paul j.j. welfens
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Introduction to Lecture Simulation Models for Policy Analysis
Paul Welfens (Part I : Welfens) and Werner Röger
(Part I I : invited) -Based on 2011 – update Jan. 2014
-Preliminary
Paul J.J. Welfens
Europäisches Institute für internationale Wirtschaftsbeziehungen/European Institute for International Economic
Relations (EIIW, www.eiiw.eu); University of Wuppertal , Jean Monnet Chair for European Integration
Economic Modelling
Purpose of modelling Alternative approaches: traditional
Keynesian macro models vs. neoclassical growth models vs. DSGE models DSGE = Dynamic Stochastic General Equilibrium
Model; common approach of most central banks, European Commission etc.
Short term forecasting (indicators: order inflow, survey results from industry...) 08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 2
Modelling short term and long run output (K is capital stock)
Long run output growth (development) is analyzed within context of growth model Capital accumulation dK/dt (t is time); net investment!
Short term/medium term analysis is based on Key-nesian model (K contant) or some other macro model Traditional model have static expectations or backward-
looking individuals (adaptive expectations; e.g. with respect to inflation); modern macro models are foreward-looking/rational expectations = based on model and available set of public information
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 3
Neoclassical Growth Model: Long run equilibrium: dk/dt=0; hence k#
Savings 1) S=sY; Production function 2) Y =KßL1-ß
Gross investment I‘= dK/dt + δK (δ is depreciation rate of capital stock; t is time)
Goods market equilibrium condition S=I‘ or 3) S/L = I‘/L; define K/L as k (capital intensity); recall that 4) dk/dt = (dK/dt)/L – k(dL/dt)/L;
5) (dK/dt)/L + δk=skß; dk/dt + nk +δk=skß; here n:= (dL/dt)/L growth rate of labor
dk/dt =skß -(n+δ)k; k#= (s/(n+δ))1/(1-ß) 08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 4
Steady state output per capita y# (y:= Y/L; # for steady state; ß=1/3)
y# = k#ß=(s/(n+δ))ß/(1-ß) Per capita income y is the higher, the higher the
savings rate is; the lower n and δ Y =L0e‘nt (s/(n+δ))ß/(1-ß); e‘ is Euler number; if L
is constant Y# = L0(s/(n+δ))ß/(1-ß) Long run growth equilibrium
Level of growth path is L0 (s/(n+δ))ß/(1-ß)
Growth rate of long run output is n Simulations: what IFF (e.g. n falls, s rises etc.)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 5
Level of Growth Path and Growth Rate of Output (increase of n in point of time t‘); gY=dlnY/dt growth rate of output
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 6
lnY
A
0 t t‘
B
C
D
F B‘
α tgα=gY
Neoclassical Growth Model
Possible modification: S = s(1-τ)Y; τ income tax rate
If there is technological progress and knowledge A as an input factor in production function Y =Kß(AL)1-ß ; y‘:=Y/(AL)= k‘ß
A is „labor augmenting“ A(t) = A0 e‘at; A0 is initial knowledge, a is the growth rate of knowledge
Capital dynamics based on dk‘/dt (with k‘:=K/(AL); AL is „labor in efficiency units), the steady state solution is now
y‘#:= (s/(a+n+δ))ß/(1-ß); note that k‘#= (s/(a+n+δ))1/(1-ß)
What happens if progress rate a is rising? At first y‘ falls, thereafter...
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 7
Four Key Aspects of Macroeconomic Development
1) Fixed exchange rate regime 1958-73; since 2013 flexible rates (vis-à-vis US $)
2) Normal cycles; recession and boom 3) Transatlantic banking crisis 2007-09 4) EU (Euro area & UK) and US facing debt
financing crisis in 2009-2013; how effective is fiscal policy in a period of very low central bank rates and high debt-GDP ratios (e.g. case of UK, Spain; worsening ratings)?
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 8
Three Important Issues (t time index, Y real output, P preice level, r interest rate)
Government budget deficit ratio; nominal stock of debt is B – thus (dB/dt)/(YP) is deficit ratio
Current account deficit-GDP ratio; if there is a current account deficit foreign indebtedness is rising; what is a critical value of foreign indebtedness? (if ratings have gone bad – close to C/bad BBB!?)
Debt-GDP ratio (b‘): rb‘ = ratio of interest expen-ditures to GDP; if increased then income tax rate τto be raised or government expenditures/Y to be cut!
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 9
Government Budget Constraint (G government expenditures in real terms; gY is the growth rate of output (dY/dt)/Y
(1) G + rB/P –τY= (dB/dt)/P Divide by Y (let γ denote G/Y), thus: (2) γ + rb‘ – τ = (dB/dt)/(PY) As db‘/dt = (dB/dt)/(PY) – b‘gY we get (3) db‘/dt = (γ – τ) + b‘(r – gY) Note that the primary deficit is the
deficit before interest payments (b‘r)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 10
Looking at r: The role of risk
Risk premium for loans from companies
Risk premium for government bonds (B, C)
Risk-free interest rate (gov. bonds, AAA)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 11
Banks, Loans, Investment Firms need loans for
1) investment financing (asymmetric information) 2) innovation financing, 3) Exporting (trade)
Banks like to give loans on the basis of collateral; loans on basis of cash-lending is complicated
Stiglitz/Weiss paper 1981: asymmetric information in loan market leads to credit rationing (price mechanism working?)
US firms rely mainly on capital markets, euro area firms on banks; hence banking problems more serious for EU
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 12
Fiscal policy, deficit and growth
Expansionary fiscal policy means to raise real government consumption (G) or to lower the income tax rate – this implies an increase in the deficit-GDP ratio; this might imply a worsening of the rating (if debt-GDP already is high). Is there a difference (case of rising G) if new roads/infrastructure built or promotion of private research & development etc. are emphasized on the expenditure side?
Expansionary monetary policy: Raising M relative to Y or lowering r; now 2008-12: in an environment of almost zero central bank interest rate – central bank buys government bonds (expansionary open market policy)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 13
Macro Analysis/Model; endogenous are Y, r, e; (1) is equilibrium condition for goods market; (3) for foreign exchange market
Standard Macro Model (Mundell Fleming) (1) Y = C(Y-T) + I(r) + G + X(Y*,q*) – q*J(Y,q*)
Y = c(1- τ)Y –λr + G + xY*q* - jY; τ is income tax rate, v is positive parameter, X=xY*q*; real imports J= jY/q*; q* is the real exchange rate:= eP*/P (e exchange rate); λ>0.
