( )0 1 1



The Effects of an The Effects of an Increase in Autonomous Increase in Autonomous Spending on OutputSpending on Output



The multiplier is the sum of successive The multiplier is the sum of successive increases in production resulting from an increases in production resulting from an increase in demand.increase in demand.

When demand is, say, $1 billion higher, the When demand is, say, $1 billion higher, the total increase in production after total increase in production after nn rounds of rounds of increase in demand equals $1 billion times:increase in demand equals $1 billion times:

This sum is called a This sum is called a geometric seriesgeometric series..

1 1 12

1 c c c n. . .


How Long Does It TakeHow Long Does It Takefor Output to Adjust?for Output to Adjust?

How do we go from one equilibrium to the How do we go from one equilibrium to the other?other?

Describing formally the adjustment of output Describing formally the adjustment of output over time is what economists call the over time is what economists call the dynamicsdynamics of adjustment. of adjustment.


Consumer Confidence and the 1990-Consumer Confidence and the 1990-1991 Recession1991 Recession

Forecast errorsForecast errors Consumer confidence indexConsumer confidence index


Consumer Confidence and the 1990-Consumer Confidence and the 1990-1991 Recession1991 Recession

Table 1 GDP, Consumption, and Forecast Errors, 1990-1991

Quarter

(1)Change inReal GDP

(2)Forecast Error

for GDP

(3)Forecast

Error for c0

(4)Index of Consumer

Confidence

1990:21990:2 1919 1717 2323 105105

1990:31990:3 2929 5757 11 9090

1990:41990:4 6363 8888 3737 6161

1991:11991:1 3131 2727 3030 6565

1991:21991:2 2727 4747 88 7777


Investment Equals Saving: An AlternativeInvestment Equals Saving: An AlternativeWay of Thinking about Goods-Market EquilibriumWay of Thinking about Goods-Market Equilibrium

SavingSaving is the sum of is the sum of privateprivate plus plus publicpublic saving. saving. Private savingPrivate saving ( (SS), is saving by consumers.), is saving by consumers.

3-4

S Y CD S Y T C

Y C I G Y T C I G T

S I G T I S T G ( )

Public savingPublic saving = T - G. = T - G. If T > G: If T > G: budget surplusbudget surplus If T < G: If T < G: budget deficitbudget deficit

Private saving



IS relationIS relation What firms want to What firms want to investinvest must be equal to must be equal to

what people and the government want to what people and the government want to savesave..

I S T G ( )



Consumption and saving decisions are one and the Consumption and saving decisions are one and the same.same.

S Y T C

S c c Y T 0 11( )( )

The term (1The term (1cc) is ) is called the called the propensity to save.propensity to save.

In equilibrium:In equilibrium:

Yc

c I G c T

1

1 10 1[ ]

I c c Y T T G 0 11( )( ) ( )

Rearranging terms, we get the same result as Rearranging terms, we get the same result as before:before:

)(10 TYccTYS


The Paradox of SavingThe Paradox of Saving

When consumers save more, spending When consumers save more, spending decreases and equilibrium output is lower.decreases and equilibrium output is lower.

Attempts by people to save more lead both to Attempts by people to save more lead both to a decline in output and to unchanged saving. a decline in output and to unchanged saving. This surprising pair of results is known as the This surprising pair of results is known as the paradox of savingparadox of saving (or the paradox of thrift). (or the paradox of thrift).


Is the Government Omnipotent?Is the Government Omnipotent?A WarningA Warning

Changing government spending or taxes may Changing government spending or taxes may be far from easy.be far from easy.

The responses of consumption, investment, The responses of consumption, investment, imports, etc, are hard to assess with much imports, etc, are hard to assess with much certainty.certainty.

Anticipations are a likely matter.Anticipations are a likely matter. Achieving a given level of output may come Achieving a given level of output may come

with unpleasant side effects.with unpleasant side effects. Budget deficits and public debt may have Budget deficits and public debt may have

adverse implications in the long run.adverse implications in the long run.

3-5


ExercisesExercises

Chapter 3, problems 4,5,6Chapter 3, problems 4,5,6





4. Financial Markets4. Financial Markets


The Demand for MoneyThe Demand for Money

MoneyMoney, , pays pays no interestno interest Used for Used for transactionstransactions Types:Types:

currencycurrency checkable depositscheckable deposits..

BondsBonds pay pay a positive interest ratea positive interest rate, , ii, , cannot be used for cannot be used for transactionstransactions. .

