Macroeconomic Policies
Gang Gong
Copyright Notes:This electronic file is
only used as a lecture notes for the
student in this class,It is not allowed to
be used for presentation anywhere else
without the permission from the author.
Introduction
? The objective of this chapter is to move
from theory to empiric,Specially,we shall
study how macroeconomic policies can be
applied to solve practical macroeconomic
problems.
Introduction
? There are basically two macroeconomic
problems on which the macroeconomic
policy can have its effect.
– Unemployment
– Inflation
The Relation between Inflation
and Unemployment
? From our all market model as established in
the last time,we could find a negative
relation between inflation and
unemployment (please consider how?)
? Yet,this is only reflected in a theoretical
model,how about in empiric?
The Relation between Inflation
and Unemployment
? The Original Phillips Curve,A,W,Phillips
(1957) find a significant negative relation
between unemployment and the growth rate
of nominal wage,In particular,he estimates
where w is the growth rate of wage (note
that the estimated ? is negative.
tt uw ????
The Relation between Inflation
and Unemployment
? The modern Phillips curve that economists
use today differs in three ways from what
Phillips examined,
– First,the modern Phillips curve substitutes
price inflation for wage inflation,This
substitution is reasonable (since price inflation
and wage inflation often move together).
The Relation between Inflation
and Unemployment
– Second,the modern Phillips curve includes
expected inflation.
– Third,the modern Phillips curve include the
supply shock.
The Relation between Inflation
and Unemployment
? The importance of Phillips Curve:
– Theoretically,it supports Keynesian
macroeconomics,
– Empirically,it indicates a trade-off between the
two most important macroeconomic problems,
Therefore,solving one problem may cause the
other.
? Debates on the Phillips curve (will be
presented in the class).
Macroeconomic Policy,
Overview
? The macroeconomic policy can be executed
by either government (ministry of finance)
or central bank
? The direct effect of macroeconomic policy
is to change aggregate demand,Therefore
the policies are often named,the demand
management policy.”
Macroeconomic Policy,
Overview
? Expansionary versus Contractionary,
– A macroeconomic policy that increases the
aggregate demand is considered to be an
expansionary (fiscal or monetary) policy,It is
often applied when the economy is in recession
(low growth and low inflation and high
unemployment)
Macroeconomic Policy,
Overview
? Expansionary versus Contractionary
– A macro economic policy that reduces the
aggregate demand is considered to be a
contractionary (fiscal or monetary) policy,It is
often applied when the economy is in
expansion (high growth and high inflation and
low unemployment)
Macroeconomic Policy,
Overview
? Fiscal Policy
– executed by government (ministry of finance)
– two instruments:
? change government expenditure
? change tax rate
– often accompanied with the budget deficit (or
surplus)
Macroeconomic Policy,
Overview
? Fiscal Policy
– three ways of financing government spending
? issuing bond
? printing money (seignorage)
? tax
Macroeconomic Policy,
Overview
? Monetary Policy
– executed by central bank
– three instruments,
? open market operation (buying or selling the
government bond)
? change discount rate
? change required reserve ratio
Problems,Debates and
Development
? The Problem of Stagflation
– Definition,the co-occurrence of inflation and
unemployment
– Cause,supply shocks (positive or negative,
shift the AS curve and Phillips curve)
– Problem,no macroeconomic policy could be
applied
– Empiric Cases,Oil crisis,Recent U.S,
Experience,South Africa
Problems,Debates and
Development
? Debates on Expansionary Fiscal Policy
– crowding-in and crowding-out
– sustainability
– the argument from rational expectation
assumption
– nonlinear effect
– the spending structure
Problems,Debates and
Development
? Development on Monetary Policy
– Before 1980’s,the target of monetary policy in
most developed countries is to control M1 or
M2,or M3,Usually,the target is often
unachieved,
– Why? In many cases,money could be
endogenous as argued by Kaldor among others,
– Recently,many countries,including U.S.,
follow the Taylor rule,that is,targeting the
federal fund rate.
