FNCE 101 Lecture Notes - Lecture 13: Ikea, Output Gap, Disinflation
Second building bloc of aggregate demand (the monetary policy rule)
1.
Second building bloc
Increase in real int rate decreases consumption investment AD and
output away from potential
○
2.
AD -- combining the IS curve and MP rule
SR output is a fcn of inflation
a.
If inflation is above central banks target central bank increases real int
rate to slowdown econ, output moves below potential
b.
If inf rate is below cent banks target they decrease real int rate and
pushes econ above potential
c.
3.
AD CURVE
Downward sloping curve
If above target, fed inc real int rate --> recession
i.
If fed sees inf being below 2% they decrease int rate in order to
simulate AD and bring inf back up
ii.
AD curve is the econ which is the IS curve
Together w agents belief of monetary policy/ that fed will
always fight inf to bring it back to cent banks target (by inc
real int rate) HENCE A DOWNWARD SLOPE
When inf is high fed inc int rate --? Recession
a)
When inf is low fed dec int rate --> spur econ growth
b)
1)
iii.
a.
4.
AD CURVE (slide 14)
AD curve becomes SR output as a fcn of inflation in deviation from
central banks target
a.
When inf =2% gap is closed and we are at potential output
b.
c.
5.
6.
Slide 16
Change in actual inflation
Shift along the AD curve
Change in inflation moves econ along AD curve1)
i.
a.
Change in inf target = shift in AD curve
Since this is a constant it acts like an intercepti.
When inflation is at central bank's target it has no incentive to
increase or decrease because they are at target so inf must be at
2% if they were not at potential firms have incentive to dec or inc
prices above central banks traget
Target must match potential outputa)
We know were at potential bc if not firms have incentive to
deviate from expectation which must be anchored by feds
target bc if it wasn’t the fed would play w econ
Since firms have no incentive to deviate above
expected inflation this means everyone is at potential
output and everybodys belief about how they set
prices is anchored at target
a)
b)
ii.
b.
Change in a (intercept) is a shift in curve
Mostly corresponds to shift in IS curve (anything that shifts IS will
shift AD)
i.
Think of it as AD shock
C I G NX -- shift in AD curve1)
ii.
Shift in a would likely shift inflation for any level of outputiii.
c.
Change in b or m = change in slope
The way econ responds to deviation or inf from cent banks targeti.
d.
7.
Slide 15
Curve is set at central banks target when econ is at potential a.
8.
Slide 17
AS curve is the firms response/ price-setting equation
Depends on:
Expected inflationa)
Demand conditionsb)
Shocks that might arise to firms input prices/ shock to
input prices
Ie increase in oil pricesi)
If you're ikea shock to price of lumberii)
Shock is usually 0 except for when it becomes a
shock
iii)
iv)
c)
1)
Important feature of AS curve
Intercept = expected future inflation a)
If you think expected futre inflation is in line with feds
target then the AS curve should aslo be anchored at
cent bank inf target --> upward sloping AS curve
where intercept is not only how we believe future inf
will behave but is also cent bank's target
Ie. Inf is roughly 2% the fed will do whatever it
takes to maintain it at that value what is
expected future inf for econ?
Answer=2%One.
i)
How do you adjust prices?
Increase price by 2% to keep demand in
line w potential
One.
ii)
b)
2)
i.
CEO of ikea u must decide prices - u believe inf will be at
potential so you increase prices by expected future inf
which is central bank's target of 2%
1)
ii.
a.
9.
Slide 19
SR model is the combiation of the AD and AS curve
In steady state the inflation rate must be constant
If inf is constant every firm is at potential so the fed doesn’t
do anything youre at potential, inf is at 2%
1)
Audio 1
Audio recording started: 11:11 AM Wednesday, March 14, 2018
If inf doesn’t change then inflation today is what inf
tomorrow will be then inf must be at cent banks target
i.
AS/AD model is in inflation and output gap space which will end
up being the 2 mandate s of the fed reserve
Helps us in terms of if we were in charge of fed goal is to
bring econ back to potential -- this is what AS/AD model
does
1)
ii.
a.