The proportions of money and bonds you wish to hold The proportions of money and bonds you wish to hold depend on your depend on your level of transactionslevel of transactions and the and the interest rate interest rate on bondson bonds. .

4-1


Semantic trapSemantic trap

Difference between Difference between a flowa flow and and a stocka stock::

Wealtht Wealtht+1

timet t+1



Wealtht Wealtht+1

timet t+1

Income

Savings



Wealtht Wealtht+1

timet t+1

Savings


Difference between Difference between flowflow and and stockstock

StockStock: Defined at a : Defined at a precise moment in timeprecise moment in time Example: Wealth, unemployment Example: Wealth, unemployment

FlowFlow: Defined : Defined over a period of timeover a period of time Examples: Savings, incomeExamples: Savings, income


Semantic Traps:Semantic Traps:Money, Income, and WealthMoney, Income, and Wealth

Money Money ≠ Wealth≠ Wealth Money ≠ IncomeMoney ≠ Income Wealth Wealth ≠≠ Saving Saving InvestmentInvestment ≠ ≠ Financial investmentFinancial investment


Deriving the Demand for MoneyDeriving the Demand for Money

The demand for money:The demand for money: increases in proportion to increases in proportion to transactions transactions (nominal (nominal

income ($income ($YY)), and)), and depends negatively on the depends negatively on the interest rateinterest rate ( (LL((ii)).)).

M Y L id $ ( )


Deriving the Demand for MoneyDeriving the Demand for Money

The Demand for MoneyThe Demand for Money


The Determination ofThe Determination ofthe Interest Rate, Ithe Interest Rate, I

In this section, we assume that only the central In this section, we assume that only the central bank supplies money, in an amount equal to bank supplies money, in an amount equal to M, so M, so MM = = MMss. .

People hold only currency as money.People hold only currency as money.

4-2

Equilibrium in financial markets requires that Equilibrium in financial markets requires that money supplymoney supply be equal to be equal to money demandmoney demand::

M Y L i $ ( )


Money Demand, Money Supply; and Money Demand, Money Supply; and the Equilibrium Interest Ratethe Equilibrium Interest Rate

The Determination of the The Determination of the Interest RateInterest Rate


Money Demand, Money Supply; and Money Demand, Money Supply; and the Equilibrium Interest Ratethe Equilibrium Interest Rate

The Effects of an The Effects of an Increase inIncrease inNominal Income on the Nominal Income on the Interest RateInterest Rate


The Demand for Money and the The Demand for Money and the Interest Rate: The EvidenceInterest Rate: The Evidence

The interest rate and the ratio of money to nominal The interest rate and the ratio of money to nominal income typically move in opposite directions.income typically move in opposite directions.


Monetary Policy andMonetary Policy andOpen-Market OperationsOpen-Market Operations

The Effects of an The Effects of an Increase in the Money Increase in the Money Supply on the Interest Supply on the Interest RateRate



Open-market operationsOpen-market operations

Bonds:Bonds:

Promise of a certain value at a certain datePromise of a certain value at a certain date: : For example: $100, 01-03-2007For example: $100, 01-03-2007

Price today: PPrice today: Ptt

Interest rate: Interest rate:

t

t

P

Pi

100$



The Balance Sheet of the The Balance Sheet of the Central Bank and the Effects of Central Bank and the Effects of an Expansionary Open Market an Expansionary Open Market OperationOperation



Expansionary open market operation

Ms Buy bonds

Contractionary open market operation

• Ms

• Sell bonds



Bonds issued by the government, promising a payment in a year or less, are called Treasury bills, or T-bills

When the central bank buys bonds, the demand for bonds goes up, increasing the price of bonds. Equivalently, the interest rate on bonds goes down.

iP

PB

B

$ 1 0 0 $

$ $

$ 1 0 0P

iB 1


The Determination ofThe Determination ofthe Interest Rate, IIthe Interest Rate, II

4-3

Financial intermediariesFinancial intermediaries are institutions that are institutions that receive funds from people and firms, and use receive funds from people and firms, and use these funds to buy bonds or stocks, or to these funds to buy bonds or stocks, or to make loans to other people and firms.make loans to other people and firms.