(2) M/P = hY/(h‘r); assumption zero inflation: r=i; so r = hY/[h‘(M/P)]; money market equilibrium
(3) v(r-r*) = jY – xY*q*; flexible exchange rate r=[r* –(xY*eP*/(vP)] +(j/v)Y;slope in r-Y diagramm: j/v
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 14
Mundell Fleming Model (very high interest elasticity of capital flows = horizontal ZZ curve)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 15
Y0
ZZ0
E0
LM0 IS0
Y
r0
r
0
Mundell Fleming Model in Fixed Exchange Rate System
Expansionary monetary (or fiscal) policy has effect on interest rate = change in demand/supply in foreign exchange market = disequilibrium Central bank will have to intervene: excess
demand requires that central bank sells reserves = reducing money supply (dM<0)
Excess supply requires that central bank buys foreign exchange = expansion of M 08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 16
a) Expansionary monetary policy b) Foreign exchange market under fixed exchange rate regime
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 17
Expansionary fiscal policy under fixed exchange rates
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 18
r1
r0 E0
E1
E2
LM1 LM0
ZZ0
IS0
IS1
r
Y Y2 Y0 0
(fiscal policy)
Standard Approach for Overcoming Recession
Mundell Fleming model (fixed versus flexible exchange rate):
Flexible exchange rate: Expansionary fiscal policy (rightward shift of IS curve in r-Y-space) will raise real interet rate – new intersection point of IS curve and LM curve) which is above the ZZ curve/balance of payments equilibrium line = excess supply of foreign exchange = appreciation of currency =decline of exports=leftward shift of IS curve; fiscal policy not effective; also: note that risk that there will be a high deficit= increase of debt-GDP ratio = worsening of rating
Expansionary monetary policy works (LM shifting to the right): interest rate falls= depreciation =higher exports = rightward shift of IS curve to the right
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 19
Expansionary monetary policy in a flexible exchange rate regime
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Expansionary fiscal policy under flexible exchange rate regime (in E1: appreciation, net exports fall, IS1 -> IS2)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 21
E0
r
r0
0 Y Y0
LM0 IS0
ZZ0
IS1
E1
E2
IS2
ZZ1 r1
New Issues after Transatlantic Banking Crisis 2008/09 and Euro Crisis 2010-2013
Central banks in the US, UK and euro area have reduced central bank interest rates to near zero (exhausting this instrument!): 2013 0.25% in euro area, close to zero in US and UK.
Quantitative easing: expansionary market policy of central bank which buys government bonds in the open market (normal instrument, but heavily used in UK/US in situation with central bank interest rate near zero 2008-2010)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 22
Special Question for Situation of Low Initial Interest Rate
If central bank‘s interest rate already is very low what should central bank do? Bank of England and FED (US Central Bank) have switched to
Quantitative Easing = expansionary open market policy = buying large amounts of government bonds = reduces interest rate for government; in the US this policy (2008-2012) has helped; in the UK (Bank of England aquiring bonds of 15% of GDP), however, the interest rates for companies did not reduce much; so investment did not increase
ECB bought bonds only to a limited extent (2% of GDP) in 2010/2011 OMT (Outright Monetary Transactions, summer 2012)= new
conditional programme under which ECB buys bonds of a country with an ESM-sponsored adjustment programme (ESM = euro rescue fund)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 23
Mundell Fleming Model Neglects Some Aspects
Structure of government expenditures not considered G= G‘ + G“ where G‘ is R&D promotion and public
investment; G“ is consumption Unclear role of expectations which are important for
investment (and consumption) Role of multinational companies and foreign direct
investment (share of foreign investors α* in K is neglected; FDI inflows depends on international difference of marginal product of capital!; parameter b(q*) depends on q*):
Y = c(1-τ)(1-α*ß)Y + I(r)+ b“(q*)(ßY/K –ß*Y/K) + Xnet(Y,Y*,q*); Note: If Y=Kß(AL)(1-ß); marginal product of capital is ßY/K
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 24
Stabilization Policy and Growth
Traditional challenge of market economies concern stabilization of output, prices; and achieving full employment
Extreme challenge was post-Lehman Brothers situation in the US, Europe, China, Japan etc. US: 2008 Economic Stimulus Act = 1,2% of GDP US: 2009 and 2010: 2.1% and 2.4% of GDP EU: fiscal stimulus about 1,1% in 2009, 0.8% in
2010; China 2009+ 08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 25
Open Economy Macroeconomics: Welfens, PJJ (2011), Innovations in Macroeconomics, 3rd ed.
Trade links countries
Foreign direct investment important for supply side
FDI in oligopolistic markets can create international interdepedence in reaction (counter-FDI)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 26
Fiscal Policy Popular view: fiscal policy through automatic
stabilizers (unemployment compensation, progressive income taxes)
Problems with identification and implementation lag = problem of fiscal policy = scepticism about fiscal policy fine tuning
Size of multiplier dY/dG about 1 in Blanchard/Perotti (2002); GALI et al. (2007) find within VAR approach 0.78 on impact and 1.74 at the end of the second year
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 27
TURRINI/ROEGER/SZEKELY 2011 (ASSA conference paper, Atlanta)
Banking Crisis, Output Loss, and Fiscal Policy DSGE model (QUEST III) paper takes at look at 56
industrialized &emerging economies for 1970-2008 Fiscal policy matters during banking crisis If economic agents are more credit constrained
fiscal multipliers during banking crisis are higher as fiscal policy de facto alleviates these constraints
Fiscal policy through tax cuts seems to work well..; (but hardly possible for highly indebted countries)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 28
Monetary Policy in Euro Area Lowering the central bank interest rate in 2011; in December 3 year liquidity injection into the banking system:
€ 490 bill. obtained by banks at ECB interest rate of 1%; also February 2012 another € 500 bill. injection of liquidity into banking system. New ECB programme for purchasing government bonds(Sept. 2012: „OMT“, conditional on adjustment programme in cooperation with rescue fund ESM) Brings down short term interest rates Greek problems still unsolved Stabilizes banks and some governments in Euro Area which is facing
debt crisis in Greece, Ireland, Portugal, Italy, Spain…
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 29
What Can Economic Policy Really Do?
