00206BBA28D XXXXXXXXXX
Slide 1
Assessment
2
Assessments Due XXXXXXXXXX
Mid-Semester test Week 7 in class 25% 25%
Essay (hand in+turnitin) Week 9 in class 10% --
Mini Research Workshop Week 12 in class 10% 20%
Final exam TBA 55% 55%
3
Topics
❖ Topic 1 (Week 1-3). Quick refresher on ISLM, ASAD and
dynamic macroeconomic models
❖ Topic 2 (Week 4-5). The design and implementation of
monetary policies; unconventional monetary policy
instruments; the optimal monetary policy;
❖ Topic 3 (Week 6). The design and implementation of
macroprudential regulation
❖ Topic 4 (Week 8-9). The design and implementation of
fiscal policies; government debt and inflation; the
intertemporal government budget constraint.
❖ Topic 5 (Week XXXXXXXXXXThe design and implement of
exchange rate policies; The impossible trinity; Optimal
cu
ency areas and the euro;
4
Week 1
Refresher of the IS-
LM model, and the
ole of expectations
PowerPoint to accompany:
Think macroeconomics as…
6
Questions: What are the things come to your mind when you think
about macroeconomics?
Think macroeconomics as…
7
Questions: What are the things come to your mind when you think
about macroeconomics?
• How output (GDP) is determined?
• What drives inflation?
• Is 5% of population unemployed a problem?
• How GDP is related to inflation?
• Why central bank lowers interest rate and government consolidate budget?
Think macroeconomics as…
• Markets:
• Goods market
• Money market
• Labour market
• Financial market
8
• Decisions:
• Consumption decisions
• Investment decisions
• Fiscal/Monetary decisions
• Export/Import decisions
Questions: What are the things come to your mind when you think
about macroeconomics?
• How output (GDP) is determined?
• What drives inflation?
• Is 5% of population unemployed a problem?
• How GDP is related to inflation?
• Why central bank lowers interest rate and government consolidate budget?
The Goods Market
The total demand for goods is written as:
Z C I G X IM + + + −
9
or in a closed economy:
Z C I G + +
Australian investment (23% of GDP) is less than half
of consumption (60%) but much more volatile
Investment is more volatile
than consumption.
Consumers do not increase
consumption more than one
for one with increases in
income. Investment, on the
other hand, may exceed an
increase in cu
ent sales.
Consumption and investment
usually move together. Both
components contribute
oughly equally to fluctuations
in output over time.
Questions
• What are the key factors drive consumption?
• What are the key factors drive investment?
11
Questions
• What are the key factors drive consumption?
• What are the key factors drive investment?
12
C C YD= ( )
( )+
Y Y TD −
( , )I I Y r= The effects of two factors
affecting investment:
▪The level of sales (+)
▪The real interest rate (-)
▪We shall assume that G and T are also exogenous.
Questions: What is real interest rate?
Nominal Versus Real Interest Rates
it = nominal interest rate for year t.
t = real interest rate for year t.
(1+ it): Lending one dollar this year
yields (1+ it) dollars next year.
Alternatively, bo
owing one dollar
this year implies paying back (1+ it)
dollars next year.
Pt = price this year.
Pet+1= expected price next year.
expected rate of inflation equals
13
e t
e
t t
t
P P
P
−+1
Consequently,
( )1
1
1
+ =
+
+
i
t
t
e
t
If the nominal interest rate and the expected rate of inflation are not too large, a
simpler expression is:
e
t t tr i −
Nominal and Real Interest Rates in Australia since 1976
• Central banks can only control the short-run nominal interest rate
• For the time being lets assume ??
? = 0 so i = r for simplicity
--- = nominal interest rate – actual future inflation rate
2019
Goods market equili
ium: IS curve
Equili
ium in the goods
market requires that
production, Y, be equal to
the demand for goods, Z:
Y Z=
Then:
? = ?(? − ?) + ?(?, ?) + ?
An increase in taxes
(or a decrease in G)
shifts the IS curve to
the left.
A fall in business
confidence reduces
investment and shifts
IS curve to the left
Shifts of the IS Curve
? = ?(? − ?) + ?(?, ? − ??) + ?
0.09
0.11
0.13
0.15
0.17
0.19
0.21
0.23
0.25
4.00
6.00
8.00
10.00
12.00
14.00
16.00
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M
$
Y
. R
a
tio
o
f m
o
n
e
y
to
a
n
n
u
a
l n
o
m
in
a
l in
c
o
m
e
.
i.
I
n
te
e
s
t
R
a
te
(
%
)
Ratio of money to
nominal income (M/$Y)
Interest Rate (i)
The Demand for Money
▪ Money, which can be used
for transactions, pays no
interest. There are two types
of money:
*cu
ency
*cu
ent account deposits
▪ Bonds, pay a positive
interest rate, i, but they
cannot be used for
transactions. (Term deposits
are equivalent)
Money Market
Type of Asset
M YL id = $ ( )
The demand for money:
▪ increases in proportion to nominal
income ($Y), and
▪ depends negatively on the interest
ate (L(i)).
