Paul J.J. Welfens

Introduction to Lecture Simulation Models for Policy Analysis

Paul Welfens (Part I : Welfens) and Werner Röger

(Part I I : invited) -Based on 2011 – update Jan. 2014

-Preliminary

Paul J.J. Welfens

Europäisches Institute für internationale Wirtschaftsbeziehungen/European Institute for International Economic

Relations (EIIW, www.eiiw.eu); University of Wuppertal , Jean Monnet Chair for European Integration

http://www.eiiw.eu/

Economic Modelling

Purpose of modelling Alternative approaches: traditional

Keynesian macro models vs. neoclassical growth models vs. DSGE models DSGE = Dynamic Stochastic General Equilibrium

Model; common approach of most central banks, European Commission etc.

Short term forecasting (indicators: order inflow, survey results from industry...) 08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 2

Modelling short term and long run output (K is capital stock)

Long run output growth (development) is analyzed within context of growth model Capital accumulation dK/dt (t is time); net investment!

Short term/medium term analysis is based on Key-nesian model (K contant) or some other macro model Traditional model have static expectations or backward-

looking individuals (adaptive expectations; e.g. with respect to inflation); modern macro models are foreward-looking/rational expectations = based on model and available set of public information

08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 3

Neoclassical Growth Model: Long run equilibrium: dk/dt=0; hence k#

Savings 1) S=sY; Production function 2) Y =KßL1-ß

Gross investment I‘= dK/dt + δK (δ is depreciation rate of capital stock; t is time)

Goods market equilibrium condition S=I‘ or 3) S/L = I‘/L; define K/L as k (capital intensity); recall that 4) dk/dt = (dK/dt)/L – k(dL/dt)/L;

5) (dK/dt)/L + δk=skß; dk/dt + nk +δk=skß; here n:= (dL/dt)/L growth rate of labor

dk/dt =skß -(n+δ)k; k#= (s/(n+δ))1/(1-ß) 08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 4

Steady state output per capita y# (y:= Y/L; # for steady state; ß=1/3)

y# = k#ß=(s/(n+δ))ß/(1-ß) Per capita income y is the higher, the higher the

savings rate is; the lower n and δ Y =L0e‘nt (s/(n+δ))ß/(1-ß); e‘ is Euler number; if L

is constant Y# = L0(s/(n+δ))ß/(1-ß) Long run growth equilibrium

Level of growth path is L0 (s/(n+δ))ß/(1-ß)

Growth rate of long run output is n Simulations: what IFF (e.g. n falls, s rises etc.)


Level of Growth Path and Growth Rate of Output (increase of n in point of time t‘); gY=dlnY/dt growth rate of output


lnY

A

0 t t‘

B

C

D

F B‘

α tgα=gY

Neoclassical Growth Model

Possible modification: S = s(1-τ)Y; τ income tax rate

If there is technological progress and knowledge A as an input factor in production function Y =Kß(AL)1-ß ; y‘:=Y/(AL)= k‘ß

A is „labor augmenting“ A(t) = A0 e‘at; A0 is initial knowledge, a is the growth rate of knowledge

Capital dynamics based on dk‘/dt (with k‘:=K/(AL); AL is „labor in efficiency units), the steady state solution is now

y‘#:= (s/(a+n+δ))ß/(1-ß); note that k‘#= (s/(a+n+δ))1/(1-ß)

What happens if progress rate a is rising? At first y‘ falls, thereafter...


Four Key Aspects of Macroeconomic Development

1) Fixed exchange rate regime 1958-73; since 2013 flexible rates (vis-à-vis US $)

2) Normal cycles; recession and boom 3) Transatlantic banking crisis 2007-09 4) EU (Euro area & UK) and US facing debt

financing crisis in 2009-2013; how effective is fiscal policy in a period of very low central bank rates and high debt-GDP ratios (e.g. case of UK, Spain; worsening ratings)?


Three Important Issues (t time index, Y real output, P preice level, r interest rate)

Government budget deficit ratio; nominal stock of debt is B – thus (dB/dt)/(YP) is deficit ratio

Current account deficit-GDP ratio; if there is a current account deficit foreign indebtedness is rising; what is a critical value of foreign indebtedness? (if ratings have gone bad – close to C/bad BBB!?)

Debt-GDP ratio (b‘): rb‘ = ratio of interest expen-ditures to GDP; if increased then income tax rate τto be raised or government expenditures/Y to be cut!


Government Budget Constraint (G government expenditures in real terms; gY is the growth rate of output (dY/dt)/Y

(1) G + rB/P –τY= (dB/dt)/P Divide by Y (let γ denote G/Y), thus: (2) γ + rb‘ – τ = (dB/dt)/(PY) As db‘/dt = (dB/dt)/(PY) – b‘gY we get (3) db‘/dt = (γ – τ) + b‘(r – gY) Note that the primary deficit is the

deficit before interest payments (b‘r)


Looking at r: The role of risk

Risk premium for loans from companies

Risk premium for government bonds (B, C)

Risk-free interest rate (gov. bonds, AAA)


Banks, Loans, Investment Firms need loans for

1) investment financing (asymmetric information) 2) innovation financing, 3) Exporting (trade)

Banks like to give loans on the basis of collateral; loans on basis of cash-lending is complicated

Stiglitz/Weiss paper 1981: asymmetric information in loan market leads to credit rationing (price mechanism working?)

US firms rely mainly on capital markets, euro area firms on banks; hence banking problems more serious for EU


Fiscal policy, deficit and growth

Expansionary fiscal policy means to raise real government consumption (G) or to lower the income tax rate – this implies an increase in the deficit-GDP ratio; this might imply a worsening of the rating (if debt-GDP already is high). Is there a difference (case of rising G) if new roads/infrastructure built or promotion of private research & development etc. are emphasized on the expenditure side?

Expansionary monetary policy: Raising M relative to Y or lowering r; now 2008-12: in an environment of almost zero central bank interest rate – central bank buys government bonds (expansionary open market policy)


Macro Analysis/Model; endogenous are Y, r, e; (1) is equilibrium condition for goods market; (3) for foreign exchange market

Standard Macro Model (Mundell Fleming) (1) Y = C(Y-T) + I(r) + G + X(Y*,q*) – q*J(Y,q*)

Y = c(1- τ)Y –λr + G + xY*q* - jY; τ is income tax rate, v is positive parameter, X=xY*q*; real imports J= jY/q*; q* is the real exchange rate:= eP*/P (e exchange rate); λ>0.

