Economics 470/570 - Monetary Theory and Policy

Syllabus for Fall 2007

[Syllabus in pdf format]

Course: Economics 470/570 Monetary Theory and Policy
Professor: Mark Thoma
Office/Hours: PLC 471 on T/Th 2:00-3:00 p.m.
Phone/Email: (541) 346-4673, [email protected]
Web Page: http://darkwing.uoregon.edu/~mthoma/

Text: Frederic S. Mishkin, The Economics of Money, Banking, and Financial Markets, 8th edition (Addison Wesley: New York).

Prerequisites: Economics 313 or the equivalent.

GTF: Andrea Giusto,  email: [email protected]
GTF's Office/Hours: TBA 

Tests and Grading: There will be two midterms and a final. The midterms will be given on Tuesday, October 16^th and Thursday, November 8^th. The final will be given on Friday, December 7^th from 8:00 a.m. – 10:00 a.m.  Each midterm is worth 30% and the final is worth 40%.  Grades will be assigned according to your relative standing in the class.

Homework: Problem sets will be assigned periodically. These are not graded, but it is strongly recommended that you do them since exam questions will be based, in part, upon the problem sets.

Course Outline:

Introduction	Mishkin Text
Introduction	Ch. 1, pgs. 8-13
The Role of Money in the Macroeconomy	Ch. 3, Ch. 4 pgs. 87-90
Central Banking and the Conduct of Monetary Policy
Structure of Central Banks and the Federal Reserve System	Ch. 12
Bank Reserves and the Money Supply	Ch. 13
Determinants of the Money Supply	Ch. 14
Tools of Monetary Policy	Ch. 15
Monetary Theory
The Demand for Money	Ch. 19
The Keynesian Framework	Ch. 20
Monetary and Fiscal Policy	Ch. 21
The AS-AD Model	Ch. 22
Money and Inflation	Ch. 24
Rational Expectations: Theory and Policy Implications	Ch. 25

Video Lectures - Fall 2007

Video Lectures for Fall 2007
Lecture 1 Media Player Google Video wmv MPEG4	Lecture 7 Media Player Google Video wmv MPEG4	Lecture 13 Media Player Google Video wmv MPEG4
Lecture 2 Media Player Google Video wmv MPEG4	Lecture 8 Media Player Google Video wmv MPEG4	Lecture 14 Media Player Google Video wmv MPEG4
Lecture 3 Media Player Google Video wmv MPEG4	Lecture 9 Media Player Google Video wmv MPEG4	Lecture 15 Media Player Google Video wmv MPEG4
Lecture 4 Media Player Google Video wmv MPEG4	Lecture 10 Media Player Google Video wmv MPEG4	Lecture 16 Media Player Google Video wmv MPEG4
Lecture 5 Media Player Google Video wmv MPEG4	Lecture 11 Media Player Google Video wmv MPEG4	Lecture 17 Media Player Google Video wmv MPEG4
Lecture 6 Media Player Google Video wmv MPEG4	Lecture 12 Media Player Google Video wmv MPEG4	Videos from Previous Classes
Midterm 1	Midterm 2	Final Exam

The Media Player and Google Video links go to new pages with embedded video players. The MPEG4 (QuickTime) and wmv (Windows Media Player) links are for downloads (right click).

Note: Google Video has been a bit problematic at times, though it generally works fine, but the Media Player link should work if there is any trouble. If not, please let me know.

Class Materials for Lecture 17

Brief Outline of Topics Covered in Lecture 17

Chapter 25 Rational Expectations and Implications for Policy

• Anti-inflation policies
  
  • Traditional model
  • New classical model
    
  • New Keynesian model

• The role of credibility in fighting inflation
  
  • Show with AD-AS and Phillips curve diagrams
    

Materials from class:

Continue with materials posted for lecture 16.

Video:

Lecture 17 [Google video] - Fall 2007
Lecture 17 [Windows Media] - Fall 2007

 

Economics 470 Lecture 17

Previous (these were taped outside of class):
Lecture 17 - Chapter 25, pgs. 652-658
Google Video

Additional Reading:

• Is the sky falling on both Wall Street and Main Street? - Maverecon
• Dreaded 'R' Word Starts Tripping Off the Tongue - Caroline Baum
• Does offshoring boost domestic productivity? Evidence from Italy - Vox EU
• Size Limits for Cable Look Likely - New York Times
• New Findings Underscore an Earth-Venus Kinship - New York Times
• Subprime Series, part 2: - Vox EU
• Trust and European capital market integration - Vox EU
• In Study of Brain Evolution, Zeal and Bitter Debate - New York Times
• The Dance of Evolution, or How Art Got Its Start - New York Times
• China Rejects Europe’s Call for Currency to Rise Faster - New York Times
• A Slowdown in Jobs Lost, and Created - New York Times

Application:

This graph is from the San Francisco Fed. It shows the relationship between unemployment and wage inflation:

The accompanying write-up says:

Conventional wisdom holds that when the unemployment rate falls below the NAIRU, wage inflation increases, which eventually feeds through to price inflation. A key question for policymakers is whether this conventional wisdom remains relevant today.

There are a number of potentially mitigating factors that might temper the relevance of this historical relationship. Three factors that have received particular study of late are: (1) mismeasurement of available workers, (2) mismeasurement of the NAIRU, and (3) changes in the sensitivity of wage inflation to the unemployment rate owing to the rising importance and stability of inflation expectations.

Although the measured unemployment rate is quite low, some would argue that it does not fully capture the population available for work. Relative to the late 1990s, the labor force participation rate (LFP) and the employment-to-population ratio remain low, suggesting that there is some room for the total workforce to expand. On the other hand, the aging of the baby boom makes the return to past peaks in LFP or the employment-to-population ratio less than certain.

The NAIRU is difficult to measure and is affected by a number of demographic and institutional factors. There is a wide range of credible estimates of the current NAIRU—4.7 to 5.2—suggesting that labor markets may not be quite as tight as the consensus estimate would imply.

The sensitivity of wage inflation to the unemployment rate depends in part on the inflation expectations of workers. Despite elevated levels of price inflation of late, inflation expectations remain well-contained, likely tempering the magnitude of cost-of-living based wage increases demanded by workers.

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.

Class Materials for Lecture 15

Brief Outline of Topics Covered in Lecture 15

Chapter 24 Money and Inflation

• Debt monetization

• The activist/non-activist debate
  
  • Policy lags and other problems in pursuing activist policies

Chapter 25 Rational Expectations and Implications for Policy

• RE and the Lucas critique

Materials from class:

None for today

Video:

Lecture 15 [Google video] - Fall 2007
Lecture 15 [Media Player] - Fall 2007

 

Economics 470 Lecture 15

Previous (these were taped outside of class):
Lecture 15 - Chapter 24, pgs. 626-635; Chapter 25, 639-641
Google Video

Additional Reading:

• Milton Friedman: Why Money Matters
• China voices alarm at dollar weakness - FT.com
• What to Look for in New, Improved Fed Minutes - WSJ Economics Blog
• Evolution is deterministic, not random, biologists conclude - EurekAlert
• Subprime fallout: Preparing for the next financial crisis - Vox EU
• Sovereign Wealth World - James Surowiecki - The New Yorker
• Inflation targeting comes to Washington DC - Maverecon
• Sovereign Wealth World - James Surowiecki - The New Yorker
• Shock treatment - Economist.com
• The death of e-mail - Chad Lorenz - Slate Magazine
• 'Noah's flood' kick-started European farming - EurekAlert
• Sex Can Influence Inflation Expectations, Really - Caroline Baum
• How long can the Gulf countries sustain their dollar pegs? - RGE Monitor

Application:

What the Fed says is different from what financial markets expect. Here's Tim Duy:

Headed For Another Game of Chicken?, by Tim Duy: Over the last two weeks, Fedspeak has been undeniably hawkish.  Does anyone listen?  As near as I can tell, pretty much no one in the global financial markets is listening. Expectations for additional easing in the months ahead are only growing. What’s a Fed watcher to do? Listen to the Fed or the financial markets? The smart money is on the markets and suggests the best move is to continue to shade expectations toward another rate cut in December.

