6. Budget Deficits and Fiscal Policy


 Kristian Barton
 1 years ago
 Views:
Transcription
1 Prof. Dr. Thomas Steger Advanced Macroeconomics II Lecture SS Budget Deficits and Fiscal Policy Introduction Ricardian equivalence Distorting taxes Debt crises
2 Introduction (1) Ricardian equivalence Keynesian theory holds that government spending financed by issuing bonds has a larger impact on aggregate demand than taxfinanced government spending. New Classical economists argue that rational, forwardlooking households do understand that issuing bonds today requires to raise taxes tomorrow such that the financing scheme is neutral w.r.t. consumption. We will look at the critical assumptions underlying this neutrality proposition and summarize the main empirical findings. Debt crises The occurrence of debt crisis remains an important topic. The answer to the following question appears especially interesting: Can economic theory help understanding causes of debt crises? Moreover, is a debt crises the result of bad fundamentals (hence unavoidable?) or is there an element of self fulfilling beliefs? 2
3 Ricardian equivalence (1) The Ricardian equivalence theorem was formulated by the British neoclassical economist David Ricardo (1817). The new classical economist Robert Barro (1974) forcefully argued that the Ricardian equivalence theorem is worthy of professional attention and yields important policy implications. Sketch of Ricardian Equivalence Theorem Proposition: For a given time path of government spending the particular method used to finance these expenditures (taxation or debt) does not affect real consumption, real investment, and real output. Corollary: Under Ricardian equivalence, government bonds held by private agents should not be counted as net wealth since it is exactly matched by future liabilities (expected tax increases). 3
4 Ricardian equivalence (2) Basic assumptions Consider a world that lasts for two periods (present,1, and future, 2) There is perfect foresight on the part of households and government. The capital market is perfect. The periodic budget constraints are given by 0 A 0 (stock variable, end of period) period 1 C 1 (flow variable) period C 2 A 1 A 2 From (2) one gets A 1 =(C 2 (1 τ 2 )Y 2 )/(1+r), noting (1) gives the intertemporal budget constraint 4
5 Ricardian equivalence (3) The government s periodic budget constraints read as follows The government does not issue money and is restricted to end without debt, i.e. B 2 =0. The government can finance government expenditures by issuing bonds or by levying taxes. Solving (4) w.r.t. B 1 gives B 1 =(τ 2 Y 2 G 2 )/(1+r). Plugging this into (3) and rearranging gives This is the intertemporal budget constraint of the government. Since government bonds are the only financial asset in the model economy, household lending (borrowing) can only take the form of positive (negative) holdings of government bonds. Hence, equilibrium in the financial market implies A i =B i for i=0,1,2. 5
6 Ricardian equivalence (4) The consolidated budget constraint of the whole economy results by merging the intertemporal budget constraints of the private sector and the government. Solving (5) w.r.t. (1+r)B 0 gives (1+r)B 0 =τ 1 Y 1 G 1 +(τ 2 Y 2 G 2 )/(1+r). Plugging the result into the household s intertemporal budget constraint yields Borrowing today requires repayment tomorrow and future repayment accordingly requires future tax revenues. Hence, rational, forward looking households take the consolidated budget constraint into account when deciding on optimal consumption plans. The consolidated intertemporal budget constraint says that the PDV of consumption {C 1,C 2 } must equal the PDV of income net of government expenditures. The time path of taxes {τ 1,τ 2 } does not show up implying that the way in which the government finances its expenditures has no effect on real consumption. 6
7 Ricardian equivalence (5) To fully understand the economic intuition behind Ricardian equivalence, we investigate the household s saving decision. The household is assumed to solve the following problem The associated Lagrangian and the first order conditions are given by 7
8 Ricardian equivalence (6) Combining FOC1 and FOC2 gives the Euler equation The Euler equation determines the optimal rate of change of consumption. The optimal levels of C 1 and C 2 can be obtained as follows Notice that the Euler equation implies C 2 =C 1 (1+r)/(1+ρ) and C 1 =C 2 (1+ρ)/(1+r). Combine these expressions with the consolidated budget constraints 8
9 Ricardian equivalence (7) Household saving in the 1 st period is as follows Optimal saving is affected by the tax rate τ 1. Consider the following Ricardian experiment : The government reduces the tax rate in the first period (dτ 1 <0) but keeps goods demand {G 1, G 2 } unchanged. Private saving changes according to ds 1 =Y 1 dτ 1 >0. The intertemporal budget constraint (5) implies A reduction in the tax rate today requires, via the intertemporal budget constraint, an increase in the tax rate tomorrow (holding {G 1, G 2 } unchanged). The household increases its saving such that it is able to repay the associated tax increase tomorrow, i.e. ds 1 = Y 1 dτ 1 =(Y 2 dτ 2 )/(1+r)>0. Hence, the expansive fiscal impulse dτ 1 <0 is offset by a reduction in C 1! 9
10 Distorting taxes (1) There are a number of simplifying assumptions which are indeed critical with regard to the Ricardian equivalence result. Even worse, most of these simplifying assumptions are critical and appear fairly unrealistic. Here, we consider the consequences of distorting taxes. Assume that noninterest income is exogenous but that there is a comprehensive income tax, and that interest income is taxable. The household s periodic budget constraints now read (noting A i =B i for i=0,1,2) Solving the 2 nd constraint w.r.t. B 1 and substituting into the 1 st constraint yields the intertemporal budget constraint 10