The Balance Sheet of Banks and the Balance The Balance Sheet of Banks and the Balance Sheet of the Central Bank RevisitedSheet of the Central Bank Revisited


What Banks DoWhat Banks Do

Banks keep as Banks keep as reservesreserves some of the funds some of the funds they have received, for three reasons:they have received, for three reasons: To honor depositors’ withdrawalsTo honor depositors’ withdrawals To pay what the bank owes to other banksTo pay what the bank owes to other banks To maintain the legal reserve requirement, or portion To maintain the legal reserve requirement, or portion

of checkable deposits that must be kept as reserves:of checkable deposits that must be kept as reserves: The The reserve ratioreserve ratio is the ratio of bank reserves to is the ratio of bank reserves to

checkable deposits (currently about 10% in the United checkable deposits (currently about 10% in the United States).States).


What Banks DoWhat Banks Do

Loans represent roughly 70% of banks’ Loans represent roughly 70% of banks’ nonreserve assets. Bonds account for the nonreserve assets. Bonds account for the other 30%.other 30%.

The assets of a central bank are the bonds it The assets of a central bank are the bonds it holds. The liabilities are the money it has holds. The liabilities are the money it has issued, issued, central bank moneycentral bank money, which is held as , which is held as currency by the public, and as reserves by currency by the public, and as reserves by banks.banks.


Bank RunsBank Runs

bank runbank run.. federal deposit insurancefederal deposit insurance.. alternative solution: alternative solution: narrow bankingnarrow banking, ,


Determinants of the Demand andDeterminants of the Demand andthe Supply of Central Bank Moneythe Supply of Central Bank Money


The Demand for Money, Reserves, The Demand for Money, Reserves, and Central Bank Moneyand Central Bank Money

Demand for currency:Demand for currency: C U cMd d

Demand for checkable deposits:Demand for checkable deposits: D c Md d ( )1

Relation between deposits (D) and reserves (R):Relation between deposits (D) and reserves (R): R Dq=

Demand for reserves by banks:Demand for reserves by banks: 1d dR ( c )Mq= -

Demand for central bank money:Demand for central bank money: H C U Rd d d

Then:Then: 1 1d d d dH cM ( c )M [ c ( c )]Mq q= + - = + -

M Y L id $ ( )SinceSince Then:Then: [ (1 )]$ ( )dH c c YL iq= + -


The Determination of the Interest RateThe Determination of the Interest Rate

In equilibrium, the supply of central bank In equilibrium, the supply of central bank money (money (HH) is equal to the demand for central ) is equal to the demand for central bank money (bank money (HHdd):):

H H d

Or restated as:Or restated as:

H [ c (1 c )]$YL( i )q= + -


The Determination of the Interest RateThe Determination of the Interest Rate

Equilibrium in the Equilibrium in the Market for Central Bank Market for Central Bank Money, and the Money, and the Determination of the Determination of the Interest RateInterest Rate


Two Alternative Ways toTwo Alternative Ways toThink about the EquilibriumThink about the Equilibrium

The equilibrium condition that the supply and The equilibrium condition that the supply and the demand for bank reserves be equal is the demand for bank reserves be equal is given by:given by:

4-4

H C U Rd d The The federal funds marketfederal funds market is a market for is a market for

bank reserves. In equilibrium, demand (bank reserves. In equilibrium, demand (RRdd) ) must equal supply (must equal supply (H-CUH-CUdd). The interest rate ). The interest rate determined in the market is called the determined in the market is called the federal federal funds ratefunds rate..


The Supply of Money, the Demand for The Supply of Money, the Demand for Money and the Money MultiplierMoney and the Money Multiplier

The overall supply of money is equal to central The overall supply of money is equal to central bank money times the bank money times the money multipliermoney multiplier: :

H [ c (1 c )]$YL( i )q= + -

Then:Then: 1H $YL( i )

[ c (1 c )]q=

+ -Supply of money = Demand for moneySupply of money = Demand for money

High-powered moneyHigh-powered money is the term used to is the term used to reflect the fact that the overall supply of money reflect the fact that the overall supply of money depends in the end on the amount of central depends in the end on the amount of central bank money (bank money (HH), or ), or monetary basemonetary base..


