Macroeconomics Lectures Semester I 1999 Shortrun Economic Fluctuations x 6 lectures Note 1 At the last class (4/10) I derived the trade balance multiplier in respect of an autonomous increase in spending for the simple Keynesian model as: (dT/dE(bar))= (dM(bar)/dE(bar))x(s/(s+m))x(m/(s+m))(1) Suppose (dM(bar)/dE(bar))=0 (ie. all spending is on goods of domestic origin)then (1) becomes (m/(s+m))(1)(a) Contrast this result with the case of an autonomous increase in exports (you'll remember this as the first comparative static experiment)where the corresponding multiplier was obtained as (dT/dM*)= 1m/(s+m) (2) So what's the intuition for the difference in the multipliers in 1(a) and (2)? In (2)there is a direct impact on the trade balance hence the unity term as well as an indirect effect. Note that if (dM(bar)/dE(bar))=0 then the national inomce multipliers are identical under the first and third comparative static experiments. Essay No. 1 "Macroeconomic Stabilisation Policy in a Small Open Economy" This essay should review the theory of stabilisation policy in an SOE to include Keynesain and rational expecations perspectives. Where relevant the essay should also refer to pertinent empirical evidence. Length: c. 5000 words max. and word processed Deadline: November 15 1999 Note 1 18/10/99 "The Missing dp" Upon reviewing my notes I discovered that I had actually postmultiplied the partical derivative (dT/dp) by DP!! so the result presented as (dp/e^)=(a*+a1)M*e^ should have read (dp/e^)DP =(a*+a1)M*e^ Note: dp (lower case) is partial derivative and DP (upper case) is the total derivative. Also a* etc denotes "alpha". If you've any queries please email me. PCM and Monetary Policy 1/11/99: REVISED 30/11/99 The material I commenced today is taken from Dornbusch Ch. 10 (p. 175) Revisiting the D. diagram (p.178) This diagram is another way (relative to the traditional ISLMBP diagram) of depicting the idea that under a fixed exchange rate system with PCM the money supply is endogenous and hence monetary policy is ineffective. Take eqt 2(a) p. 177. Suppose D increases, holding everything else constant, then the money supply is increased, domestic interest rates fall and there is a capital outflow (a fall in R used to prop up the currency) that exactly matches the rise in D. In the diagram on p.178 this would be shown by a leftward shift in the diagram and with r=r* reserves would fall to exactly match the rise in D so there is no change in R+D. This point can be made in a different way. Suppose Y increases and holding everything else constant (this I didn't do earlier today because I implied that D changed as well!!) the demand for money increases (ie L(r,Y)) shifts up and hence so does L(r,Y)D ,remember D is assumed constant. What happens? The interest rate r would be bid upwards which would tend to attract a capital inflow. The CB would then have to buy up foreign currency (selling national currency) to stave off an appreciation of the national currency which implies an increase in reserves, R and hence the money supply grows to match the additional demand. In terms of the diagram the L(r,Y)D curve shifts up and the new equilibrium occurs where the interest rate (unchanged) cuts the new L(r,Y)D curve. R is seen to increase. Let's look at the detailed processes whereby the additional money demanded is satisfied by a change in reserves: Step 1: money demand rises as Y rises (transactions'motive) Step 2: domestic bond owners sell bonds to increase money in their wealth portfolio. If they sell off some of their foreign bond holdings this causes a rise in demand for Irish £s. as IR£s are repatriated to the domestic economy. This rise would also be supplmented by foreigners demanding Ir£s. because of the initial high interest rates. This additional demand for £s forces the CB to buy up foreign currency (selling national currency) to prevent the appreciation so reserves grow by a matching amount and hence the domestic money supply. A note on the traditional ISLMBP model With PCM the money supply is endogenous. As Dornbusch notes on the bottom of p.179 this implies that the LM is perfectly elastic (horrizontal) at the given world interest rate. One can rationalise this with the traditional upward sloping LM curve by interpreting the upward sloping LM curve as a highly shortrun curve. This aids the understanding the process of adjustment. Thus if there is a fiscal expansion. The IS shifts up the very shortrun LM curve which tends to raise interest rates causing a capital inflow and a shift of this very shortrun LM curve to the right as R increase. This very shortrun curve shifts until interest rates are back at the given world levels. Thus the longrun LM curve under PCM may be interpreted as a flat curve drawn through the given world interest rate. I intend to post some sample short Qs. for Thursday. Some Sample Questions Update on Exams 7/12/99 The format of the M.A. macro exam will be different to last year. Students must answer three questions from a choice of any six. There will be no compulsory short Qs but there will be a question of the type (not compulsory)which requires you to answer 3 "shorts" from a choice of 6 (1 of these will be from Maurice's material). Four of the remaining 5 questions will be based on my lectures (2 on open economy macro); 2 on growth and 1 from Maurice. Some Sample Qs  Open Economy Macro Shorts 1) Interpret the exogenous expenditure multiplier in a Keynesian model with repercussion effects 2) Explain the Jcurve effect 3) Explain the relationship between Net Foreign Assets and the Current Account of the BOP 4) What is meant by the endogeneity of the money supply under PCM? 5) Explain why monetary policy is effective when domestic and foreign assets are imperfectly substitutable. 6) Explain the "offset coefficient" 7) Provide a brief intuition for Dornbusch's "overshooting" result. Essays 1) Explain the short and long run effects of a fiscal contraction. What would be the consequences if there were also a simultaneous monetary expansion? 2) Discuss stabilisation policy in the presence of real wage resistance. 3) What are the impications of capital mobility assumptions for the conduct of stabilisation policy. 4) Is it rational to postulate that the expected change in the exchange rate is inversely related to the change in the actual exchange rate? Growth questions given on HANDOUT Clarification re exams 4/1/00 Short Qs. Do 3 of 6. Of the 6 I've set 5 and Maurice has set 1. Three of mine relate to shortrun economic fluctuations and 2 to growth.

