Here are some Q&As, from my mailbox.
Topic 4
1. What is the intuition of the positive relationship between income and demand for loan?
If you read the paper, Bernanke and Blinder, they say "The dependence on GNP ( y ) captures the trans- actions demand for credit, whch might arise, for example, from working capital or liquid- ity considerations." This means the higher income the economy has, the bigger are the firms, and the greater need for loans to finance working capital or the need for more cash to run the business.
2. Is the condition "R greater than 1 and diminishing marginal utility" enough for C1* greater than 1 and C2* less than R? How risk aversion involves in this?
"R>1 and diminishing marginal utility" are enough to infer that C2* is greater than C1* (see equation 3). But to ensure that C1* is greater than 1 and C2* is less than R, we showed in the lecture that we need gamma*u''/u' being less than 1 for all gamma. This is exactly the definition of relative risk aversion. So we do need risk aversion.
3. Is there a typo on Diamond&Dybvig p.408? And are you gonna include the stochastic t in the exam? Or we should focus on the model studied in class?
The mathematical question will only be based on what we covered in lectures. For essays or discussion, I set no ceiling, you're free to discuss whatever you learn from the readings. (which line do u see the typo?)
Topic 5
I get the concept that time inconsistency arises when preference before and after are different, but Im confused about the graph and relationship among pies.
1. For time inconsistency problem, can you elaborate more about the implication when L = 1/2(pie-pie star)2 , so it is the same as commitment case?
And after we arrive at pie = pie star, which leaves total loss fn to be only 1/2 (y-y*)2, what is the implication? Do you expect further explanation or just how to get there?
Im also confused about the relationship btw pies, expected pie and pie star, can you explain more on it. is it correct that the optimal solution is
for both society and cb to set pie and expected pie equal to pie star? is this the essence of it already? Also, can you elaborate more about how to interprete the graph?
Let me lay out the basics.
pi is the actual inflation. The solution for pi will have to be determined by an equilibrium condition. In this case, it is a Nash equilibrium, or in other words when we have both the central bank minimizing its loss function and the public holding rational expectations.
pi-star is a parameter, a number, that tells us what the ideal level of inflation is for the central bank. pi-star is in other words the targeted inflation. Now, in the lecture, I say pi-star happens to be what the society thinks of as ideal inflation as well, but this needs not be the case. If the society prefers some other inflation, then what this means is that the social loss function will be different from the central bank's loss function.
Expected pi, that's the expectation of inflation. Under rational expectations, it will have to be the same as actual inflation. This is the same definition of rational expectations that we work with since the first semester.
Your last statement, that the optimal solution entails that both the society and central bank should set pi and expected pi to pi-star is generally wrong. What do u mean by optimal? If optimal means that everyone is optimizing, then the time-inconsistency result precisely tells us that the optimal outcome could be a higher inflation than pi-star. That's our standard result (unless we consider some limiting case). But if you mean what is the outcome that yields the highest welfare, then yes, if the central bank can somehow make sure that pi=pi-star will be delivered in equilibrium, we have maximum welfare possible (assuming the society also thinks of pi-star as ideal). This will be 1/2(ybar-y*)2 by the way, in our original model.
Topic 6
(1) why the science of monetary paper really makes clear about cost-push and demand-pull? why the shock,u, can only can only cost push?
In the model we consider, 'u' is the shock applied directly to the Phillips curve, i.e. it's an inflation shock. That's why we call it the cost-push shock, or equivalently, it is a supply-side shock because it shifts the aggregate supply curve. The demand shock in this model is very easy to deal with, we just operate monetary policy to offset it. Remember I skip the details about the aggregate demand side because we assume the LM curve can be chosen to be anything we like….so even if IS shifts up or down, the LM can be chosen to move to offset it.
Intuitively, with demand shock, there is no interesting tradeoff. Negative shock hits, inflation and growth will be lower, so u want to expand monetary policy to boost demand. When there's a supply shock, that's interesting. Do you want a higher inflation, or a lower growth? Or a combination of both? How much?"
(2) in the case of commitment rule, is it always that k must equals to zero?
It doesn't have to be. 'k' is a preference parameter, so it depends on the central bank's preference. I let it equal zero for simplicity, and to highlight the key point here that even if k is zero, there is a gain to commitment (check that you understand why). In the standard simple time-inconsistency problem, if k=0 we don't have any time-inconsistency, and commitment or not it doesn't matter.
EE432 2010: Extra problems for topics 6 and 7
Download them here. There is no need to submit them, as these are just for practice.
For those of you resubmitting problem set 4, I left them at the BE office some time last week so you can pick them up.
As for extra tutorial class, we may not be able to use a room at Thammasat, as the exams already started. I will try to look for an alternative location. In the mean time, if you have questions, you can send them in right away, there's no need to wait.
For those of you resubmitting problem set 4, I left them at the BE office some time last week so you can pick them up.