The hawk parade was kicked off when Federal Reserve Governor Frederic Mishkin stepped up to the podium to reinforce the recent FOMC statement – delivering a clear message that he sees growth and inflation risks as equally balanced, and that the data, not the markets, will drive the outcome of the December meeting. Mishkin’s remarks were clearly intended to reduce expectations that the Federal Reserve is driving an unstoppable rate cut train. More interestingly, he waived the inflation flag, suggesting that Fed officials are starting to worry that inflation expectations are fraying. In total, he wants us to believe that if the data stream remains consistent with recent patterns, the Fed will hold tight in December. He bolstered that warning with a reminder that the Fed can always take back what was given in the last two outings of the FOMC:

The FOMC perhaps could have waited for more clarity and left policy unchanged last week, but I believe that the potential costs of inaction outweighed the benefits, especially because, should the easing eventually appear to have been unnecessary, it could be removed.

Pretty much a clear message – don’t take another rate cut for granted. And the hawkish beat kept up through the week; a nice little compilation can be found in the WSJ Marketbeat blog. A particularly blunt statement came from Philadelphia Fed President Charles Plosser:

Review Questions - Material after Midterm 2

Review Questions - Material after Midterm 2

Definitions

Potential or natural rate of output
Short-run aggregate supply
Long-run aggregate supply
Implicit and explicit contracts
Deficit and Debt
Debt monetization
Inflation
Cost push inflation
Demand pull inflation
Activist/non-activist
Data lag
Recognition lag
Legislative lag
Implementation lag
Effectiveness lag
Policy ineffectiveness proposition
Rational expectations
Natural rate hypothesis
Price rigidity

Essay

1. Explain the Monetarist view of aggregate demand. Explain why Monetarists do not believe that shifts in the IS curve affect aggregate demand.

2. Explain the Keynesian view of aggregate demand.

3. Why does the short-run aggregate supply curve slope upward? What factors cause the aggregate supply curve to shift?

4. Is the economy self-correcting?

5. What causes the LRAS curve to shift, i.e. what factors affect the natural rate of output? Explain.

6. Do Monetarists agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model.

7. Do Keynesians agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model.

8. Explain how the pursuit of a high employment target by policymakers can lead to inflation.

9. Can budget deficits lead to inflation? Explain.

10. Why might governments choose to monetize the debt?

11. Explain the activist and non-activist positions on the use of government policy to stabilize macroeconomic variables such as real output. What problems are encountered in the pursuit of activist policies?

12. Explain and give an example of the Lucas critique. Why is this important?

13. What are the essential differences between the Classical, Keynesian, New Classical, and New Keynesian models?

14. Show that it is possible in a model with expectations (e.g. using the New Classical model) for an increase in the money supply to reduce output if the change in the money supply is smaller than expected.

15. Compare and contrast the effects of an unexpected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

16. Compare and contrast the effects of an expected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

17. Suppose the monetary authority wants to reduce the inflation rate. Compare the costs (in terms of output) of reducing inflation in the traditional Keynesian, New Classical, and New Keynesian models. Be sure to cover both an expected and an unexpected change in policy. Why is the credibility of policymakers important?

Midterm 2 Solution

Midterm 2 and Solution.

Class Materials for Lecture 14

Brief Outline of Topics Covered in Lecture 14

Chapter 22 Aggregate Demand and Supply Analysis

• Shifts in the AS curve
  
  • Shifts in the SRAS
  • Shifts in the LRAS and RBC models

Chapter 24 Money and Inflation

• Inflation
  
  • Monetarist view
  • Keynesian view
  • Supply shocks
  • Always a monetary phenomena?

• How does inflationary policy arise?
  
  • Cost push - demand for higher wages
  • Demand pull - shooting at the wrong target

• Budget deficits and inflation

Materials from class:

Video:

Lecture 14 [Google video] - Fall 2007
Lecture 14 [Media Player] - Fall 2007

 

Economics 470 Lecture 14

Previous (these were taped outside of class):
Lecture 14 - Chapter 22, pgs. 569-580; Chapter 24, pgs 613-626
Google Video

Additional Reading:

• Bernanke Sets Plan to Make Fed More Transparent - washingtonpost.com
• Federal Reserve Communications - FRB: Speech--Bernanke
• World too complex for one-size-fits-all models - Dani Rodrik
• International financial stability by design - Vox EU
• The Coming Foreclosure Tsunami - Chris Hayes
• Understanding the Falling Dollar - Brad Setser - washingtonpost.com
• Facts and fallacies about US FDI in China - Vox EU
• China's October Inflation Matches Decade High of 6.5% - Bloomberg
• Subprime crisis: time for an inflation-targeting rethink? - Vox EU
• SpongeBob and the proper role of the State - Salon.com
• Yes, Virginia, the Fed Has an Inflation Target ... And It’s Missing It - WSJ

Application:

Bloomberg's John Berry on changes in Fed transparency:

Fed Changes More Than the Number of Forecasts, by John M. Berry, Bloomberg: Federal Reserve officials are going public with lots of the details missing from their traditional bare-bones forecasts, and they're going to do it four times a year instead of two.

The Federal Open Market Committee announced the changes yesterday in a statement, and Chairman Ben S. Bernanke discussed them in detail in a speech at the Cato Institute in Washington.

One thing the changes won't include is a formal target for inflation. And all the added information being released won't necessarily provide better guidance about what policy makers will do with their overnight lending-rate target at the next FOMC meeting. Minutes of the meetings already provide significant information about participants' views on the short- term economic outlook and the balance of risks to growth and inflation.

But what's really going to be new is that along with all the figures will be explanations that, according to the FOMC statement, ''will provide a fuller discussion of the projections, covering not only the outcomes that most meeting participants see as most likely, but also the risks to the economic outlook and the dispersion of views among policymakers.''

Class Materials for Lecture 13

Brief Outline of Topics Covered in Lecture 13

Chapter 22 Aggregate Demand and Supply Analysis

• Aggregate Demand
  
  • Monetarist view
  • Keynesian view

• Shifts in the AD curve
  
  • Monetary policy (M)
  • Fiscal policy (G,T)
  • Other factors

• Aggregate supply
  
  • Aggregate supply in the short-run
  • Aggregate supply in the long-run

• Equilibrium
  
  • Does the economy self-correct?

