NoteClassical

NoteClassical - Lecture Note on Classical Macroeconomic...

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1 Lecture Note on Classical Macroeconomic Theory Econ 135 - Prof. Bohn This course will examine the linkages between money and interest rates in more detail than Mishkin’s book. While you have taken intermediate macro, most of Mishkin’s book is meant to be accessible to much less prepared students. Interest rates interact with output, inflation, and the price level. The topic is therefore an opportunity to examine the overall macro effects of monetary policy. Mishkin provides a synopsis in the book’s final chapters, but not a full analysis. The class will largely follow this note. Section 1 gives you an broader introduction and overview. Section 2 covers the interaction of money, prices, and inflation in a market-clearing “Classical” model where money is “neutral.” Section 3 comments briefly on optimal policy. Keynesian analysis is split off into a separate lecture note—to follow. My lecture notes are intended to supplement Mishkin and to establish common ground for discussing macroeconomic questions. Different instructors in Principles and Intermediate Macro place different emphasis on Keynesian versus Classical theories. Suggestions: (1) Study whichever theory your previous instructors emphasized least. (2) Try to reconcile any conflicts with what you have learned before (if any). Seemingly conflicting answers are usually due to differences in assumptions that can be clarified if you ask—don’t hesitate to ask me. 1. Overview on Money and Interest Rates How does monetary policy affect interest rates? Mishkin’s Chapter 5 provides several perspectives essentially side-by-side, without much integration. To fill in the gaps, I asked you to stop reading after you have read the examples on Expected Inflation/Fisher effect and on Business Cycles. The next topic in Mishkin would be Liquidity Preference Analysis, which – as we will see – requires assumptions that are inconsistent with the Fisher effect. Everyone agrees that increased money supply causes inflation. The Fisher effect implies therefore that increased money supply should raise interest rates. Yet financial analysts and policy makers widely agree that increased money supply reduces interest rates “in the short run” because it provides “liquidity” to financial markets. (The terms in quotes will be explained.) Mishkin goes on to conclude that an increased money supply may reduce interest rates, or raise them, or reduce and raise them at different times, all depending on the relative magnitude of various “liquidity”, “income”, “price”, and “expected inflation” effects. One objective of this and the next Lecture Note is to give you a better understanding of these claims and show how they claims relate to what you may have learned in Econ 101.
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2 The central analytical issue is the Neutrality of Money (or non-neutrality). Money is called neutral if monetary changes have no impact on real economic activity. Some economic theories, often labeled Keynesian, presume that money does influence real output and real interest rates. Other theories, often
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NoteClassical - Lecture Note on Classical Macroeconomic...

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