As for extra tutorial class, we may not be able to use a room at Thammasat, as the exams already started. I will try to look for an alternative location. In the mean time, if you have questions, you can send them in right away, there's no need to wait.
EE432 2010: Topic 7 Materials
Presentation file and reading pack for our final topic is now available for download
Key readings are articles in the JEP symposium, contained in a separate 'JEP articles' folder.
Key readings are articles in the JEP symposium, contained in a separate 'JEP articles' folder.
EE432 2010: Topic 6 Materials
Lecture note and the reading pack for topic 6 is now available for download at:
As I mentioned, the key reading is the paper by Clarida et al, up until the part covered by the lecture note. Among other highly recommended readings (though not required) are
As I mentioned, the key reading is the paper by Clarida et al, up until the part covered by the lecture note. Among other highly recommended readings (though not required) are
- Blinder's "What can central bankers learn from academics and vice versa", from the perspective of someone who's been on both sides of the fence.
- Bernanke's "Inflation targeting: a new framework?" published 3 years before Thailand imported the idea, which we still use to this day.
- Woodford's survey article on the optimal monetary policy for the Handbook for Monetary Economics, which is the most up-to-date account of what the current research frontier is. This is quite advanced, so perhaps just skim through to get some general ideas.
Modern Bank Failures
Diamond-Dybvig tells us that deposit insurance should have prevented bank runs and bank failures. The US has been having the insurance system for decades, so what was new in 2007-2008?
Krugman's recent post
Krugman's recent post
Other commenters say that lessons from the 1930s are no longer relevant, because now we have deposit insurance. Um, shadow banking? That’s the point I keep trying to make: what happened to us in 2007-8 was that a large banking system had grown up, relying on repo and other forms of short-term borrowing rather than deposits, that wasn’t covered by New Deal-era protections and regulation. So what we had was the 21st-century version of a bank run; not crowds of people lining up at bank doors, but crowds of investors demanding haircuts on repo, which has the same effect.
EE432 2010: Topic 5 Materials and Problem sets
The lecture note and reference materials for topic 5 is here:
These attached articles are for reference only, but these are original papers that introduce this concept to monetary policy issues. The key reading is, as I mentioned in class, the relevant sections from Romer's book.
Copies of the problem sets are available here:
Both of these are due in the evening of April 21st (We have a makeup class in the evening).
These attached articles are for reference only, but these are original papers that introduce this concept to monetary policy issues. The key reading is, as I mentioned in class, the relevant sections from Romer's book.
Copies of the problem sets are available here:
Both of these are due in the evening of April 21st (We have a makeup class in the evening).
EE432 2010: Revision for Mid-term
Q1: What do we mean by the following statement, " the key source of uncertainty is the fact that workers cannot always discern whether they are experiencing a relative price change or a general price change"?
Both Friedman and Lucas agree that, in the world of completely flexible prices, the only reason that any individual firm will produce more or less than the 'normal' or 'natural' level is if it thinks there is really a greater or lesser demand for its goods, relative to other goods in the economy. As the analogy I used in the lecture went, the firm's entrepreneur may expand output if he believes he has become the new Steve Job, whose product is relatively more popular than others. In terms of prices, this means there is a relative price change: the price of my product may now increase, while prices of other goods are unchanged, because there's more demand for my good only.
However the price of my good can rise for 2 reasons. (1) There can be a relative price change, in the sense that my good really becomes more popular and there's more demand for it. If I knew that was really the case, I would quite rightly expand my output (the same way Steve Job expands his company in response to greater demand). Or (2), there's simply an increase in aggregate demand stemming from expansionary monetary policy for example. Here, everyone's prices will tend to increase, and there's a change in general prices rather than relative prices. If I knew that this was the case, my reaction would be to produce the same amount I did before, but simply readjust my price in line with the new general price level.
In practice, firms cannot always differentiate between the two. So even if there is purely an aggregate demand shock, which affects general prices only, some firms may mistakenly (given their imperfect information about both the relative price and general price shocks) think that there have been some relative price changes and hence they will respond by changing the output produced. When all firms respond to aggregate demand in the same way, the result is a huge macro level change in output, GDP if you like. This is the mechanism, according to Friedman and Lucas, how changes in aggregate demand can bring about changes in total output, i.e. 'money matters'.
Both Friedman and Lucas agree that, in the world of completely flexible prices, the only reason that any individual firm will produce more or less than the 'normal' or 'natural' level is if it thinks there is really a greater or lesser demand for its goods, relative to other goods in the economy. As the analogy I used in the lecture went, the firm's entrepreneur may expand output if he believes he has become the new Steve Job, whose product is relatively more popular than others. In terms of prices, this means there is a relative price change: the price of my product may now increase, while prices of other goods are unchanged, because there's more demand for my good only.