10.
Slide 21
Bookmark added at 01:21 in Audio 1a.
AD curve slopes downward bc of central banks response to inf
Int rate responds to inflation i.
If cent bank observes high inf rateii.
Policy makers slow econ when they see a high inf rate bc they
know it will bring inf down
iii.
b.
If agent understands inf is higher than cent bank target they know fed
will throw econ into recession to fight inflation
c.
If were above target fed willd.
AS curve is upward sloping bc of firms price setting behavior
When actual output exceeds demand, there is incentive to
increse prices to keep it in line
i.
e.
11.
Example 1: an inflation shock -- increase in price of oil
What would happen to AS/AD model a.
Shows up in aggregate supply in O
Increase in firms inputi.
This is a constant which acts like in put
Bookmark added at 04:28 in Audio 11)
ii.
AS curve will shift up and to the left
The agent understands that if inf is higher than 2% fed
icnreases int rate and throws econ into recession moving
econ from point A to B
1)
Firms demand for product is lower than potential
Means you cant sell product, firms have incentive to
lower prices, AS curve shifts back to A
This is how fed fights inflation i)
a)
2)
iii.
Increase in input is reflected on to the consumer iv.
Shows up in AS curve
Inciteful way: if you see year after year price of good prices
your inf expectations drift downward too which will
reanchor AS curve to feds inflation target
1)
As long as the fed 2)
Math: ppl form expectation of inf for the month based on
what they observed in the previous month
Bookmark added at 07:47 in Audio 1a)
3)
v.
b.
12.
Example 2: a disinflation
Bookmark added at 08:32 in Audio 1a.
70s: 2 price shocks
Ppl tired of seeing inf in the US i.
Goal: reduce level of inf in the USii.
b.
What happens?
FED decides inf target is 10 and they ened to reduce it to
2%
AD curve will move a)
Move from A to B
Firms feel pain of cent bank -- they are willing
to increase the int rate in order to make
i)
Firms feel the pain, start slacking prices
They get reanchored at potential where
target is 2%
One.
ii)
Firms are forced to slack fprices you restore
econ to potential output with new target of 2%
iii)
b)
1)
What would have happenef if Volker had been credible? If
he said he'd bring inf down to 2%
Bookmark added at 12:12 in Audio 1a)
Then the AD curve would have shifted -- representing
his new inf target but ppls expected future inf would
shift, we'd move down to lower level of int rate with
no recession
Int rate went down bc no one belived fe d had
the guts to do this
i)
b)
2)
Ppl's expectation was still 10% when fed had new target of
2% so AS curve stayed the same while AD curve shifted
putting the econ below potential
3)
i.
c.
13.
Example 3
Bookmark added at 15:33 in Audio 1a.
The great recession is a huge drop in aggregate demand coming from 2
sources
Negative shock to households
Decline in house prices, reduces household wealth,
decreasing PVLR and consumption
1)
i.
AD = C+I+G+NXii.
No one knew who had mortgage backed securities so if you had
to borrow money you had to borrow w increased risk premium
Leads to increase in user cost of capital and increase in
investment
Shows up as another component of AD, shifting it
down and to the left
a)
1)
iii.
2007 we're at A, 2009 we're at B we are 6% below capacity
At B te fed can lower int rates --bring it down to 0 to spur
consumption and investment as much as possible to
reanchor econ
The Fed can pump more money into econ a)
Fiscal policy: stimulus package
Increase govt spending tor estimulate AD to
bring output back to potential
If fed doesn’t do anything and if govt
would not have passed stimulus package
We would be in recession ,firms
would slack prices to go back to
potential but new inf rate would
be -2% (at point C) firms prices will
go down enough to go into
negative inflation
This brings AD further
down -- if you know value is
gonna go down you cut down
consumption
1.