Materials from class:

Video:

Lecture 13 [Google video] - Fall 2007
Lecture 13 [Media Player] - Fall 2007

 

Economics 470 Lecture 13

Previous (these were taped outside of class):
Lecture 13 - Chapter 22, pgs. 561-568
Google Video

Additional Reading:

• Dani Rodrik Seminar at Crooked Timber
• Consumer Spending Won't Fall and Cause Recession - John M. Berry
• A Necessary Profession, Reinvented (Develop. Econ.) - Economic Principals
• Astronomers' big news from the habitable zone - The Boston Globe
• From Ants to People, an Instinct to Swarm - New York Times
• Striking Out - James Surowiecki - The New Yorker
• Some Wonder if the Banks’ Stabilization Fund Will Work - New York Times
• Science-based approach in poverty fight - MIT News Office
• The Fed's policy space is not one-dimensional - Interfluidity
• The Man Who Imagined Wormholes and Schooled Hawking - Discover
• Do stronger patents limit the circulation of ideas? - Vox EU
• Solow reviews A Farewell to Alms - The Bayesian Heresy

Application:

This is from Bruce Blonigen and a co-author, Alyson Ma:

Will China soon be making not only cheaper, but also better, products than everyone else?, by Bruce Blonigen and Alyson C. Ma, Vox EU: The opening of China and its breathtaking ascendancy to major-player status in world markets has led to significant hand-wringing by the rest of the world on many fronts. The huge outflow of cheap unskilled-labour-intensive products from China and its ramifications for wages and welfare in both developed and other less-developed countries has been a primary concern.

Recently, new hand-wringing concerns have been raised by various commentators. As it turns out, the composition of China’s exports is much closer to that of OECD countries than its level of per-capita income would suggest.[1] This has substantial implications not only for China’s ability to sustain its growth, but also for real wages of all workers in developed countries, not just unskilled ones.

A significant factor behind this surprising export sophistication by China may be the role of industrial policy to promote technologically-advanced industries. While it is well known that the Chinese government has historically had preferential tax treatment and free trade zones for foreign firms, it also often negotiates technology transfer arrangements with foreign firms. These are either through restrictions that limit FDI to joint venturing with a domestic partner or simply offering quid pro quo arrangements of technology transfer from the foreign firm to domestic ones in exchange for the foreign firm’s ability to sell to the huge Chinese market.[2]

Class Materials for Lecture 12

Brief Outline of Topics Covered in Lecture 12

Chapter 21 Monetary and Fiscal Policy in the IS-LM Model

• The Fed cannot control both i and M simultaneously

• Poole's Pules
  
  • Unstable IS curve
  • Unstable LM curve

• The IS-LM model in the long-run
  
  • Natural rate of output
  • Monetary and fiscal policy in the short-run and long-run

• The aggregate demand curve
  
  • Derive from IS-LM model
  • Slope of aggregate demand curve
  • Shifts in the aggregate demand curve

Materials from class:

Video:

Lecture 12 [Google video] - Fall 2007
Lecture 12 [Media Player] - Fall 2007

 

Economics 470 Lecture 12

Previous (these were taped outside of class):
Lecture 12 - Chapter 20, pgs. 549-558
Google Video

Additional Reading:

• Performance-pay Perplexes - James Surowiecki
• Putting an End to Abusive Lending - New York Times
• Study Finds Working At Work Improves Productivity - The Onion
• In Portland, Cultivating a Culture of Two Wheels - New York Times
• Competitively Priced Electricity Costs More, Studies Show - New York Time
• Financial Instability and Monetary Policy - FRB: Speech--Mishkin
• Cognitive Dissonance (monkeys rationalize) - New York Times
• The Decline in the U.S. Personal Saving Rate - FRB St. Louis
• Religiosity and income in the U.S. - Andrew Gelman
• Gesturing helps solve math problems - EurekAlert
• Fed Cuts, Signals Markets Don't Look for Another - John M. Berry
• How the Brain Maps Symbols to Numbers - Scientific American
• Video of a sphere turning inside out without creasing - Sciam Observations
• $75 Billion Fund Is Seen as Stopgap - New York Times
• Helpful tax competition: new empirical evidence - Vox EU

Application:

Justin Fox on how Federal Reserve Governor Frederic Mishkin views the risk management approach to monetary policy in the current financial environment, and Mishkin's view of whether further rate cuts will be needed:

Rick Mishkin says the Fed is out to fight feedback loops, not bail out investors, by Justin Fox: Federal Reserve governor Frederic Mishkin gave a speech Monday... He said some interesting stuff:

Two types of risks are particularly important for understanding financial instability. The first is ... valuation risk: The market, realizing the complexity of a security or the opaqueness of its underlying creditworthiness, finds it has trouble assessing the value of the security. For example, ... during the turmoil of the past few months ... investors have struggled to understand how potential losses in subprime mortgages might filter through the layers of complexity that such products entail.

The second type of risk that I consider central to the understanding of financial stability is what I call macroeconomic risk--that is, an increase in the probability that a financial disruption will cause significant deterioration in the real economy. Because economic downturns typically result in even greater uncertainty about asset values, such episodes may involve an adverse feedback loop whereby financial disruptions cause investment and consumer spending to decline, which, in turn, causes economic activity to contract. Such contraction then increases uncertainty about the value of assets, and, as a result, the financial disruption worsens. In turn, this development causes economic activity to contract further in a perverse cycle.

So what is the Fed to do?

Class Materials for Lecture 11

Brief Outline of Topics Covered in Lecture 11

Chapter 21 Monetary and Fiscal Policy in the IS-LM Model

• Effectiveness of Monetary and Fiscal Policy Graphically and Intuitively
  
  • Responsiveness of money demand to the interest rate
  • Responsiveness of investment to the interest rate

Materials from class:

None for today

Video:

Lecture 11 [Google video] - Fall 2007
Lecture 11 [Media Player] - Fall 2007

 

Economics 470 Lecture 11

Previous (these were taped outside of class):
Lecture 11 - Chapter 20, pgs. 546-549
Google Video

Additional Reading:

• Voter turnout not increased by early voting measures - EurekAlert
• Tangled web of the insect, plant and parasite arms race - EurekAlert
• Biofuels: a tale of special interests and subsidies - Martin Wolf
• Why do so many species live in tropical forests and coral reefs? - EurekAlert
• Fed Watch: Just Six Weeks to the Next FOMC Meeting!, by Tim Duy
• Greenhouse gases: Demand control, supply and carbon prices - Vox EU
• "Free is More Complicated Than You'd Think"

Application:

The Federal Reserve Open Market Committee decided to cut the federal funds rate to 4.50%. The decision was not unanimous with Kansas City Fed president Thomas Hoenig preferring no change. Thus, the vote was 9-1 (the committee currently has two positions unfilled). Also, only six banks submitted requests to lower the discount rate. It's clear from the statement that the Committee does not want to set up expectations of further cuts with the fairly direct statement that "after this action, the upside risks to inflation roughly balance the downside risks to growth."

Here's the Press Release:

Press Release

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/2 percent.

Economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance.  However, the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction.  Today’s action, combined with the policy action taken in September, should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time.

Readings on core inflation have improved modestly this year, but recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation.  In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth.  The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Voting for the FOMC monetary policy action were:  Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; William Poole; Eric S. Rosengren; and Kevin M. Warsh.  Voting against was Thomas M. Hoenig, who preferred no change in the federal funds rate at this meeting.

In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 5 percent.  In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Richmond, Atlanta, Chicago, St. Louis, and San Francisco.

