models of stagflation
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EC6012 Lecture 9Models of Stagflation
Stephen Kinsella
March 23, 2008
Today
IntroductionData
A Simple Macrodynamic ModelIntroductionThe ModelThe Output MarketEquilibrium in the product and money markets
Examples
Aggregate supply
The Phillips curve
Dynamics of asset accumulationExpectations
Bernanke-Blinder Model
An SFC Inside-Outside Model
Stagflation
A stagflationary economy experiences a slowing of growthcombined with rising inflation. Episodes of stagflation occurred inthe world economy in the late 1970’s and early 1980’s.
Data
Sept 18! CPI (consumer price index) 2.3%! PPI (producer price index) 2.3%! PCE (personal consumption expenditure)
deflator 2.5%! Gold $714
Oct 31! CPI 3.5%! PPI 6.1%! PCE deflator 3.0%! Gold $790
Dec 11! CPI 4.1%! PPI 6.3%! PCE deflator 3.6%! Gold $811
Jan 22! CPI 4.3%! PPI 7.4%! PCE deflator 3.7%! Gold $893
Jan 30! CPI 4.3%! PPI 7.4%! PCE deflator 3.7%! Gold $921
Mar 18! CPI 4.0%! PPI 6.4%! PCE deflator 3.7%! Gold $1004
Real GDP Growth for the US Economy, current andforecasted
Figure: Real GDP Growth for the US Economy, current and forecasted.
Industrial Production for the US Economy, current andforecasted.
Figure: Industrial Production for the US Economy, current andforecasted.
Historical CPI, trends to date.
Figure: Historical CPI, trends to date.
Recent US CPI data, current and forecasted.
Figure: Recent US CPI data, current and forecasted.
Recent US Unemployment.
Figure: Recent US Unemployment.
Definitions
Macrodynamics
Macrodynamics studies the evolution of the macroeconomy overtime. The macroeconomy is assumed to evolve from an initialstate towards a steady state, encountering exogenous shocks as itdoes so. These shocks can be studied using comparative staticsand dynamics to come up with policy proposals to help theeconomy deal with these shocks in the future.
A Macro Model with Four Sectors
! The product market,
! The money market,
! The bond market,
! The labour market.
Setup
GDP = C + I + G , (1)
GNP = C + I + G + (X !M). (2)
GDP = C + S + T . (3)
The Output Market
Y = C + I + G (4)
(Caution)C = C (Y ). (5)
Y = C (Y ) + I + G . (6)
Derivation
C = C (YD). (7)
C = C (YD,A, r). (8)
A =M + PkB + PkK
P. (9)
The Investment Function
I ! I (r ! !). (10)
Put it all together
Y = C
!T ! T , r ! !,
M + B + PkK
P
"+ I (r ! !) + G . (11)
The IS Curve
Figure: The IS curve.
Shifts in IS Curve
1. an increase the expected rate of inflation, or
2. a fall in the price of output, or
3. a rise in the stock of assets, or
4. an increase in the price of capital, or
5. a reduction in the level of taxes.
Money Markets
MD
P= L
!Y ,!!, r ! !, rk ,
M + B + PkK
P
"(12)
BD
P= J
!Y ,!!, r ! !, rk ,
M + B + PkK
P
"(13)
PkK
P= N
!Y ,!!, r ! !, rk ,
M + B + PkK
P
"(14)
MD + BD + PkKD
P=
M + B + PkK
P= A (15)
rk =P " R
#YK
$
Pk(16)
Put this all together
M
P= L
%Y ,!!, r ! !, rk ,
M + B
P+
RK
rk
&(17)
B
PJ
%Y ,!!, r ! !, rk ,
M + B
P+
RK
rk
&(18)
Edging towards LM
rk = r ! !. (19)
M
P= L(Y , r ,A) (20)
LM Curve
Figure: The LM Curve.
Slot IS into LM to get
Y = Y (P;M,B,K ,!, G ,T ). (21)
Which looks like
Figure: Equilibrium in the IS-LM model
[Bush’s fiscal stimulus]
C
onsider a standard IS-LM model in equilibrium. Graphically analysethe e!ects of a large increase in government expenditure financedthrough taxation on output/income and the interest rate, andbriefly explain your reasoning.
[Numerical example]
I
magine a closed economy with equilibrium output given byY = C + I + G . Total supply is given by Y = 5, 000.Consumption is determined by C = 250 + 0.75(Y ! T ).Investment is given by I = 1000! 50r . Initially, fix G and T atG = 1, 000,T = 1, 000. Suppose the government pursues anexpansionary policy, driving G from 1000 to 1250. What happensto national savings? Is there a deficit? How much of one? Will theinterest rate decrease or increase? By how much?
Aggregate Supply
This aggregate production function relates the labour input L andthe level of the capital stock employed to the level of output in theeconomy.
Y = F (K , L). (22)
Labour/Leisure Tradeo!
" = Pf (LD)! wL. (23)
W
P= "LD , (24)
Household utility maximisers
max(Y , Le) (25)
subject toLe = Tot ! LS , (26)
Y =W
PLS . (27)
LS = LD = L. (28)
Household utility maximisers
W
P= "(L) = #(L). (29)
The Phillips Curve
The Phillips curve relates changes in inflation to changes inunemployment.
p =P
P= $(Y ! (Y )) + ! (30)
Govt. Budget Constraint; Growth theory
M + B = P[G ! T ] + rB. (31)
K = I . (32)
Expectations
! = %(p ! !). (33)
! = p. (34)
Setup
LD = L(&, i , y). (35)
L(&, i , y) = '(&, i)D(i ! (), (36)
D(i , y) = m(i)R (37)
Setup
y = Y (i , &) (38)
& = "(i , y ,R) (39)
y = Y (i , "(i , y ,R)). (40)
Solution
Figure: Bernanke-Blinder Model Equilibrium.
E!ects of Shocks on Observable Variables. (Bernanke andBlinder, 1988, pg. 438.)
Rise in Income Money Credit Interest RateBank Reserves + + + -Money Demand - + - +Credit Supply + + + +
Credit Demand - - + -Commodity Demand + + + +
Table: E!ects of Shocks on Observable Variables. (Bernanke andBlinder, 1988, pg. 438.)
SFC
Godley and Lavoie (2006, Chapter 10) build a model capable ofsimulating the e!ects of a stagflation on a growing economy. Thesetup of model INSOUT is complicated, and the handout from thebook will show the setup. All we need here is the steady statecondition:
y! = (G + rbB! + BL!)" 1 + (
&((41)
References
B. Bernanke and A. Blinder. Credit money and aggregate demand.American Economic Review, 78(2):435–439, May 1988.
Wynne Godley and Marc Lavoie. Monetary Economics AnIntegrated Approach to Credit, Money, Income, Production andWealth. Palgrave-Macmillan, 2006. URL http://www.palgrave.com/products/Catalogue.aspx?is=0230500552.