This could lead into a
downward spiral where firms
want to keep slacking
prices --> great depression
Big stimulus package --
was meant so we
would not get into a
depression that would
have been triggered by
inf rate below 0
1.
2.
First.
One.
i)
b)
When firms experience demand below potential they
slack prices
This is an increase in AS bc the only way to sell
is to slack prices -- this is the only way to return
to potential output
i)
Consumers and firms postposne ii)
c)
1)
iv.
b.
14.
Slide 30
Bookmark added at 30:31 in Audio 1a.
Negative inflation rate raises real int rate
Use fisher eqi.
Deflation increases real int rate, reducing C and I, pushing output
further below potential
ii.
b.
In normal time, ctrl bank cets inf to influence rt
Becomes difficult to lower int rate futher when it approaches 0 i.
c.
When it=0 rt=-expectrd future inflation
No one wants to consume firms don’t want to invest --
everythign stored in banks -- no econ stimulation
i.
d.
To avoid this
We can try to increase AD through unconventional monetary
policy (QE) or fiscal stimulation
i.
Or manage inf expectations
Tell ppl we will do whatever it takes 1)
ii.
e.
15.
Lecture 13 -AD AND AS
Wednesday, March 14, 2018
10:50 AM
Second building bloc of aggregate demand (the monetary policy rule) 1.
Second building bloc
Increase in real int rate decreases consumption investment AD and
output away from potential
○
2.
AD -- combining the IS curve and MP rule
SR output is a fcn of inflationa.
If inflation is above central banks target central bank increases real int
rate to slowdown econ, output moves below potential
b.
If inf rate is below cent banks target they decrease real int rate and
pushes econ above potential
c.
3.
AD CURVE
Downward sloping curve
If above target, fed inc real int rate --> recessioni.
If fed sees inf being below 2% they decrease int rate in order to
simulate AD and bring inf back up
ii.
AD curve is the econ which is the IS curve
Together w agents belief of monetary policy/ that fed will
always fight inf to bring it back to cent banks target (by inc
real int rate) HENCE A DOWNWARD SLOPE
When inf is high fed inc int rate --? Recessiona)
When inf is low fed dec int rate --> spur econ growth b)
1)
iii.
a.
4.
AD CURVE (slide 14)
AD curve becomes SR output as a fcn of inflation in deviation from
central banks target
a.
When inf =2% gap is closed and we are at potential outputb.
c.
5.
6.
Slide 16
Change in actual inflation
Shift along the AD curve
Change in inflation moves econ along AD curve
1)
i.
a.
Change in inf target = shift in AD curve
Since this is a constant it acts like an intercept
i.
When inflation is at central bank's target it has no incentive to
increase or decrease because they are at target so inf must be at
2% if they were not at potential firms have incentive to dec or inc
prices above central banks traget
Target must match potential output
a)
We know were at potential bc if not firms have incentive to
deviate from expectation which must be anchored by feds
target bc if it wasn’t the fed would play w econ
Since firms have no incentive to deviate above
expected inflation this means everyone is at potential
output and everybodys belief about how they set
prices is anchored at target
a)
b)
ii.
b.
Change in a (intercept) is a shift in curve
Mostly corresponds to shift in IS curve (anything that shifts IS will
shift AD)
i.
Think of it as AD shock
C I G NX -- shift in AD curve
1)
ii.
Shift in a would likely shift inflation for any level of output
iii.
c.
Change in b or m = change in slope
The way econ responds to deviation or inf from cent banks target
i.
d.
7.
Slide 15
Curve is set at central banks target when econ is at potential
a.
8.
Slide 17
AS curve is the firms response/ price-setting equation
Depends on:
Expected inflationa)
Demand conditionsb)
Shocks that might arise to firms input prices/ shock to
input prices
Ie increase in oil pricesi)
If you're ikea shock to price of lumberii)
Shock is usually 0 except for when it becomes a
shock
iii)
iv)
c)
1)
Important feature of AS curve
Intercept = expected future inflation a)
If you think expected futre inflation is in line with feds
target then the AS curve should aslo be anchored at
cent bank inf target --> upward sloping AS curve
where intercept is not only how we believe future inf
will behave but is also cent bank's target
Ie. Inf is roughly 2% the fed will do whatever it
takes to maintain it at that value what is
expected future inf for econ?