Review Questions for Midterm 2

Definitions

Quantity equation
Velocity of money
Equation of exchange
Consumption, disposable income, MPC and MPS
Investment
Government spending
Aggregate demand or expenditures
Autonomous expenditures
Expenditure multiplier
Autonomous money demand
IS curve
LM curve
Policy effectiveness
Crowding out
Short-run and long-run in AD/AS model

Essay

These are from the first set of review questions and cover the material we didn't get to for the first exam:

21. Use the supply and demand model for bank reserves to explain and illustrate the effects of (a) an open market operation to buy bonds, (b) a decrease in the discount rate, and (c) an increase in required reserves.

22. Describe the three tools available to the Fed for controlling the money supply. How do defensive and dynamic open-market operations differ? How do primary, seasonal, and secondary credit differ? What are the advantages of open-market operations relative to the other tools?

23. What is meant by the phrase lender of last resort? Why is this important? Explain and show graphically how the Fed uses discount rate policy to act as a lender of last resort and how this serves to limit the amount the federal funds rate can rise.

And here are the rest:

1. Explain the quantity theory of money. Explain the Cambridge approach and illustrate that it leads to the same identity as the quantity theory. What assumptions are imposed to arrive at a theoretical statement?

2. Is velocity a constant in Keynes liquidity preference theory? When actual data is examined, does velocity appear to be a constant? Why is this important?

3. What is the money demand function in the classical model?

4. Discuss the transactions, precautionary, and speculative motives for holding money in Keynes liquidity preference theory. When all three motives are put together, what theory of money demand emerges?

5. Show the money demand curve graphically and explain why it slopes downward. Show how the money demand curve shifts when income increases.

6. According to Baumol, the transactions demand for money depends upon the interest rate as well as nominal income. Explain why the transactions demand for money depends upon the interest rate. Why is this important?

7. What did Tobin add to Keynes theory of the speculative demand for money? Why was this development important?

8. Explain Friedman's Modern Quantity Theory of the Demand for Money.

9. What is the 45 degree line diagram? What is the expenditure multiplier? What is the slope of the expenditure function? What factors cause the expenditure function to shift?

10. Derive the IS curve. Explain intuitively why it slopes downward. What factors cause the IS curve to shift? In what direction do they shift the IS curve?

11. Derive the LM curve. Explain intuitively why it slopes upward.  What factors cause the LM curve to shift? In what direction do they shift the LM curve?

12. Is the equilibrium in the IS-LM model stable? Explain.

13. Show graphically and explain intuitively how an increase in government spending affects income and the interest rate in the IS-LM model.

14. Show graphically and explain intuitively how an increase in the money supply affects income and the interest rate in the IS-LM model.

15. Explain why the LM curve is vertical when money demand is unaffected by changes in the interest rate (as in the classical model).

16. Use the IS-LM model to show that monetary policy becomes more effective relative to fiscal policy as money demand becomes less sensitive to the interest rate. Explain the result intuitively.

17. Explain why investment is less sensitive to interest rate changes in recessions as compared to when the economy is operating closer to full employment. Explain why the IS curve is vertical when investment is completely insensitive to changes in the interest rate.

18. Use the IS-LM model to show that fiscal policy becomes more effective relative to monetary policy as investment becomes less sensitive to the interest rate. Explain the result intuitively. What does this imply about the use of monetary and fiscal policy over the business cycle?

19. Show that the Fed cannot continuously hit both a money supply target and an interest rate target, i.e. that it must choose one or the other.

20. Explain Poole's rules.

21. Do changes in the money supply and government spending affect output in the long-run? Explain using the IS-LM model.

[End of material for midterm 2. Question 22, and definitions related to AD-AS, will not be on this test.]

22. Derive the aggregate demand curve from the IS-LM model and explain intuitively why it slopes downward. What factors cause the AD curve to shift? In what direction do they shift the AD curve?

Class Materials for Lecture 10

Brief Outline of Topics Covered in Lecture 10

Chapter 20 The IS-LM Model

• The LM Curve
  
  • Derive LM curve from money demand - money supply diagram
  • Shifts in the LM curve
• Equilibrium
  • Stability of equilibrium

Chapter 21 Monetary and Fiscal Policy in the IS-LM Model

• Changes in the equilibrium values of output and the interest rate
  
  • Monetary policy in the IS-LM model
  • Fiscal policy in the IS-LM model

Materials from class:

Video:

Lecture 10 [Google video] - Fall 2007
Lecture 10 [Media Player] - Fall 2007

 

Economics 470 Lecture 10

Previous (these were taped outside of class):
Lecture 10 - Chapter 20, pgs. 531-535; Chapter 21, pgs. 539-546
Google Video

Additional Reading:

• Monitoring the euro area economy in real-time - Vox EU
• The economic impacts of climate change policy - Environmental Economics
• IMF reform: a marathon, not a sprint - Vox EU
• US private equity groups in China talks - FT.com
• Sugar’s Sweetheart Deal - NY Times
• The AMT Must Go - Charles Rangel
• Political Scientists Discover New Form Of Government - The Onion
• Fed concern at expectation of rate cut - FT.com
• Don’t believe the hype: renminbi flexibility - Vox EU
• Q&A With St. Louis Fed's Poole - WSJ Economics Blog
• Oil price movements in other currencies - Worthwhile Canadian Initiative
• What Kind of Caution by the Fed This Time? - New York Times
• Some housing pictures - Paul Krugman - Blog
• Predators and parasites may increase evolutionary stability - EurekAlert
• Dozens of Species of Primates Are Under Threat - New York Times
• Why is oil above $90? - Econbrowser
• Do We Have an Inventory Problem? - Economics Blog
• New ideas about human migration from Asia to Americas - EurekAlert
• Cap-and-trade bill is second-rate - Los Angeles Times
• Subprime Roadmap Laid Out in Gramlich's Last Act - Gene Sperling
• World's hottest chile pepper discovered - EurekAlert

Application:

Tim makes a contrarian call on the outcome of the Fed's rate setting meeting:

And So It Begins, by Tim Duy: The Fed begins a two-day meeting today, with market participants widely expecting a rate cut. I am mentally prepared to be on the wrong side of this call, joining the lonely few, but I just can’t tease another rate cut out of the incoming data.

In my mind, the argument for a rate cut hinges on one crucial assumption – that the market is expecting a rate cut, and the Fed will not want to disappoint. From Bloomberg:

''The Fed is reluctant to ease,'' says Louis Crandall, chief economist at Jersey City, New Jersey-based Wrightson ICAP LLC, a unit of ICAP Plc, the world's largest broker for banks and other financial institutions. ''But it also doesn't want to unsettle the financial markets unnecessarily.''

If the Fed fails to ease, so the story goes, they will be blamed for failure to communicate effectively. After all, given their push for transparency, shouldn’t they make an effort to send a signal when the markets are headed in the wrong direction? The problem with this view is that Fed Chairman Ben Bernanke does not believe it is his job to lead markets around by the nose like his predecessor. I think under the new regime, the Fed expects their comments to be taken at face value. And I think they are pretty effectively communicating their view on the economy: Outside of housing, there is minimal spillover, and whatever spillover exists is completely expected. From Bernanke on October 15 (italics mine):

Class Materials for Lecture 9

Brief Outline of Topics Covered in Lecture 9

Chapter 20 The IS-LM Model

• Review of the expenditure function and the 45 degree line diagram
  • Consumption, investment, government spending, and net exports
  • Autonomous expenditures
  • The MPC
  • The expenditure function and equilibrium in the 45 degree line diagram
  • The expenditure multiplier
• The IS curve
  • Investment and the interest rate
  • Net exports and the interest rate
  • Derive the IS curve from 45 degree line diagram

Materials from class:

Video:

Lecture 9 [Google video] - Fall 2007 - Note: I'm having trouble with Google video. I've been trying to get the videos uploaded for three days without success (which is why they are being posted later than usual). I will keep trying...
Lecture 9 [Media Player] - Fall 2007

 

Economics 470 Lecture 9

Previous (these were taped outside of class):
Lecture 9 - Chapter 20,  pgs. 513-531
Google Video

Additional Reading:

• Should the Fed Target Asset Prices - WSJ Economics Blog
• Home improvement - Dean Baker
• Why Credit-rating Agencies Blew It: Mystery Solved - Robert Reich
• Europe Tries to Attract Migrants It Prefers - New York Times
• Solution to Energy and Climate Crises? - Scientific American
• House price bubbles made in Europe - Daniel Gros - Vox EU

Application:

Tim Duy is losing sleep:

Runaway Rate Cut Train?, by Tim Duy: I agonize over this stuff.  Constantly.  And it is not really part of my job. Just can’t get it out of my mind.