Fiscal policy versus monetary policy Traditional view in the Mundell Fleming model is
that fiscal policy is effective in system of fixed exchange rate; while under flexible exchange rate regime monetary policy is effective
Question: Which policy is effective in a two country model (home country I, foreign country II); symmetric vs. asymmetric model
How can we take into account role of banking crisis and sovereign debt crisis
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 30
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 31
Long Run Growth
Analysis of economic growth is based on Savings function S= S(…) Macroeconomic production function (factor inputs
capital K and labor L); e.g. Cobb Douglas production function Y=KßL1-ß
Constant growth rate (n) of population Given depreciation rate of capital K
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 32
Long Run Development of Economy (τ income tax rate)
Short term fluctuations in Keynesian Model (1) Y = C(Y…) + I(r) + G + X(q*,Y*) – q*J(q*,Y) (2) M/P = m(Y,i); closed economy gives solution Keynesian model assumes unemployment and hence
aggregate demand (right hand side of equation determines real income)
One key issue is the consumption function C(…) Ct = c [1- τ]Yt or C = cYpermanent (expected long run
income: Friedman). Let Y# denote steady income C =(1- α)c[1- τ] Y + α[1- τ] Y#/(1+r) [see Welfens,2007]
Demand Driven Keynesian Model
Economy with underutilization of capacity Aggregate demand determines real GDP The higher the savings rate (s), the
lower is medium term equilibrium income
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 33
Simple Model of Closed Economy (World Economy)
1) Y =cY +[δK–b‘r] + G; uses side of GDP (δ is depreciation rate of capital; b‘ parameter which is positive)
Uses side of household income Y=C +S +T (T=0)
Consumption C=cY; gross investment [δK–b‘r]; if M/P= hY – h‘r (money market equilibrium). Hence r= (h/h‘)Y –(M/P)/h‘
Y =cY +[δ K– b‘(h/h‘)Y + (b/h‘)(M/P] + G
Y=[δK + (b/h‘)(M/P) + G]/[s + b‘(h/h‘)]; s=1-c 08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 34
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 35
Long Run Neoclassical Growth Model; real GDP is Y=KßL1-ß; y:=Y/L; k:=K/L; y=kß
Goods market equilibrium (closed economy) Savings 1) S= s(1- τ)Y; divide by L: S/L =s(1- τ)y; 2) S =dK/dt +δK (gross investment; δ is deprecia-tion
rate on the capital stock K; t time index) 3) S/L = (dK/dt)/L+ δk; here k is capital intensity
Note k:=K/L; hence we differentiation gives 4) dk/dt = (dK/dt)/L – nk; here n:= (dL/dt)/L 5) s(1- τ)kß = dk/dt + nk + δk 6) dk/dt = s(1- τ)kß – (n+δ)k; equilibrium dk/dt=0 k#=[s(1- τ)/(n+δ)]1/(1-ß) ; y#=[s(1- τ)/(n+δ)]ß/(1-ß)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 36
Some Reflections on Neoclassical Growth; e‘ is Euler Number
Recall that labor develops over time L(t)= L0e‘nt y #= Y#/L = [s(1- τ)/(n+ δ)] ß /(1-ß)
Y# = {L0 [s(1- τ)/(n+ δ)]ß/(1-ß)} e‘nt; δ’:= 1-δ The higher s the higher equilibrium real GDP lnY# ≈ {lnL0 + ß‘[lns –τ+ δ‘ - n]} + nt
ß‘:= ß/(1-ß)-note that we have used ln(1+x) ≈x for x close to zero {…}level of the growth path; n is growth rate of output Change in output due to parameter shocks (e.g. savings ratio s,
income tax rate τ, populuation growth rate n…)
Graphical Solution (with τ=0)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 37
dk/dt
Level of Growth Path (point F) and Growth Rate (tang α)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 38
Effect of an Increase in Population Growth Rate n (in t‘)
Role of Knowledge
1) knowledge A(t); 2) growth rate of knowledge a:=dlnA/dt 3) Harrod-neutral technology/progress:
Y = Kß (AL) 1-ß ; labor-saving technological progress; AL is dubbed labor in efficiency units
Y/(AL):=y‘; k‘:=K/(AL) we can write y‘=k‘ß 08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 39
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 40
Consider Knowledge A and Technolo-gical Progress (e‘ is Euler number); AL is dubbed labor in efficiency units
1) Y=Kß (AL)1-ß; define y‘:=Y/(AL); 2) y‘=k‘ß; k‘:=K/(AL) Assumption about development of knowledge is A(t)= A0e‘at
Considering 3) S=sY(1- τ); 4) dk‘/dt =(dK/dt)/L + (a+n+δ)k‘ Growth rate (n) of labor and growth rate of knowledge(a) given 5) k‘# = [s(1- τ)/(a + n + δ)]1/(1-ß)
6) y‘# = [s(1-τ)/(a + n + δ)]ß/(1-ß)
7) Y# = e‘(a+n)t {[A0L0][s(1-τ)/(a + n + δ)]ß/(1-ß)} Growth rate of output is a+n; level {…} of growth path Rise of progress rate(a) raises growth rate of Y,but reduces the
level of the growth path (similar to rise of population growth n)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 41
Level of Industrial Production and Trend Growth Rate, Euro Area (M / Q / Y)
60
70
80
90
100
110
120
1998
Q1
1999
Q1
2000
Q1
2001
Q1
2002
Q1
2003
Q1
2004
Q1
2005
Q1
2006
Q1
2007
Q1
2008
Q1
2009
Q1
2010
Q1
2011
Q1
Industrial Production Industrial Production (Trend using HP-Filter)Source: IFS Database
How Can One Measure Technological Dynamics
1) Information and communication technology is the most dynamic sector in OECD countries – in terms of innovation
2) Taking a look at ICT patent developments 3) Temporary acceleration of ICT patents per
capita (countries differ!)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 42
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 43
ICT Patent Aplications at the European Patent Office (M / Q / Y)
0.000
5.000
10.000
15.000
20.000
25.000
30.000
35.000
40.000
45.000
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Greece Spain France Italy United KingdomSource: Eurostat
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 44
Endogenous Growth Model: Explaining Progress Rate (a)
Y# = e‘(a+n)t {[A0L0][s(1- τ)/(a + n + δ)]ß/(1-ß)} Note that output growth is a+n; the progress
