CASE STUDY Volcker's Monetary Tightening.ppt

1、slide 0,CASE STUDY Volckers Monetary Tightening,Late 1970s: 10% Oct 1979: Fed Chairman Paul Volcker announced that monetary policy would aim to reduce inflation. Aug 1979-April 1980: Fed reduces M/P 8.0% Jan 1983: = 3.7%,How do you think this policy change would affect interest rates?,slide 1,Volcke

2、rs Monetary Tightening, cont.,i 0,i 0,1/1983: i = 8.2%,8/1979: i = 10.4% 4/1980: i = 15.8%,flexible,sticky,Quantity Theory, Fisher Effect (Classical),Liquidity Preference (Keynesian),slide 2,EXERCISE: Analyze shocks with the IS-LM model,Use the IS-LM model to analyze the effects of A boom in the sto

3、ck market makes consumers wealthier. After a wave of credit card fraud, consumers use cash more frequently in transactions. For each shock, use the IS-LM diagram to show the effects of the shock on Y and r . determine what happens to C, I, and the unemployment rate.,slide 3,What is the Feds policy i

4、nstrument?,What the newspaper says: “the Fed lowered interest rates by one-half point today” What actually happened: The Fed conducted expansionary monetary policy to shift the LM curve to the right until the interest rate fell 0.5 points.,The Fed targets the Federal Funds rate: it announces a targe

5、t value, and uses monetary policy to shift the LM curve as needed to attain its target rate.,slide 4,What is the Feds policy instrument?,Why does the Fed target interest rates instead of the money supply? 1) They are easier to measure than the money supply 2) The Fed might believe that LM shocks are

6、 more prevalent than IS shocks. If so, then targeting the interest rate stabilizes income better than targeting the money supply.,slide 5,Interaction between monetary & fiscal policy,Model: monetary & fiscal policy variables (M, G and T ) are exogenous Real world: Monetary policymakers may adjust M

7、in response to changes in fiscal policy, or vice versa. Such interaction may alter the impact of the original policy change.,slide 6,The Feds response to G 0,Suppose Congress increases G. Possible Fed responses: 1. hold M constant 2. hold r constant 3. hold Y constant In each case, the effects of th

8、e G are different:,slide 7,If Congress raises G, the IS curve shifts right,Response 1: hold M constant,If Fed holds M constant, then LM curve doesnt shift. Results:,slide 8,If Congress raises G, the IS curve shifts right,Response 2: hold r constant,r1,r2,To keep r constant, Fed increases M to shift

9、LM curve right.,Results:,slide 9,If Congress raises G, the IS curve shifts right,Response 3: hold Y constant,r2,To keep Y constant, Fed reduces M to shift LM curve left.,Results:,slide 10,CASE STUDY The U.S. economic slowdown of 2001,What happened 1. Real GDP growth rate1994-2000: 3.9% (average annu

10、al)2001: 1.2% 2. Unemployment rateDec 2000: 4.0%Dec 2001: 5.8%,slide 11,CASE STUDY The U.S. economic slowdown of 2001,Shocks that contributed to the slowdown 1. Falling stock prices From Aug 2000 to Aug 2001: -25% Week after 9/11: -12% 2. The terrorist attacks on 9/11 increased uncertainty fall in c

11、onsumer & business confidence Both shocks reduced spending and shifted the IS curve left.,slide 12,The Great Depression,slide 13,The Spending Hypothesis: Shocks to the IS Curve,asserts that the Depression was largely due to an exogenous fall in the demand for goods & services - a leftward shift of t

12、he IS curve evidence: output and interest rates both fell, which is what a leftward IS shift would cause,slide 14,The Spending Hypothesis: Reasons for the IS shift,Stock market crash exogenous C Oct-Dec 1929: S&P 500 fell 17% Oct 1929-Dec 1933: S&P 500 fell 71% Drop in investment “correction” after

13、overbuilding in the 1920s widespread bank failures made it harder to obtain financing for investment Contractionary fiscal policy in the face of falling tax revenues and increasing deficits, politicians raised tax rates and cut spending,slide 15,The Money Hypothesis: A Shock to the LM Curve,asserts

14、that the Depression was largely due to huge fall in the money supply evidence: M1 fell 25% during 1929-33. But, two problems with this hypothesis:P fell even more, so M/P actually rose slightly during 1929-31. nominal interest rates fell, which is the opposite of what would result from a leftward LM