It is even more agonizing when expectation flip-flop so strongly, from rate cut to no rate cut back to rate cut certainty. From the Cleveland Fed:

Fed Chairman Ben Bernanke’s speech kicked off a shift in expectations, reinforced by additional Fed speakers. The ongoing risk management theme was reiterated by new Chicago Fed President Charles Evans:

To me, the uncertainties about how financial conditions might evolve and affect the real economy mean that risk management considerations have an important role in the current policy environment…However, there is a less benign possibility. Housing demand and prices could weaken a good deal more than we expect — either because a new shock hits the sector or because we have underestimated the weakness already in train….

I want to emphasize that I do not see this extreme outcome as likely. But it is one of those high cost outcomes that we should guard against. The challenge is to calibrate the insurance in light of the lower probability of the spillover event occurring.

The upshot of such speeches has been to entrench expectations that as long as housing is deteriorating, the downside risks to the economy are too great to be ignored, and therefore rate cuts will continue regardless of the relatively minimal impact the housing downturn has had on the rest of the economy. Still unsteady credit markets argue further for additional cutting.

Class Materials for Lecture 8

Brief Outline of Topics Covered in Lecture 8

Chapter 19 Money Demand

• Further Developments in the Keynesian Approach
  • Why Transactions demand depends upon i (Baumol)
  • Tobin's Uncertainty Theory
• Friedman’s Modern Quantity Theory of Money

Materials from class:

Video:

Lecture 8 [Google video] - Fall 2007
Lecture 8 [Media Player] - Fall 2007

 

Economics 470 Lecture 8

Previous (these were taped outside of class):
Lecture 8 - Chapter 19,  pgs. 501-510
Google Video

Additional Reading:

• Come with Me to the FOMC, Remarks by Governor Laurence H. Meyer, Willamette University
• Poole Sees Improvement but Says Threat Remains - WSJ Economics Blog
• Deflation in Japan: worse than you think - Vox EU
• Microsoft Concedes in European Antitrust Case - New York Times
• Agricultural Trade Reforms - Vox EU
• How to encourage the road-to-rail shift in Europe - Vox EU
• Poor Countries Wag Fingers at Rich Ones - New York Times
• Will the Bottom Billion Ever Catch Up? - washingtonpost.com
• Greenspan questions 'superfund' - FT.com
• IMF fails to make progress on reforms - FT.com
• Some firms replace offshoring with onshoring - Los Angeles Times
• In Search of Wireless Wiggle Room - New York Times
• St. Louis Fed Monetary Policy Conference
• Monetary Policy under Uncertainty - FRB: Speech--Bernanke
• Rules versus discretion in monetary policy - Econbrowser
• The Econoblogosphere is Not in Danger - Finance Blog - Felix Salmon
• Exotic I.R.A.’s: Leaving Stocks and Bonds Behind - New York Times
• Nobel Prize: What is mechanism design and why does it matter? - Vox EU
• Study: Housing Boom Has Limited Effect on Growth - WSJ Economics Blog

Application:

This is a speech by Ben Bernanke on conducting monetary policy in the presence of uncertainty of various types (Bill Poole is president of the St. Louis Fed, we will learn about "Pooles Rules" for conducting monetary policy later in the course):

Monetary Policy under Uncertainty, by Ben Bernanke: Bill Poole's career in the Federal Reserve System spans two decades separated by a quarter of a century. From 1964 to 1974 Bill was an economist on the staff of the Board's Division of Research and Statistics. He then left to join the economics faculty at Brown University, where he stayed for nearly twenty-five years. Bill rejoined the Fed in 1998 as president of the Federal Reserve Bank of St. Louis, so he is now approaching the completion of his second decade in the System.

As it happens, each of Bill's two decades in the System was a time of considerable research and analysis on the issue of how economic uncertainty affects the making of monetary policy, a topic on which Bill has written and spoken many times. I would like to compare the state of knowledge on this topic during Bill's first decade in the System with what we have learned during his most recent decade of service. The exercise is interesting in its own right and has the added benefit of giving me the opportunity to highlight Bill's seminal contributions in this line of research.

Class Materials for Lecture 7

Brief Outline of Topics Covered in Lecture 7

Chapter 19 Money Demand

• Quantity Theory of Money
  • Velocity of Money and Equation of Exchange
  • Quantity Theory
  • Quantity Theory of Money Demand
• The Cambridge Approach
• Is velocity a Constant?
• Keynes’s Liquidity Preference Theory
  • Transactions Motive
  • Precautionary Motive
  • Speculative Motive
  • Putting the Three Motives Together
• Further Developments in the Keynesian Approach

Materials from class:

Video:

Lecture 7 [Google video] - Fall 2007
Lecture 7 [Media Player] - Fall 2007

 

Economics 470 Lecture 7

Previous (these were taped outside of class):
Lecture 7 - Chapter 19,  pgs. 493-500
Google Video

Additional Reading:

• The brave new world of state capitalism - Martin Wolf
• Foreign investors slash holdings of US securities - FT.com
• Text of Paulson's Remarks on Housing - WSJ Economics Blog
• Some at Fed Favored A Smaller Rate Cut - WSJ.com
• Can the Fed Deflate Market Bubbles? - WSJ Economics Blog
• South America creates regional bank, sign of ending Bretton Woods - Rybinski
• Recent Financial Turmoil and its Economic and Policy Consequences - Bernanke
• Bernanke sees better near-term outlook - FT.com
• China hikes bank reserve rate to 13% - China Daily
• Their own private S&Ls - Paul Krugman - Blog
• Fed Won't Cut Again Unless Data Show It's Needed - John M. Berry
• John Taylor's Contributions - Fisher - FRB Dallas
• Contributions of John Taylor - FRB: Speech--Bernanke
• The Roles of the Federal Reserve - FRB: Speech--Kroszner
• John Taylor’s Contributions - Yellen - FRB SF
• Explaining the T-bond 'conundrum' - New Economist
• Monetary policy transparency - what impact? - New Economist
• Real Estate, Financial Markets, and the Economy - FRBB Speeches

• Harvard scientists predict the future of the past tense - EurekAlert
• American lawbreaking: How laws die. - Tim Wu - Slate
• Blogonomics: Paying for Content - Finance Blog - Felix Salmon
• Discrimination: Evidence from Internet-based CV Database - Journal of Interest
• The Great Cosmic Roller-Coaster Ride - Scientific American
• EMU and inequality: the facts - Vox EU
• Hooked on whales - International Herald Tribune
• Money Can't Buy You Taste - The Borjas Blog
• Stretching the Search for Signs of Life - New York Times
• Study finds that people are programmed to love chocolate - EurekAlert
• Hypertime -- why we need 2 dimensions of time - EurekAkert
• Genes influence people's choices in economics game - MIT News Office

Application:

This is from the WSJ. It's about whether Fed policy encourages excessive risk-taking [discussion of Koenig version of Taylor rule discussed below]:

Fed Policy and Moral Hazard, by Harvey Rosenblum, WSJ: Accusations of moral hazard have been tossed around quite a bit since the Federal Reserve lowered the federal-funds rate by half a percentage point a month ago today. Moral hazard, if you're neither an actuary nor a practitioner of the "dismal science," occurs when investors or property owners are protected from the downside risks of bad investment decisions, thus encouraging them to take still more unwise risks in the future.