(2) M/P = hY/(h‘r); assumption zero inflation: r=i; so r = hY/[h‘(M/P)]; money market equilibrium

(3) v(r-r*) = jY – xY*q*; flexible exchange rate r=[r* –(xY*eP*/(vP)] +(j/v)Y;slope in r-Y diagramm: j/v


Mundell Fleming Model (very high interest elasticity of capital flows = horizontal ZZ curve)


Y0

ZZ0

E0

LM0 IS0

Y

r0

r

0

Mundell Fleming Model in Fixed Exchange Rate System

Expansionary monetary (or fiscal) policy has effect on interest rate = change in demand/supply in foreign exchange market = disequilibrium Central bank will have to intervene: excess

demand requires that central bank sells reserves = reducing money supply (dM<0)

Excess supply requires that central bank buys foreign exchange = expansion of M 08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 16

a) Expansionary monetary policy b) Foreign exchange market under fixed exchange rate regime


Expansionary fiscal policy under fixed exchange rates


r1

r0 E0

E1

E2

LM1 LM0

ZZ0

IS0

IS1

r

Y Y2 Y0 0

(fiscal policy)

Standard Approach for Overcoming Recession

Mundell Fleming model (fixed versus flexible exchange rate):

Flexible exchange rate: Expansionary fiscal policy (rightward shift of IS curve in r-Y-space) will raise real interet rate – new intersection point of IS curve and LM curve) which is above the ZZ curve/balance of payments equilibrium line = excess supply of foreign exchange = appreciation of currency =decline of exports=leftward shift of IS curve; fiscal policy not effective; also: note that risk that there will be a high deficit= increase of debt-GDP ratio = worsening of rating

Expansionary monetary policy works (LM shifting to the right): interest rate falls= depreciation =higher exports = rightward shift of IS curve to the right


Expansionary monetary policy in a flexible exchange rate regime


Expansionary fiscal policy under flexible exchange rate regime (in E1: appreciation, net exports fall, IS1 -> IS2)


E0

r

r0

0 Y Y0

LM0 IS0

ZZ0

IS1

E1

E2

IS2

ZZ1 r1

New Issues after Transatlantic Banking Crisis 2008/09 and Euro Crisis 2010-2013

Central banks in the US, UK and euro area have reduced central bank interest rates to near zero (exhausting this instrument!): 2013 0.25% in euro area, close to zero in US and UK.

Quantitative easing: expansionary market policy of central bank which buys government bonds in the open market (normal instrument, but heavily used in UK/US in situation with central bank interest rate near zero 2008-2010)


Special Question for Situation of Low Initial Interest Rate

If central bank‘s interest rate already is very low what should central bank do? Bank of England and FED (US Central Bank) have switched to

Quantitative Easing = expansionary open market policy = buying large amounts of government bonds = reduces interest rate for government; in the US this policy (2008-2012) has helped; in the UK (Bank of England aquiring bonds of 15% of GDP), however, the interest rates for companies did not reduce much; so investment did not increase

ECB bought bonds only to a limited extent (2% of GDP) in 2010/2011 OMT (Outright Monetary Transactions, summer 2012)= new

conditional programme under which ECB buys bonds of a country with an ESM-sponsored adjustment programme (ESM = euro rescue fund)


Mundell Fleming Model Neglects Some Aspects

Structure of government expenditures not considered G= G‘ + G“ where G‘ is R&D promotion and public

investment; G“ is consumption Unclear role of expectations which are important for

investment (and consumption) Role of multinational companies and foreign direct

investment (share of foreign investors α* in K is neglected; FDI inflows depends on international difference of marginal product of capital!; parameter b(q*) depends on q*):

Y = c(1-τ)(1-α*ß)Y + I(r)+ b“(q*)(ßY/K –ß*Y/K) + Xnet(Y,Y*,q*); Note: If Y=Kß(AL)(1-ß); marginal product of capital is ßY/K


Stabilization Policy and Growth

Traditional challenge of market economies concern stabilization of output, prices; and achieving full employment

Extreme challenge was post-Lehman Brothers situation in the US, Europe, China, Japan etc. US: 2008 Economic Stimulus Act = 1,2% of GDP US: 2009 and 2010: 2.1% and 2.4% of GDP EU: fiscal stimulus about 1,1% in 2009, 0.8% in

2010; China 2009+ 08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 25

Open Economy Macroeconomics: Welfens, PJJ (2011), Innovations in Macroeconomics, 3rd ed.

Trade links countries

Foreign direct investment important for supply side

FDI in oligopolistic markets can create international interdepedence in reaction (counter-FDI)


Fiscal Policy Popular view: fiscal policy through automatic

stabilizers (unemployment compensation, progressive income taxes)

Problems with identification and implementation lag = problem of fiscal policy = scepticism about fiscal policy fine tuning

Size of multiplier dY/dG about 1 in Blanchard/Perotti (2002); GALI et al. (2007) find within VAR approach 0.78 on impact and 1.74 at the end of the second year


TURRINI/ROEGER/SZEKELY 2011 (ASSA conference paper, Atlanta)

Banking Crisis, Output Loss, and Fiscal Policy DSGE model (QUEST III) paper takes at look at 56

industrialized &emerging economies for 1970-2008 Fiscal policy matters during banking crisis If economic agents are more credit constrained

fiscal multipliers during banking crisis are higher as fiscal policy de facto alleviates these constraints

Fiscal policy through tax cuts seems to work well..; (but hardly possible for highly indebted countries)


Monetary Policy in Euro Area Lowering the central bank interest rate in 2011; in December 3 year liquidity injection into the banking system:

€ 490 bill. obtained by banks at ECB interest rate of 1%; also February 2012 another € 500 bill. injection of liquidity into banking system. New ECB programme for purchasing government bonds(Sept. 2012: „OMT“, conditional on adjustment programme in cooperation with rescue fund ESM) Brings down short term interest rates Greek problems still unsolved Stabilizes banks and some governments in Euro Area which is facing

debt crisis in Greece, Ireland, Portugal, Italy, Spain…


What Can Economic Policy Really Do?