Answer=2%One.
i)
How do you adjust prices?
Increase price by 2% to keep demand in
line w potential
One.
ii)
b)
2)
i.
CEO of ikea u must decide prices - u believe inf will be at
potential so you increase prices by expected future inf
which is central bank's target of 2%
1)
ii.
a.
9.
Slide 19
SR model is the combiation of the AD and AS curve
In steady state the inflation rate must be constant
If inf is constant every firm is at potential so the fed doesn’t
do anything youre at potential, inf is at 2%
1)
Audio 1
Audio recording started: 11:11 AM Wednesday, March 14, 2018
If inf doesn’t change then inflation today is what inf
tomorrow will be then inf must be at cent banks target
i.
AS/AD model is in inflation and output gap space which will end
up being the 2 mandate s of the fed reserve
Helps us in terms of if we were in charge of fed goal is to
bring econ back to potential -- this is what AS/AD model
does
1)
ii.
a.
10.
Slide 21
Bookmark added at 01:21 in Audio 1a.
AD curve slopes downward bc of central banks response to inf
Int rate responds to inflation i.
If cent bank observes high inf rateii.
Policy makers slow econ when they see a high inf rate bc they
know it will bring inf down
iii.
b.
If agent understands inf is higher than cent bank target they know fed
will throw econ into recession to fight inflation
c.
If were above target fed willd.
AS curve is upward sloping bc of firms price setting behavior
When actual output exceeds demand, there is incentive to
increse prices to keep it in line
i.
e.
11.
Example 1: an inflation shock -- increase in price of oil
What would happen to AS/AD model a.
Shows up in aggregate supply in O
Increase in firms inputi.
This is a constant which acts like in put
Bookmark added at 04:28 in Audio 11)
ii.
AS curve will shift up and to the left
The agent understands that if inf is higher than 2% fed
icnreases int rate and throws econ into recession moving
econ from point A to B
1)
Firms demand for product is lower than potential
Means you cant sell product, firms have incentive to
lower prices, AS curve shifts back to A
This is how fed fights inflation i)
a)
2)
iii.
Increase in input is reflected on to the consumer iv.
Shows up in AS curve
Inciteful way: if you see year after year price of good prices
your inf expectations drift downward too which will
reanchor AS curve to feds inflation target
1)
As long as the fed 2)
Math: ppl form expectation of inf for the month based on
what they observed in the previous month
Bookmark added at 07:47 in Audio 1a)
3)
v.
b.
12.
Example 2: a disinflation
Bookmark added at 08:32 in Audio 1a.
70s: 2 price shocks
Ppl tired of seeing inf in the US i.
Goal: reduce level of inf in the USii.
b.
What happens?
FED decides inf target is 10 and they ened to reduce it to
2%
AD curve will move a)
Move from A to B
Firms feel pain of cent bank -- they are willing
to increase the int rate in order to make
i)
Firms feel the pain, start slacking prices
They get reanchored at potential where
target is 2%
One.
ii)
Firms are forced to slack fprices you restore
econ to potential output with new target of 2%
iii)
b)
1)
What would have happenef if Volker had been credible? If
he said he'd bring inf down to 2%
Bookmark added at 12:12 in Audio 1a)
Then the AD curve would have shifted -- representing
his new inf target but ppls expected future inf would
shift, we'd move down to lower level of int rate with
no recession
Int rate went down bc no one belived fe d had
the guts to do this
i)
b)
2)
Ppl's expectation was still 10% when fed had new target of
2% so AS curve stayed the same while AD curve shifted
putting the econ below potential
3)
i.
c.
13.
Example 3
Bookmark added at 15:33 in Audio 1a.
The great recession is a huge drop in aggregate demand coming from 2
sources
Negative shock to households
Decline in house prices, reduces household wealth,
decreasing PVLR and consumption
1)
i.
