EC210 ~ MACRO

[e]

EC210 ~ MACRO

[e]

<style>

/*** WORKINGS ***/
.editlink, .editlink A { color: white; }
#rightHand div div .editlink A { color: #bbb; }
textarea { font-family: inherit; width: 100%; height: 500px; }

/*** STYLE ***/
 BODY, P, TD, TEXTAREA { font-family: palatino linotype; font-size: 10pt; }
 H2 { text-align: center; }
H1, H2, H3 { margin-bottom: 0px; padding-bottom: 0px; }
H3 { color: red; }
 A { text-decoration: none; color: #b00; }
 A:Hover { text-decoration: underline; }
 #michaelmasReading P, #lentReading P, #summerReading P { margin: 0px; }
 OL LI { margin-bottom: 1em; }
EM { color: blue; font-style: normal; font-weight: bold; }
 sub { font-size: 9px; position: relative; top: 3px; }

/*** ToC ***/
#innertoc { margin-left: 150px; }
#innertoc a { display: list-item; font-weight: bold; }
a.pageindent { }
a.pageextraindent { }

/*** LAYOUT ***/
 DIV { border: 0px; margin: 0px; padding: 0px; }
 #index { width: 1300px; }
 HR { border: 0px; border-top: 1px solid #900; }
 IMG { border: 0px; }

#leftHand { 
     width: 275px; float: left;
     color: black; 
     padding: 15px;
     padding-top: 0px; margin-top: 0px;
    border-right: black solid 1px;
}

#rightHand {
    margin-left: 5px;
    width: 600px; float: left;
    padding-left: 30px;
 }

@media print {
   .editlink { display: none; }
   #leftHand { display: none; }
  #rightHand { width: 80%; }
}

</style>

add breaks

[e]

Ec210 MACRO (Tom C)

Comments to:
t(.)e(.)cunningham(at)lse(.)ac(.)uk

logout | edit css | edit index | edit menu | backup

<h2 style="margin-top: 0px;">Ec210 MACRO (Tom C)</h2>
<p align="center"><a href="./?body=Home"><img src="http://www.ex-premie.org/pix/mrnatt.JPG" 
 style="left: -20px; top: -23px; position: relative;" />
</a>

<ol>
<li> <a href="./?body=Home">Home</a><br />
<li> <a href="./?body=Handout">Handout</a>
<li> <a href="./?body=Notes">Economic Modelling</a>
<li> <a href="./?body=FirstTerm">First Term Summary</a>
<li> <a 
href="./?body=Definitions">Definitions</a>
<li> <a href="./?body=Models">Models</a>
<li> <a href="./?body=Issues">Issues</a>
<li> <a href="./?body=PDVs">Present Discounted Values</a>
<li> <a href="./?body=Questions">Questions</a>
</ol>

<p>Comments to:<br /> t(.)e(.)cunningham(at)lse(.)ac(<b></b>.)uk</p>

<hr />

<p align="center">
<a href="./?logout=1">logout</a> 
| <a href="javascript:make_editable('css')">edit css</a> 
| <a href="javascript:make_editable('index')">edit index</a>
| <a href="javascript:make_editable('leftHand')">edit menu</a>
| <a href="./?a=backup">backup</a>

add breaks

[e]

IMPORTANT: This is not official LSE teaching material, use at your own risk!

[e]

Economics Issues

Effectiveness of Fiscal Stimulus

Fiscal policy can be used to change the output of the economy, at least in the short-run. Different models can be used to estimate the effect of fiscal policy, i.e. used to estimate ΔY/ΔG:

You can analyse the effect in the Goods market, with the Keynesian consumption and investment functions. This shows that higher MPC and MPI make fiscal policy more effective.
You can use extend the analysis to include the money market by using the IS-LM model, so allowing the interest rate to change. This shows that a fiscal expansion will push up interest rates, and so crowd out investment; so this model will show a lower effectiveness of fiscal policy.

Effectiveness of Monetary Stimulus

Monetary policy can be used (in the short-run) to change the output of the economy; using a model will let us estimate the effectiveness of monetary policy, i.e. ΔY/ΔM.