As entertaining as this discussion of the nexus between the Federal Reserve and moral hazard has been, the analysis is incomplete because it lacks one key element -- something called the Taylor Rule. The namesake of this bit of economic wisdom is John Taylor, perhaps the best scholar on monetary policy in our times. His rule, a description of monetary policy decision-making formulated a decade and a half ago, has a good deal of relevance to any discussion of Fed policy and moral hazard.

So what exactly is Taylor's Rule? Put simply, it prescribes higher interest rates when inflation crosses certain thresholds and the economy is near full employment; and lower rates when the opposite is true. When these goals are in conflict the Rule provides guidance on how to adjust rates accordingly.

But before we get to why Mr. Taylor's work matters, we've got to better understand moral hazard, which, as Mr. Bernanke defined it in a textbook he coauthored, is "the tendency of people to expend less effort protecting those goods that are insured against theft and damage."

Why has moral hazard reared its head after the Federal Open Market Committee cut interest rates at a time of turmoil and uncertainty in financial markets?

Midterm 1 Solution

Midterm 1 and  Solution.

Review Questions for Midterm 1

These are homework/review questions for the first exam which will be on Tuesday, October 16. The list is extensive - it covers all the topics we have covered or will cover in class. A thorough understanding of these questions is a good study guide for the exam.

Definitions

Medium of exchange/Double coincidence of wants
Unit of account/Multiplicity of prices
Store of value/Liquidity
Business cycle
fully backed, fractionally backed, and fiat money
M1
FOMC
FAC
Discount window
Discount rate
Member bank
Type A, B, and C directors
Board of Governors
Beige book
Monetary base
Borrowed and Non-borrowed reserves
Federal funds rate
Margin requirement
Asset
Liability
Demand Deposit
Bank Reserves
Reserve Requirement
Required Reserves
Excess Reserves
Currency
Lender of Last Resort
Money multiplier
Dynamic and defensive open-market operations
Primary, secondary, and seasonal credit

Essay

Chapter 3

1. What are the functions of money, i.e. why does money exist? Relative to a barter economy, what problems are overcome by the use of money?

2. To be useful as a medium of exchange, what properties should money have?

3. Describe the evolution of money from barter to fiat money. How did paper money arise?

4. How is money measured? Why is there more than one definition of the money supply? Are data on the money supply reliable?

Chapter 4

5. How do nominal interest rates, ex-ante real interest rates, and ex-post real interest rates differ? Of the two real rates, which is the most important for understanding economic decisions?

Chapter 12

6. Briefly describe the major functions of Federal Reserve district banks.

7. How do member banks differ from other banks? How did the difference change in 1980?

8. Who is on the FOMC? What does the FOMC do?

9. Describe the structure of Federal Reserve districts and Federal Reserve banks.

10. Describe the structure and function of the Board of Governors of the Federal Reserve System.

11. How has the power structure of the Federal Reserve System shifted over time?

12. How independent is the Fed? What factors contribute to independence? What factors work against independence? Discuss arguments for and against the independence of the Fed.

13. Write down the government budget constraint and explain each term.

Chapter 13

14. Use t-accounts to show that the Fed can control the monetary base better than it can control either currency or reserves. What does this result tell us?

15. Suppose that a bank has $100,000 in excess reserves that it loans out. Assuming that the required reserve ratio is 20%, use t-accounts to illustrate the multiple deposit creation process. Use this to obtain the simple deposit multiplier.

16. Suppose that the required reserve ratio is 20%, and the monetary base is 1,000. (a) Find the money supply. (b) Let open market operations increase the monetary base by 200. Use the money multiplier to find the new value of the money supply.

Chapter 14

17. Explain why the multiplier falls when people hold currency or when banks hold excess reserves.

18. Suppose that the required reserve ratio is 20%, the currency to deposit ratio is .25, the excess reserve to deposit ratio is .05, and the monetary base is 1,000. (a) Find the money supply. (b) Let open market operations increase the monetary base by 200. Use the money multiplier to find the new value of the money supply.

19. Explain how and why the money multiplier changes when (a) the required reserve ratio increases, (b) the currency to demand deposit ratio increases, and (c) the excess reserve to demand deposit ratio increases. Who determines each of these quantities?

Chapter 15

20. (a) Explain why the demand curve for reserves slopes downward. (b) Explain the shape of the supply curve for reserves.

[Update: Exam ends here, i.e. it covers questions 1-20].

21. Use the supply and demand model for bank reserves to explain and illustrate the effects of (a) an open market operation to buy bonds, (b) a decrease in the discount rate, and (c) an increase in required reserves.

22. Describe the three tools available to the Fed for controlling the money supply. How do defensive and dynamic open-market operations differ? How do primary, seasonal, and secondary credit differ? What are the advantages of open-market operations relative to the other tools?

23. What is meant by the phrase lender of last resort? Why is this important? Explain and show graphically how the Fed uses discount rate policy to act as a lender of last resort and how this serves to limit the amount the federal funds rate can rise.

Class Materials for Lecture 6

Brief Outline of Topics Covered in Lecture 6

Chapter 14 Determinants of the Money Supply

The Money Supply Model and the Money Multiplier

• Deriving the Money Multiplier

Factors That Determine the Money Multiplier

• Changes in the Required Reserve Ratio, r
• Changes in the Currency Ratio, c = C/D
• Changes in the Excess Reserves Ratio, e = ER/D

Additional Factors That Determine the Money Supply

• Changes in the Nonborrowed Monetary Base, MB_n
• Changes in Borrowed Reserves, BR, from the Fed

Chapter 15 Tools of Monetary Policy

The Market for Reserves and the Federal Funds Rate

• Supply and Demand in the Market for Reserves
• How Open Market Operations, Discount Lending, and Changes in Reserve Requirements Affect the Federal Funds Rate

Open Market Operations

• Daily Conduct
• Advantages of Open Market Operations

Discount Policy

• Operations of the Discount Window
• Lender of Last Resort
• Advantages and Disadvantages of Discount Policy

Reserve Requirements

• Disadvantages of Reserve Requirements

Materials from class:

Video:

Lecture 6 [Google video] - Fall 2007
Lecture 6 [Media Player] - Fall 2007

 

Economics 470 Lecture 6

Previous (these were taped outside of class):
Lecture 6 - Chapter 14,  pgs. 351-367; Chapter 15, pgs. 373-389
Google Video

Additional Reading:

• Regulatory Relief for Banking Organizations (eliminating open market operations)
• EU plans market reforms to avert crisis - FT.com
• Recent Financial Developments and the Economic Outlook -Yellen - SF Fed
• Real Estate in the U.S. Economy - Poole - St. Louis Fed
• FOMC minutes show unity on rate cut - FT.com
• Banks that say "sorry," and the investors who love them too much - D. Gross
• NASA: major step toward knowing origin of cosmic rays - EurekAlert
• Cassini on the trail of a runaway mystery - EurekAlert
• Fed Left Plans for Further Cuts Dependent on Data - Bloomberg
• Herding aphids -- how 'farmer' ants keep control of their food - EurekAlert
• There May Be an Out for Some Subprime Borrowers: John M. Berry

Application:

John Berry says there may be hopeful news on the subprime crisis:

There May Be an Out for Some Subprime Borrowers, by John M. Berry, Bloomberg: The subprime mortgage market is largely a mystery to most of the public, and to many of the public officials trying to find ways to mitigate the damage done to borrowers caught up in it. ...