11 Distorting taxes (2) The periodic budget constraint of the government reads Solving the 2 nd constraint w.r.t. B 1 and substituting into the 1 st constraint yields the intertemporal budget constraint Finally, solving the preceding equation w.r.t. (1+(1 τ 1 )r))b 0 and substituting the result into the household s intertemporal budget constraint gives the consolidated budget constraint The income tax τ 2 does not drop out (τ 1 does not appear because it operates like a lump sum tax). The optimal consumption plan is affected by the timing of taxation. The tax rate in the 2 nd period changes the intertemporal prices of consumption now versus tomorrow and, hence, distorts the saving decision. 11
12 Summary and conclusion Some critical assumption underlying the Ricardian equivalence proposition Altruistic connection between generations in an infinite horizon context (such that a bond issued today is not viewed as wealth due to the future tax burden) Taxes do not affect allocations (intertemporal consumption, leisure versus working time) The capital market is perfect. Households are completely rational, not myopic, endowed with the cognitive power to calculate optimal consumption plans, and have all relevant information available. Notice that for Ricardian equivalence to hold, theses assumptions must be satisfied simultaneously; for critical comments, see Akerlof (AER, 2007). Sketch of empirical evidence The empirical evidence appears inconclusive. Seater (JEL, 1993) concludes that Ricardian equivalence is a good approximation, while Bernheim (NBER Macroeconomics Annual, 1987) comes to the conclusion that it is at variance with the facts. 12
13 A model of debt crises (1) A stylized model of debt crises is setup which rests on the following basic assumptions Government has a quantity D of maturing liabilities (debt). It has no funds immediately available and wants to roll the debt over (i.e. issue new bonds to repay principal and interest). Next period it will be obtaining tax revenues T and so wants the investors to hold the debt for one period. Tax revenues T is random and described by the continuous CDF F(T), described below. Government offers an interest factor of R. Two simplifying assumptions maturing Liabilities D 1 =RD 0 debt rollover, i.e. issuing new bonds: D 1 timing of events current period tax revenues are realized: T debt repay: RD 1 or complete default Default is all or nothing: if the government cannot pay RD, it repudiates the debt entirely. Investors are risk neutral and the riskfree interest factor R is independent of R and D. 13
14 A model of debt crises (2) Capital market equilibrium requires Notice that investors are assumed to be risk neutral. We distinguish between the expected probability of default π e and the fundamentally warranted probability of default π fw, to be explained bellow. Overall equilibrium requires that π e =π fw. R=
15 A model of debt crises (3) Tax revenues are uncertain and distributed according to a bellshaped density function f(t). The (fundamentally warranted) probability of default can be described by π fw =P(T<RD). Let T min denote the smallest possible value for T and T max the largest possible value. For RD<T min we have P(T<RD)=0. For RD>T max we have P(T<RD)=1. Given f(t) the probability of default π fw =P(T<RD) in response to RD is Sshaped. Moreover, given f(t) and holding D fix, the probability of default π fw =P(T<RD) in response to R is Sshaped too. 15
16 A model of debt crises (4) B A B A C Equilibrium requires that two conditions must hold simultaneously: Condition 1: The interest factor on government debt R makes the investors willing to purchase the debt given the expected probability of default π e, i.e. π e =(RR)/R. Condition 2: The fundamentally warranted probability of default π fw is the probability that tax revenues are insufficient to pay off the debt given the interest factor R, i.e. π fw =P(T<RD). The intersections of the two curves π e =(R R)/R and π fw =P(T<RD) describe two equilibria. There is a third equilibrium, namely R=, π=1. If investors refuse to purchase the debt at any R, the probability of default is π fw =1. If π e =1, investors refuse to purchase the debt at any interest factor. Equilibrium A and C are stable, while equilibrium B is unstable (reasoning?). Multiplicity of equilibria implies that there can be a selffulfilling element of default. Assume that the economy is in B initially. Investors now start to believe that the probability of default has increased ( a rating agency has published new figures ), i.e. π e increases. Investors demand a higher interest factor, RD increases, such that π fw does indeed go up. The process converges to C where the government pays a very high interest rate and default occurs. 16
17 A model of debt crises (5) A A C Assume the economy is in the good equilibrium, point A, initially. Assume further that the riskfree interest factor R increases (USA start to borrow extensively). At first the equilibrium changes smoothly. An increase in R leads to a gradual increase in R and π. As R increase further, however, drastic changes may occur. The (good) equilibrium, characterized by combination of low R and π, collapses and the economy moves to the (bad) equilibrium (R=, π=1). The equilibrium probability of a default results from the interaction between fundamentals, as captured by R, D, and E(T) and self fulfilling beliefs. 17
18 Notation and abbreviations Notation A i B i C i G i r R R S i T Y i λ π e π fw Ω ρ τ i assets in period i debt in period i consumption in period i government purchases in period i interest rate interest factor offered by government riskfree interest factor Household saving in period i tax revenue income in period i Lagrangian multiplier expected probability of default fundamentally warranted probability of default wealth time preference rate tax rate in period i Abbreviations CDF cumulative distribution function FOC firstorder conditions PDV present discounted value w.r.t. with respect to 18
. In this case the leakage effect of tax increases is mitigated because some of the reduction in disposable income would have otherwise been saved.
