I NTERMEDIATE M ACROECONOMICS

E CONOMICS 110B

Johannes Wieland
jfwieland@ucsd.edu

Spring 2016
 N EXT S TEPS

1 All pieces together: ASAD.

2 Testing the model.

3 Business cycle policy options.

4 Depressions.

1 / 21
 N OTE

On TED you can find notes on “ASAD” that work through the
material.

They also contain exercises that will help you understand the material.

Solutions to these exercises are also posted.

2 / 21
 B IG P ICTURE Q UESTIONS

What predictions does our ASAD model make?

Are they supported by the data?

3 / 21
 AS-AD: F ROM SHORT- RUN TO LONG - RUN

π LRAS
SRASSR (π e = π 0 )

π0 A SRASLR (π e = πLR )
πSR
πLR B

AD

YSR YLR Y

4 / 21
 AS-AD: S HORT- RUN TO L ONG - RUN
From short-run to long-run:
1 Because π < π e , workers’ expectations of future inflation will gradually
fall over time.

2 As this occurs, equilibrium employment in the labor market for any

given inflation level rises, shifting the aggregate supply curve to the
right. While this occurs π falls, so the central bank lowers R (the
Taylor principle), which raises consumption and investment and thus
output (movement along the AD curve).

3 This shift will continue to occur until π e = π, i.e.until expectations

have fully adjusted.

The adjustment from the short-run to the long-run always(!)

occurs through shifts in the SRAS curve due to the adjustment
of inflation expectations.

5 / 21
 D ISINFLATION : ↑ r̄

π LRAS

SRAS1 (π e = π1 )

π1 A SRASLR (π e = πLR )
B
πSR
πLR C
AD2 (↑ r̄) AD1

YSR YLR

6 / 21
 D ISINFLATION : ↑ r̄

M Pold (π = π1 , ↑ r̄)
RSR M PSR (π = πSR , ↑ r̄)
B A=C
R1 = RLR M P1 (π = π1 ) = M PLR

IS1

YSR YLR Y

7 / 21
 D ISINFLATION : ↑ r̄
Investment:

I = I (SP , R )
+ −

I SR: R1 increases to RSR , so ISR falls.

I LR: RLR same as R1 , so ILR = I1 is unchanged.

Consumption:

C = C (Y − T , CS , R )
+ + −

I SR: R1 increases to RSR and YSR < 0, so CSR falls.

I LR: RLR = R1 and Y = 0, so CLR = C1 is unchanged.

8 / 21
 D ISINFLATION : ↑ r̄

(W/P )

e
(1+π )
(W
P )SR
z (1+π SR )
B
A=C e
(W W
P )1 = ( P )LR
z (1+π )
(1+π) = z

Ld

LSR LLR L

9 / 21
 D ISINFLATION : ↑ r̄

We can summarize our results for the effects of an increase in r̄ in the

following way:

Y π R C I L W /P
SR: − − + − − − +
∧
LR: 0 − 0 0 0 0 0

This feature of the model, that a change in money supply has no

effect on output in the long-run, is known as monetary neutrality.

In the long-run, increases in the nominal interest rate have no effect

on real variables (measured in goods) but simply cause inflation (a
nominal variable) to change by the same amount.

10 / 21
 G OVERNMENT SPENDING : ↑ G

π LRAS
SRASLR (π e = πLR )

πLR C B SRAS1 (π e = π1 )
πSR
π1 A
AD2 (↑ G)

AD1

YLR YSR Y

11 / 21
 G OVERNMENT SPENDING : ↑ G

RLR C M PLR (π = πLR )

B
RSR M PSR (π = πSR )
R1 M P1 (π = π1 )
A IS2 (↑ G)

IS1

YLR YSR Y

12 / 21
 G OVERNMENT SPENDING : ↑ G
Investment:

I = I (SP , R )
+ −

I SR: R1 increases to RSR , so ISR falls.

I LR: RLR > RSR > R1 , so ILR < ISR < I1 .

The decline in investment is called crowding out.

Consumption:

C = C (Y − T , CS , R )
+ + −

I SR: R1 increases to RSR but YSR > 0, so CSR ambiguous.

I LR: RLR > R1 and Y = 0, so CLR < C1 unambiguously declines.

13 / 21
 G OVERNMENT SPENDING : ↑ G

(W/P )

A=C e
(W W
P )1 = ( P )LR
z (1+π )
(1+π) = z

e
(1+π )
(W
P )SR
z (1+π SR )
B
Ld

L1 = LLR LSR L

14 / 21
 G OVERNMENT SPENDING : ↑ G

We can summarize our results for the effects of an increase in G in

the following way:

Y π R C I L W /P
SR: + + + ? − + −
∧ ∧ ∧
LR: 0 + + − − 0 0

A (permanent) increase in government spending has no effect on

long-run output, but does crowd out private investment and
consumption.

15 / 21
 I MPROVEMENT IN TECHNOLOGY: ↑ A

LRAS1LRAS2 (↑ A)
π
SRAS1 (π e = π1 )

SRASSR (π e = π1 , ↑ A)
π1 A
πSR SRASLR (π e = πLR , ↑ A)
πLR B C

AD1

Y1 YSR YLR Y

16 / 21
 I MPROVEMENT IN TECHNOLOGY: ↑ A

A
R1 = RLR M P1 (π = π1 )

RSR M PSR (π = πSR )

B
RLR M PLR (π = πLR )
C
IS

Y1 YSR YLR Y

17 / 21
 I MPROVEMENT IN TECHNOLOGY: ↑ A
Investment:

I = I (SP , R )
+ −

I SR: R1 falls to RSR , so ISR rises.

I LR: RLR = R1 , so ILR = I1 .

Consumption:

C = C (Y − T , CS , R )
+ + −

I SR: R1 falls to RSR and YSR > 0, so CSR increases.

I LR: RLR = R1 and Y = 0, so CLR = C1 is unchanged.

18 / 21
 I MPROVEMENT IN TECHNOLOGY: ↑ A

(W/P )

B e
(1+π )
(W
P )SR
z (1+π SR )
C e
(W W
P )1 = ( P )LR
z (1+π )
(1+π1 ) = z
A
Ld2 (↑ A)

Ld1

L1 LSR LLR L

19 / 21
 I MPROVEMENT IN TECHNOLOGY: ↑ A

We can summarize our results for the effects of an increase in A in

the following way:

Y π R C I L W /P
SR: + − − + + + +
∧ ∧ ∧ ∧ ∧ ∧
LR: + − − + + + 0

20 / 21
 B IG PICTURE :
1 Document the facts: Measure how the U.S. economy behaves in a
recession.

2 Build a model of the economy that can simultaneously explain the

behavior of RGDP, inflation, UE: AS-AD.

3 Test the model.

4 Use this model to shed light on what causes recessions and the
business cycle.

5 Once we’ve identified the types of shocks that can cause business
cycle fluctuations, we can use the model to figure out how
policy-makers can/should respond to economic fluctuations.

21 / 21