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Our analysis leads us to believe that recovery is sound only

Freeing up resources from dying to thriving industries. Monetary and fiscal stimulus. Our analysis leads us to believe that recovery is sound only if it does come of itself. For any revival which is merely due to artificial stimulus leaves part of the work of depressions

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Our analysis leads us to believe that recovery is sound only

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  1. Freeing up resources from dying to thriving industries Monetary and fiscal stimulus Our analysis leads us to believe that recovery is sound only if it does come of itself. For any revival which is merely due to artificial stimulus leaves part of the work of depressions undone and adds, to an undigested remnant of maladjustment, new maladjustments of its own. Joseph A. Schumpeter, 1934 Gold, commodities foreign property Excess Housing and debt

  2. Short Run Aggregate Supply Curve DP/P = (DP/P)et+1 + g [Y – YP] + r SRAS curve implies that wages and prices are sticky in the short-run (the aggregate price level adjusts slowly over time). The more flexible wages and prices are, the more DP/P responds to deviations of output, Y, from potential output, YP. This will increase the absolute value of g and create a steeper curve. If wages and prices are completely flexible, then g gets very large and the SRAS = LRAS. Shifts in SRAS  (DP/P)et+1 . (shifts curve up and to the left)  Supply shock, r. (shifts curve up and to the left) Persistent output gap, [Y – YP] => D (DP/P)et+1 . If [Y – YP] > 0 is persistent, then the rise in DP/P due to the movement along the SRAS curve, (g [Y – YP]) =>  (DP/P)et+1 which shifts the SRAS curve up and back. When [Y – YP] = 0 , then the SRAS stops shifting up because DP/P and (DP/P)et+1 stop rising. If [Y – YP] < 0 is persistent, then the fall in DP/P due to the movement along the SRAS curve, (g [Y – YP]) =>  (DP/P)et+1 which shifts the SRAS curve down and to the right. Shifting stops when Y = YP

  3. General Equilibrium in the AD & AS Analysis All markets are simultaneously in equilibrium – Quantity of aggregate output demanded is equal to quantity of aggregate output supplied. Self-Correcting Mechanism – over time the short-run equilibrium moves/migrates to the long-run equilibrium. So if Y* = YP ,the short-run equilibrium, Y* will move over time to reach YP. If the current level of DP/P changes from its initial level, the SRAS curve will shift as wages and prices adjust to a new DP/P)et+1. This shift over time will restore the economy to long-run equilibrium at full employment and YP.

  4. Translation: • Wisdom is limited to an awareness of your own ignorance. • You are only educated when you understand how ignorant you are. I only know, that I know nothing. Socrates, 400 BC The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design. F.A. Hayek, 1988 The Fatal Conceit Economic Wisdom Unknown unknowns Example: Unknown monetary channels Known unknowns Example: Sensitivity coefficients of some economic variables Knowns: What we know Example: 10 transmission channels of monetary policy Unknown knowns: Things we think we know but are wrong Example: Inaccurate economic parameters/coefficients

  5. Loanable Funds DP/P LRAS Fed’s new money Bank AS1 Reserves Deposits 4% AS2 Loans 2% I = S 1% AD04 AD06 = C + I + G + X - M AD08 Bust YP Boom Y  DH Animal Spirits • Pessimism =>  savings =>  C (Paradox of Thrift) • Sticky wages => no D SRAS (“In L.R. we are all dead”) • Monetary stimulus => shift AD (if “liquidity trap”, then deficits) • Fiscal stimulus => G => Shift AD (bailouts, payoffs by politicians?) Feedback Loop  Lending  PH Low Interest Rates & Capital Structure: •  credit => mal-investment => surplus housing =>  PH => foreclosures => broke banking system => credit crunch • Monetary stimulus => “pushing on a string” to  C,  I (hair of the dog)

  6. Shift AD Curve (due to D r ) • Assume 2% DP/P • The debt crisis => Fed’s “Financial Repression” => r falls from 1 to -2. (autonomous easing of MP) => r falls from 2 to -1 =>  I,  NX, =>  Y, at every given DP/P => Y at point B. LRAS DP/P SRAS B 4.0% 2.0% A AD1 AD2 YP Y MP Curve r = r + l (DP/P)et+1 r % r % IS Curve 2 = 1 + 0.5(2) 2.0% A 2.0% A -1 = -2 + 0.5(2) 2% $14 T $15T Y DP/P -1.0% -1.0% B B

  7. THE GREAT DEBATE: Stimulus Vs Austerity J.M. Keynes 1883-1946 Father of Modern Macroeconomics “The General Theory of Employment, Interest and Money” Advocated the use of fiscal and monetary measures to offset recessions. AD determines the overall level of economic activity. The modern capitalist economy does not automatically work at top efficiency, but can be raised to that level by government intervention. F.A. Hayek 1899-1992 1974 Nobel Prize “The Road to Serfdom” Changing prices communicate signals to enable individuals to coordinate their plans. This leads to an efficient exchange and use of resources. Leading critic of collectivism/socialism because it required a central planner that would eventually become totalitarianism. The free price system is a spontaneous order – the result of human action, but not of human design. Central banks do not possess the relevant info to govern the money supply, nor the ability to use it correctly.