Chapter 4 Review Questions. Explain how an increase in government spending and an equal increase in lump sum taxes can generate an increase in equilibrium output. Under what conditions will a balanced
More informationSpending, taxes, and the budget deficit
Spending, taxes, and the budget deficit Chapter 13 slide 0 Outline Government budgets Fluctuations in the deficit: purchases, transfers and taxes The effects of the government deficit slide 1 13.1 GOVERNMENT
More informationLecture 2 Dynamic Equilibrium Models : Finite Periods
Lecture 2 Dynamic Equilibrium Models : Finite Periods 1. Introduction In macroeconomics, we study the behavior of economywide aggregates e.g. GDP, savings, investment, employment and so on  and their
More informationMoney and Public Finance
Money and Public Finance By Mr. Letlet August 1 In this anxious market environment, people lose their rationality with some even spreading false information to create trading opportunities. The tales about
More informationcrowding out Crowding out at full employment
C000452 Crowding out refers to all the things which can go wrong when debtfinanced fiscal policy is used to affect output. While the initial focus was on the slope of the LM curve, now refers to a multiplicity
More informationThe Real Business Cycle Model
The Real Business Cycle Model Ester Faia Goethe University Frankfurt Nov 2015 Ester Faia (Goethe University Frankfurt) RBC Nov 2015 1 / 27 Introduction The RBC model explains the comovements in the uctuations
More information2. Real Business Cycle Theory (June 25, 2013)
Prof. Dr. Thomas Steger Advanced Macroeconomics II Lecture SS 13 2. Real Business Cycle Theory (June 25, 2013) Introduction Simplistic RBC Model Simple stochastic growth model Baseline RBC model Introduction
More informationThe Optimal Path of Government Debt
Chapter 4 The Optimal Path of Government Debt Up to this point we have assumed that the government must pay for all its spending each period. In reality, governments issue debt so as to spread their costs
More informationCurrent Accounts in Open Economies Obstfeld and Rogoff, Chapter 2
Current Accounts in Open Economies Obstfeld and Rogoff, Chapter 2 1 Consumption with many periods 1.1 Finite horizon of T Optimization problem maximize U t = u (c t ) + β (c t+1 ) + β 2 u (c t+2 ) +...
More informationPrep. Course Macroeconomics
Prep. Course Macroeconomics Intertemporal consumption and saving decision; Ramsey model TomReiel Heggedal tomreiel.heggedal@bi.no BI 2014 Heggedal (BI) Savings & Ramsey 2014 1 / 30 Overview this lecture
More information12.10 A Model of Debt Crises
632 Chapter 12 BUDGET DEFICITS AND FISCAL POLICY and intermediaries are not bankrupted by the crisis, the worsening of their financial positions magnifies the effects of financialmarket imperfections.