However the price of my good can rise for 2 reasons. (1) There can be a relative price change, in the sense that my good really becomes more popular and there's more demand for it. If I knew that was really the case, I would quite rightly expand my output (the same way Steve Job expands his company in response to greater demand). Or (2), there's simply an increase in aggregate demand stemming from expansionary monetary policy for example. Here, everyone's prices will tend to increase, and there's a change in general prices rather than relative prices. If I knew that this was the case, my reaction would be to produce the same amount I did before, but simply readjust my price in line with the new general price level.
In practice, firms cannot always differentiate between the two. So even if there is purely an aggregate demand shock, which affects general prices only, some firms may mistakenly (given their imperfect information about both the relative price and general price shocks) think that there have been some relative price changes and hence they will respond by changing the output produced. When all firms respond to aggregate demand in the same way, the result is a huge macro level change in output, GDP if you like. This is the mechanism, according to Friedman and Lucas, how changes in aggregate demand can bring about changes in total output, i.e. 'money matters'.
3 Letters from Economists
Fiscal sustainability is no doubt the next looming concern, not least for those advanced economies that have stretched their budgets in dealing with the 2007 financial crisis.
On the Valentines day, Besley, Goodhart, Pissarides, Vickers, Muellbauer, Rogoff , Sargent and others, cosigned a letter stating:
Then on Feb 18th, followed 2 more letters.
Layard, Allsopp, Blinder, Hendry, Solow and Vines argued:
The last letter signed by Skidelsky, Marcus Miller, Blanchflower, De Grauwe, DeLong, Freeman, Hammond, Kirman, Manning, Richard Smith, Stiglitz and others also disagreed with Tim Besley and co.:
Lord Keynes certainly won't be disappointed by sons of the land.
On the Valentines day, Besley, Goodhart, Pissarides, Vickers, Muellbauer, Rogoff , Sargent and others, cosigned a letter stating:
In order to minimise this risk and support a sustainable recovery, the next [British] government should set out a detailed plan to reduce the structural budget deficit more quickly than set out in the 2009 pre-budget report.
The exact timing of measures should be sensitive to developments in the economy, particularly the fragility of the recovery. However, in order to be credible, the government’s goal should be to eliminate the structural current budget deficit over the course of a parliament, and there is a compelling case, all else being equal, for the first measures beginning to take effect in the 2010-11 fiscal year.
Then on Feb 18th, followed 2 more letters.
Layard, Allsopp, Blinder, Hendry, Solow and Vines argued:
We disagree.
First, while unemployment is still high, it would be dangerous to reduce the government’s contribution to aggregate demand beyond the cuts already planned for 2010-11 (which amount to 1 per cent of gross domestic product). History is littered with examples of premature withdrawal of the government stimulus, from the US in 1937 to Japan in 1997. With people’s livelihoods at stake, a responsible government should avoid reckless actions.
Second, Britain’s level of government debt is not out of control. The net debt relative to GDP is lower than the Group of Seven average, and on present government plans it will peak at 78 per cent of annual GDP in 2014-15, and then fall. Moreover British debt has a longer maturity than most other countries, and current interest rates on government debt at 4 per cent are also low by recent standards.
Third, since the crisis began, private households and businesses have had to increase their saving in order to reduce their debts. It is this saving that finances the government deficit. If the government did not take up the slack, there would be a deeper recession.
Of course there needs to be a clear plan for reducing the government deficit. But the existing one for next year appears sensible. What is needed then is much more detail for the following years, and a radical plan for the medium term. That is what the debate should be about.
The last letter signed by Skidelsky, Marcus Miller, Blanchflower, De Grauwe, DeLong, Freeman, Hammond, Kirman, Manning, Richard Smith, Stiglitz and others also disagreed with Tim Besley and co.:
We believe they are wrong.
What they fail to point out is that the current deficit reflects the deepest and longest global recession since the war, with extraordinary public sector fiscal and financial support needed to prevent the UK economy falling off a cliff.
There is no disagreement that fiscal consolidation will be necessary to put UK public finances back on a sustainable basis. But the timing of the measures should depend on the strength of the recovery. The Treasury has committed itself to more than halving the budget deficit by 2013-14, with most of the consolidation taking place when recovery is firmly established. In urging a faster pace of deficit reduction to reassure the financial markets, the signatories of the Sunday Times letter implicitly accept as binding the views of the same financial markets whose mistakes precipitated the crisis in the first place!
They seek to frighten us with the present level of the deficit but mention neither the automatic reduction that will be achieved as and when growth is resumed nor the effects of growth on investor confidence. How do the letter’s signatories imagine foreign creditors will react if implementing fierce spending cuts tips the economy back into recession? To ask – as they do – for independent appraisal of fiscal policy forecasts is sensible. But for the good of the British people – and for fiscal sustainability – the first priority must be to restore robust economic growth. The wealth of the nation lies in what its citizens can produce.
Lord Keynes certainly won't be disappointed by sons of the land.
EE432 2010: Topic 3 Materials and Problem set 2
The reading pack for topic 3 is now available for download
The following problem set is due on Friday 19th next week.
The following problem set is due on Friday 19th next week.
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