  8. “Fear the Boom and Bust” Lyrics Keynes’s Viewpoint 30. So forget about saving, get it straight out of your head31. Like I said, in the long run—we’re all dead32. Savings is destruction, that’s the paradox of thrift33. Don’t keep money in your pocket, or that growth will never lift… because… 34. Business is driven by the animal spirits35. The bull and the bear, and there’s reason to fear its36. Effects on capital investment, income and growth37. That’s why the state should fill the gap with stimulus both… 38. The monetary and the fiscal, they’re equally correct39. Public works, digging ditches, war has the same effect40. Even a broken window helps the glass man have some wealth41. The multiplier driving higher the economy’s health 42. And if the Central Bank’s interest rate policy tanks43. A liquidity trap, that new money’s stuck in the banks!44. Deficits could be the cure, you been looking for45. Let the spending soar, now that you know the score 46. My General Theory’s made quite an impression47. [a revolution] I transformed the econ profession48. You know me, modesty, still I’m taking a bow49. Say it loud, say it proud, we’re all Keynesians now 50. We’ve been goin’ back n forth for a century51. [Keynes] I want to steer markets,52. [Hayek] I want them set free53. There’s a boom and bust cycle and good reason to fear it54. [Keynes] I made my case, Freddie H55. Listen up , Can you hear it? Hayek sings: 1. We’ve been going back and forth for a century2. [Keynes] I want to steer markets,3. [Hayek] I want them set free4. There’s a boom and bust cycle and good reason to fear it5. [Hayek] Blame low interest rates.6. [Keynes] No… it’s the animal spirits 7. [Keynes Sings:] 8. John Maynard Keynes, wrote the book on modern macro9. The man you need when the economy’s off track, [whoa]10. Depression, recession now your question’s in session11. Have a seat and I’ll school you in one simple lesson 12. BOOM, 1929 the big crash13. We didn’t bounce back—economy’s in the trash14. Persistent unemployment, the result of sticky wages15. Waiting for recovery? Seriously? That’s outrageous! 16. I had a real plan any fool can understand17. The advice, real simple—boost aggregate demand!18. C, I, G, all together gets to Y19. Make sure the total’s growing, watch the economy fly 20. We’ve been going back and forth for a century21. [Keynes] I want to steer markets,22. [Hayek] I want them set free23. There’s a boom and bust cycle and good reason to fear it24. [Hayek] Blame low interest rates.25. [Keynes] No… it’s the animal spirits 26. You see it’s all about spending, hear the register cha-ching27. Circular flow, the dough is everything28. So if that flow is getting low, doesn’t matter the reason29. We need more government spending, now it’s stimulus season

  9. “Fear the Boom and Bust” Lyrics Hayek’s Viewpoint 56. I’ll begin in broad strokes, just like my friend Keynes57. His theory conceals the mechanics of change,58. That simple equation, too much aggregation59. Ignores human action and motivation 60. And yet it continues as a justification61. For bailouts and payoffs by pols with machinations62. You provide them with cover to sell us a free lunch63. Then all that we’re left with is debt, and a bunch 64. If you’re living high on that cheap credit hog65. Don’t look for cure from the hair of the dog66. Real savings come first if you want to invest67. The market coordinates time with interest 68. Your focus on spending is pushing on thread69. In the long run, my friend, it’s your theory that’s dead70. So sorry there, buddy, if that sounds like invective71. Prepared to get schooled in my Austrian perspective 72. We’ve been going back and forth for a century73. [Keynes] I want to steer markets,74. [Hayek] I want them set free75. There’s a boom and bust cycle and good reason to fear it76. [Hayek] Blame low interest rates.77. [Keynes] No… it’s the animal spirits 78. The place you should study isn’t the bust79. It’s the boom that should make you feel leery, that’s the thrust80. Of my theory, the capital structure is key.81. Malinvestments wreck the economy 82. The boom gets started with an expansion of credit83. The Fed sets rates low, are you starting to get it?84. That new money is confused for real loanable funds85. But it’s just inflation that’s driving the ones 86. Who invest in new projects like housing construction87. The boom plants the seeds for its future destruction88. The savings aren’t real, consumption’s up too89. And the grasping for resources reveals there’s too few 90. So the boom turns to bust as the interest rates rise91. With the costs of production, price signals were lies92. The boom was a binge that’s a matter of fact93. Now its devalued capital that makes up the slack. 94. Whether it’s the late twenties or two thousand and five95. Booming bad investments, seems like they’d thrive96. You must save to invest, don’t use the printing press97. Or a bust will surely follow, an economy depressed 98. Your so-called “stimulus” will make things even worse99. It’s just more of the same, more incentives perversed100. And that credit crunch ain’t a liquidity trap101. Just a broke banking system, I’m done, that’s a wrap. 102. We’ve been goin’ back n forth for a century103. [Keynes] I want to steer markets,104. [Hayek] I want them set free105. There’s a boom and bust cycle and good reason to fear it106. [Hayek] Blame low interest rates.107. [Keynes] No it’s the animal spirits

