Class Materials for Lecture 16

Brief Outline of Topics Covered in Lecture 16

Chapter 25 Rational Expectations and Implications for Policy

• New Classical Macroeconomics Model
  • Effects of unanticipated and anticipated policy
  • Can an expansionary policy lead to a decline in aggregate output?
  • Policy ineffectiveness and implications for policymakers

• New Keynesian Model 
  • Effects of unanticipated and anticipated policy
  • Implications for policymakers

• Comparisons of New Classical, New Keynesian, and Traditional Keynesian Models 
  • Short-Run Output and Price Responses

Materials from class:

Video:

Lecture 16 [Google video] - Fall 2007
Lecture 16 [Windows Media] - Fall 2007

 

Economics 470 Lecture 16

Previous (these were taped outside of class):
Lecture 16 - Chapter 25, pgs. 641-652
Google Video

Additional Reading:

• Greenspan Shrugged - Economic Principals
• F.C.C. Chief Seeks Votes to Tighten Cable Rules - New York Times
• Subprime Series, part 1: Financial Crises Are Not Going Away - Vox EU
• Do firm-level productivity differences explain wage inequality? - Vox EU
• EU to press China over yuan - International Herald Tribune
• Why Does a Salad Cost More Than a Big Mac? - Mathew Yglesias
• August in November - Paul Krugman Blog
• Economy May Defy Past and Disregard Housing - New York Times
• Polar Bears for the South Pole? - Spiegel
• A new fashion in modelling - Economist.com
• The Ice-Cream Scoop Taken Out of the Universe - Discover
• Have we sealed the universe's fate by looking at it? - EurekAlert
• Who’s the Richest [Country] of Them All? - WSJ Economics Blog
• Intergenerational payoffs from mothers’ education - Vox EU
• Dollar Will Weather the Whines, Jeers and Jokes - John M. Berry
• Giant fossil sea scorpion bigger than man - EurekAlert
• Fed’s New Forecasts: What’s Surprising and What Isn’t - WSJ Econ Blog
• Dovish Fed vs. Hawkish Fed: More on the FOMC Minutes - WSJ Econ Blog
• What to Look for in New, Improved Fed Minutes - WSJ Economics Blog
• China voices alarm at dollar weakness - FT.com
• European vision blurred by the fog of finance - Project Syndicate
• Monkeys Have Sense of Fairness, Study Finds - Emory Wheel
• A Swarm of Swindlers - New York Times
• Bills Would Let Judges Remake Mortgages - washingtonpost.com
• Fed Watch: Long Run Forecast vs. Short Run Reality - Tim Duy

Application:

Wake up to the dangers of a deepening crisis, by Lawrence Summers, Commentary, Financial Times: Three months ago it was reasonable to expect that the subprime credit crisis would ... not ... threaten ... economic growth. This is still a possible outcome but no longer the preponderant probability.

Even if necessary changes in policy are implemented, the odds now favour a US recession that slows growth significantly on a global basis. Without stronger policy responses..., moreover, there is the risk that the adverse impacts will be felt for the rest of this decade and beyond.

Several streams of data indicate how much more serious the situation is than was clear a few months ago. First, forward-looking indicators suggest that the housing sector may be in free-fall from what felt like the basement levels of a few months ago. ... [I]t is hard to believe declines of anything like this magnitude will not lead to a dramatic slowing in the consumer spending that has driven the economy in recent years.

Second, it is now clear that only a small part of the financial distress that must be worked through has yet been faced. On even the most optimistic estimates, the rate of foreclosure will more than double over the next year...

Third, the capacity of the financial system to provide credit in support of new investment on the scale necessary to maintain economic expansion is in increasing doubt. ...

Then there are the potentially adverse effects on confidence of a sharply falling dollar, rising energy costs, geopolitical uncertainties especially in the Middle East, or lower global growth as economic slowdown and a falling dollar cause the US no longer to fulfil its traditional role of importer of last resort.

In such an environment, economic policy needs to be governed by the clear and public recognition that restoring the normal functioning of the financial system and containing any damage its breakdown may do the real economy is the central macro-economic and financial challenge facing the US. ...

What concrete steps are necessary? First, maintaining demand must be the over-arching macro-economic priority. That means the Fed has to get ahead of the curve and recognise – as the market already has – that levels of the Fed Funds rate that were neutral when the financial system was working normally are quite contractionary today. As important as long-run deficit reduction is, fiscal policy needs to be on stand-by to provide immediate temporary stimulus through spending or tax benefits for low- and middle-income families if the situation worsens.

Second, policymakers need to articulate a clear strategy addressing the various pressures leading to contractions in credit. .... The time for worrying about imprudent lending is past. The priority now has to be maintaining the flow of credit. The current main policy thrust – the so-called “super conduit” ... has never been publicly explained in any detail by the US Treasury. On the information available, the “super conduit” has worrying similarities with Japanese banking practices of the 1990s that aroused criticism from American authorities for their lack of transparency, suppression of genuine market pricing of bad credits, and inhibiting effect on new lending. Perhaps there is a strong case for it, but that case has yet to be made.

Third, there needs to be a comprehensive approach taken to maintaining demand in the housing market to the maximum extent possible. The government operating through the Federal Housing Administration, through Fannie Mae and Freddie Mac, or through some kind of direct lending, needs to assure that there is a continuing flow of reasonably priced loans to credit worthy home purchasers. At the same time there need to be templates established for the restructuring of mortgages to homeowners who cannot afford their resets, so every case does not have to be managed individually.

All of this may not be enough to avert a recession. But it is much more than is under way right now.