MIT14_02F09_lec14_15_ans

MIT14_02F09_lec14_15_ans - Classical Classical vs Keynesian...

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Classical Classical vs vs Keynesian Theory Keynesian Theory
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To sum up: What is an Equilibrium? SHORT RUN EQUILIBRIUM: AD = SRAS and IS = LM The Labor Market need not be in equilibrium We need not be at the potential level of GDP Y* If Y<Y* we are in a recession , if Y>Y* in a boom LONG RUN EQUILIBRIUM: AD = SRAS = Y* and IS = LM = Y* and N d = N s = N* By definition, the labor market will clear y, By definition, we will move to Y* . 2
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Classical Theory
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Real Business Cycle (RBC) h t ll d i th b i l ? What really drives the business cycle? Kydland and Prescott developed the RBC theory that argues that al shocks to the economy are the primary cause of business cycle real shocks to the economy are the primary cause of business cycle. Real shocks are shocks that affect the production function, the size of e labor force the spending and savings decisions Nominal shocks the labor force, the spending and savings decisions,…Nominal shocks are shocks to money supply or demand particular the RBC theory refer to roductivity shocks In particular the RBC theory refer to productivity shocks The RBC theory is consistent with our IS-LM and AD-AS models. A negative productivity shock (A decreases) has two effects: gp y ( ) 1) reduces MPN and hence the demand for labor and N* 2) Decreases Y* directly 4 Both effects make Y* to decrease (LRAS) and hence LM has to adjust!
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Real Business Cycle (RBC) 5 Real interest rate, r Output, 1 IS LM 1 FE 1 E Output, 1 2 IS LM 1 LM 2 FE 1 FE 2 E F 2. Prices increase 2. Adverse supply shock Figure by MIT OpenCourseWare.
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Real Business Cycle: Facts Consistent with the following stylized facts: 1) Continuous productivity shocks generate recurrent fluctuations 2) Employment will move procyclically 3) Real Wages will be higher in booms ) verage labor productivity is procyclical 4) Average labor productivity is procyclical Fact 4 is crucial: with no productivity shocks, the expansion of ployment during booms will tend to reduce average labor employment during booms will tend to reduce average labor productivity because of diminishing marginal returns! Fact against RBC: inflation tends to slow down during or immediately after recessions (is this evidence controversial?) 6 For RBC theory a negative shock is associated with inflation!
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Real Business Cycle: Calibration 7 Standard deviation (percent per year) 6 5 4 3 2 1 0 Real GNP Consumption Investment Inventory stocks Total hours worked Productivity Variable Actual Simulated using the RBC model Figure by MIT OpenCourseWare.
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Classical Economists lassical Economist believe that adjust instantaneously Classical Economist believe that adjust instantaneously This implies that money is neutral, that is, monetary shocks do not affect real variables Evidence: money is very procyclical!
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MIT14_02F09_lec14_15_ans - Classical Classical vs Keynesian...

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