More informationdr Bartłomiej Rokicki Chair of Macroeconomics and International Trade Theory Faculty of Economic Sciences, University of Warsaw
Chair of Macroeconomics and International Trade Theory Faculty of Economic Sciences, University of Warsaw Intertemporal trade and consumption Intertemporal trade  occurs when resources are transferable
More informationGraduate Introductory Macroeconomics: Exam 1
Graduate Introductory Macroeconomics: Exam Name: Student ID: You have 60 minutes. Answer in English or Japanese.. Consumption tax in a oneperiod model 0 points) The household determines the consumption
More informationOn the irrelevance of government debt when taxes are distortionary
On the irrelevance of government debt when taxes are distortionary Marco Bassetto a,b,, Narayana Kocherlakota c,b a Department of Economics, University of Minnesota, 271 19th Ave. S., Minneapolis, MN 55455,
More informationInflation. Chapter 8. 8.1 Money Supply and Demand
Chapter 8 Inflation This chapter examines the causes and consequences of inflation. Sections 8.1 and 8.2 relate inflation to money supply and demand. Although the presentation differs somewhat from that
More informationAt t = 0, a generic intermediary j solves the optimization problem:
Internet Appendix for A Model of hadow Banking * At t = 0, a generic intermediary j solves the optimization problem: max ( D, I H, I L, H, L, TH, TL ) [R (I H + T H H ) + p H ( H T H )] + [E ω (π ω ) A
More informationEconomic Policy. Economic policy has 3 main goals
MACROECONOMIC POLICY Functions of State Economic Policy (Policy Goals) Instruments of Economic Policy (Policy Tools) Types of Economic Policy Efficiency of Economic Policy Economic Policy Economic policy
More informationUniversidad de Montevideo Macroeconomia II. The RamseyCassKoopmans Model
Universidad de Montevideo Macroeconomia II Danilo R. Trupkin Class Notes (very preliminar) The RamseyCassKoopmans Model 1 Introduction One shortcoming of the Solow model is that the saving rate is exogenous
More informationFISCAL BALANCE AND PUBLIC DEBT. Outline: Chapter 12 FISCAL BALANCE AND PUBLIC DEBT. 5. Burden of the Debt
02/10/2015 C h a p t e r 12 FISCAL BALANCE AND PUBLIC DEBT Public Finance, 10 th Edition David N. Hyman Adapted by Chairat Aemkulwat for Public Economics 2952331 Chairat Aemkulwat, Public Economics 2952331
More informationChapter 4 Consumption, Saving, and Investment
Chapter 4 Consumption, Saving, and Investment Multiple Choice Questions 1. Desired national saving equals (a) Y C d G. (b) C d + I d + G. (c) I d + G. (d) Y I d G. 2. With no inflation and a nominal interest
More informationA Note on Optimal Fiscal Policy in an Economy with Private Borrowing Limits
A Note on Optimal Fiscal Policy in an Economy with Private Borrowing Limits Marina Azzimonti y Pierre Yared z October 28, 206 Abstract This note considers the implications for optimal scal policy when
More informationLecture 1: current account  measurement and theory
Lecture 1: current account  measurement and theory What is international finance (as opposed to international trade)? International trade: microeconomic approach (many goods and factors). How cross country
More informationdoes the debt matter? comments
9 does the debt matter? comments Serge Coulombe The Point The question at issue in the Ricardian equivalence debate is whether a given path of public expenditure is best financed by raising taxes or issuing
More informationFigure 1: ISLM Intersection
ISLM Intersection In the short run, the economy moves to the intersection of the IS and LM curves (figure 1). Production adjusts to demand to put the economy on the IS curve. Bond prices and the interest
More informationPart II Money and Public Finance Lecture 7 Selected Issues from a Positive Perspective
Part II Money and Public Finance Lecture 7 Selected Issues from a Positive Perspective Leopold von Thadden European Central Bank and University of Mainz Monetary and Fiscal Policy Issues in General Equilibrium
More informationLecture 1: The intertemporal approach to the current account
Lecture 1: The intertemporal approach to the current account Open economy macroeconomics, Fall 2006 Ida Wolden Bache August 22, 2006 Intertemporal trade and the current account What determines when countries
More informationECON20310 LECTURE SYNOPSIS REAL BUSINESS CYCLE
ECON20310 LECTURE SYNOPSIS REAL BUSINESS CYCLE YUAN TIAN This synopsis is designed merely for keep a record of the materials covered in lectures. Please refer to your own lecture notes for all proofs.
More informationIntroduction to Macroeconomics
Robert M. Kunst robert.kunst@univie.ac.at University of Vienna and Institute for Advanced Studies Vienna March 18, 2011 Outline Introduction National accounts The goods market The financial market The
More informationTopic 1 : Saving and Investment
Topic 1 : Saving and Investment April 26, 2006 The key to thinking about how to relate these concepts together in the framework of the Keynesian neoclassical synthesis is to use a number of important
More informationCHAPTER 3. THE GOODS MARKET
CHAPTER 3. THE GOODS MARKET I. MOTIVATING QUESTION How Is Output Determined in the Short Run? Output is determined by equilibrium in the goods market, i.e., by the condition that supply (production of
More informationChapter 4. Saving and Investment. 4.1 The Model Structure
Chapter 4 Saving and Investment The models I have discussed so far are missing a central component of the General Theory; the idea that investment is the driving force of business cycles. Chapter 4 introduces
More informationMacroeconomics, 6e (Abel et al.) Chapter 4 Consumption, Saving, and Investment. 4.1 Consumption and Saving
Macroeconomics, 6e (Abel et al.) Chapter 4 Consumption, Saving, and Investment 4.1 Consumption and Saving 1) Desired national saving equals A) Y  C d  G. B) C d + I d + G. C) I d + G. D) Y  I d  G.