Fiscal policy versus monetary policy Traditional view in the Mundell Fleming model is

that fiscal policy is effective in system of fixed exchange rate; while under flexible exchange rate regime monetary policy is effective

Question: Which policy is effective in a two country model (home country I, foreign country II); symmetric vs. asymmetric model

How can we take into account role of banking crisis and sovereign debt crisis



Long Run Growth

Analysis of economic growth is based on Savings function S= S(…) Macroeconomic production function (factor inputs

capital K and labor L); e.g. Cobb Douglas production function Y=KßL1-ß

Constant growth rate (n) of population Given depreciation rate of capital K


Long Run Development of Economy (τ income tax rate)

Short term fluctuations in Keynesian Model (1) Y = C(Y…) + I(r) + G + X(q*,Y*) – q*J(q*,Y) (2) M/P = m(Y,i); closed economy gives solution Keynesian model assumes unemployment and hence

aggregate demand (right hand side of equation determines real income)

One key issue is the consumption function C(…) Ct = c [1- τ]Yt or C = cYpermanent (expected long run

income: Friedman). Let Y# denote steady income C =(1- α)c[1- τ] Y + α[1- τ] Y#/(1+r) [see Welfens,2007]

Demand Driven Keynesian Model

Economy with underutilization of capacity Aggregate demand determines real GDP The higher the savings rate (s), the

lower is medium term equilibrium income


Simple Model of Closed Economy (World Economy)

1) Y =cY +[δK–b‘r] + G; uses side of GDP (δ is depreciation rate of capital; b‘ parameter which is positive)

Uses side of household income Y=C +S +T (T=0)

Consumption C=cY; gross investment [δK–b‘r]; if M/P= hY – h‘r (money market equilibrium). Hence r= (h/h‘)Y –(M/P)/h‘

Y =cY +[δ K– b‘(h/h‘)Y + (b/h‘)(M/P] + G

Y=[δK + (b/h‘)(M/P) + G]/[s + b‘(h/h‘)]; s=1-c 08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 34


Long Run Neoclassical Growth Model; real GDP is Y=KßL1-ß; y:=Y/L; k:=K/L; y=kß

Goods market equilibrium (closed economy) Savings 1) S= s(1- τ)Y; divide by L: S/L =s(1- τ)y; 2) S =dK/dt +δK (gross investment; δ is deprecia-tion

rate on the capital stock K; t time index) 3) S/L = (dK/dt)/L+ δk; here k is capital intensity

Note k:=K/L; hence we differentiation gives 4) dk/dt = (dK/dt)/L – nk; here n:= (dL/dt)/L 5) s(1- τ)kß = dk/dt + nk + δk 6) dk/dt = s(1- τ)kß – (n+δ)k; equilibrium dk/dt=0 k#=[s(1- τ)/(n+δ)]1/(1-ß) ; y#=[s(1- τ)/(n+δ)]ß/(1-ß)


Some Reflections on Neoclassical Growth; e‘ is Euler Number

Recall that labor develops over time L(t)= L0e‘nt y #= Y#/L = [s(1- τ)/(n+ δ)] ß /(1-ß)

Y# = {L0 [s(1- τ)/(n+ δ)]ß/(1-ß)} e‘nt; δ’:= 1-δ The higher s the higher equilibrium real GDP lnY# ≈ {lnL0 + ß‘[lns –τ+ δ‘ - n]} + nt

ß‘:= ß/(1-ß)-note that we have used ln(1+x) ≈x for x close to zero {…}level of the growth path; n is growth rate of output Change in output due to parameter shocks (e.g. savings ratio s,

income tax rate τ, populuation growth rate n…)

Graphical Solution (with τ=0)


dk/dt

Level of Growth Path (point F) and Growth Rate (tang α)


Effect of an Increase in Population Growth Rate n (in t‘)

Role of Knowledge

1) knowledge A(t); 2) growth rate of knowledge a:=dlnA/dt 3) Harrod-neutral technology/progress:

Y = Kß (AL) 1-ß ; labor-saving technological progress; AL is dubbed labor in efficiency units

Y/(AL):=y‘; k‘:=K/(AL) we can write y‘=k‘ß 08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 39


Consider Knowledge A and Technolo-gical Progress (e‘ is Euler number); AL is dubbed labor in efficiency units

1) Y=Kß (AL)1-ß; define y‘:=Y/(AL); 2) y‘=k‘ß; k‘:=K/(AL) Assumption about development of knowledge is A(t)= A0e‘at

Considering 3) S=sY(1- τ); 4) dk‘/dt =(dK/dt)/L + (a+n+δ)k‘ Growth rate (n) of labor and growth rate of knowledge(a) given 5) k‘# = [s(1- τ)/(a + n + δ)]1/(1-ß)

6) y‘# = [s(1-τ)/(a + n + δ)]ß/(1-ß)

7) Y# = e‘(a+n)t {[A0L0][s(1-τ)/(a + n + δ)]ß/(1-ß)} Growth rate of output is a+n; level {…} of growth path Rise of progress rate(a) raises growth rate of Y,but reduces the

level of the growth path (similar to rise of population growth n)


Level of Industrial Production and Trend Growth Rate, Euro Area (M / Q / Y)

60

70

80

90

100

110

120

1998

Q1

1999

Q1

2000

Q1

2001

Q1

2002

Q1

2003

Q1

2004

Q1

2005

Q1

2006

Q1

2007

Q1

2008

Q1

2009

Q1

2010

Q1

2011

Q1

Industrial Production Industrial Production (Trend using HP-Filter)Source: IFS Database

How Can One Measure Technological Dynamics

1) Information and communication technology is the most dynamic sector in OECD countries – in terms of innovation

2) Taking a look at ICT patent developments 3) Temporary acceleration of ICT patents per

capita (countries differ!)



ICT Patent Aplications at the European Patent Office (M / Q / Y)

0.000

5.000

10.000

15.000

20.000

25.000

30.000

35.000

40.000

45.000

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Greece Spain France Italy United KingdomSource: Eurostat


Endogenous Growth Model: Explaining Progress Rate (a)

Y# = e‘(a+n)t {[A0L0][s(1- τ)/(a + n + δ)]ß/(1-ß)} Note that output growth is a+n; the progress

rate a can be explained by investment (H) in research and development;

S= dK/dt + δK + H; let H =vY; a= v‘v [s(1- τ) – v]y‘ – (v‘v+n+δ)k‘= dk‘/dt Assume ß=0.5; k‘# = [s(1- τ) – v]/(v‘v+n+δ) Growth rate depends on parameters v‘ and v


Real GDP (left scale) and Annual Growth Rate in the Euro Area (Q)

0

500000

1000000

1500000

2000000

2500000

3000000

1996

Q1

1997

Q1

1998

Q1

1999

Q1

2000

Q1

2001

Q1

2002

Q1

2003

Q1

2004

Q1

2005

Q1

2006

Q1

2007

Q1

2008

Q1

2009

Q1

2010

Q1

2011

Q1

-6

-4

-2

0

2

4

6

8

10

Real GDP Annual Real GDP GrowthSource: Eurostat


Real GDP and Quarterly Growth Rate in the Euro Area (M / Q / Y)