The M^s-M^d model shows that, if you keep the interest rate constant, a monetary expansion will get exactly the same output expansion (i.e., ΔY/ΔM=1). This is not very useful, because the interest rate is not going to be constant.
The IS-LM model extends the analysis by adding the goods market, allowing the interest rate to be endogenously determined. This reduces the effectiveness of monetary policy, because (XXX).
Note: In the long-run, all shifts in the money supply will be entirely accommodated by the price level. This is what is meant by "long-run money neutrality," which is generally agreed upon.
Note: The central bank can either maintain a certain level of money supply, or a certain interest rate, but not both, because once one of these variables is chosen the other one depends on the demand for money.

Credit Crunch

Since 2000, central bank interest rates have been low, stimulating the economy in many countries. Many economists think that this has driven output and house prices above their natural levels, so that both will naturally fall at some point.

Since around June 2007, there has been a "credit crunch", which has triggered a fall in output and house prices, though not as large as the fall which some people have said is required. The direct cause of this was a discovery that US sub-prime mortgages, which many banks had been investing in, were less valuable than previously expected. The consequence of this, indirectly, has been that banks are less happy to lend money, so that the interest rate on loans has gone up, even though the central bank interest rate is the same (or lower). In turn the higher interest rates cause less investment, and lower house prices.

This could cause the economy to settle back to its "natural" position, but it may overshoot into recession. Central banks may keep lowering interest rates to prevent the economy from going into recession.

<h2>Economics Issues</h2>

<h3>Effectiveness of Fiscal Stimulus</h3>

<p> Fiscal policy can be used to change the output of the economy, at least in the short-run.  Different models can be used to estimate the effect of fiscal policy, i.e. used to estimate &Delta;Y/&Delta;G:<ol>
 <li> You can analyse the effect in the Goods market, with the Keynesian consumption and investment functions. This shows that higher MPC and MPI make fiscal policy more effective.
 <li> You can use extend the analysis to include the money market by using the IS-LM model, so allowing the interest rate to change. This shows that a fiscal expansion will push up interest rates, and so crowd out investment; so this model will show a lower effectiveness of fiscal policy. 
</ol>

<h3>Effectiveness of Monetary Stimulus</h3>

<p> Monetary policy can be used (in the short-run) to change the output of the economy; using a model will let us estimate the effectiveness of monetary policy, i.e. &Delta;Y/&Delta;M.<ol>
  <li> The M<sup>s</sup>-M<sup>d</sup> model shows that, if you keep the interest rate constant, a monetary expansion will get exactly the same output expansion (i.e., &Delta;Y/&Delta;M=1). This is not very useful, because the interest rate is not going to be constant.
  <li> The IS-LM model extends the analysis by adding the goods market, allowing the interest rate to be endogenously determined. This reduces the effectiveness of monetary policy, because (XXX). 
  <li> <i>Note:</i> In the long-run, all shifts in the money supply will be entirely accommodated by the price level. This is what is meant by "long-run money neutrality," which is generally agreed upon.
  <li> <i>Note:</i> The central bank can either maintain a certain level of money supply, or a certain interest rate, but not both, because once one of these variables is chosen the other one depends on the demand for money. 
</ol>

<h3>Credit Crunch</h3>

<p> Since 2000, central bank interest rates have been low, stimulating the economy in many countries. Many economists think that this has driven output and house prices above their natural levels, so that both will naturally fall at some point.

<p> Since around June 2007, there has been a "credit crunch", which has triggered a fall in output and house prices, though not as large as the fall which some people have said is required. The direct cause of this was a discovery that US sub-prime mortgages, which many banks had been investing in, were less valuable than previously expected. The consequence of this, indirectly, has been that banks are less happy to lend money, so that the interest rate on loans has gone up, even though the central bank interest rate is the same (or lower). In turn the higher interest rates cause less investment, and lower house prices.

<p> This could cause the economy to settle back to its "natural" position, but it may overshoot into recession. Central banks may keep lowering interest rates to prevent the economy from going into recession.

add breaks