rate a can be explained by investment (H) in research and development;
S= dK/dt + δK + H; let H =vY; a= v‘v [s(1- τ) – v]y‘ – (v‘v+n+δ)k‘= dk‘/dt Assume ß=0.5; k‘# = [s(1- τ) – v]/(v‘v+n+δ) Growth rate depends on parameters v‘ and v
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 45
Real GDP (left scale) and Annual Growth Rate in the Euro Area (Q)
0
500000
1000000
1500000
2000000
2500000
3000000
1996
Q1
1997
Q1
1998
Q1
1999
Q1
2000
Q1
2001
Q1
2002
Q1
2003
Q1
2004
Q1
2005
Q1
2006
Q1
2007
Q1
2008
Q1
2009
Q1
2010
Q1
2011
Q1
-6
-4
-2
0
2
4
6
8
10
Real GDP Annual Real GDP GrowthSource: Eurostat
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 46
Real GDP and Quarterly Growth Rate in the Euro Area (M / Q / Y)
0
500000
1000000
1500000
2000000
2500000
3000000
1995
Q1
1996
Q1
1997
Q1
1998
Q1
1999
Q1
2000
Q1
2001
Q1
2002
Q1
2003
Q1
2004
Q1
2005
Q1
2006
Q1
2007
Q1
2008
Q1
2009
Q1
2010
Q1
2011
Q1
-15
-10
-5
0
5
10
15
Real GDP Quarterly Growth Rate of Real GDPSource: Eurostat
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 47
Mexico Growth Rate of Real GDP (M / Q / Y)
-8
-6
-4
-2
0
2
4
6
8
10
12
14
1961 1966 1971 1976 1981 1986 1991 1996 2001 2006
Source: World Bank
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 48
Inflation Rates (M / Q / Y)
-2
0
2
4
6
8
10
1990
Q1
1991
Q1
1992
Q1
1993
Q1
1994
Q1
1995
Q1
1996
Q1
1997
Q1
1998
Q1
1999
Q1
2000
Q1
2001
Q1
2002
Q1
2003
Q1
2004
Q1
2005
Q1
2006
Q1
2007
Q1
2008
Q1
2009
Q1
2010
Q1
2011
Q1
United Kingdom United States EurozoneSource: IFS Database
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 49
Unemployment Rates in the Euro Area (M / Q / Y)
6
7
8
9
10
11
12
13
14
15
2005Q1 2006Q1 2007Q1 2008Q1 2009Q1 2010Q1 2011Q1
Source: Eurostat
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 50
Real GDP and Industrial Production in the Eurozone (M / Q / Y)
0
500000
1000000
1500000
2000000
2500000
3000000
1998
Q1
1999
Q1
2000
Q1
2001
Q1
2002
Q1
2003
Q1
2004
Q1
2005
Q1
2006
Q1
2007
Q1
2008
Q1
2009
Q1
2010
Q1
2011
Q1
0
20
40
60
80
100
120
Real GDP Industrial ProductionSource: Eurostat and IFS
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 51
Growth Rate of M3 in the Eurozone (M / Q / Y)
-2
0
2
4
6
8
10
12
14
1990
Q1
1991
Q1
1992
Q1
1993
Q1
1994
Q1
1995
Q1
1996
Q1
1997
Q1
1998
Q1
1999
Q1
2000
Q1
2001
Q1
2002
Q1
2003
Q1
2004
Q1
2005
Q1
2006
Q1
2007
Q1
2008
Q1
2009
Q1
2010
Q1
2011
Q1
Source: IMF Database
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 52
Growth Rates of M3 (M / Q / Y)
-5
0
5
10
15
20
25
1991
Q1
1992
Q1
1993
Q1
1994
Q1
1995
Q1
1996
Q1
1997
Q1
1998
Q1
1999
Q1
2000
Q1
2001
Q1
2002
Q1
2003
Q1
2004
Q1
2005
Q1
Germany M3 Growth USA M3 GrowthSource: IFS
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 53
Growth Rates of M1 (M / Q / Y)
-10
-5
0
5
10
15
20
25
30
1991
Q1
1992
Q1
1993
Q1
1994
Q1
1995
Q1
1996
Q1
1997
Q1
1998
Q1
1999
Q1
2000
Q1
2001
Q1
2002
Q1
2003
Q1
2004
Q1
2005
Q1
2006
Q1
2007
Q1
2008
Q1
2009
Q1
2010
Q1
2011
Q1
Germany M1 Growth USA M1 GrowthSource: IFS
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 54
Real Interest Rates in the Eurozone (M / Q / Y) (long term interest rate minus inflation rate)
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
1998
Q1
1999
Q1
2000
Q1
2001
Q1
2002
Q1
2003
Q1
2004
Q1
2005
Q1
2006
Q1
2007
Q1
2008
Q1
2009
Q1
2010
Q1
2011
Q1
Source: IFS Database
International Competitiveness
Measurement Current account GDP Ratio (CA ratio<0!!) Share of high technology products or medium term
technology products in total production and exports; high technology: expenditures on research & development relative to sales exceed 8.5%; medium technology 3.5-8.5%.
Export unit value: development over time (relati-ve to benchmark country: relevant market e.g. EU)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 55
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 56
Nace Classification Manufacturing
15 Manufacture of food products and beverages 16 Manufacture of tobacco products 17 Manufacture of textiles 18 Manufacture of wearing apparel; dressing and dyeing of fur 19 Tanning and dressing of leather; manufacture of luggage, handbags, saddlery, harness, footwear 20 Manufacture of wood and of products of wood and cork, except furniture; manufacture of
articles of straw and plaiting materials 21 Manufacture of pulp, paper and paper products 22 Publishing, printing and reproduction of recorded media 23 Manufacture of coke, refined petroleum products and nuclear fuel 24 Manufacture of chemicals and chemical products 25 Manufacture of rubber and plastic products 26 Manufacture of other non-metallic mineral products 27 Manufacture of basic metals 28 Manufacture of fabricated metal products, except machinery and equipment 29 Manufacture of machinery and equipment n.e.c. 30 Manufacture of office machinery and computers 31 Manufacture of electrical machinery and apparatus n.e.c. 32 Manufacture of radio, television and communication equipment and apparatus 33 Manufacture of medical, precision and optical instruments, watches and clocks 34 Manufacture of motor vehicles, trailers and semi-trailers 35 Manufacture of other transport equipment 36 Manufacture of furniture; manufacturing n.e.c.
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 57
Greek Export Unit Value (EUV) Relative to Germany (M/Q /Y)