AD = C+I+G+NXii.
No one knew who had mortgage backed securities so if you had
to borrow money you had to borrow w increased risk premium
Leads to increase in user cost of capital and increase in
investment
Shows up as another component of AD, shifting it
down and to the left
a)
1)
iii.
2007 we're at A, 2009 we're at B we are 6% below capacity
At B te fed can lower int rates --bring it down to 0 to spur
consumption and investment as much as possible to
reanchor econ
The Fed can pump more money into econ a)
Fiscal policy: stimulus package
Increase govt spending tor estimulate AD to
bring output back to potential
If fed doesn’t do anything and if govt
would not have passed stimulus package
We would be in recession ,firms
would slack prices to go back to
potential but new inf rate would
be -2% (at point C) firms prices will
go down enough to go into
negative inflation
This brings AD further
down -- if you know value is
gonna go down you cut down
consumption
1.
This could lead into a
downward spiral where firms
want to keep slacking
prices --> great depression
Big stimulus package --
was meant so we
would not get into a
depression that would
have been triggered by
inf rate below 0
1.
2.
First.
One.
i)
b)
When firms experience demand below potential they
slack prices
This is an increase in AS bc the only way to sell
is to slack prices -- this is the only way to return
to potential output
i)
Consumers and firms postposne ii)
c)
1)
iv.
b.
14.
Slide 30
Bookmark added at 30:31 in Audio 1a.
Negative inflation rate raises real int rate
Use fisher eqi.
Deflation increases real int rate, reducing C and I, pushing output
further below potential
ii.
b.
In normal time, ctrl bank cets inf to influence rt
Becomes difficult to lower int rate futher when it approaches 0 i.
c.
When it=0 rt=-expectrd future inflation
No one wants to consume firms don’t want to invest --
everythign stored in banks -- no econ stimulation
i.
d.
To avoid this
We can try to increase AD through unconventional monetary
policy (QE) or fiscal stimulation
i.
Or manage inf expectations
Tell ppl we will do whatever it takes 1)
ii.
e.
15.
Lecture 13 -AD AND AS
Wednesday, March 14, 2018 10:50 AM
Second building bloc of aggregate demand (the monetary policy rule) 1.
Second building bloc
Increase in real int rate decreases consumption investment AD and
output away from potential
○
2.
AD -- combining the IS curve and MP rule
SR output is a fcn of inflationa.
If inflation is above central banks target central bank increases real int
rate to slowdown econ, output moves below potential
b.
If inf rate is below cent banks target they decrease real int rate and
pushes econ above potential
c.
3.
AD CURVE
Downward sloping curve
If above target, fed inc real int rate --> recessioni.
If fed sees inf being below 2% they decrease int rate in order to
simulate AD and bring inf back up
ii.
AD curve is the econ which is the IS curve
Together w agents belief of monetary policy/ that fed will
always fight inf to bring it back to cent banks target (by inc
real int rate) HENCE A DOWNWARD SLOPE
When inf is high fed inc int rate --? Recessiona)
When inf is low fed dec int rate --> spur econ growth b)
1)
iii.
a.
4.
AD CURVE (slide 14)
AD curve becomes SR output as a fcn of inflation in deviation from
central banks target
a.
When inf =2% gap is closed and we are at potential outputb.
c.
5.
6.
Slide 16
Change in actual inflation
Shift along the AD curve
Change in inflation moves econ along AD curve1)
i.
a.
Change in inf target = shift in AD curve
Since this is a constant it acts like an intercepti.
When inflation is at central bank's target it has no incentive to
increase or decrease because they are at target so inf must be at
2% if they were not at potential firms have incentive to dec or inc
prices above central banks traget
Target must match potential outputa)
We know were at potential bc if not firms have incentive to
deviate from expectation which must be anchored by feds
target bc if it wasn’t the fed would play w econ
Since firms have no incentive to deviate above
expected inflation this means everyone is at potential
output and everybodys belief about how they set
prices is anchored at target
a)
b)
ii.
b.
