Econ110BW11 - Lec 24- GRol

Econ110BW11 - Lec 24- GRol - Macroeconomics B Econ 110B,...

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Macroeconomics B Econ 110B, Winter 2011 Prof. Giacomo Rondina Lecture 24
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Depressions and Slumps ¾ Disinflation, Deflation and Liquidity Trap ± Automatic Stabilizer ± What can go wrong? o Inflation Expectations (Deflationary Expectations) o Liquidity Trap o Deflation – Liquidity Trap Spiral 2 Depressions and Slumps (Ch. 22)
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Depressions and Slumps ± Automatic Stabilizer 3 Depressions and Slumps (Ch. 22) IS i Y LM i 0 Y 0 Y N ² equilibrium is at output below the natural rate ( Y 0 <Y N ) ² when Y 0 <Y N unemployment rate is above natural rate, u 0 >u N ² when u 0 >u N inflation slows down (Phillips Curve) so that π t < π t-1 ( disinflation) ² disinflation affects real money growth. Suppose that, initially, g m - π = 0, so that M/P is constant. When π then g m - π > 0 and so M/P . Therefore LM shifts right. ² stabilization process stops when Y=Y N . LM’ LM’’ M/P
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Depressions and Slumps ± Automatic Stabilizer Breakdown: ¾ Deflationary Expectations 4 Depressions and Slumps (Ch. 22) IS i Y LM i 0 Y 0 Y N ² previous argument kept expected inflation constant as π ² when π ( disinflation) it is possible that π e ² if this happens the IS will shift left (downward) ² output will not recover as fast as before LM’ LM’’ IS’ IS’’ Y 1 Y 2 π e M/P
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Depressions and Slumps ± Automatic Stabilizer Breakdown: ¾ Deflationary Expectations 5 Depressions and Slumps (Ch. 22) IS i Y LM i 0 Y 0 Y N ² previous argument kept expected inflation constant as π ² when π ( disinflation) it is possible that π e ² if this happens the IS will shift left (downward) ² output will not recover as fast as before LM’ LM’’ IS’ IS’’ π e M/P Y 1 Extreme case: ² if π e faster than i (from M/P ) then i π e = r (strong shift in IS) ² if r output will not increase, the stabilization process will not take place
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Depressions and Slumps ± Automatic Stabilizer Breakdown: ¾ Liquidity Trap 6 i M/P i A What is a Liquidity Trap? ² as i demand for money is higher (demand for bonds is lower) ² when i = 0 agents are indifferent between holding money or bonds ² when i = 0 any additional amount of money supplied will not change the nominal interest rate. M d M/P A M S /P M’ S /P M’’ S /P i B M/P B M/P C i C Deriving the LM with Liquidity Trap i M/P M d M S /P M d =YL ( i ) M’ d d Y i LM i i’ i’’ Y’ Y’’ Y Let Y’’<Y’<Y M d =YL ( i ) M’ d =Y’L ( i ) d =Y’’L ( i ) Liquidity Trap
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Depressions and Slumps ± Automatic Stabilizer Breakdown: ¾ Liquidity Trap 7 Depressions and Slumps (Ch. 22) IS i Y LM i 0 Y 0 Y N ² automatic stabilizer: When π then g m - π > 0 and so M/P . Therefore LM shifts right.
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This note was uploaded on 01/18/2012 for the course ECON 101 taught by Professor Bansak during the Summer '07 term at San Diego State.

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Econ110BW11 - Lec 24- GRol - Macroeconomics B Econ 110B,...

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