Nace 2000 2001 2002 2003 2004 2005 2006 2007 200815 1.50 1.34 1.45 1.47 1.51 1.50 1.41 0.99 0.6116 0.10 0.10 0.10 0.09 0.09 0.09 0.09 0.14 0.2117 0.63 0.62 0.63 0.71 0.66 0.59 0.48 0.52 0.6118 1.90 1.73 1.47 1.36 1.53 1.70 1.82 2.03 1.8619 3.14 3.32 1.10 1.34 1.53 1.77 1.80 1.78 1.3820 1.77 1.94 2.32 2.53 2.47 2.61 2.71 2.90 2.5121 0.90 0.89 0.84 0.90 0.89 0.88 0.81 0.76 0.8422 1.56 1.31 1.50 2.11 2.59 2.67 2.62 2.93 3.2823 0.85 0.79 0.66 0.52 0.59 0.66 0.79 0.80 0.7424 0.58 0.62 0.67 0.78 0.89 0.96 0.97 0.94 1.0225 0.71 0.73 0.74 0.75 0.74 0.72 0.79 0.79 0.8726 0.18 0.19 0.24 0.28 0.28 0.25 0.24 0.26 0.3227 1.23 1.29 1.25 1.09 0.91 0.80 0.82 0.82 0.7528 1.01 1.03 1.03 0.93 0.91 0.86 0.85 0.84 0.8629 0.63 0.62 0.59 0.58 0.58 0.60 0.47 0.44 0.5030 0.97 1.22 0.98 1.34 1.56 2.35 4.59 11.04 11.8631 0.35 0.33 0.30 0.27 0.34 0.38 0.45 0.54 0.7432 2.18 2.33 2.47 2.55 2.31 2.13 1.15 2.12 1.9833 0.84 0.97 1.03 0.91 0.72 0.61 0.64 1.22 1.3834 0.66 0.69 0.79 0.88 0.87 0.78 1.44 2.09 2.4935 1.57 1.61 0.89 0.11 0.08 0.11 0.34 0.69 0.7036 1.86 1.75 1.82 1.89 1.84 1.68 1.43 1.31 1.37
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 58
Italian EUVs relative to Germany (M / Q / Y)
Nace 2000 2001 2002 2003 2004 2005 2006 2007 200815 0.98 1.01 1.00 0.88 0.74 0.64 0.70 1.83 2.5916 0.63 0.59 0.67 0.76 0.84 0.71 0.69 0.42 0.3417 2.31 2.36 2.25 2.22 2.35 2.49 2.26 1.90 1.4918 0.95 1.23 1.28 1.49 1.22 1.46 1.85 1.46 0.9119 1.28 1.00 0.68 0.56 0.65 0.73 0.99 0.93 0.9320 1.93 1.92 1.71 1.34 1.23 1.06 1.11 0.96 1.0121 1.61 1.62 1.65 1.54 1.52 1.52 1.51 1.51 1.3422 0.54 0.64 0.58 0.45 0.34 0.33 0.34 0.32 0.3023 0.89 0.87 0.82 0.82 0.78 0.72 0.58 0.59 0.6524 2.53 2.35 2.10 1.68 1.50 1.30 1.28 1.30 1.2925 1.25 1.21 1.18 1.19 1.22 1.24 1.19 1.07 1.0026 7.16 6.72 5.88 5.23 5.63 6.46 6.63 6.23 5.4227 0.86 0.84 0.90 1.14 1.28 1.33 1.24 1.20 1.4428 0.91 0.93 0.92 0.95 0.98 1.11 1.16 1.12 1.1129 1.09 1.13 1.20 1.27 1.27 1.23 2.17 2.14 2.2330 1.37 1.15 3.98 3.55 3.63 0.60 0.79 0.52 0.4931 1.53 1.63 1.76 1.85 1.68 1.57 1.34 1.21 1.0732 0.34 0.30 0.28 0.24 0.38 0.47 1.01 1.12 1.3133 0.52 0.59 0.82 1.14 1.31 1.11 0.79 0.41 0.8334 1.22 1.15 1.03 0.88 0.89 0.96 0.95 0.91 1.0335 13.06 2.05 4.12 8.64 13.82 13.59 9.52 2.61 1.6936 0.55 0.57 0.57 0.55 0.55 0.54 0.64 0.64 0.63
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 59
Spanish EUVs relative to Germany (M / Q / Y)
Nace 2000 2001 2002 2003 2004 2005 2006 2007 200815 1.26 1.28 1.23 1.40 1.50 1.70 1.57 1.53 1.4516 7.91 8.63 6.84 7.73 8.49 11.23 12.35 14.61 11.7017 0.64 0.55 0.51 0.52 0.60 0.67 0.82 0.90 1.1718 2.54 2.43 2.33 1.36 1.35 1.14 0.75 2.10 2.7919 1.24 1.28 1.22 1.27 1.12 1.09 0.92 1.12 1.5020 0.65 0.62 0.60 0.70 0.70 0.66 0.48 0.41 0.4521 0.73 0.73 0.72 0.71 0.71 0.81 0.96 1.13 1.0922 1.14 1.20 1.21 1.20 1.19 1.30 1.13 1.13 1.0123 1.03 1.00 1.12 1.10 1.08 1.06 1.07 1.19 1.3724 0.57 0.61 0.64 0.67 0.66 0.66 0.66 0.66 0.6425 1.11 1.08 1.06 1.04 1.10 1.16 1.25 1.39 1.3926 0.78 0.75 0.73 0.75 0.78 0.76 0.76 0.74 0.7527 1.16 1.13 1.08 1.06 1.05 1.10 1.10 1.12 0.9828 0.88 0.89 0.89 0.90 0.87 0.84 0.84 0.88 0.8829 1.02 1.03 0.95 0.92 0.89 0.96 0.93 0.98 0.9630 0.46 0.59 0.59 0.79 0.80 0.99 1.07 3.50 3.7131 1.01 0.97 0.97 0.96 0.98 1.03 1.19 1.32 1.5032 0.47 0.56 0.68 0.96 1.03 1.00 0.95 1.07 1.3233 1.37 1.25 1.11 0.93 0.91 1.05 1.13 1.35 1.0834 1.05 1.07 1.08 1.08 1.07 1.16 0.95 0.73 0.3935 0.82 0.56 0.79 1.12 1.42 1.54 1.63 2.60 2.7636 0.96 0.83 0.84 0.88 1.00 1.03 0.98 1.07 1.11
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 60
French EUVs relative to Germany (M / Q / Y)
Nace 2000 2001 2002 2003 2004 2005 2006 2007 200815 0.73 0.71 0.70 0.71 0.77 0.76 0.77 0.74 0.7616 1.12 0.95 0.93 0.85 0.71 0.59 0.42 0.40 0.5517 0.94 1.09 1.32 1.14 1.01 0.97 1.05 0.99 0.8918 0.74 0.70 0.76 0.95 1.07 1.17 1.07 0.82 0.5519 1.01 0.98 1.37 1.43 1.74 1.47 1.19 0.73 0.4520 0.47 0.46 0.46 0.45 0.46 0.57 0.66 0.76 0.7221 1.00 0.96 0.93 0.89 0.87 0.79 0.72 0.61 0.6222 1.03 1.04 1.09 1.13 1.13 1.03 1.20 1.17 1.2623 1.44 2.33 3.13 3.94 3.80 3.61 4.15 3.73 3.5824 1.49 1.37 1.35 1.36 1.34 1.36 1.35 1.39 1.4225 1.08 1.13 1.16 1.17 1.09 1.08 1.05 1.06 0.9926 1.30 1.32 1.35 1.27 1.20 1.21 1.23 1.20 1.1127 0.68 0.68 0.67 0.65 0.65 0.64 0.68 0.70 0.7828 1.23 1.21 1.27 1.26 1.32 1.36 1.42 1.42 1.4329 1.21 1.19 1.30 1.31 1.32 1.17 1.18 1.10 0.9330 1.59 1.48 1.29 1.50 1.31 1.13 0.81 0.89 0.8931 1.28 1.36 1.41 1.24 1.13 0.97 1.00 0.99 1.0532 3.27 2.92 1.78 1.89 1.59 1.94 2.10 2.43 2.2733 1.20 1.58 1.54 1.71 1.86 2.22 2.67 2.90 3.0434 1.08 1.07 1.07 1.07 1.08 1.05 1.08 1.22 1.3935 4.12 4.97 4.04 2.89 2.13 1.59 1.21 0.58 0.7536 1.20 1.38 1.42 1.40 1.23 1.31 1.32 1.22 1.05
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 61
UK EUVs relative to Germany (M / Q / Y)
Nace 2000 2001 2002 2003 2004 2005 2006 2007 200815 1.91 2.04 2.07 1.97 1.91 1.87 1.86 1.78 1.6916 1.61 1.24 1.45 1.88 2.18 2.14 2.37 2.46 2.2617 1.52 1.57 1.42 1.82 1.80 1.75 1.57 1.48 1.4418 1.16 1.19 0.99 0.64 0.53 0.56 0.66 0.90 1.1419 0.90 1.04 1.22 1.34 1.25 1.19 1.67 1.55 1.8220 2.01 1.83 1.53 1.47 1.48 1.38 1.30 1.42 1.5221 1.29 1.26 1.21 1.20 1.19 1.18 1.14 1.14 1.1822 3.08 3.04 2.86 2.82 2.65 2.56 2.64 2.68 2.6123 0.77 0.70 0.58 0.51 0.55 0.55 0.53 0.53 0.5124 1.27 1.29 1.24 1.18 1.17 1.16 1.17 1.17 1.1625 1.16 1.18 1.17 1.13 1.09 1.03 1.01 1.02 1.0926 1.35 1.49 1.39 1.36 1.34 1.28 1.20 1.11 1.1627 1.50 1.50 1.45 1.50 1.54 1.58 1.50 1.37 1.3128 1.48 1.51 1.44 1.36 1.22 1.15 1.11 1.11 1.0029 0.91 0.98 1.09 1.20 1.18 1.22 1.23 1.19 1.2930 1.14 1.18 1.20 1.16 1.46 1.41 1.36 1.46 1.4131 1.63 1.74 1.76 2.15 2.07 2.15 1.71 1.53 1.2132 1.83 2.03 2.23 1.66 1.40 0.90 0.78 0.55 0.5533 2.94 0.82 0.72 0.91 0.88 0.89 0.91 0.88 0.7034 1.07 1.09 1.07 1.05 1.04 1.10 1.48 1.81 2.1135 1.06 0.97 0.82 0.64 0.70 1.35 1.43 1.38 0.7136 1.52 1.65 1.59 1.60 1.52 1.41 1.56 1.82 2.12
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 62
Traditional Macro Models vs. New Keynesian Economics NKE
Traditional models have certain characteristics: they are mainly backward-looking expectations are not important or expectations play
a role but as adaptive expectations –with expectation formation based on the history of the variable = bias in „learning“ of economic agents