Helping owners already faced with the possibility of foreclosure requires knowing how the problems developed, which is why Eric S. Rosengren, president of the Boston Federal Reserve Bank, initiated a project to gather data on the subprime market in New England and what has happened to the people who used such mortgages. ...

What the Boston Fed researchers have found so far has convinced Rosengren that many of the troubled homeowners may qualify for a prime loan that could be profitable for community banks in the region if they are willing to go after the business. ...

Class Materials for Lecture 5

Brief Outline of Topics Covered in Lecture 5

Chapter 13 Multiple Deposit Creation and the Money Supply Process

Control of the Monetary Base

• Open Market Operations with Bank
• Open Market Operations with an Individual and shifts between Currency and Deposits
• Discount Loans
• Overview of the Fed’s Ability to Control the Monetary Base

Multiple Deposit Creation: A Simple Model

• Deposit Creation
• Deriving the Formula for Multiple Deposit Creation
• Critique of the Simple Model

Materials from class:

Chalk only today.

Video:

Lecture 5 [Google video] - Fall 2007
Lecture 5 [Media Player] - Fall 2007

 

Economics 470 Lecture 5

Previous (these were taped outside of class):
Lecture 5 - Chapter 13,  pgs. 340-347
Google Video

Additional Reading:

• Economic Outlook - FRB: Speech, Kohn
• Financial Stability and the Federal Reserve - FRB Speech, Warsh
• Inflation Measurement and Price Volatility - Richard Fisher - FRB Dallas
• Outdated tax policy - Edward L. Glaeser - The Boston Globe
• The Rubin-Bernanke Phone Call - Felix Salmon
• A better way to organise securities markets - FT.com
• Daily Fed Open Market Operations: The Pattern of Fed Liquidity Provision
• More Tools the Fed Can Use to Inject Liquidity

Application:

1. The market is split between holding the federal funds rate at 4.75%, and cutting another quarter to 4.50% when the FOMC meets on October 30 and 31 [source]:

2. Estimating Potential Output

This is a very nice summary of how economists measure the economy's maximum sustainable level of output from Mishkin.

The term "maximum sustainable level of output" is a better description of what we are trying to measure than the more common terms such "potential output" or "full employment." Let me try an example to illustrate. For a graduate student, over the course of an entire quarter, there is a certain maximum sustainable level of effort. It might be, say, 14 hours of class and study per day on average. That is "full employment" or "potential output." But in the short-run it's possible to exceed  that level of output. Right before a test students can work 20+ hours a day, more than full employment, but such a level of output is not sustainable over the longer run. People need a minimum level of sleep, time to eat, etc. So, potential output for students is the level of effort that is sustainable day after day after day, not the most that can be accomplished in a given 24 hour time period.

A business can do the same thing. If it has 10% of its trucks off the road for maintenance at any given time (i.e. "sleeping"), it can keep those on the road when demand is really high to deliver a little extra, keep workers overtime, run the production lines 24 hours a day without maintenance, etc. But that kind of effort, though possible in short bursts, is not sustainable over the longer haul (with the existing level of resources). Trucks and production lines have to be taken down for maintenance every so often or there will be big problems down the road, people won't work long days continuously, etc. Here, too, when we talk about potential output we don't mean how much the economy can produce in the short-run when it's overheated (sort of like just before an exam), but rather what it can do on a sustainable basis over time with a given quantity of inputs.

More formally, then, we can define potential output as the level of output the economy would produce if labor and all other resources are fully and efficiently employed, where full employment means the maximum sustainable level of activity.

But how do we actually measure potential output? Here' Frederic Mishkin with the details on three different approaches. It's not easy:

Estimating Potential Output, by Governor Frederic S. Mishkin, Federal Reserve: This conference focuses on measurement issues, and in my remarks I want to focus on one of the most important measurement issues that we at the Federal Reserve and other central banks face:  How do we determine whether the economy is operating above or below its maximum sustainable level?  That is, how do we estimate the path of potential output?¹

Class Materials for Lecture 4

Brief Outline of Topics Covered in Lecture 4

Chapter 12 Structure of Central Banks and the Federal Reserve System

Informal Structure of the Federal Reserve System

• How Power Has Been Centralized Over Time

How Independent is the Fed?

Should The Fed Be Independent?

• The Case for Independence
• The Case Against Independence

Chapter 13 Multiple Deposit Creation and the Money Supply Process

Four Players in the Money Supply Process

The Fed’s Balance Sheet

• Liabilities
• Assets

Control of the Monetary Base

• Open Market Operations with Bank
• Open Market Operations with an Individual and shifts between Currency and Deposits

Materials from class:

Central Bank Independence and Inflation

From "Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence," by Alberto Alesina and Lawrence H. Summers, Journal of Money, Credit and Banking, Vol. 25, No. 2. (May, 1993), pp. 151-162  (the link will work on UO net, but I don't expect you to read the paper as it is a bit technical):

This has changed with the adoption of inflation targeting by central banks. Note also that Adam Posen casts doubt on whether causality runs from central bank independence to improved macroeconomic performance in Central Bank Independence and Disinflationary Credibility: A Missing Link?, NY Fed Staff Report, May 1995.

Video:

Lecture 4 [Google video] - Fall 2007
Lecture 4 [Media Player] - Fall 2007

 

Economics 470 Lecture 4 (Google chooses the fixed frame...)

Previous (these were taped outside of class):
Lecture 4 - Chapter 12,  pgs. 321-330; Chapter 13, pgs. 333-340
Google Video

Lecture 4 Wiki

This is an area you can edit as you wish [edit password=lecture4].

Additional Reading:

• Dodd to Keep Fed Short-Handed - WSJ Economics Blog
• Securitisation: life after death - Martin Wolf
• What makes an economist? - Free Exchange
• In the Lap of the Gods - Richard Fisher - FRB Dallas
• In a Primitive Tool, Evidence of Trading in the Pacific - New York Times
• A Few Days in the South of Ethiopia… - Stiglitz - New York Times

Application:

On global finance:

Financial Globalization's New Power Source, by David Wessel, WSJ: In the blizzard of headlines about borrowing by private-equity firms, rising oil prices and accumulating hoards of cash at Asian central banks, it's hard to tell if this is part of the same old story of money sloshing around the globe, or if something big is happening.

Pension funds, mutual funds and insurers still hold a bigger chunk of the world's financial assets ($59.4 trillion) than more recent pools of capital. But four newcomers are gaining rapidly: Asian central banks, hedge funds, private-equity funds and petrodollar investors, the ones pocketing the proceeds from $80-a-barrel oil.