0

500000

1000000

1500000

2000000

2500000

3000000

1995

Q1

1996

Q1

1997

Q1

1998

Q1

1999

Q1

2000

Q1

2001

Q1

2002

Q1

2003

Q1

2004

Q1

2005

Q1

2006

Q1

2007

Q1

2008

Q1

2009

Q1

2010

Q1

2011

Q1

-15

-10

-5

0

5

10

15

Real GDP Quarterly Growth Rate of Real GDPSource: Eurostat


Mexico Growth Rate of Real GDP (M / Q / Y)

-8

-6

-4

-2

0

2

4

6

8

10

12

14

1961 1966 1971 1976 1981 1986 1991 1996 2001 2006

Source: World Bank


Inflation Rates (M / Q / Y)

-2

0

2

4

6

8

10

1990

Q1

1991

Q1

1992

Q1

1993

Q1

1994

Q1

1995

Q1

1996

Q1

1997

Q1

1998

Q1

1999

Q1

2000

Q1

2001

Q1

2002

Q1

2003

Q1

2004

Q1

2005

Q1

2006

Q1

2007

Q1

2008

Q1

2009

Q1

2010

Q1

2011

Q1

United Kingdom United States EurozoneSource: IFS Database


Unemployment Rates in the Euro Area (M / Q / Y)

6

7

8

9

10

11

12

13

14

15

2005Q1 2006Q1 2007Q1 2008Q1 2009Q1 2010Q1 2011Q1

Source: Eurostat


Real GDP and Industrial Production in the Eurozone (M / Q / Y)

0

500000

1000000

1500000

2000000

2500000

3000000

1998

Q1

1999

Q1

2000

Q1

2001

Q1

2002

Q1

2003

Q1

2004

Q1

2005

Q1

2006

Q1

2007

Q1

2008

Q1

2009

Q1

2010

Q1

2011

Q1

0

20

40

60

80

100

120

Real GDP Industrial ProductionSource: Eurostat and IFS


Growth Rate of M3 in the Eurozone (M / Q / Y)

-2

0

2

4

6

8

10

12

14

1990

Q1

1991

Q1

1992

Q1

1993

Q1

1994

Q1

1995

Q1

1996

Q1

1997

Q1

1998

Q1

1999

Q1

2000

Q1

2001

Q1

2002

Q1

2003

Q1

2004

Q1

2005

Q1

2006

Q1

2007

Q1

2008

Q1

2009

Q1

2010

Q1

2011

Q1

Source: IMF Database


Growth Rates of M3 (M / Q / Y)

-5

0

5

10

15

20

25

1991

Q1

1992

Q1

1993

Q1

1994

Q1

1995

Q1

1996

Q1

1997

Q1

1998

Q1

1999

Q1

2000

Q1

2001

Q1

2002

Q1

2003

Q1

2004

Q1

2005

Q1

Germany M3 Growth USA M3 GrowthSource: IFS


Growth Rates of M1 (M / Q / Y)

-10

-5

0

5

10

15

20

25

30

1991

Q1

1992

Q1

1993

Q1

1994

Q1

1995

Q1

1996

Q1

1997

Q1

1998

Q1

1999

Q1

2000

Q1

2001

Q1

2002

Q1

2003

Q1

2004

Q1

2005

Q1

2006

Q1

2007

Q1

2008

Q1

2009

Q1

2010

Q1

2011

Q1

Germany M1 Growth USA M1 GrowthSource: IFS


Real Interest Rates in the Eurozone (M / Q / Y) (long term interest rate minus inflation rate)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

1998

Q1

1999

Q1

2000

Q1

2001

Q1

2002

Q1

2003

Q1

2004

Q1

2005

Q1

2006

Q1

2007

Q1

2008

Q1

2009

Q1

2010

Q1

2011

Q1

Source: IFS Database

International Competitiveness

Measurement Current account GDP Ratio (CA ratio<0!!) Share of high technology products or medium term

technology products in total production and exports; high technology: expenditures on research & development relative to sales exceed 8.5%; medium technology 3.5-8.5%.

Export unit value: development over time (relati-ve to benchmark country: relevant market e.g. EU)



Nace Classification Manufacturing

15 Manufacture of food products and beverages 16 Manufacture of tobacco products 17 Manufacture of textiles 18 Manufacture of wearing apparel; dressing and dyeing of fur 19 Tanning and dressing of leather; manufacture of luggage, handbags, saddlery, harness, footwear 20 Manufacture of wood and of products of wood and cork, except furniture; manufacture of

articles of straw and plaiting materials 21 Manufacture of pulp, paper and paper products 22 Publishing, printing and reproduction of recorded media 23 Manufacture of coke, refined petroleum products and nuclear fuel 24 Manufacture of chemicals and chemical products 25 Manufacture of rubber and plastic products 26 Manufacture of other non-metallic mineral products 27 Manufacture of basic metals 28 Manufacture of fabricated metal products, except machinery and equipment 29 Manufacture of machinery and equipment n.e.c. 30 Manufacture of office machinery and computers 31 Manufacture of electrical machinery and apparatus n.e.c. 32 Manufacture of radio, television and communication equipment and apparatus 33 Manufacture of medical, precision and optical instruments, watches and clocks 34 Manufacture of motor vehicles, trailers and semi-trailers 35 Manufacture of other transport equipment 36 Manufacture of furniture; manufacturing n.e.c.


Greek Export Unit Value (EUV) Relative to Germany (M/Q /Y)

Nace 2000 2001 2002 2003 2004 2005 2006 2007 200815 1.50 1.34 1.45 1.47 1.51 1.50 1.41 0.99 0.6116 0.10 0.10 0.10 0.09 0.09 0.09 0.09 0.14 0.2117 0.63 0.62 0.63 0.71 0.66 0.59 0.48 0.52 0.6118 1.90 1.73 1.47 1.36 1.53 1.70 1.82 2.03 1.8619 3.14 3.32 1.10 1.34 1.53 1.77 1.80 1.78 1.3820 1.77 1.94 2.32 2.53 2.47 2.61 2.71 2.90 2.5121 0.90 0.89 0.84 0.90 0.89 0.88 0.81 0.76 0.8422 1.56 1.31 1.50 2.11 2.59 2.67 2.62 2.93 3.2823 0.85 0.79 0.66 0.52 0.59 0.66 0.79 0.80 0.7424 0.58 0.62 0.67 0.78 0.89 0.96 0.97 0.94 1.0225 0.71 0.73 0.74 0.75 0.74 0.72 0.79 0.79 0.8726 0.18 0.19 0.24 0.28 0.28 0.25 0.24 0.26 0.3227 1.23 1.29 1.25 1.09 0.91 0.80 0.82 0.82 0.7528 1.01 1.03 1.03 0.93 0.91 0.86 0.85 0.84 0.8629 0.63 0.62 0.59 0.58 0.58 0.60 0.47 0.44 0.5030 0.97 1.22 0.98 1.34 1.56 2.35 4.59 11.04 11.8631 0.35 0.33 0.30 0.27 0.34 0.38 0.45 0.54 0.7432 2.18 2.33 2.47 2.55 2.31 2.13 1.15 2.12 1.9833 0.84 0.97 1.03 0.91 0.72 0.61 0.64 1.22 1.3834 0.66 0.69 0.79 0.88 0.87 0.78 1.44 2.09 2.4935 1.57 1.61 0.89 0.11 0.08 0.11 0.34 0.69 0.7036 1.86 1.75 1.82 1.89 1.84 1.68 1.43 1.31 1.37