Change in a (intercept) is a shift in curve
Mostly corresponds to shift in IS curve (anything that shifts IS will
shift AD)
i.
Think of it as AD shock
C I G NX -- shift in AD curve1)
ii.
Shift in a would likely shift inflation for any level of outputiii.
c.
Change in b or m = change in slope
The way econ responds to deviation or inf from cent banks targeti.
d.
7.
Slide 15
Curve is set at central banks target when econ is at potential
a.
8.
Slide 17
AS curve is the firms response/ price-setting equation
Depends on:
Expected inflation
a)
Demand conditions
b)
Shocks that might arise to firms input prices/ shock to
input prices
Ie increase in oil prices
i)
If you're ikea shock to price of lumber
ii)
Shock is usually 0 except for when it becomes a
shock
iii)
iv)
c)
1)
Important feature of AS curve
Intercept = expected future inflation
a)
If you think expected futre inflation is in line with feds
target then the AS curve should aslo be anchored at
cent bank inf target --> upward sloping AS curve
where intercept is not only how we believe future inf
will behave but is also cent bank's target
Ie. Inf is roughly 2% the fed will do whatever it
takes to maintain it at that value what is
expected future inf for econ?
Answer=2%
One.
i)
How do you adjust prices?
Increase price by 2% to keep demand in
line w potential
One.
ii)
b)
2)
i.
CEO of ikea u must decide prices - u believe inf will be at
potential so you increase prices by expected future inf
which is central bank's target of 2%
1)
ii.
a.
9.
Slide 19
SR model is the combiation of the AD and AS curve
In steady state the inflation rate must be constant
If inf is constant every firm is at potential so the fed doesn’t
do anything youre at potential, inf is at 2%
1)
Audio 1
Audio recording started: 11:11 AM Wednesday, March 14, 2018
If inf doesn’t change then inflation today is what inf
tomorrow will be then inf must be at cent banks target
i.
AS/AD model is in inflation and output gap space which will end
up being the 2 mandate s of the fed reserve
Helps us in terms of if we were in charge of fed goal is to
bring econ back to potential -- this is what AS/AD model
does
1)
ii.
a.
10.
Slide 21
Bookmark added at 01:21 in Audio 1a.
AD curve slopes downward bc of central banks response to inf
Int rate responds to inflation i.
If cent bank observes high inf rateii.
Policy makers slow econ when they see a high inf rate bc they
know it will bring inf down
iii.
b.
If agent understands inf is higher than cent bank target they know fed
will throw econ into recession to fight inflation
c.
If were above target fed willd.
AS curve is upward sloping bc of firms price setting behavior
When actual output exceeds demand, there is incentive to
increse prices to keep it in line
i.
e.
11.
Example 1: an inflation shock -- increase in price of oil
What would happen to AS/AD model a.
Shows up in aggregate supply in O
Increase in firms inputi.
This is a constant which acts like in put
Bookmark added at 04:28 in Audio 11)
ii.
AS curve will shift up and to the left
The agent understands that if inf is higher than 2% fed
icnreases int rate and throws econ into recession moving
econ from point A to B
1)
Firms demand for product is lower than potential
Means you cant sell product, firms have incentive to
lower prices, AS curve shifts back to A
This is how fed fights inflation i)
a)
2)
iii.
Increase in input is reflected on to the consumer iv.
Shows up in AS curve
Inciteful way: if you see year after year price of good prices
your inf expectations drift downward too which will
reanchor AS curve to feds inflation target
1)
As long as the fed 2)
Math: ppl form expectation of inf for the month based on
what they observed in the previous month
Bookmark added at 07:47 in Audio 1a)
3)
v.
b.
12.
Example 2: a disinflation
Bookmark added at 08:32 in Audio 1a.
70s: 2 price shocks
Ppl tired of seeing inf in the US i.
Goal: reduce level of inf in the USii.
b.
What happens?