More informationThe Multiplier Effect of Fiscal Policy
We analyze the multiplier effect of fiscal policy changes in government expenditure and taxation. The key result is that an increase in the government budget deficit causes a proportional increase in consumption.
More informationSumming up ECON4310 Lecture. Asbjørn Rødseth. University of Oslo 27/
Summing up 4310 ECON4310 Lecture Asbjørn Rødseth University of Oslo 27/11 2013 Asbjørn Rødseth (University of Oslo) Summing up 4310 27/11 2013 1 / 20 Agenda Solow, Ramsey and Diamond Real Business Cycle
More informationChapter 10 Fiscal Policy Macroeconomics In Context (Goodwin, et al.)
Chapter 10 Fiscal Policy Macroeconomics In Context (Goodwin, et al.) Chapter Overview This chapter introduces you to a formal analysis of fiscal policy, and puts it in context with realworld data and
More informationSEMINAR 16: INTERGENERATIONAL JUSTICE
SEMINAR 16: INTERGENERATIONAL JUSTICE Lecture 4: Public Debt and Intergenerational Redistribution Prof. Christian KEUSCHNIGG University of St. Gallen, FGNHSG FGNHSG Alpbach, August 2011 Christian Keuschnigg
More informationLongTerm Debt Pricing and Monetary Policy Transmission under Imperfect Knowledge
LongTerm Debt Pricing and Monetary Policy Transmission under Imperfect Knowledge Stefano Eusepi, Marc Giannoni and Bruce Preston The views expressed are those of the authors and are not necessarily re
More informationNoah Williams Economics 312. University of Wisconsin Spring 2013. Midterm Examination Solutions
Noah Williams Economics 31 Department of Economics Macroeconomics University of Wisconsin Spring 013 Midterm Examination Solutions Instructions: This is a 75 minute examination worth 100 total points.
More informationLecture 3: Growth with Overlapping Generations (Acemoglu 2009, Chapter 9, adapted from Zilibotti)
Lecture 3: Growth with Overlapping Generations (Acemoglu 2009, Chapter 9, adapted from Zilibotti) Kjetil Storesletten September 10, 2013 Kjetil Storesletten () Lecture 3 September 10, 2013 1 / 44 Growth
More informationFiscal Theory of the Price Level
Fiscal Theory of the Price Level Marco Bassetto Federal Reserve Bank of Chicago, University of Minnesota, and NBER Abstract The fiscal theory of the price level (FTPL) describes fiscal and monetary policy
More informationEndogenous Growth Models
Endogenous Growth Models Lorenza Rossi Goethe University 20112012 Endogenous Growth Theory Neoclassical Exogenous Growth Models technological progress is the engine of growth technological improvements
More informationFinal. 1. (2 pts) What is the expected effect on the real demand for money of an increase in the nominal interest rate? How to explain this effect?
Name: Number: Nova School of Business and Economics Macroeconomics, 11031st Semester 20132014 Prof. André C. Silva TAs: João Vaz, Paulo Fagandini, and Pedro Freitas Final Maximum points: 20. Time: 2h.
More informationU = x 1 2. 1 x 1 4. 2 x 1 4. What are the equilibrium relative prices of the three goods? traders has members who are best off?
Chapter 7 General Equilibrium Exercise 7. Suppose there are 00 traders in a market all of whom behave as price takers. Suppose there are three goods and the traders own initially the following quantities:
More informationThe Real Business Cycle model
The Real Business Cycle model Spring 2013 1 Historical introduction Modern business cycle theory really got started with Great Depression Keynes: The General Theory of Employment, Interest and Money Keynesian
More informationSchooling, Political Participation, and the Economy. (Online Supplementary Appendix: Not for Publication)
Schooling, Political Participation, and the Economy Online Supplementary Appendix: Not for Publication) Filipe R. Campante Davin Chor July 200 Abstract In this online appendix, we present the proofs for
More informationNOTES ON OPTIMAL DEBT MANAGEMENT
Journal of Applied Economics, Vol. II, No. 2 (Nov 1999), 281289 NOTES ON OPTIMAL DEBT MANAGEMENT 281 NOTES ON OPTIMAL DEBT MANAGEMENT ROBERT J. BARRO Harvard University Consider the finance of an exogenous