Italian EUVs relative to Germany (M / Q / Y)

Nace 2000 2001 2002 2003 2004 2005 2006 2007 200815 0.98 1.01 1.00 0.88 0.74 0.64 0.70 1.83 2.5916 0.63 0.59 0.67 0.76 0.84 0.71 0.69 0.42 0.3417 2.31 2.36 2.25 2.22 2.35 2.49 2.26 1.90 1.4918 0.95 1.23 1.28 1.49 1.22 1.46 1.85 1.46 0.9119 1.28 1.00 0.68 0.56 0.65 0.73 0.99 0.93 0.9320 1.93 1.92 1.71 1.34 1.23 1.06 1.11 0.96 1.0121 1.61 1.62 1.65 1.54 1.52 1.52 1.51 1.51 1.3422 0.54 0.64 0.58 0.45 0.34 0.33 0.34 0.32 0.3023 0.89 0.87 0.82 0.82 0.78 0.72 0.58 0.59 0.6524 2.53 2.35 2.10 1.68 1.50 1.30 1.28 1.30 1.2925 1.25 1.21 1.18 1.19 1.22 1.24 1.19 1.07 1.0026 7.16 6.72 5.88 5.23 5.63 6.46 6.63 6.23 5.4227 0.86 0.84 0.90 1.14 1.28 1.33 1.24 1.20 1.4428 0.91 0.93 0.92 0.95 0.98 1.11 1.16 1.12 1.1129 1.09 1.13 1.20 1.27 1.27 1.23 2.17 2.14 2.2330 1.37 1.15 3.98 3.55 3.63 0.60 0.79 0.52 0.4931 1.53 1.63 1.76 1.85 1.68 1.57 1.34 1.21 1.0732 0.34 0.30 0.28 0.24 0.38 0.47 1.01 1.12 1.3133 0.52 0.59 0.82 1.14 1.31 1.11 0.79 0.41 0.8334 1.22 1.15 1.03 0.88 0.89 0.96 0.95 0.91 1.0335 13.06 2.05 4.12 8.64 13.82 13.59 9.52 2.61 1.6936 0.55 0.57 0.57 0.55 0.55 0.54 0.64 0.64 0.63


Spanish EUVs relative to Germany (M / Q / Y)

Nace 2000 2001 2002 2003 2004 2005 2006 2007 200815 1.26 1.28 1.23 1.40 1.50 1.70 1.57 1.53 1.4516 7.91 8.63 6.84 7.73 8.49 11.23 12.35 14.61 11.7017 0.64 0.55 0.51 0.52 0.60 0.67 0.82 0.90 1.1718 2.54 2.43 2.33 1.36 1.35 1.14 0.75 2.10 2.7919 1.24 1.28 1.22 1.27 1.12 1.09 0.92 1.12 1.5020 0.65 0.62 0.60 0.70 0.70 0.66 0.48 0.41 0.4521 0.73 0.73 0.72 0.71 0.71 0.81 0.96 1.13 1.0922 1.14 1.20 1.21 1.20 1.19 1.30 1.13 1.13 1.0123 1.03 1.00 1.12 1.10 1.08 1.06 1.07 1.19 1.3724 0.57 0.61 0.64 0.67 0.66 0.66 0.66 0.66 0.6425 1.11 1.08 1.06 1.04 1.10 1.16 1.25 1.39 1.3926 0.78 0.75 0.73 0.75 0.78 0.76 0.76 0.74 0.7527 1.16 1.13 1.08 1.06 1.05 1.10 1.10 1.12 0.9828 0.88 0.89 0.89 0.90 0.87 0.84 0.84 0.88 0.8829 1.02 1.03 0.95 0.92 0.89 0.96 0.93 0.98 0.9630 0.46 0.59 0.59 0.79 0.80 0.99 1.07 3.50 3.7131 1.01 0.97 0.97 0.96 0.98 1.03 1.19 1.32 1.5032 0.47 0.56 0.68 0.96 1.03 1.00 0.95 1.07 1.3233 1.37 1.25 1.11 0.93 0.91 1.05 1.13 1.35 1.0834 1.05 1.07 1.08 1.08 1.07 1.16 0.95 0.73 0.3935 0.82 0.56 0.79 1.12 1.42 1.54 1.63 2.60 2.7636 0.96 0.83 0.84 0.88 1.00 1.03 0.98 1.07 1.11


French EUVs relative to Germany (M / Q / Y)

Nace 2000 2001 2002 2003 2004 2005 2006 2007 200815 0.73 0.71 0.70 0.71 0.77 0.76 0.77 0.74 0.7616 1.12 0.95 0.93 0.85 0.71 0.59 0.42 0.40 0.5517 0.94 1.09 1.32 1.14 1.01 0.97 1.05 0.99 0.8918 0.74 0.70 0.76 0.95 1.07 1.17 1.07 0.82 0.5519 1.01 0.98 1.37 1.43 1.74 1.47 1.19 0.73 0.4520 0.47 0.46 0.46 0.45 0.46 0.57 0.66 0.76 0.7221 1.00 0.96 0.93 0.89 0.87 0.79 0.72 0.61 0.6222 1.03 1.04 1.09 1.13 1.13 1.03 1.20 1.17 1.2623 1.44 2.33 3.13 3.94 3.80 3.61 4.15 3.73 3.5824 1.49 1.37 1.35 1.36 1.34 1.36 1.35 1.39 1.4225 1.08 1.13 1.16 1.17 1.09 1.08 1.05 1.06 0.9926 1.30 1.32 1.35 1.27 1.20 1.21 1.23 1.20 1.1127 0.68 0.68 0.67 0.65 0.65 0.64 0.68 0.70 0.7828 1.23 1.21 1.27 1.26 1.32 1.36 1.42 1.42 1.4329 1.21 1.19 1.30 1.31 1.32 1.17 1.18 1.10 0.9330 1.59 1.48 1.29 1.50 1.31 1.13 0.81 0.89 0.8931 1.28 1.36 1.41 1.24 1.13 0.97 1.00 0.99 1.0532 3.27 2.92 1.78 1.89 1.59 1.94 2.10 2.43 2.2733 1.20 1.58 1.54 1.71 1.86 2.22 2.67 2.90 3.0434 1.08 1.07 1.07 1.07 1.08 1.05 1.08 1.22 1.3935 4.12 4.97 4.04 2.89 2.13 1.59 1.21 0.58 0.7536 1.20 1.38 1.42 1.40 1.23 1.31 1.32 1.22 1.05


