中级宏观 lecture 5

June 1, 2012Q: What is the relationship between interest elasticity of demand for money (h) and the slope of the LM curve?P84An increase in income from Y o to Y i increase M d=L(i,Y) from L(i, Y o) to L(i, Y i )1. If h is small (low interest elasticity of demand for money)Then i must raise a lot to i1 to bring the money market into equilibrium. This is consistent with the steep LM illustrated.2. If h is large (high interest elasticity), then i only needs to rise a little to i' to bring the money market into equilibrium. This is consistent with the flat LM' illustrated.Implication: small h >>steep LMBig h>>flat LMQ: What happens as h>>0?A: LM gets steeperQ: What if real money demand is perfectly in elastic w.r.t. i (i.e. h=0)?A: M/P=kY-hi+u=kY+uP85People will hold less money then is available, M d will be independent of i, and the LM curve is vertical at national income.Q: What will cause h=0?A: If bonds and other interest bearing securities(financial assets) are not viewed as substitutes for money, then there does not exist an interest rate high enough to get people to substitute money for a security(bond, financial asset)Q: If h=0, how much money would people hold?A: M d =kY+uM s=M/PAt equilibrium M d = M skY+u=M/PY=1/h (M/P-u)There would be strict proportionality between real money supply(M s =M/P) and national income(Y). Only the supply of money determines national income.The goods market would be irrelevant in determining national income.Q: What would happen if real money demand is perfectly elastic wrt i so that h is infinitely large?A: This is the famous case proposed by Keynes of liquidity trapP85-86Notice that under liquidity trap, any increase in the money supply will have no impact on the interest rate. People will gobble up every dollar they can get.Q: Can horizontal LM curve occur if we have normal downward sloping M d curve?A: Yes, if the monetary authority is committed to maintaining a fixed interest rate by deliberately altering M s to be i unchanged.P87Q: What causes the LM curve to shift?A; There are two reasons why the LM curve will shift:1) Change in the nominal money supplyP882) a change in the M d curve unrelated to income Y or interest(i) will also cause the LM curve to shift. P88Q: What will cause M d to change if neither i nor Y changed?A: M d decrease if people lose confidence in their currency, this can happen if they expect a devaluation or some sort of currency reform.Monetary flight: Argentina; Zimbabwe; Thailand; Indonesia; Germany 1920's etc.Q: What determines macroeconomic equilibrium?A: P89Q: What causes the business cycle?A: Keynesians believe that the animal spirit of the market cause changes to consumer and business confidence, which can have larger real effect on the economy.Fall in consumer confidence>>C o falls>>AE falls>> IS curve Shifts left>>recessionfall in business confidence >>I o falls>>AE falls>>IS curve shifts leftP 90Q: Are we in a world wide recession?A: Interest rate is very low and unemployment is high in most of the developed world.Q: What do monetarists believe to the cause of business cycle?A: Monetary instability by the monetary authorities creates economic instability. In particular, recessions are caused by monetary contractions.P95The current downturn in the world economy looks like a Keynesian recession.Q: How does fiscal policy affect macroeconomic equilibrium?P95 and P92 crowding out effectGo raise >>AE rise to AE' >>IS curve shifts right by ^Y>>i rise to I' >>I=Io-bi falls to I=I o-b1' >>AE' falls a little>>equilibrium At Y'Crowing out of private investmentQ: How does monetary policy affect macroeconomic equilibrium?A: Suppose the monetary authority increases Ms.M↑>>LM shifts to LM' >>i falls to i'>> I rises>> AE shifts up by –b△i>>Y rises to Y'P95Notice: expansionary fiscal policy hurts private investor through crowding out. Expansion fiscal policy benefits private investors by encouraging investment.Implication: Monetarists became associated with right-wing pro-business ideologyKeynesians became associated with left-wing pro-government ideology.Q: What are the multipliers of the ISLM model?A: Crowing out cause the fiscal multiplier to be smaller than then Keynesian cross multiplier-monetary policy multiplier is new-the ISLM framework changes things.-to find the ISLM multipliers follows these steps1) Equate IS and LM curve and solve for equilibrium Y* i*2) Differentiate Y* to get multipliersCase 1 P90Assumption: all taxes are lump-sum T=T oNo international tradeQ: How are the ISLM multipliers different from the Keynesian cross multiplier?A: Recall that under autarky (no trade) and lump-sum taxation in Keynesian cross.The ISLM multiplier is smaller.Q: Why?P92Keynesian multiplier tells how much the IS shiftsThe ISLM multiplier tells how much Y increase after crowding out (-b△i=△I) of private investment.。