Lecture 11 Slides After

Lecture 11 Slides After - Economics 134 Spring 2012...

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L ECTURE 11 Extending the IS/MP/IA Framework February 21, 2012 Economics 134 Christina Romer Spring 2012 David Romer

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Announcement Problem Set 2 is being distributed. It is due a week from today.
I. I NTRODUCTION

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II. T HE IS-MP-IA M ODEL E XTENDED
Key Assumptions: 1 The nominal interest rate cannot be negative The central bank would like to set r = r(Y, π ). Since the real interest rate, r, equals i – π e , this means that r cannot be less than 0 – π e . Thus: + = otherwise π 0 0 π π) , Y ( r if ) π , Y ( r r e e

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Key Assumptions: 2 In the baseline model, expected inflation follows actual inflation That is, π e = π .
Two Comments before We Proceed We will continue to use the usual IS-MP-IA model (that is, the model without the zero lower bound) in cases where it is appropriate. Although the assumption that expected inflation follows actual inflation is a natural starting point, it is often not a great approximation. Thus, we will need to be careful in using this assumption.

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Where We Are Headed: The Aggregate Demand Curve Accounting for the Zero Lower Bound Y π AD
The IS and MP Curves Accounting for the Zero Lower Bound: Step 1 Y r r(Y, π ) 0 – π e IS

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The IS and MP Curves Accounting for the Zero Lower Bound: Step 2 Y r MP 0 – π IS
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Lecture 11 Slides After - Economics 134 Spring 2012...

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