ExercisesExercises

Chapter 4, problems 4, 5, 6, 7 Chapter 4, problems 4, 5, 6, 7





5. Goods and5. Goods andFinancial Markets:Financial Markets:The IS-LM ModelThe IS-LM Model


Diagram for Goods and Financial (Money) Diagram for Goods and Financial (Money) Markets Relation in IS-LM FrameworkMarkets Relation in IS-LM Framework

interest rate, i I = f (Y, i)interest rate, i I = f (Y, i)

Monetary policyMonetary policy

Fiscal PolicyFiscal Policy

Income, YIncome, Y

Money market equilibrium

M-supply = M-demand

LM curve (I,Y)

Goods market equilibrium

Y=Z

IS curve (i,Y)


Goods and Financial marketsGoods and Financial markets

1) Equilibrium on the Goods market: Y 1) Equilibrium on the Goods market: Y 2) Equilibrium on the financial market: I2) Equilibrium on the financial market: I 3) Link these two markets3) Link these two markets

YY = C + = C + I(Y,i)I(Y,i) + G + G IS IS $Y$Y L( L(ii) = M) = M LMLM

Graph with Y on the horizontal axis and i on the Graph with Y on the horizontal axis and i on the vertical axis vertical axis ii IS LMIS LM

Y Y (see 5.3.)(see 5.3.)


The Goods MarketThe Goods Marketand the and the ISIS Relation Relation

Equilibrium in the goods market exists when Equilibrium in the goods market exists when production, production, YY, is equal to the demand for , is equal to the demand for goods, goods, ZZ..

In the simple model developed in chapter 3, In the simple model developed in chapter 3, the interest rate did not affect the demand for the interest rate did not affect the demand for goods. The equilibrium condition was given goods. The equilibrium condition was given by:by:

5-1

Y C Y T I G ( )


Investment, Sales,Investment, Sales,and the Interest Rateand the Interest Rate

In this chapter, we capture the effects of In this chapter, we capture the effects of two factors affecting investment:two factors affecting investment:The level of sales (+)The level of sales (+)The interest rate (-)The interest rate (-)

I I Y i ( , )


The Determination of OutputThe Determination of Output

I I Y i ( , )

Y C Y T I Y i G ( ) ( , )

Taking into account the investment relation Taking into account the investment relation above, the equilibrium condition in the goods above, the equilibrium condition in the goods market becomes:market becomes:


The Determination of OutputThe Determination of Output

Equilibrium in the Goods Equilibrium in the Goods MarketMarket


Deriving the Deriving the ISIS Curve Curve

The Effects of an The Effects of an Increase inIncrease inthe Interest Rate on the Interest Rate on OutputOutput


Deriving the Deriving the ISIS Curve Curve

The Derivation of the IS The Derivation of the IS CurveCurve


Shifts of the Shifts of the ISIS Curve Curve

Shifts of the IS Shifts of the IS CurveCurve


Financial MarketsFinancial Marketsand the and the LMLM Relation Relation

The interest rate is determined by the equality The interest rate is determined by the equality of the supply of and the demand for money:of the supply of and the demand for money:

5-2

M Y L i $ ( )

MM = nominal money stock = nominal money stock$YL$YL((ii) = demand for money) = demand for money$Y$Y = nominal income = nominal incomeii = nominal interest rate = nominal interest rate


Real Money, Real Income,Real Money, Real Income,and the Interest Rateand the Interest Rate

The The LMLM relation relation: In equilibrium, the real money : In equilibrium, the real money supply is equal to the real money demand, which supply is equal to the real money demand, which depends on real income, Y, and the interest rate, i:depends on real income, Y, and the interest rate, i:

M

PY L i ( )

$Y Y P

From chapter 2, recall that Nominal GDP = Real GDP From chapter 2, recall that Nominal GDP = Real GDP multiplied by the GDP deflator:multiplied by the GDP deflator:

$Y

PY

Equivalently:Equivalently:


Deriving the Deriving the LMLM Curve Curve

The Effects of an The Effects of an Increase in Income on Increase in Income on the Interest Ratethe Interest Rate


Deriving the Deriving the LMLM Curve Curve

The Derivation of the The Derivation of the LM CurveLM Curve


Shifts of the Shifts of the LMLM Curve Curve

Shifts of the LM Shifts of the LM CurveCurve


Putting the Putting the ISIS and the and theLMLM Relations Together Relations Together

5-3

IS re la tio n : Y C Y T I Y i G( ) ( , )

L M rela tio n: M

PY L i( )

The IS-LM ModelThe IS-LM Model


Fiscal Policy, Activity,Fiscal Policy, Activity,and the Interest Rateand the Interest Rate

Fiscal contractionFiscal contraction or or Fiscal consolidationFiscal consolidation Fiscal expansionFiscal expansion.. affects the affects the ISIS curve curve, not the , not the LMLM curve. curve.


