a dynamic model of aggregate demand and aggregate supply - bilgin bari … · 2018. 7. 17. ·...

IntroductionElements of ModelSolving the Model

Monetary Policy

A Dynamic Model of Aggregate Demand andAggregate Supply

Bilgin Bari

Bilgin Bari A Dynamic Model of Aggregate Demand and Aggregate Supply


Monetary Policy

1 IntroductionTheoritical Backround

2 Elements of Model

3 Solving the Model

4 Monetary Policy



Monetary Policy

Theoritical Backround

Introduction I

The model emphasizes the dynamic nature of economicfluctuations.

The economy is continually exposured by various shocks.

These shocks have on immediate impact on economy’sshort-run equilibrium.

The model focuses attention on how output and inflationrespond over time to exogenous changes in the economicenvironment.

The model explicitly incorporates the response of monetarypolicy to economic conditions.



Monetary Policy

Output : The Demand for Goods and Services I

Yt = Yt − α(rt − ρ) + εt

Yt : the total ouput of goods and servicesYt : the economy’s natural level of outputrt : the real interest rateεt : random demand shockα, ρ : parameters greater than zero

the key feature : the negative relationship between the realinterest rate (rt) and the demand for goods and services (Yt)

the parameter α shows how sensitive demand is to changes inthe real interest rate.

Yt is economy’s natural level of output.



Monetary Policy

Output : The Demand for Goods and Services II

εt is random variable whose values are determined by chance.

It is zero on average but fluctuates over time.Animal spirits are captured by εtIt also captures changes in fiscal policy.

ρ is the real interest rate at which, in the absence of anyshock ( εt = 0 ) the demand for goods and services equals thenatural level of output.

We can call ρ the natural level of interest.

ρ plays a key role in the setting of monetary policy.



Monetary Policy

The Real Interest Rate : The Fisher Equation

rt = it − Etπt+1

Etπt+1 is the expectation of what the inflation rate will be inperiod t+1 based on information avaliable in period t.



Monetary Policy

Inflation : The Phillips Curve I

πt = Et−1πt + φ(Yt − Yt) + υt

Et−1πt : previously expected inflationYt − Yt : the deviation of output from its natural levelυt : exogenous supply shock

Inflation depends on expected inflation because some firms setprices in advance.



Monetary Policy

Inflation : The Phillips Curve II

φ(φ > 0) shows how much inflation responds when outputfluctuates around its natural level.

φ reflects both how much marginal cost responds to the stateof economic activity and how quickly firms adjust prices inresponse to changes in cost.

υt is supply shock. It is a random variable whose averagevalue is zero.



Monetary Policy

Expected Inflation : Adaptive Expectations

Etπt+1 = πt

People form their expectations of inflation based on theinflation the have recently observed.



Monetary Policy

The Nominal Interest Rate : The Monetary-Policy Rule

it = πt + ρ+ θπ(πt − πTt ) + θY (Yt − Yt)

rt = it − πt = ρ+ θπ(πt − πTt ) + θY (Yt − Yt)

for the equilibrium : πt − πTt and Yt − Yt

we get rt = ρ



Monetary Policy

The Taylor Rule

it = πt + 2.0 + 0.5(πt − 2.0) + 0.5(Yt − Yt)



Monetary Policy

Equations


rt = it − Etπt+1


Etπt+1 = πt

it = πt + ρ+ θπ(πt − πTt ) + θY (Yt − Yt)



Monetary Policy

The Starting Point : The Long-Run Equilibrium

The long-run equilibrium represents the normal state aroundwhich the economy fluctuates.

It occurs when there are no shocks (εt = υt = 0) and inflationstabilized (πt = πt − 1)

Yt = Yt ; rt = ρ ; πt = πttT ; Etπt+1 = πTt ; it = ρ+ πTt

The long-run equilibrium of this model reflects two relatedprinciples : the classical dichotomy and monetary neutrality.



Monetary Policy

The Dynamic Aggregate Supply Curve




Monetary Policy

The Dynamic Aggregate Demand Curve I

We begin with the demand for goods and services


to eliminate the endogenous variable rt , we use Fisher equation

Yt = Yt − α(it − Etπt+1 − ρ) + εt

to eliminate another endogenous variable it , we put Taylor rule andadaptive expectations

Yt = Yt − α[πt + ρ+ θπ(πt − πTt ) + θY (Yt − Yt) − πt − ρ] + εt



Monetary Policy

The Dynamic Aggregate Demand Curve II

equation simplifies to

Yt = Yt − α[θπ(πt − πTt ) + θY (Yt − Yt)] + εt

solving for Yt

Yt = Yt − [αθπ

(1 + αθY )](πt − πTt ) − [

1

(1 + αθY )]εt



Monetary Policy

The Dynamic Aggregate Demand Curve III



Monetary Policy

The Short-Run Equilibrium I

Dynamic Aggregate Demand

Yt = Yt − [αθπ

(1 + αθY )](πt − πTt ) − [

1

(1 + αθY )]εt

Dynamic Aggregate Supply

πt = πt−1 + φ(Yt − Yt) + υt



Monetary Policy

The Short-Run Equilibrium II



Monetary Policy

Long-Run Growth



Monetary Policy

A Shock to Aggregate Supply



Monetary Policy

A Shock to Aggregate Demand



Monetary Policy

A Shift in Monetary Policy



Monetary Policy

The Tradeoff Between Output and Inflation

Yt = Yt − [αθπ

(1 + αθY )](πt − πTt ) − [

1

(1 + αθY )]εt



Monetary Policy

References

Mankiw, Macroeconomics, 9th Edition - Chapter 15


a dynamic model of aggregate demand and aggregate supply - bilgin bari … · 2018. 7. 17. ·...

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