UK EUVs relative to Germany (M / Q / Y)

Nace 2000 2001 2002 2003 2004 2005 2006 2007 200815 1.91 2.04 2.07 1.97 1.91 1.87 1.86 1.78 1.6916 1.61 1.24 1.45 1.88 2.18 2.14 2.37 2.46 2.2617 1.52 1.57 1.42 1.82 1.80 1.75 1.57 1.48 1.4418 1.16 1.19 0.99 0.64 0.53 0.56 0.66 0.90 1.1419 0.90 1.04 1.22 1.34 1.25 1.19 1.67 1.55 1.8220 2.01 1.83 1.53 1.47 1.48 1.38 1.30 1.42 1.5221 1.29 1.26 1.21 1.20 1.19 1.18 1.14 1.14 1.1822 3.08 3.04 2.86 2.82 2.65 2.56 2.64 2.68 2.6123 0.77 0.70 0.58 0.51 0.55 0.55 0.53 0.53 0.5124 1.27 1.29 1.24 1.18 1.17 1.16 1.17 1.17 1.1625 1.16 1.18 1.17 1.13 1.09 1.03 1.01 1.02 1.0926 1.35 1.49 1.39 1.36 1.34 1.28 1.20 1.11 1.1627 1.50 1.50 1.45 1.50 1.54 1.58 1.50 1.37 1.3128 1.48 1.51 1.44 1.36 1.22 1.15 1.11 1.11 1.0029 0.91 0.98 1.09 1.20 1.18 1.22 1.23 1.19 1.2930 1.14 1.18 1.20 1.16 1.46 1.41 1.36 1.46 1.4131 1.63 1.74 1.76 2.15 2.07 2.15 1.71 1.53 1.2132 1.83 2.03 2.23 1.66 1.40 0.90 0.78 0.55 0.5533 2.94 0.82 0.72 0.91 0.88 0.89 0.91 0.88 0.7034 1.07 1.09 1.07 1.05 1.04 1.10 1.48 1.81 2.1135 1.06 0.97 0.82 0.64 0.70 1.35 1.43 1.38 0.7136 1.52 1.65 1.59 1.60 1.52 1.41 1.56 1.82 2.12


Traditional Macro Models vs. New Keynesian Economics NKE

Traditional models have certain characteristics: they are mainly backward-looking expectations are not important or expectations play

a role but as adaptive expectations –with expectation formation based on the history of the variable = bias in „learning“ of economic agents

Lucas critique (traditional models): As institutional setup/policy changes agents learn; historical corre-lation patterns collapse = difficult to make forecast; DSGE better as institutions are built into the model

not much forward-looking (intertemporal choice)


New Keynesian Econonomics Key elements

Monopolistic competition = market power= mark-up pricing P=(W/(Y/L))(1+ϕ); W/(Y/L) is unit labor cost; ϕ mark-up which is a cyclical variable

Rational expectations (John Muth) = forward-looking behavior

Market imperfections = wage and price stickiness Matching frictions in labor markets Moral hazard in labor markets System is no guarantee for full employment Possible multiple equilibriums


Simple New Keynesian Models in a Stochastic Context (stochastic distur-bance terms u”, v”); rational expectations

(1) Ydt = G”t + b(m”t – pt) + u”t ; (m“ is lnM, p is lnP)

(2) Yst= Y# + h(pt – p’t) + v”t ; b and h positive parameters

(3) Yt = G”t + b(m”t – pt) + u”t

(4) Yt = Y# + h(pt – p’t) + v”t Apply expectation operator E: (5) YE

t = G”Et + b(m” Et – p’t)

(6) YEt = Y#

p’ is expected price level: (7) p’t = m”Et – (Y# – G”E

t )/b (8) Yt – YE

t = (G”t–G”Et) + b(m”t – m” Et) – b(pt–p’t) + u”t

(9) Yt – YEt = h(pt – p’t) + v”t


The Non-neutrality of Economic Policy in a Consistent New Keynesian Models

(8) Yt – YEt = (G”t–G”E

t) + b(m”t – m” Et) – b(pt–p’t) + u”t

(9) Yt – YEt = h(pt – p’t) + v”t

(10) pt = p’t + [1/(b + h)] [ (G”t – G”Et) + b

(m”t – m” Et) + u”t – v”t]; b and h parameters

(11) Yt = Y# + [h/(b + h)] [ (G”t – G”Et) +

b(m”t – m” Et) + u”t + b/h v”t]


Some Leading Scholars of NKE

Mankiw & Romer: book New Keynesian Economics, Vol. 1, 2; (micro foundations, 1991)

Michael Woodford: Interest and Prices: Foundations of a Theory of Monetary Policy

Goodfriend, Gali, Blanchard, Kiyotaki


NKE DSGE Models Dynamic stochastic equilibrium models

(with rational expectations) Goods market and labor market etc. considered in a

stochastic context; Raondom shocks: White noise error term (e.g. η) in each

equation: expectation value E(η) is zero, finite variance σ Monopolistic firms face price stickiness; Output is a function of household‘s real demand which is

partly determined by (monopolistic) price level interaction of housholds, firms, gov., central bank; „Special

technique“ to solve models with rational expectations


DSGE Models (continued) Dynamic model which shows how the economy system is

developping over time Stochastic quasi-Walrasian system Households:

Maximize utility function (consumption, leisure) Firms

Profit maximization Government: Budget constraint (aim: e.g. full employment,

welfare maximization?); central bank: low inflation rate (price stability)


Competing Schools of DSGE Modelling

Approaches: Real business cycle (RBC) model is based on

neoclassical growth model in a setting with flexible prices: Real shocks to the system can cause business cycle flutuations (KYDLAND/PRESCOTT, 1982; GOODFRIEND/KING, 1997)

New-Keynesian DSGE based on a structure which is similar to RBC but here prices set in a system of monopolistic competition and adjustment costs (ROTEMBERG/WOODFORD, 1997; GOODFRIEND/KING, 1997; CLARIDA/GALI/GERTLER, 1999; GALI, 2008)


Read the following papers Goodfriend, M.; King, R. (1997), The New Neoclassical

Synthesis and the Role of Monetary Policy, NBER Macroeconomics Annual 1997, Vol. 12, p. 231 -296.