  10. “Fight of the Century” Lyrics “Fight of the Century” Lyrics Written by John Papola and Russ Roberts KEYNES Here we are… peace out! great recessionthanks to me, as you see, we’re not in a depressionRecovery, destiny if you follow my lessonLord Keynes, here I come, line up for the procession HAYEKWe brought out the shovels and we’re still in a ditch…And still digging. don’t you think that it’s time for a switch…From that hair of the dog. Friend, the party is over.The long run is here. It’s time to get sober! KEYNESAre you kidding? my cure works perfectly fine…have a look, the great recession ended back in ’09.I deserve credit. Things would have been worseAll the estimates prove it—I’ll quote chapter and verse HAYEKEconometricians, they’re ever so piousAre they doing real science or confirming their bias?Their “Keynesian” models are tidy and neatBut that top down approach is a fatal conceit REFRAINWhich way should we choose?more bottom up or more top down…the fight continues…Keynes and Hayek’s second round it’s time to weigh in…more from the top or from the ground…lets listen to the greatsKeynes and Hayek throwing down KEYNESWe could have done better, had we only spent moreToo bad that only happens when there’s a World WarYou can carp all you want about stats and regressionDo you deny World War II cut short the Depression? HAYEKWow. One data point and you’re jumping for joythe Last time I checked, wars only destroyThere was no multiplier, consumption just shrankAs we used scarce resources for every new tank Pretty perverse to call that prosperityRationed meat, Rationed butter… a life of austerityWhen that war spending ended your friends cried disasteryet the economy thrived and grew faster KEYNESYou too only see what you want to seeThe spending on war clearly goosed GDPUnemployment was over, almost down to zeroThat’s why I’m the master, that’s why I’m the hero HAYEKCreating employment’s a straightforward craftWhen the nation’s at war, and there’s a draftIf every worker was staffed in the army and fleetWe’d have full employment and nothing to eat REFRAIN REPEATS HAYEKjobs are a means, not the ends in themselvespeople work to live better, to put food on the shelvesreal growth means production of what people demandThat’s entrepreneurship not your central plan KEYNESMy solution is simple and easy to handle..its spending that matters, why’s that such a scandal?The money sloshes through the pipes and the sluicesrevitalizing the economy’s juices it’s just like an engine that’s stalled and gone darkTo bring it to life, we need a quick sparkSpending’s the life blood that gets the flow goingWhere it goes doesn’t matter, just get spending flowing HAYEKYou see slack in some sectors as a “general glut”But some sectors are healthy, only some in a rutSo spending’s not free – that’s the heart of the mattertoo much is wasted as cronies get fatter. The economy’s not a car, there’s no engine to stallno expert can fix it, there’s no “it” at all.The economy’s us, we don’t need a mechanicPut away the wrenches, the economy’s organic REFRAIN REPEATS KEYNESso what would you do to help those unemployed?this is the question you seem to avoidwhen we’re in a mess, would you just have us wait?Doing nothing until markets equilibrate? HAYEKI don’t want to do nothing, there’s plenty to doThe question I ponder is who plans for whom?Do I plan for myself or leave it to you?I want plans by the many, not by the few. Let’s not repeat what created our troublesI want real growth not a series of bubblesStop bailing out loser, let prices workIf we don’t try to steer them they won’t go berserk KEYNESCome on, Are you kidding? Don’t Wall Street’s gyrationsChallenge your world view of self-regulation?Even you must admit that the lesson we’ve learnedIs more oversight’s needed or else we’ll get burned HAYEKOversight? The government’s long been in bedWith those Wall Street execs and the firms that they’ve bledCapitalism’s about profit and lossyou bail out the losers there’s no end to the cost the lesson I’ve learned? It’s how little we know,the world is complex, not some circular flowthe economy’s not a class you can master in collegeto think otherwise is the pretense of knowledge REFRAIN REPEATS

  11. “Fight of the Century” Lyrics Continued KEYNESYou get on your high horse and you’re off to the racesI look at the world on a case by case basisWhen people are suffering I roll up my sleevesAnd do what I can to cure our disease The future’s uncertain, our outlooks are frailThats why free markets are so prone to failIn a volatile world we need more discretionSo state intervention can counter depression HAYEKPeople aren’t chessmen you move on a boardat your whim–their dreams and desires ignoredWith political incentives, discretion’s a jokeThose dials you’re twisting… just mirrors and smoke We need stable rules and real market pricesso prosperity emerges and cuts short the crisisgive us a chance so we can discoverthe most valuable ways to serve one another FINAL REFRAINWhich way should we choose?more bottom up or more top downthe fight continues…Keynes and Hayek’s second round it’s time to weigh in…more from the top or from the ground…lets listen to the greatsKeynes and Hayek throwing down

  12. Econ 330 Chapter 23 Homework Chapter 23 Review the attached lyrics and YouTube video, “Fear the Boom and Bust”. Then ask yourself, who do you believe is right, Keynes or Hayek? Debate this with other econ students. You do not need to hand in anything to your TA.

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