Lucas critique (traditional models): As institutional setup/policy changes agents learn; historical corre-lation patterns collapse = difficult to make forecast; DSGE better as institutions are built into the model
not much forward-looking (intertemporal choice)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 63
New Keynesian Econonomics Key elements
Monopolistic competition = market power= mark-up pricing P=(W/(Y/L))(1+ϕ); W/(Y/L) is unit labor cost; ϕ mark-up which is a cyclical variable
Rational expectations (John Muth) = forward-looking behavior
Market imperfections = wage and price stickiness Matching frictions in labor markets Moral hazard in labor markets System is no guarantee for full employment Possible multiple equilibriums
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 64
Simple New Keynesian Models in a Stochastic Context (stochastic distur-bance terms u”, v”); rational expectations
(1) Ydt = G”t + b(m”t – pt) + u”t ; (m“ is lnM, p is lnP)
(2) Yst= Y# + h(pt – p’t) + v”t ; b and h positive parameters
(3) Yt = G”t + b(m”t – pt) + u”t
(4) Yt = Y# + h(pt – p’t) + v”t Apply expectation operator E: (5) YE
t = G”Et + b(m” Et – p’t)
(6) YEt = Y#
p’ is expected price level: (7) p’t = m”Et – (Y# – G”E
t )/b (8) Yt – YE
t = (G”t–G”Et) + b(m”t – m” Et) – b(pt–p’t) + u”t
(9) Yt – YEt = h(pt – p’t) + v”t
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 65
The Non-neutrality of Economic Policy in a Consistent New Keynesian Models
(8) Yt – YEt = (G”t–G”E
t) + b(m”t – m” Et) – b(pt–p’t) + u”t
(9) Yt – YEt = h(pt – p’t) + v”t
(10) pt = p’t + [1/(b + h)] [ (G”t – G”Et) + b
(m”t – m” Et) + u”t – v”t]; b and h parameters
(11) Yt = Y# + [h/(b + h)] [ (G”t – G”Et) +
b(m”t – m” Et) + u”t + b/h v”t]
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 66
Some Leading Scholars of NKE
Mankiw & Romer: book New Keynesian Economics, Vol. 1, 2; (micro foundations, 1991)
Michael Woodford: Interest and Prices: Foundations of a Theory of Monetary Policy
Goodfriend, Gali, Blanchard, Kiyotaki
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 67
NKE DSGE Models Dynamic stochastic equilibrium models
(with rational expectations) Goods market and labor market etc. considered in a
stochastic context; Raondom shocks: White noise error term (e.g. η) in each
equation: expectation value E(η) is zero, finite variance σ Monopolistic firms face price stickiness; Output is a function of household‘s real demand which is
partly determined by (monopolistic) price level interaction of housholds, firms, gov., central bank; „Special
technique“ to solve models with rational expectations
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 68
DSGE Models (continued) Dynamic model which shows how the economy system is
developping over time Stochastic quasi-Walrasian system Households:
Maximize utility function (consumption, leisure) Firms
Profit maximization Government: Budget constraint (aim: e.g. full employment,
welfare maximization?); central bank: low inflation rate (price stability)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 69
Competing Schools of DSGE Modelling
Approaches: Real business cycle (RBC) model is based on
neoclassical growth model in a setting with flexible prices: Real shocks to the system can cause business cycle flutuations (KYDLAND/PRESCOTT, 1982; GOODFRIEND/KING, 1997)
New-Keynesian DSGE based on a structure which is similar to RBC but here prices set in a system of monopolistic competition and adjustment costs (ROTEMBERG/WOODFORD, 1997; GOODFRIEND/KING, 1997; CLARIDA/GALI/GERTLER, 1999; GALI, 2008)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 70
Read the following papers Goodfriend, M.; King, R. (1997), The New Neoclassical
Synthesis and the Role of Monetary Policy, NBER Macroeconomics Annual 1997, Vol. 12, p. 231 -296.
Clarida, R.; Gali, J.; Gertler, M. (1999), The Science of Monetary Policy: A New Keynesian Perspective, Journal of Economic Literature, Vol. 37, 1661-1707.
Sbordone, A.; Tambalotti, A.; Rao, K.; Walsh K. (2010), Policy analysis using DSGE models: an introduction, Federal Reserve of New York Economic Policy Review 16 (2)
Paper by STIGLITZ
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 71
Critique on DSGE
Wllem Buiter: DSGE models are unable to catch the largely non-linear economic dynamics
Counter-argument/Woodword: DSGE is evolutionary development along Keynesian macro modeling…
Kocherlakota (FED of Minneapolis): argues that DSGE models not useful for analyzing the financial crisis of 2007-2010
US Congress hosted hearings on macroeconomic modeling approaches (July 20, 2010) to understand why financial crisis 07/08 not foreseen: Solow critique (assumptions: DSGE presents economy like a „machine“) ; V.V. Chari defends DSGE: heterogenous actors are considered
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 72
Some Criticism (Welfens, 2012a, Welfens 2011: Innovations in Macroeconomics, 3rd edition)
Moral hazard in capital markets/the banking system! Hybrid consumption function is more realistic
(microfoundation can always be found if empirical finding for hybrid function ok; Welfens 2011)
Investment function is not consistent with steady state: proposed solution see Welfens (2012a)
Implausible that households behavior etc. is not affected by the size of the variance of disturbance terms (e.g. in the goods market; see Welfens 2012a and the following reflections)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 73
Modern NKE Models: Rational Expectations and New Keynesian Economics (e.g. GOODFRIEND)
Rational expectations revolution (MUTH): Economic agents are forward-looking Expectation formation based on a model of the economy =
rational expectations There are, however, random shocks so that people cannot
adjust in a perfect manner; but people have „on average“ expectations which are correct.