Gang Gong
Copyright Notes:This electronic file is
only used as a lecture notes for the
student in this class,It is not allowed to
be used for presentation anywhere else
without the permission from the author.
Introduction
? The objective of this chapter is to move
from theory to empiric,Specially,we shall
study how macroeconomic policies can be
applied to solve practical macroeconomic
problems.
Introduction
? There are basically two macroeconomic
problems on which the macroeconomic
policy can have its effect.
– Unemployment
– Inflation
The Relation between Inflation
and Unemployment
? From our all market model as established in
the last time,we could find a negative
relation between inflation and
unemployment (please consider how?)
? Yet,this is only reflected in a theoretical
model,how about in empiric?
The Relation between Inflation
and Unemployment
? The Original Phillips Curve,A,W,Phillips
(1957) find a significant negative relation
between unemployment and the growth rate
of nominal wage,In particular,he estimates
where w is the growth rate of wage (note
that the estimated ? is negative.
tt uw ????
The Relation between Inflation
and Unemployment
? The modern Phillips curve that economists
use today differs in three ways from what
Phillips examined,
– First,the modern Phillips curve substitutes
price inflation for wage inflation,This
substitution is reasonable (since price inflation
and wage inflation often move together).
The Relation between Inflation
and Unemployment
– Second,the modern Phillips curve includes
expected inflation.
– Third,the modern Phillips curve include the
supply shock.
The Relation between Inflation
and Unemployment
? The importance of Phillips Curve:
– Theoretically,it supports Keynesian
macroeconomics,
– Empirically,it indicates a trade-off between the
two most important macroeconomic problems,
Therefore,solving one problem may cause the
other.
? Debates on the Phillips curve (will be
presented in the class).
Macroeconomic Policy,
Overview
? The macroeconomic policy can be executed
by either government (ministry of finance)
or central bank
? The direct effect of macroeconomic policy
is to change aggregate demand,Therefore
the policies are often named,the demand
management policy.”
Macroeconomic Policy,
Overview
? Expansionary versus Contractionary,
– A macroeconomic policy that increases the
aggregate demand is considered to be an
expansionary (fiscal or monetary) policy,It is
often applied when the economy is in recession
(low growth and low inflation and high
unemployment)
Macroeconomic Policy,
Overview
? Expansionary versus Contractionary
– A macro economic policy that reduces the
aggregate demand is considered to be a
contractionary (fiscal or monetary) policy,It is
often applied when the economy is in
expansion (high growth and high inflation and
low unemployment)
Macroeconomic Policy,
Overview
? Fiscal Policy
– executed by government (ministry of finance)
– two instruments:
? change government expenditure
? change tax rate
– often accompanied with the budget deficit (or
surplus)
Macroeconomic Policy,
Overview
? Fiscal Policy
– three ways of financing government spending
? issuing bond
? printing money (seignorage)
? tax
Macroeconomic Policy,
Overview
? Monetary Policy
– executed by central bank
– three instruments,
? open market operation (buying or selling the
government bond)
? change discount rate
? change required reserve ratio
Problems,Debates and
Development
? The Problem of Stagflation
– Definition,the co-occurrence of inflation and
unemployment
– Cause,supply shocks (positive or negative,
shift the AS curve and Phillips curve)
– Problem,no macroeconomic policy could be
applied
– Empiric Cases,Oil crisis,Recent U.S,
Experience,South Africa
Problems,Debates and
Development
? Debates on Expansionary Fiscal Policy
– crowding-in and crowding-out
– sustainability
– the argument from rational expectation
assumption
– nonlinear effect
– the spending structure
Problems,Debates and
Development
? Development on Monetary Policy
– Before 1980’s,the target of monetary policy in
most developed countries is to control M1 or
M2,or M3,Usually,the target is often
unachieved,
– Why? In many cases,money could be
endogenous as argued by Kaldor among others,
– Recently,many countries,including U.S.,
follow the Taylor rule,that is,targeting the
federal fund rate.