FED decides inf target is 10 and they ened to reduce it to
2%
AD curve will move a)
Move from A to B
Firms feel pain of cent bank -- they are willing
to increase the int rate in order to make
i)
Firms feel the pain, start slacking prices
They get reanchored at potential where
target is 2%
One.
ii)
Firms are forced to slack fprices you restore
econ to potential output with new target of 2%
iii)
b)
1)
What would have happenef if Volker had been credible? If
he said he'd bring inf down to 2%
Bookmark added at 12:12 in Audio 1a)
Then the AD curve would have shifted -- representing
his new inf target but ppls expected future inf would
shift, we'd move down to lower level of int rate with
no recession
Int rate went down bc no one belived fe d had
the guts to do this
i)
b)
2)
Ppl's expectation was still 10% when fed had new target of
2% so AS curve stayed the same while AD curve shifted
putting the econ below potential
3)
i.
c.
13.
Example 3
Bookmark added at 15:33 in Audio 1a.
The great recession is a huge drop in aggregate demand coming from 2
sources
Negative shock to households
Decline in house prices, reduces household wealth,
decreasing PVLR and consumption
1)
i.
AD = C+I+G+NXii.
No one knew who had mortgage backed securities so if you had
to borrow money you had to borrow w increased risk premium
Leads to increase in user cost of capital and increase in
investment
Shows up as another component of AD, shifting it
down and to the left
a)
1)
iii.
2007 we're at A, 2009 we're at B we are 6% below capacity
At B te fed can lower int rates --bring it down to 0 to spur
consumption and investment as much as possible to
reanchor econ
The Fed can pump more money into econ a)
Fiscal policy: stimulus package
Increase govt spending tor estimulate AD to
bring output back to potential
If fed doesn’t do anything and if govt
would not have passed stimulus package
We would be in recession ,firms
would slack prices to go back to
potential but new inf rate would
be -2% (at point C) firms prices will
go down enough to go into
negative inflation
This brings AD further
down -- if you know value is
gonna go down you cut down
consumption
1.
This could lead into a
downward spiral where firms
want to keep slacking
prices --> great depression
Big stimulus package --
was meant so we
would not get into a
depression that would
have been triggered by
inf rate below 0
1.
2.
First.
One.
i)
b)
When firms experience demand below potential they
slack prices
This is an increase in AS bc the only way to sell
is to slack prices -- this is the only way to return
to potential output
i)
Consumers and firms postposne ii)
c)
1)
iv.
b.
14.
Slide 30
Bookmark added at 30:31 in Audio 1a.
Negative inflation rate raises real int rate
Use fisher eqi.
Deflation increases real int rate, reducing C and I, pushing output
further below potential
ii.
b.
In normal time, ctrl bank cets inf to influence rt
Becomes difficult to lower int rate futher when it approaches 0 i.
c.
When it=0 rt=-expectrd future inflation
No one wants to consume firms don’t want to invest --
everythign stored in banks -- no econ stimulation
i.
d.
To avoid this
We can try to increase AD through unconventional monetary
policy (QE) or fiscal stimulation
i.
Or manage inf expectations
Tell ppl we will do whatever it takes 1)
ii.
e.
15.
Lecture 13 -AD AND AS
Wednesday, March 14, 2018 10:50 AM
Document Summary
Second building bloc of aggregate demand (the monetary policy rule) Increase in real int rate decreases consumption investment ad and output away from potential. Ad -- combining the is curve and mp rule a. b. c. If inflation is above central banks target central bank increases real int rate to slowdown econ, output moves below potential. If inf rate is below cent banks target they decrease real int rate and pushes econ above potential. If above target, fed inc real int rate --> recession. If fed sees inf being below 2% they decrease int rate in order to simulate ad and bring inf back up. Ad curve is the econ which is the is curve. Together w agents belief of monetary policy/ that fed will always fight inf to bring it back to cent banks target (by inc real int rate) hence a downward slope a) b) When inf is low fed dec int rate --> spur econ growth.