More informationDynamics of Small Open Economies
Dynamics of Small Open Economies Lecture 2, ECON 4330 Tord Krogh January 22, 2013 Tord Krogh () ECON 4330 January 22, 2013 1 / 68 Last lecture The models we have looked at so far are characterized by:
More informationi = nominal interest rate earned by alternative nonmonetary assets
Chapter 7 Addendum Demand for Money: the quantity of monetary assets people choose to hold. In our treatment of money as an asset we need to briefly discuss three aspects of any asset 1. Expected Return:
More informationChapter 9 The ISLM/ADAS Model: A General Framework for Macroeconomic Analysis
Chapter 9 The ISLM/ADAS Model: A General Framework for Macroeconomic Analysis Multiple Choice Questions 1. The FE line shows the level of output at which the market is in equilibrium. (a) Goods (b) Asset
More informationIntertemporal approach to current account: small open economy
Intertemporal approach to current account: small open economy Ester Faia Johann Wolfgang Goethe Universität Frankfurt a.m. March 2009 ster Faia (Johann Wolfgang Goethe Universität Intertemporal Frankfurt
More informationTowards a Structuralist Interpretation of Saving, Investment and Current Account in Turkey
Towards a Structuralist Interpretation of Saving, Investment and Current Account in Turkey MURAT ÜNGÖR Central Bank of the Republic of Turkey http://www.muratungor.com/ April 2012 We live in the age of
More informationEconomics II (macroeconomics)
Course: Economics II (macroeconomics) Chapter 4 4.1 Aggregate Demand and Aggregate Supply, Part I Author: Ing. Vendula Hynková, Ph.D. Introduction We will focus here on the clarification of the economic
More informationCHAPTER 7: AGGREGATE DEMAND AND AGGREGATE SUPPLY
CHAPTER 7: AGGREGATE DEMAND AND AGGREGATE SUPPLY Learning goals of this chapter: What forces bring persistent and rapid expansion of real GDP? What causes inflation? Why do we have business cycles? How
More informationChapter 18. MODERN PRINCIPLES OF ECONOMICS Third Edition
Chapter 18 MODERN PRINCIPLES OF ECONOMICS Third Edition Fiscal Policy Outline Fiscal Policy: The Best Case The Limits to Fiscal Policy When Fiscal Policy Might Make Matters Worse So When Is Fiscal Policy
More information.SECTION A: MICROECONOMICS
Solution 1.SECTION A: MICROECONOMICS a) The concept of equilibrium under demand and supply analysis refers to a situation where at a price the quantity demanded equals the quantity supplied. Graphically,
More informationECON 5110 Class Notes Overview of New Keynesian Economics
ECON 5110 Class Notes Overview of New Keynesian Economics 1 Introduction The primary distinction between Keynesian and classical macroeconomics is the flexibility of prices and wages. In classical models
More information= C + I + G + NX ECON 302. Lecture 4: Aggregate Expenditures/Keynesian Model: Equilibrium in the Goods Market/Loanable Funds Market
Intermediate Macroeconomics Lecture 4: Introduction to the Goods Market Review of the Aggregate Expenditures model and the Keynesian Cross ECON 302 Professor Yamin Ahmad Components of Aggregate Demand
More informationMacroeconomic Analysis Econ 6022 Level I
1 / 66 Macroeconomic Analysis Econ 6022 Level I Lecture 8 Fall, 2011 2 / 66 Business Cycle Analysis: A Preview What explains business cycle fluctuations? Two major business cycle theories  Classical theory
More informationEquilibrium with Complete Markets
Equilibrium with Complete Markets Jesús FernándezVillaverde University of Pennsylvania February 12, 2016 Jesús FernándezVillaverde (PENN) Equilibrium with Complete Markets February 12, 2016 1 / 24 ArrowDebreu
More informationWORKING PAPER SERIES 092013. Government Debt, the Real Interest Rate and External Balance in an Endogenous Growth Model of a Small Open Economy
ATHENS UNIVERSITY OF ECONOMICS AND BUSINESS DEPARTMENT OF ECONOMICS WORKING PAPER SERIES 092013 Government Debt, the Real Interest Rate and External Balance in an Endogenous Growth Model of a Small Open
More information3. a. If all money is held as currency, then the money supply is equal to the monetary base. The money supply will be $1,000.