Debate on Phillips curve looks different under rational expectations than under adaptive expectations: No short-term trade off that can be exploited by policymakers (here: central bank)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 74
Short-term and Long-run Phillips Curve
π
π1
π2
0 u0 u2 u
G F
LP
E H
SP0
SP1
u1
expected inflation rate is low
Higher expected inflation rate
Long term Phillips Curve
Short term Phillips curve
Simple theoretical perspective: V is velocity, Y is real GDP
Quantity equation M V = P Y gP = gM – gY (assuming V is constant; g
is growth rate); central bank can raise the growth rate of stock of money (M); could be M1 (cash+time deposits) or M3
If Y=Kexpß (AL)exp(1-ß); gY = ßgK + (1-ß)(a+n);
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 75
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 76
New Keynesian Models There are rigidities in labor markets or
goods markets (realistic adjustment costs) People: rational expectations about inflation
rate; expectations also relevant for other variables. Unclear with respect to gov. Debt (see the debt crisis in OECD countries 2010/11)
Households maximize utility of consumption within a model of intertemporal optimization: Infinitely lived households with time preference ρ Ricardian households (Ricardo equivalence theorem)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 77
What the Ricardo Equivalence Theorem Says/Implies
Should government finance infrastructure investment rather through issuing government bonds or through imposing immediately higher tax rates? Ricardo equivalence emphasizes that both ways
of financing public infrastructure are equivalent If government relies for a new project on issuing
government debt households will effectively interprete higher debt as a promise that government will impose higher future tax rats…
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 78
Government budget constraint in a gro-wing economy (b“ is the debt GDP ratio)
(1) G + rB/P –τY = (dB/dt)/P; define b“:= (B/P)/Y
(2) G/Y + rb“ - τ = db“/dt + b“gY; for simplicity we will assume a constant price level Denoting (dY/dt)/Y:= gY and taking into account that we
have by definition db“/dt = [(dB/dt)/P]/Y – b“gY
Implication of (2) for db“/dt<0 thus is: (2.1) db“/dt = (γ – τ) + [b“(r - gY)] Debt-GDP ratio will fall if primary surplus –(γ – τ)
exceeds [b“(r - gY)]; long run: neoclassical model gY = a+n
DOMAR Model on Debt and Growth
DOMAR (1944) assumes that θ is exogenous deficit GDP ratio
Assume that growth rate is given: a+n Long run debt-GDP ratio b“= θ/(a+n)
If the trend deficit ratio is 1% and the growth rate of output is 2% the implication is that the long run debt-GDP ratio is 0.5
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 79
Deficit-GDP Ratio
Deficit-GDP ratio = total deficit/GDP Deficit without interest payments relative
to GDP is the primary deficit ratio
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 80
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 81
Table: Primary deficit-GDP ratio in OECD countries
0
20
40
60
80
100
120
2011
2009
2007
2005
2003
2001
1999
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
1973
1971
Germany France United Kingdom United StatesSource: Ameco Database
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 82
Table: Primary deficit-GDP ratio in OECD countries
0
20
40
60
80
100
120
140
160
180
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
Greece Portugal Spain ItalySource: Ameco Database
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 83
The Ricardian Equivalence is Important in Several Ways:
Issuing new governments bonds can be inter-preted as announcing a higher future tax rate
Definition of private sector wealth has to be consistent: nominal wealth A“ = M + (1-ε)B + P‘K where M is the stock of money, B is government bonds (short-term), P‘ is the stock market price index and ε (in the interval 0,1) the „Ricardian parameter“: If ε= 1 we have full Ricardian equivalence
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 84
Can Government Excape Ricardian Equivalence?
Government faces problem that high debt-GDP ratio will raise fear of higher future income tax rates or of higher future inflation
Government could rely on selling more debt to foreigners who in turn are unlikely to anticipate that acquiring foreign bonds will mean higher future income tax rates…
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 85
Monetary Policy (Taylor Rule) Popular Taxlor Rule suggests that central
bank should fix nominal interest rate i on the basis of simple formula: i = r (normal real rate) + difference between actual πt and target infla-tion rate π“ plus element reflecting role of out-put gap (the difference between full employment equili-brium
output Y# and current output Y t ; parameters ψ and ψ’>0): i t = r t + ψ(π t – π“) + ψ‘(Y t – Y#)
Central banks seem to follow Taylor rule
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 86
Impulse response function:
Consider (any) dynamic system of equations: Impulse = external shocks (e.g. technology shock,
change of time preference, change of degree of risk aversion, fiscal policy, monetary policy – anticipated or not??)
The impulse response shows the reaction of the system‘s variables over time
APPLICATION: DSGE models of central banks, IMF or European Commission
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 87
VAR Models The structure of a VAR model is such that
the vector of variables Xt is explained by Xt-n and exogenous policy vector Zt
No a priori assumption about the causal links is needed
Important to understand how strong the influence of past Xt-n are (and how far backward a significant impact is)
Simulations: Policy impact, BAU scenario
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 88
Inflation, the Phillips curve and monetary policy: x is output, u, e, v are stochastic disturbance terms
Aggregate Supply Aggregate Demand Monetary Policy Rule (Interest Rate rule/Taylor)
tttt uxxk +−+= − )(1ππ
ttttt eixxxx +−−−=− −
∗−
∗ )()( 11 πλφ
ttx
Ttt vxxri +−+−+= ∗∗ )()( αππαπ
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 89
New-Keynesian Model (forward-looking)
Aggregate Supply
Aggregate Demand
Monetary Policy Rule (Interest Rate)
ttttt ukxE ++= −1πβπ
ttttttt eEixEx +−−= −− )( 11 πλ
ttx
Tt
Tt vxri ++−++= ∗ αππαπ π )(
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 90
Simple production function and profit maximization (A is knowledge or - indeed - labor productivity!)
ALY tt =
t
t
t
t
t
t
LY
Ap
WLY
===δδ
)1( tt
ttt m
YLW
p +=
xx =+ )1log( x is smaller than 0,01
m: Price Mark up Mark up fluctuates counter-cyclical. Intuition: Boom in t, i.e. current inflation is higher than expected inflation. Companies increase prices not so strong to avoid price adjustment costs in the next period.