Together the four hold $8.4 trillion, excluding overlap, roughly $1 of every $20 in the global financial system. Their assets have tripled since 2000.

Even if oil prices fall back to $50 a barrel, China's giant trade surplus shrinks and growth in private-equity and hedge funds slows, McKinsey Global Institute, the think-tank arm of the big consulting firm, projects the assets of these Big Four will double by 2012.

Their rise amounts to a new phase in the globalization of financial markets. They are one important way in which economic earthquakes spread from one country to another. Europe's economy is shuddering not because the U.S. is importing fewer Mercedes or bottles of French wine, but because financial shock waves from defaults on subprime mortgages in Detroit are jolting banks in Düsseldorf.

"The new power brokers represent a structural shift in global capital markets," McKinsey says in a 174-page analysis out today. Their growth, the analysts add, is "mutually reinforcing" as oil barons put their petrodollars in hedge funds, and so on.

How big is big? The carefully researched report, "The New Power Brokers," is studded with morsels like these:

Class Materials for Lecture 3

Brief Outline of Topics Covered in Lecture 3

Chapter 12 Structure of Central Banks and the Federal Reserve System

Origins of the Federal Reserve System

• Distribute power to geographic regions, the public sector, the private sector, the business sector, and the financial sector

Formal Structure of the Federal Reserve System

• Federal Reserve Banks
• Member Banks
• Board of Governors of the Federal Reserve System
• Federal Open Market Committee (FOMC)
• The Federal Advisory Council (FAC)

Informal Structure of the Federal Reserve System

• How Power Has Been Centralized Over Time

Materials from class:

The Twelve Federal Reserve Districts
Addresses and phone numbers Banks Branches Boston New York Philadelphia Cleveland Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco Board

Video:

Lecture 3 [Google video] - Fall 2007
Lecture 3 [Media Player] - Fall 2007

 

Economics 470 Lecture 3 (Google chooses the fixed frame...)

Previous (these were taped outside of class):
Lecture 3 - Chapter 12,  pgs. 311-321
Google Video

Lecture 3 Wiki

This is an area you can edit as you wish [edit password=lecture3].

Additional Reading:

• Dual Banking in the U.S.
• A brief History of the U.S. Payments Mechanism
• The Evolution of Central Banking in the U.S.
• The Revolution in Monetary Policymaking Institutions, by Alex Cukierman

 

Application:

Core versus Headline Inflation

• Why the Fed Looks at Measures of Core Inflation
• Should the Fed Focus on Core or Headline Inflation?
• Which Measure of Inflation is Best for Monetary Policy?

Class Materials for Lecture 2

Brief Outline of Topics Covered in Lecture 2

Chapter 3 What is Money? [pages 49-61]

Evolution of the Payments System

• Commodity Money
• Partially backed paper money
• Full backed paper money
• Fiat Money

Measuring Money

• The Federal Reserve’s Monetary Aggregates

How Reliable Are the Money Data?

Chapter 5 The Behavior of Interest Rates [pages 87-90]

The Distinction between Real and Nominal Interest Rates

• Nominal interest rates
• Ex-ante real rates
• Ex-post real rates

Materials from class:

Video:

Lecture 2 [Media Player] - Fall 2007
Lecture 2 [Google video] - Fall 2007

 

Economics 470 Lecture 2

Previous (these were taped outside of class):
Lecture 2 - Chapter 3, pgs. 53-61; Chapter 4, pgs. 87-90
Google Video

Lecture 2 Wiki

This is an area you can edit as you wish [edit password=lecture2].

Additional Reading:

The Stone Money of Yap
Technology and Class Attendance (a worry of mine...)
Benjamin Franklin and the Birth of a Paper Money Economy
Will Monetary Policy Become More of a Science?, by Frederic S. Mishkin

Application:

Greenspan says inflation will accelerate in the next twenty five years, but does ne make persuasive case?

Greenspan Says 'Pending Tsunami' May Hurt Fed, by John M. Berry, Bloomberg: In the final chapter of his book, ''The Age of Turbulence,'' Alan Greenspan lays out what he sees for the next quarter-century: falling world saving, rising inflation, higher interest rates and extreme political pressure on the Fed to let 'er rip.

His scenario isn't impossible. However, he doesn't really build a convincing case for it.

''It is possible that Congress has observed the remarkable prosperity that emerged in the United States and elsewhere as a consequence of low inflation and has learned from this happy circumstance'' the former Federal Reserve chairman writes. ''But I fear that containing inflation through higher interest rates will be as unpopular in the future as it was when Paul Volcker did it more than 25 years ago.''

Some of the reasons cited by Greenspan for his concern -- such as the potential for greatly increased federal government spending as the Baby Boom generation retires -- are certainly valid.

Another, however, isn't.

Class Materials for Lecture 1

Brief Outline of Topics Covered in Lecture 1

Chapter 1 Why Study Money, Banking, and Financial Markets? [pages 8-13]

Why Study Money and Monetary Policy?

Money and Business Cycles
Money and Inflation
Money and Interest Rates
Conduct of Monetary Policy
Fiscal Policy and Monetary Policy

Chapter 3 What is Money? [pages 49-52]

Meaning of Money
Functions of Money

Medium of Exchange
Unit of Account
Store of Value

Materials from class:

Video:

Lecture 1 [Media Player] - Fall 2007
Lecture 1 [Google Video] - Fall 2007

 

Economics 470 Lecture 1

Previous (these were taped outside of class):
Lecture 1 [Media Player] - Chapter 1, pgs. 8-13; Chapter 3, pgs. 49-52
Lecture 1 [Google Video]

Lecture 1 Wiki

This is an area you can edit as you wish [edit password=lecture1].

Additional Reading:

• Housing IS the Business Cycle - Leamer - NBER
• Greenspan Slams Ratings Agencies - Economics Blog
• Education and Economic Competitiveness - FRB: Bernanke
• Fed Study: Dollar’s Impact on Prices in U.S. Is Muted - WSJ Economics Blog
• "Which Institutions Matter for Economic Growth?"
• Greenspan Sticks to His Guns, as Well He Should
• "Does a Downward-Sloping Yield Curve Predict a Recession?"
• Larry Summers: Beware Moral Hazard Fundamentalists
• "Economists and Other Humans Don’t Always See Eye to Eye"

Application:

We will begin these next lecture.

Update: This article from the WSJ's economics blog goes into more detail about something I mentioned today in class:

Atlanta Fed: Mortgage Innovation Boosted Home Ownership: After holding steady for three decades, the share of U.S. households owning their own home jumped from 64% in 1994 to 69% in 2005. The primary cause, argues a new staff study from the Federal Reserve Bank of Atlanta, was the introduction of new mortgage products that reduced the initial down payment needed by a home buyer.

The paper, by Matthew Chambers, Carlos Garriga, and Don E. Schlagenhauf, examines changes in home ownership by age cohort. The U.S. population aged in the last decade, boosting the share of the population in age cohorts that are more likely to own a home. But the authors conclude this explains just 16% to 31% of the rise in total home ownership. The introduction of new mortgage products, in particular those that allowed little or no down payment, accounts for 56% to 70% of the increase. Such loans tend to be the contract of choice for younger cohorts which explains an important part of the increase in the aggregate homeownership rate observed since 1994, they say. Indeed, while the homeownership rate rose for all age groups in that period, it rose most for households under age 35: it jumped to 43% from 37.3%.

Source: Atlanta Fed