Macroeconomics ECON 2204 Prof. Murphy Problem Set 2 Answers Chapter 4 #2, 3, 4, 5, 6, 7, and 9 (on pages 102103) 2. a. When the Fed buys bonds, the dollars that it pays to the public for the bonds increase
More informationChapter 3 A Classical Economic Model
Chapter 3 A Classical Economic Model what determines the economy s total output/income how the prices of the factors of production are determined how total income is distributed what determines the demand
More informationMoney and Capital in an OLG Model
Money and Capital in an OLG Model D. Andolfatto June 2011 Environment Time is discrete and the horizon is infinite ( =1 2 ) At the beginning of time, there is an initial old population that lives (participates)
More informationGeneral Equilibrium Theory: Examples
General Equilibrium Theory: Examples 3 examples of GE: pure exchange (Edgeworth box) 1 producer  1 consumer several producers and an example illustrating the limits of the partial equilibrium approach
More informationLending in Last Resort to Governments
Olivier Jeanne, Johns Hopkins University Indiana University, March 2015 Introduction Fiscal fundamentals in 2009: an international comparison Net debt/gdp (%) 40 50 60 70 80 90 100 110 120 US JAP UK EUR
More informationEndogenous Growth Theory
Chapter 3 Endogenous Growth Theory 3.1 OneSector Endogenous Growth Models 3.2 Twosector Endogenous Growth Model 3.3 Technological Change: Horizontal Innovations References: Aghion, P./ Howitt, P. (1992),
More informationPractice Problems on the Capital Market
Practice Problems on the Capital Market 1 Define marginal product of capital (i.e., MPK). How can the MPK be shown graphically? The marginal product of capital (MPK) is the output produced per unit of
More informationA Theory of Capital Controls As Dynamic Terms of Trade Manipulation
A Theory of Capital Controls As Dynamic Terms of Trade Manipulation Arnaud Costinot Guido Lorenzoni Iván Werning Central Bank of Chile, November 2013 Tariffs and capital controls Tariffs: Intratemporal
More informationQuestion 1: Deriving and Solving the ISLM Model (closed economy)
ECON 222 Macroeconomic Theory I Fall Term 2010 Assignment 4 Due: Drop Box 2nd Floor Dunning Hall by noon November 26th 2010 No late submissions will be accepted No group submissions will be accepted No
More information10. When monetary policy becomes ineffective: liquidity traps.
10. When monetary policy becomes ineffective: liquidity traps. A liquidity trap is a situation in which monetary policy becomes ineffective because the policymaker s attempt to influence nominal interest
More informationDebt Maturity Management, Monetary and Fiscal Policy Interactions
Debt Maturity Management, Monetary and Fiscal Policy Interactions Hao Jin April 22, 23 Abstract This paper examines the interactions of debt maturity management, monetary and fiscal policy in a DSGE model.
More informationVII. ECONOMIC FLUCTUATIONS AND MACROECONOMIC POLICY
VII. ECONOMIC FLUCTUATIONS AND MACROECONOMIC POLICY A. Aggregate Demand and Prices 1. The aggregate demand/inflation (ADI) curve  graphical representation of the negative relationship (downward sloping
More informationChapter 3: The effect of taxation on behaviour. Alain Trannoy AMSE & EHESS
Chapter 3: The effect of taxation on behaviour Alain Trannoy AMSE & EHESS Introduction The most important empirical question for economics: the behavorial response to taxes Calibration of macro models
More informationOpen Economy Macroeconomics: The ISLMBP Model
Open Economy Macroeconomics: The ISLMBP Model When we open the economy to international transactions we have to take into account the effects of trade in goods and services (i.e. items in the current
More informationAnswers to Textbook Problems
88 Krugman/Obstfeld International conomics: Theory and Policy, Seventh dition nswers to Textbook Problems. decline in investment demand decreases the level of aggregate demand for any level of the exchange
More informationTRADE AND INVESTMENT IN THE NATIONAL ACCOUNTS This text accompanies the material covered in class.
TRADE AND INVESTMENT IN THE NATIONAL ACCOUNTS This text accompanies the material covered in class. 1 Definition of some core variables Imports (flow): Q t Exports (flow): X t Net exports (or Trade balance)
More informationLecture 10: Aggregate Demand and Aggregate Supply I
EC201 Intermediate Macroeconomics EC201 Intermediate Macroeconomics Lecture 10: Aggregate Demand and Aggregate Supply I Lecture Outline:  how to derive the aggregate demand from the ISLM model;  a preliminary
More informationPolitics, Surpluses, Deficits, and Debt
Defining Surpluses and Debt Politics, Surpluses,, and Debt Chapter 11 A surplus is an excess of revenues over payments. A deficit is a shortfall of revenues relative to payments. 2 Introduction After having
More information2.If actual investment is greater than planned investment, inventories increase more than planned. TRUE.
Macro final exam study guide True/False questions  Solutions Case, Fair, Oster Chapter 8 Aggregate Expenditure and Equilibrium Output 1.Firms react to unplanned inventory investment by reducing output.