Fiscal Policy, Activity,Fiscal Policy, Activity,and the Interest Rateand the Interest Rate

The Effects of an The Effects of an Increase in TaxesIncrease in Taxes


Monetary Policy, Activity,Monetary Policy, Activity,and the Interest Rateand the Interest Rate

Monetary contractionMonetary contraction, or , or monetary monetary tighteningtightening

Monetary expansionMonetary expansion..


Monetary Policy, Activity,Monetary Policy, Activity,and the Interest Rateand the Interest Rate

The Effects of a The Effects of a Monetary ExpansionMonetary Expansion


Monetary and Fiscal policiesMonetary and Fiscal policies

Monetary Policy: Monetary Policy: MM, shifts the , shifts the LM curveLM curve Fiscal Policy: Fiscal Policy: T,GT,G, shifts the , shifts the IS curveIS curve


Using a Policy MixUsing a Policy Mix

The combination of monetary and fiscal polices is The combination of monetary and fiscal polices is known as the known as the monetary-fiscal policy mix,monetary-fiscal policy mix, or simply, or simply, the the policy mix.policy mix.

5-4

Table 5-1 The Effects of Fiscal and Monetary Policy.

Shift of ISShift of ISShift of Shift of

LMLMMovement of Movement of

OutputOutputMovement in Movement in Interest RateInterest Rate

Increase in taxes left none down down

Decrease in taxes right none up up

Increase in spending right none up up

Decrease in spending left none down down

Increase in money none down up down

Decrease in money none up down up


The Clinton-Greenspan Policy MixThe Clinton-Greenspan Policy Mix

Table 5-2 Selected Macro Variables for the United States,

1991-199819911991 19921992 19931993 19941994 19951995 19961996 19971997 19981998

Budget surplus (% of GDP) (minus sign = deficit)

3.3 4.5 3.8 2.7 2.4 1.4 0.3 0.8

GDP growth (%) 0.9 2.7 2.3 3.4 2.0 2.7 3.9 3.7

Interest rate (%) 7.3 5.5 3.7 3.3 5.0 5.6 5.2 4.8


The Clinton-Greenspan Policy MixThe Clinton-Greenspan Policy Mix

Deficit Reduction and Deficit Reduction and Monetary ExpansionMonetary Expansion


German Unification and the German German Unification and the German Monetary-Fiscal Tug of WarMonetary-Fiscal Tug of War

Table 5-2 Selected Macro Variables for West Germany, 1988-1991

19911991 19921992 19931993 19941994

GDP growth (%) 3.7 3.8 4.5 3.1

Investment growth (%) 5.9 8.5 10.5 6.7

Budget surplus (% of GDP) (minus sign = deficit)

2.1 0.2 1.8 2.9

Interest rate (%) 4.3 7.1 8.5 9.2


German Unification and the German German Unification and the German Monetary-Fiscal Tug of WarMonetary-Fiscal Tug of War

The Monetary-Fiscal The Monetary-Fiscal Policy Mix of Post-Policy Mix of Post-Unification GermanyUnification Germany


DynamicsDynamics

1.1. Starting point: Suppose the equilibrium is at Starting point: Suppose the equilibrium is at the natural rate of output => Pthe natural rate of output => Pee = P = P**

2.2. Determine whether the shock affects the Determine whether the shock affects the natural rate of unemploymentnatural rate of unemployment Changes in Changes in , , z (AS curve)z (AS curve) Monetary policy, budgetary policies: no (AD curve)Monetary policy, budgetary policies: no (AD curve)


Dynamics (II)Dynamics (II)

3.3. Determine the shifts in the AS-AD diagramDetermine the shifts in the AS-AD diagram

4.4. AdjustmentsAdjustments1.1. Determine the expected price level PDetermine the expected price level Pee

2.2. Determine the equilibrium price level PDetermine the equilibrium price level P

3.3. If PIf Pe e > P> P** P Pe e AS shifts downwards AS shifts downwards P P**

4.4. If PIf Pe e < P< P** P Pe e AS shifts upwards AS shifts upwards P P**

5.5. In the IS-LM modelIn the IS-LM model1.1. Determine which curve shiftsDetermine which curve shifts

2.2. Remember that LM will always shift as well since Remember that LM will always shift as well since P changesP changes


ExercisesExercises

Chapter 5, problems 2, 3, 5, 6Chapter 5, problems 2, 3, 5, 6 See also data of Indonesia cases in last See also data of Indonesia cases in last

lecture (i.e., lecture III)lecture (i.e., lecture III)

KuliahImoneter Chap 2-5

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