Clarida, R.; Gali, J.; Gertler, M. (1999), The Science of Monetary Policy: A New Keynesian Perspective, Journal of Economic Literature, Vol. 37, 1661-1707.

Sbordone, A.; Tambalotti, A.; Rao, K.; Walsh K. (2010), Policy analysis using DSGE models: an introduction, Federal Reserve of New York Economic Policy Review 16 (2)

Paper by STIGLITZ


Critique on DSGE

Wllem Buiter: DSGE models are unable to catch the largely non-linear economic dynamics

Counter-argument/Woodword: DSGE is evolutionary development along Keynesian macro modeling…

Kocherlakota (FED of Minneapolis): argues that DSGE models not useful for analyzing the financial crisis of 2007-2010

US Congress hosted hearings on macroeconomic modeling approaches (July 20, 2010) to understand why financial crisis 07/08 not foreseen: Solow critique (assumptions: DSGE presents economy like a „machine“) ; V.V. Chari defends DSGE: heterogenous actors are considered


Some Criticism (Welfens, 2012a, Welfens 2011: Innovations in Macroeconomics, 3rd edition)

Moral hazard in capital markets/the banking system! Hybrid consumption function is more realistic

(microfoundation can always be found if empirical finding for hybrid function ok; Welfens 2011)

Investment function is not consistent with steady state: proposed solution see Welfens (2012a)

Implausible that households behavior etc. is not affected by the size of the variance of disturbance terms (e.g. in the goods market; see Welfens 2012a and the following reflections)


Modern NKE Models: Rational Expectations and New Keynesian Economics (e.g. GOODFRIEND)

Rational expectations revolution (MUTH): Economic agents are forward-looking Expectation formation based on a model of the economy =

rational expectations There are, however, random shocks so that people cannot

adjust in a perfect manner; but people have „on average“ expectations which are correct.

Debate on Phillips curve looks different under rational expectations than under adaptive expectations: No short-term trade off that can be exploited by policymakers (here: central bank)


Short-term and Long-run Phillips Curve

π

π1

π2

0 u0 u2 u

G F

LP

E H

SP0

SP1

u1

expected inflation rate is low

Higher expected inflation rate

Long term Phillips Curve

Short term Phillips curve

Simple theoretical perspective: V is velocity, Y is real GDP

Quantity equation M V = P Y gP = gM – gY (assuming V is constant; g

is growth rate); central bank can raise the growth rate of stock of money (M); could be M1 (cash+time deposits) or M3

If Y=Kexpß (AL)exp(1-ß); gY = ßgK + (1-ß)(a+n);



New Keynesian Models There are rigidities in labor markets or

goods markets (realistic adjustment costs) People: rational expectations about inflation

rate; expectations also relevant for other variables. Unclear with respect to gov. Debt (see the debt crisis in OECD countries 2010/11)

Households maximize utility of consumption within a model of intertemporal optimization: Infinitely lived households with time preference ρ Ricardian households (Ricardo equivalence theorem)


What the Ricardo Equivalence Theorem Says/Implies

Should government finance infrastructure investment rather through issuing government bonds or through imposing immediately higher tax rates? Ricardo equivalence emphasizes that both ways

of financing public infrastructure are equivalent If government relies for a new project on issuing

government debt households will effectively interprete higher debt as a promise that government will impose higher future tax rats…


Government budget constraint in a gro-wing economy (b“ is the debt GDP ratio)

(1) G + rB/P –τY = (dB/dt)/P; define b“:= (B/P)/Y

(2) G/Y + rb“ - τ = db“/dt + b“gY; for simplicity we will assume a constant price level Denoting (dY/dt)/Y:= gY and taking into account that we

have by definition db“/dt = [(dB/dt)/P]/Y – b“gY

Implication of (2) for db“/dt<0 thus is: (2.1) db“/dt = (γ – τ) + [b“(r - gY)] Debt-GDP ratio will fall if primary surplus –(γ – τ)

exceeds [b“(r - gY)]; long run: neoclassical model gY = a+n

DOMAR Model on Debt and Growth

DOMAR (1944) assumes that θ is exogenous deficit GDP ratio

Assume that growth rate is given: a+n Long run debt-GDP ratio b“= θ/(a+n)

If the trend deficit ratio is 1% and the growth rate of output is 2% the implication is that the long run debt-GDP ratio is 0.5


Deficit-GDP Ratio

Deficit-GDP ratio = total deficit/GDP Deficit without interest payments relative

to GDP is the primary deficit ratio



Table: Primary deficit-GDP ratio in OECD countries

0

20

40

60

80

100

120

2011

2009

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

1979

1977

1975

1973

1971

Germany France United Kingdom United StatesSource: Ameco Database


Table: Primary deficit-GDP ratio in OECD countries

0

20

40

60

80

100

120

140

160

180

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

Greece Portugal Spain ItalySource: Ameco Database


The Ricardian Equivalence is Important in Several Ways:

Issuing new governments bonds can be inter-preted as announcing a higher future tax rate

Definition of private sector wealth has to be consistent: nominal wealth A“ = M + (1-ε)B + P‘K where M is the stock of money, B is government bonds (short-term), P‘ is the stock market price index and ε (in the interval 0,1) the „Ricardian parameter“: If ε= 1 we have full Ricardian equivalence


Can Government Excape Ricardian Equivalence?

Government faces problem that high debt-GDP ratio will raise fear of higher future income tax rates or of higher future inflation

Government could rely on selling more debt to foreigners who in turn are unlikely to anticipate that acquiring foreign bonds will mean higher future income tax rates…


Monetary Policy (Taylor Rule) Popular Taxlor Rule suggests that central

bank should fix nominal interest rate i on the basis of simple formula: i = r (normal real rate) + difference between actual πt and target infla-tion rate π“ plus element reflecting role of out-put gap (the difference between full employment equili-brium

output Y# and current output Y t ; parameters ψ and ψ’>0): i t = r t + ψ(π t – π“) + ψ‘(Y t – Y#)

Central banks seem to follow Taylor rule


Impulse response function:

Consider (any) dynamic system of equations: Impulse = external shocks (e.g. technology shock,

change of time preference, change of degree of risk aversion, fiscal policy, monetary policy – anticipated or not??)