15、 shift.,slide 16,The Money Hypothesis Again: The Effects of Falling Prices,asserts that the severity of the Depression was due to a huge deflation:P fell 25% during 1929-33. This deflation was probably caused by the fall in M, so perhaps money played an important role after all. In what ways does a

16、deflation affect the economy?,slide 17,The Money Hypothesis Again: The Effects of Falling Prices,The stabilizing effects of deflation: P (M/P ) LM shifts right Y Pigou effect: P (M/P ) consumers wealth C IS shifts right Y,slide 18,The Money Hypothesis Again: The Effects of Falling Prices,The destabi

17、lizing effects of unexpected deflation: debt-deflation theory P (if unexpected) transfers purchasing power from borrowers to lenders borrowers spend less, lenders spend more if borrowers propensity to spend is larger than lenders, then aggregate spending falls, the IS curve shifts left, and Y falls,

18、slide 19,The Money Hypothesis Again: The Effects of Falling Prices,The destabilizing effects of expected deflation:e r for each value of i I because I = I (r ) planned expenditure & agg. demand income & output ,slide 20,Why another Depression is unlikely,Policymakers (or their advisors) now know muc

19、h more about macroeconomics: The Fed knows better than to let M fall so much, especially during a contraction. Fiscal policymakers know better than to raise taxes or cut spending during a contraction. Federal deposit insurance makes widespread bank failures very unlikely. Automatic stabilizers make

20、fiscal policy expansionary during an economic downturn.,slide 21,Percentage,of GDP,40,35,30,25,20,15,10,5,0,Canada,France,Germany,Italy,Japan,U.K.,U.S.,Imports,Exports,Imports and Exports as a percentage of output: 2000,slide 22,Three experiments,1. Fiscal policy at home 2. Fiscal policy abroad 3. A

21、n increase in investment demand,slide 23,1. Fiscal policy at home,An increase in G or decrease in T reduces saving.,Results:,slide 24,NX and the Government Budget Deficit,slide 25,2. Fiscal policy abroad,Expansionary fiscal policy abroad raises the world interest rate.,Results:,slide 26,3. An increa

22、se in investment demand,EXERCISE: Use the model to determine the impact of an increase in investment demand on NX, S, I, and net capital outflow.,slide 27,3. An increase in investment demand,ANSWERS:I 0,S = 0, net capital outflows and net exports fall by the amount I,slide 28,U.S. Net Exports and th

23、e Real Exchange Rate, 1975-2002,slide 29,Four experiments,1. Fiscal policy at home 2. Fiscal policy abroad 3. An increase in investment demand 4. Trade policy to restrict imports,slide 30,1. Fiscal policy at home,A fiscal expansion reduces national saving, net capital outflows, and the supply of dol

24、lars in the foreign exchange market,causing the real exchange rate to rise and NX to fall.,slide 31,2. Fiscal policy abroad,An increase in r* reduces investment, increasing net capital outflows and the supply of dollars in the foreign exchange market,causing the real exchange rate to fall and NX to

25、rise.,slide 32,3. An increase in investment demand,An increase in investment reduces net capital outflows and the supply of dollars in the foreign exchange market,causing the real exchange rate to rise and NX to fall.,slide 33,4. Trade policy to restrict imports,At any given value of , an import quo

26、ta IM NX demand for dollars shifts right,Trade policy doesnt affect S or I , so capital flows and the supply of dollars remains fixed.,slide 34,4. Trade policy to restrict imports,Results: 0 (demand increase) NX = 0 (supply fixed) IM 0 (policy) EX 0 (rise in ),slide 35,Inflation and nominal exchange

27、 rates,Percentage,change,in nominal,exchange,rate,10,9,8,7,6,5,4,3,2,1,0,-,1,-,2,-,3,-,4,Inflation differential,Depreciation,relative to,U.S. dollar,Appreciation,relative to,U.S. dollar,-,1,-,2,-,3,1,0,2,3,4,5,6,8,7,France,Canada,Sweden,Australia,UK,Ireland,Spain,South Africa,Italy,New Zealand,Netherlands,Germany,Japan,Belgium,Switzerland,slide 36,Data: decade averages; all except r and are expressed as a percent of GDP; is a trade-weighted index.,CASE STUDY The Reagan Deficits revisited,