More informationTheories of Money Demand. Prof. Irina A. Telyukova UBC Economics 345 Fall 2008
Theories of Money Demand Prof. Irina A. Telyukova UBC Economics 345 Fall 2008 Outline We have studied in some detail where money supply comes from the study of monetary policy We now go back and take a
More informationChapter 5. Saving and Investment in the Open Economy. 2008 Pearson AddisonWesley. All rights reserved
Chapter 5 Saving and Investment in the Open Economy Chapter Outline Balance of Payments Accounting Goods Market Equilibrium in an Open Economy Saving and Investment in a Small Open Economy Saving and Investment
More informationS m. D m0. D m1 Q m Amount of money demanded and supplied
Rate of interest, i (p ercent) Chapter  Interest Rates and Monetary Policy Chapter Interest Rates and Monetary Policy QUESTIONS 1. What is the basic determinant of (a) the transactions demand and (b)
More informationCONCEPT OF MACROECONOMICS
CONCEPT OF MACROECONOMICS Macroeconomics is the branch of economics that studies economic aggregates (grand totals):e.g. the overall level of prices, output and employment in the economy. If you want to
More informationThe Macroeconomy in the Long Run The Classical Model
PP556 Macroeconomic Questions The Macroeconomy in the ong Run The Classical Model what determines the economy s total output/income how the prices of the factors of production are determined how total
More informationBehavior of Interest Rates
Behavior of Interest Rates Notes on Mishkin Chapter 5 (pages 91108) Prof. Leigh Tesfatsion (Iowa State U) Last Revised: 21 February 2011 Mishkin Chapter 5: Selected Key InClass Discussion Questions and
More informationThis paper is not to be removed from the Examination Halls
This paper is not to be removed from the Examination Halls UNIVERSITY OF LONDON EC2065 ZA BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the Social Sciences, the Diplomas
More informationAn example of externalities  the multiplicative case
An example of externalities  the multiplicative case Yossi Spiegel Consider an exchange economy with two agents, A and B, who consume two goods, x and y. This economy however, differs from the usual exchange
More informationEcon 102 Section 1 Homework #5 Due July 7, Tuesday in class
Econ 102 Section 1 Homework #5 Due July 7, Tuesday in class Multiple Choice Questions (110: 10x1=10 points; 1155: 45 x 2=90 points) 1.The principal amount of a bond is the amount: A) originally lent.
More informationSo we can use either equilibrium condition to get the same result.
Numerical Problems 1. (a) S d = Y C d G = Y (4000 4000r + 0.2Y) 2000 = 6000 + 4000r + 0.8Y. (b) (1) Using the equation that goods supplied equals goods demanded gives Y = C d + I d + G = (4000 4000r +
More informationMULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
Suvey of Macroeconomics, MBA 641 Fall 2006, Final Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Modern macroeconomics emerged from
More informationChapter 4. Consumption, Saving, and Investment. 2008 Pearson AddisonWesley. All rights reserved
Chapter 4 Consumption, Saving, and Investment Chapter Outline Consumption and Saving Investment Goods Market Equilibrium 42 Consumption and Saving The importance of consumption and saving Desired consumption:
More informationLecture Recessions and Fiscal Policy
Lecture 51 5. Recessions and Fiscal Policy A change in planned autonomous spending (A p ) will cause a change in equilibrium income. Is such a multiplier expansion or contraction desirable or not? Yes,
More informationFinancial Development and Macroeconomic Stability
Financial Development and Macroeconomic Stability Vincenzo Quadrini University of Southern California Urban Jermann Wharton School of the University of Pennsylvania January 31, 2005 VERY PRELIMINARY AND
More informationCapital Structure. Itay Goldstein. Wharton School, University of Pennsylvania
Capital Structure Itay Goldstein Wharton School, University of Pennsylvania 1 Debt and Equity There are two main types of financing: debt and equity. Consider a twoperiod world with dates 0 and 1. At
More information7: The CRR Market Model
Ben Goldys and Marek Rutkowski School of Mathematics and Statistics University of Sydney MATH3075/3975 Financial Mathematics Semester 2, 2015 Outline We will examine the following issues: 1 The CoxRossRubinstein
More informationInflation: Its Causes, Effects, and Social Costs
CHAPTER5 Inflation: Its Causes, Effects, and Social Costs Modified for ECON 2204 by Bob Murphy 2016 Worth Publishers, all rights reserved IN THIS CHAPTER, YOU WILL LEARN: The classical theory of inflation
More informationReforming the Tax System Lecture II: The Taxation of Savings. December 2015 Richard Blundell University College London
Econ 3007 Economic Policy Analysis Reforming the Tax System Lecture II: The Taxation of Savings December 205 Richard Blundell niversity ollege London Teaching Resources at: http://www.ucl.ac.uk/~uctp39a/lect.html
More informationEconomics 407: Topics in Macroeconomics Problem Set #1: Answers These problems are due on Tuesday, January 28 th.
Economics 407: Topics in Macroeconomics Problem Set #1: Answers These problems are due on Tuesday, January 28 th. 1. Consider the following equations describing the supplyside of a macroeconomy: Y = 800L
More informationGovernment spending and fiscal policy
4 Government spending and fiscal policy 4.1 GOVERNMENT SPENDING The scale of government spending Government spending is divided into the five categories shown in figure 4.1, where the different items are
More informationMULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Based on our understanding of the Keynesian cross, we know with certainty that an equal
More information