Questions: Why money demand is
important?
Money Supply, Monetary Policy and Open-Market
Operations
The assets of the central bank are the bonds it holds. The liabilities are
the stock of money in the economy. An open-market operation in
which the central bank buys (sells) bonds and issues(withdraws)
money increases(reduces) both assets and liabilities by the same
amount.
Monetary Policy and Open-Market Operations
An increase in the
supply of money leads
to a decrease in the
interest rate.
The Effects of an
Increase in the
Money Supply on the
Interest Rate
Equivalently, if the
central bank wants to
lower the interest rate,
it must increase the
supply of money
Equili
ium in the money market: LM relation
The interest rate is determined by the equality of the supply
of and the demand for money:
M = nominal money stock
$YL(i) = demand for money
$Y = nominal income
P = price level
i = nominal interest rate
$ XXXXXXXXXXdM M YL i PYL i= =
The LM relation: In equili
ium, the real money supply
is equal to the real money demand, which depends on real
income, Y, and the interest rate, i:
M
P
YL i= ( )
Deriving the LM Curve
Equili
ium in financial markets implies that an
increase in income leads to an increase in the interest
ate. The LM curve is upward-sloping.
Shifts of the LM Curve
An increase in
money leads the
LM curve to shift
down.
M
P
YL i= ( )
Putting the IS and the LM Relations Togethe
▪ Equili
ium in the goods
market implies that an
increase in the interest rate
leads to a decrease in
output.
▪ Equili
ium in financial
markets implies that an
increase in output leads to an
increase in the interest rate.
▪ When the IS curve intersects
the LM curve, both goods
and financial markets are in
equili
ium.
IS relation: Y = − + +C Y T I Y i G( ) ( , )
LM relation:
M
P
= YL i( )
The IS-LM Model
Questions: How fiscal and
monetary may affect the economy?
Fiscal Policy, Activity, and the Interest Rate
▪ Fiscal contraction, or fiscal consolidation, refers to
fiscal policy that reduces the budget deficit.
▪ An increase in the deficit is called a fiscal expansion.
An increase in taxes
shifts the IS curve to the
left, and leads to a
decrease in the
equili
ium level of
output and the
equili
ium interest rate.
Monetary Policy, Activity, and the Interest Rate
▪ Monetary contraction, or monetary tightening, here
efers to a decrease in the money supply.
▪ An increase in the money supply is called monetary
expansion.
Monetary expansion
leads to higher
output and a lower
interest rate.
Using a Policy Mix
▪ Monetary and fiscal policy is never conducted in complete
isolation.The combination of monetary and fiscal policies
is known as the monetary-fiscal policy mix.
▪ To see the importance, consider fiscal contraction (G or
↑T), with 2 alternative approaches to monetary policy:
1. Central bank keeps M constant
2. Central bank keeps i constant at i0
(Most central banks use 2. They decide on i and allow M to be
determined endogenously in market equili
ium)
Five Australian Policy Mixes, XXXXXXXXXX
3. Howard-Macfarlane
Tight fiscal,
easy monetary.
2. Keating-Frase
Easy fiscal,
easy monetary.
1. Hawke-
Johnston/ Frase
Tight fiscal,
tight monetary.
4. Howard-
Macfarlane
Stevens
Tight fiscal,
tight monetary
5. Rudd/Gillard-
Stevens
Easy fiscal,
easy monetary.
Expectations
28 Ben Wang 2013
Questions:
• How do you form your expectations, say on interest rate? inflation?
• Do people’s expectations about future matter to the performance of
the economy?
• If yes, in what way?
The Stock Market
Standard & Poor’s ASX 200
Stock Price Index, in
Nominal and Real Terms,
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Australian nominal stock prices have
een multiplied by about 9 since
1980. Real stock prices have only
multiplied by almost 2.5.
After the October 1987 stock-market
crash, real stock prices went through
a slump until 1993.The upward trend
ended in
Australia in September 2007, and the
nominal index fell by 45 per cent in
the next 1.5 years, while the real
index fell by 49 per cent.
Stock prices follow a random walk if each step they take is as likely to be up as it is to be
down. Their movements are therefore unpredictable.
Major movements in stock prices cannot be predicted. But we can look back and explain
how macro news has affected the market.
Questions: How do you think the share price of Apple is determined?
Stock Prices as Present Values
The price of a stock should equal the present value of
future expected dividends
$
$
( )
$
( )( )
Q
D
i
D
i it
e
t
t
e
t
t
e
t
=
+
+
+ +
+
+ +
+
1
1
2
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▪ In real terms,
1 2
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