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 91
)( 1 tttm πβπα −= +
))(1(1 1 tt
t
tt
YpLW
πβπαα
−+= +
zz ≈+ )1ln( if z is small
ttttt ypw απαβπα −+−−−= +1)()(0
[ ])()(21
1 tttttt ypw −−−+= +βππ
xyyt =− ∗
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 92
Wage Setting Rule Wage Rule (small case letters are logs!) Labor Demand
)exp( 0
1 γγt
tEt
t LLY
pW
=
)exp( 0
1 γγt
t
tEtt L
LY
pW
=
01)( γγ ++−=− ttt
ett ypw
tttt ypw −=−
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 93
Equilibrium Employment
Output Gap
t
et pp = 001 =+∗ γγ
00 γγ −=∗
)()( 1∗−+−=− ttttt ypw γ
)()( 1∗−+=−−− ttttt ypw γ
∗∗ −=−= ttt yyx ay tt += ay += ∗∗
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 94
Household Optimization 1: Maximize discounted life time consumption
[ ]∑ ∑∞
=
∞
=−− −++−+=
0 011
)()1(log
t ttttt
tttt
t
BcYCBrBCLMax
tt
βλβ 1<tβ
)1(
11 ρρ
−≈+
ρρ −≈− )1ln(
),( tt BCLL =
01=−= t
tt CCL λ
δδ
t
tt CCL λ
δδ
==1
0)1(1 =+−= + tttt
rBL βλλ
δδ
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 95
Household Optimization 2
)1(
11
tt
t
r+=+
βλλ
)1(1
tt
t r+=+
βλλ
)1(1
tt
t rC
C+=+ β
t
t
t rC
C+≈
+ βlnln 1
prgC −≈
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 96
Household Optimization 3
Concave utility function: households try to avoid fluctuations in consumption. E is prefered to the average of F and F’.
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 97
Household Optimization 4
)1()1(1 prr
CC
ttt
t −+=+=+ β
β)1(1
t
tt r
CC+
= +
1<β e
e−≈
+= 1
11β
)1(1 erCC ttt −++=+
)1(1 erCC ttt −+−= +
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 98
Household Optimization 5
Equilibrium #CCt =
#rr =
#CCx tt −=
)( #1 rrxx ttt −−= +
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 99
Traditional Model
)()( 1∗−+−=− ttt
ett ypw γ
1−−=∆ ttt www
1−−= t
et
et ppπ
)()()()( 11111∗
−−−− −+−−−=−−− ttttttettt yyppww γ
1111 −−−− −=− tttt ypw
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 100
Expectations
)( 1111 −−−− ∆−∆−∆== ttttet yw ππ
tttt yw ∆−∆+=∆ π
)()()( 11∗
− −+∆−∆+=∆−∆+ ttttttt yy γππ
)(11∗
− −+= ttt γππ
+
=
−
−
−
−
t
t
t
t
t
t
t
t
t
UeU
aaa
iYA
iY 1
3231
21
1
1
1
101001 πππ
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 101
Collateral Constraint
t
Httt HPXDest =
tt YaaC 10 += ↓↓CY
−
+
+= ∑∞
=0)1(
11
j
wt
j
t tYr
BFC
ettri π+=
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 102
Some Impulse Response Patterns of Euro Area
Impulse= change in exogenous variable
Response = change in the endogenous variable (over time)
Special Issue … Traditional issue of fiscal policy versus
monetary policy New issue in an environment with (close to) 0
central bank interest rate = special challenge (recession) in 08/09/10/11 in Japan, UK and US
Quantitative Easing in Japan, UK and UK (expansionary open market operation: central bank buys government bonds = dM>0)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 103
Effects of Quantitative Easing Central bank interest rate 0; but UK/US in
recession – so what should be done? Main effects in UK (and US) in 2009/10
Interest rates falls by about 1 % Nominal and real depreciation of British pound
and $ stimulates net exports of goods and services = appreciation of the Euro in 2009/2010
Also direct fiscal expenditure effect (or tax cutting effect): see WELFENS (2012a) 08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 104
The impact of a banking crisis on fiscal multipliers: alternative channels
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 105
(1) Forward-looking aggregate demand schedule derived from the Euler equation of inter-temporally maximising agents, where Xt is the output gap, itB is the nominal interest rate charged by the banking sector, π t is inflation, gt is a government expenditure shock, ut
d is a demand shock, and Et is the expectation operator
(2) Standard forward-looking new-Keynesian Phillips curve
(3) Standard Taylor rule summarising the behaviour of monetary
policy
(4) Bank interest rate decision rule
The impact of a banking crisis on fiscal multipliers: alternative channels
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 106
(5) Government expenditure multiplier
While at the zero bound:
The impact of a banking crisis on fiscal multipliers: alternative channels
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 107
(6) Panel autoregressive model to assess the impact of banking crises on real GDP growth and potential growth
(7) Model to estimate the impact of a banking crises on fiscal policy
Temporary Increase in Government Consumption (1/2)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 108
Note: RIC_ : model with 40% liquidity constrained, 60% Ricardian households; CC_ : model with 40% liquidity
constrained, 30% Ricardian households and 30% credit-constrained households.
Temporary Increase in Government Consumption (2/2)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 109
Source: Turrini, A.; Roeger, W.; Székely, I.P. (2011): Banking Crises, Output Loss, and Fiscal Policy
Temporary Increase in Government Consumption with Monetary Policy at the Zero-Bound (1/2)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 110
Note: RIC_ : model with 40% liquidity constrained, 60% Ricardian households; CC_ : model with 40% liquidity
constrained, 30% Ricardian households and 30% credit-constrained households.
Temporary Increase in Government Consumption with Monetary Policy at the Zero-Bound (2/2)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 111
Source: Turrini, A.; Roeger, W.; Székely, I.P. (2011): Banking Crises, Output Loss, and Fiscal Policy
Temporary Reduction in Labour Taxes (1/2)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 112
Note: RIC_ : model with 40% liquidity constrained, 60% Ricardian households; CC_ : model with 40% liquidity
constrained, 30% Ricardian households and 30% credit-constrained households.
Temporary Reduction in Labour Taxes (2/2)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 113
Source: Turrini, A.; Roeger, W.; Székely, I.P. (2011): Banking Crises, Output Loss, and Fiscal Policy
Temporary Reduction in Labour Taxes with Monetary Policy at the Zero-Bound (1/2)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 114
Note: RIC_ : model with 40% liquidity constrained, 60% Ricardian households; CC_ : model with 40% liquidity
constrained, 30% Ricardian households and 30% credit-constrained households.
Temporary Reduction in Labour Taxes with Monetary Policy at the Zero-Bound (2/2)
08.01.2014 Prof. Dr. P. Welfens / Dr. W. Röger 115
Source: Turrini, A.; Roeger, W.; Székely, I.P. (2011): Banking Crises, Output Loss, and Fiscal Policy
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