Lecture 8 Slides

Lecture 8 Slides - Economics 210c/236a Fall 2011 Christina...

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L ECTURE 8 Monetary Policy at the Zero Lower Bound October 19, 2011 Economics 210c/236a Christina Romer Fall 2011 David Romer
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I. P AUL K RUGMAN , “I T S B AAACK : J APAN S S LUMP AND THE R ETURN OF THE L IQUIDITY T RAP
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Krugman’s Baseline Model – Assumptions (I) Discrete time. Identical, infinitely-lived agents. Representative agent has U = t D t ln c t , 0 < D < 1. Each agent receives an endowment y of the consumption good each period. Can sell endowment for money, and buy goods with money. Economy is competitive and prices are perfectly flexible (!). Perfect foresight.
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Krugman’s Baseline Model – Assumptions (II) Cash-in-advance constraint. Within period t: Agents start with some holdings of money and bonds (from period t-1). There’s then a market for trading money and bonds. Call the representative agent’s holdings after these trades M t and B t . The cash-in-advance constraint is c t ≤ M t /P t . After the agent has bought and sold goods, it receives interest on its bond holdings, and any lump-sum taxes or transfers are implemented. The cash-in-advance constraint and perfect foresight imply that c t = M t /P t or i t = 0 (or both).
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Households’ First-Order Condition Suppose the economy is in equilibrium, and consider an agent thinking of spending $1 less on c t and using the proceeds to increase c t+1 . => … => (*) Note that this holds even if i t = 0. ) y / 1 )( P / 1 ( MC t = ) y / D ]( P / ) i 1 [( MB 1 t t + + = 1 ) P / P )( D / 1 ( i t 1 t t = +
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The Steady State with Constant M Suppose M is constant at some level (denoted M*). If there is a steady state, P is constant. Call this P*. Then equation (*), , simplifies to for all t, or Note that i* > 0. 1 ) P / P )( D / 1 ( i t 1 t t = + 1 ) D / 1 ( i t = . D / ) D 1 ( * i =
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The Possibility of a “Liquidity Trap” Assume that starting in Period 2, the economy is in steady state.
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Lecture 8 Slides - Economics 210c/236a Fall 2011 Christina...

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