The impulse response shows the reaction of the system‘s variables over time

APPLICATION: DSGE models of central banks, IMF or European Commission


VAR Models The structure of a VAR model is such that

the vector of variables Xt is explained by Xt-n and exogenous policy vector Zt

No a priori assumption about the causal links is needed

Important to understand how strong the influence of past Xt-n are (and how far backward a significant impact is)

Simulations: Policy impact, BAU scenario


Inflation, the Phillips curve and monetary policy: x is output, u, e, v are stochastic disturbance terms

Aggregate Supply Aggregate Demand Monetary Policy Rule (Interest Rate rule/Taylor)

tttt uxxk +−+= − )(1ππ

ttttt eixxxx +−−−=− −

∗−

∗ )()( 11 πλφ

ttx

Ttt vxxri +−+−+= ∗∗ )()( αππαπ


New-Keynesian Model (forward-looking)

Aggregate Supply

Aggregate Demand

Monetary Policy Rule (Interest Rate)

ttttt ukxE ++= −1πβπ

ttttttt eEixEx +−−= −− )( 11 πλ

ttx

Tt

Tt vxri ++−++= ∗ αππαπ π )(


Simple production function and profit maximization (A is knowledge or - indeed - labor productivity!)

ALY tt =

t

t

t

t

t

t

LY

Ap

WLY

===δδ

)1( tt

ttt m

YLW

p +=

xx =+ )1log( x is smaller than 0,01

m: Price Mark up Mark up fluctuates counter-cyclical. Intuition: Boom in t, i.e. current inflation is higher than expected inflation. Companies increase prices not so strong to avoid price adjustment costs in the next period.


)( 1 tttm πβπα −= +

))(1(1 1 tt

t

tt

YpLW

πβπαα

−+= +

zz ≈+ )1ln( if z is small

ttttt ypw απαβπα −+−−−= +1)()(0

[ ])()(21

1 tttttt ypw −−−+= +βππ

xyyt =− ∗


Wage Setting Rule Wage Rule (small case letters are logs!) Labor Demand

)exp( 0

1 γγt

tEt

t LLY

pW

=

)exp( 0

1 γγt

t

tEtt L

LY

pW

=

01)( γγ ++−=− ttt

ett ypw

tttt ypw −=−


Equilibrium Employment

Output Gap

t

et pp = 001 =+∗ γγ

00 γγ −=∗

)()( 1∗−+−=− ttttt ypw γ

)()( 1∗−+=−−− ttttt ypw γ

∗∗ −=−= ttt yyx ay tt += ay += ∗∗


Household Optimization 1: Maximize discounted life time consumption

[ ]∑ ∑∞

=

∞

=−− −++−+=

0 011

)()1(log

t ttttt

tttt

t

BcYCBrBCLMax

tt

βλβ 1<tβ

)1(

11 ρρ

−≈+

ρρ −≈− )1ln(

),( tt BCLL =

01=−= t

tt CCL λ

δδ

t

tt CCL λ

δδ

==1

0)1(1 =+−= + tttt

rBL βλλ

δδ


Household Optimization 2

)1(

11

tt

t

r+=+

βλλ

)1(1

tt

t r+=+

βλλ

)1(1

tt

t rC

C+=+ β

t

t

t rC

C+≈

+ βlnln 1

prgC −≈



Concave utility function: households try to avoid fluctuations in consumption. E is prefered to the average of F and F’.



)1()1(1 prr

CC

ttt

t −+=+=+ β

β)1(1

t

tt r

CC+

= +

1<β e

e−≈

+= 1

11β

)1(1 erCC ttt −++=+

)1(1 erCC ttt −+−= +



Equilibrium #CCt =

#rr =

#CCx tt −=

)( #1 rrxx ttt −−= +


Traditional Model

)()( 1∗−+−=− ttt

ett ypw γ

1−−=∆ ttt www

1−−= t

et

et ppπ

)()()()( 11111∗

−−−− −+−−−=−−− ttttttettt yyppww γ

1111 −−−− −=− tttt ypw


Expectations

)( 1111 −−−− ∆−∆−∆== ttttet yw ππ

tttt yw ∆−∆+=∆ π

)()()( 11∗

− −+∆−∆+=∆−∆+ ttttttt yy γππ

)(11∗

− −+= ttt γππ

+

=

−

−

−

−

t

t

t

t

t

t

t

t

t

UeU

aaa

iYA

iY 1

3231

21

1

1

1

101001 πππ


Collateral Constraint

t

Httt HPXDest =

tt YaaC 10 += ↓↓CY

−

+

+= ∑∞

=0)1(

11

j

wt

j

t tYr

BFC

ettri π+=


Some Impulse Response Patterns of Euro Area

Impulse= change in exogenous variable

Response = change in the endogenous variable (over time)

Special Issue … Traditional issue of fiscal policy versus

monetary policy New issue in an environment with (close to) 0

central bank interest rate = special challenge (recession) in 08/09/10/11 in Japan, UK and US

Quantitative Easing in Japan, UK and UK (expansionary open market operation: central bank buys government bonds = dM>0)


Effects of Quantitative Easing Central bank interest rate 0; but UK/US in

recession – so what should be done? Main effects in UK (and US) in 2009/10

Interest rates falls by about 1 % Nominal and real depreciation of British pound

and $ stimulates net exports of goods and services = appreciation of the Euro in 2009/2010

Also direct fiscal expenditure effect (or tax cutting effect): see WELFENS (2012a) 08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 104

The impact of a banking crisis on fiscal multipliers: alternative channels


(1) Forward-looking aggregate demand schedule derived from the Euler equation of inter-temporally maximising agents, where Xt is the output gap, itB is the nominal interest rate charged by the banking sector, π t is inflation, gt is a government expenditure shock, ut

d is a demand shock, and Et is the expectation operator

(2) Standard forward-looking new-Keynesian Phillips curve

(3) Standard Taylor rule summarising the behaviour of monetary

policy

(4) Bank interest rate decision rule



(5) Government expenditure multiplier

While at the zero bound:



(6) Panel autoregressive model to assess the impact of banking crises on real GDP growth and potential growth

(7) Model to estimate the impact of a banking crises on fiscal policy

Temporary Increase in Government Consumption (1/2)


Note: RIC_ : model with 40% liquidity constrained, 60% Ricardian households; CC_ : model with 40% liquidity

constrained, 30% Ricardian households and 30% credit-constrained households.

Temporary Increase in Government Consumption (2/2)


Source: Turrini, A.; Roeger, W.; Székely, I.P. (2011): Banking Crises, Output Loss, and Fiscal Policy

Temporary Increase in Government Consumption with Monetary Policy at the Zero-Bound (1/2)




Temporary Increase in Government Consumption with Monetary Policy at the Zero-Bound (2/2)



Temporary Reduction in Labour Taxes (1/2)




Temporary Reduction in Labour Taxes (2/2)



Temporary Reduction in Labour Taxes with Monetary Policy at the Zero-Bound (1/2)




Temporary Reduction in Labour Taxes with Monetary Policy at the Zero-Bound (2/2)



Documents

Paul J.J. Welfens