Thursday, April 14, 2016

Brad DeLong — We Are so S---ed. Econ 1-Level Edition

As I told my undergraduates yesterday:
Y = μ[co + Io + NX] + μG - μIrr
  • Y is real GDP
  • μ = 1/(1-cy) is the Keynesian multiplier
  • co is consumer confidence
  • cy is the marginal propensity to consume
  • C = co + cyY is the consumption function--how households' spending on consumption goods and services varies with consumer confidence, with their income which is equal to real GDP Y, and with the marginal propensity to consume
  • Io is businesses' and banks' "animal spirits"--their confidence in enterprise
  • r is "the" long-term risky real interest rate r
  • Ir is the sensitivity of business investment to r
  • NX is foreigners' net demand for our exports
  • And G is government purchases. Read MOAR
And as I am going to tell them next Monday, real GDP Y will be equal to potential output Y* whenever "the" interest rate r is equal to the Wicksellian neutral rate r*, which by simple algebra is:
r* = [co + Io + NX]/Ir + G/Ir - Y*/μIr
If interest rates are low and inflation is not rising it is not because monetary policy is too easy, but because r* is low--and r* can be low because:
  • consumers are terrified (co low)
  • investors' animal spirits are depressed (Io low)
  • foreigners' demand for our exports inadequate (NX low)
  • or fiscal policy too contractionary (G low)
  • for the economy's productive potential Y*.
The central bank's task in the long run is to try to do what it can to stabilize psychology and so reduce fluctuations in r*. The central bank's task in the short run is to adjust the short-term safe nominal interest rate it controls i in such a way as to match the market rate of interest r to r*. For only then will Say's Law, false in theory, be true in practice….
Grasping Reality
We Are so S---ed. Econ 1-Level Edition
Brad DeLong | Professor of Economics, UCAL Berkeley


Matt Franko said...

"Some will object that the decline in real interest rates is solely the result of monetary policy, not real forces. This is wrong....We must regard ultra-low rates as symptoms of our disease, not its cause...."

So all of you ZIRP advocates want to ride with Martin Wolf and DeLong here?????

Be careful who you associate yourselves with....

Matt Franko said...

"Monetary policy cannot be for the benefit of creditors alone. A policy that stabilises the eurozone must help the debtors, too. Furthermore, the overreliance on monetary policy is a result of choices, particularly over fiscal policy, on which Germany has strongly insisted."

Yeah but they dont understand the relationship between the policy rate and fiscal via interest income for savers...

Ryan Harris said...

It's hard to believe that universities are still teaching this stupid and inane analysis. What gets me is that there is no useful purpose to any human being learning or understanding the concepts being taught. We don't teach people about the universe orbiting earth, or flat earth theories "because it is important to understand the philosophy" or "they are important basic concepts to be learned." It's just wrong and a waste of time. I realize professors have too much time on their hands, and economics curriculum is a strung-out hot mess after the economists blew up the economy. But to require undergraduates, with their short time in university, to take away from valuable real learning that is needed for an adult to have a functional role in society, to learn this stuff is criminal. Loading kids up with debt, 40% now in default, to learn non-sense. TINA university education. Better go get another degree.

Auburn Parks said...

I'd rather be a ZIRP advocate then an advocate for trickle down fiscal spending via higher interest spending and rates.

Ryan Harris said...

Short term mon pol rates don't necessarily pass through to long term treasury rates paid to foreigners. The 10 year treasury rate has fallen from around 2.25% when the fed raised rates in December, to now 1.75%. Interest rates are more about the external balance and capital account than real/fiscal/current account issues. It gets swept under the rug in MMT because it complicates things, muddies the waters a bit and interferes with the important mechanics of understanding domestic money.

Tom Hickey said...

The 10 year treasury rate has fallen from around 2.25% when the fed raised rates in December, to now 1.75%.

That says that the market thinks ("expects") that the Fed lowering the interest rate is more probable than raising the interest rate further. That is, to say, the trend is still toward lower rates and the bull market in bonds Is not over.

Ryan Harris said...

Right, inflation/employment expectations and knowledge of reaction function of fed.
Portfolio shifts.
Collateral demand with insufficient supply.
Foreign mon-pol filters through...negative rates on most debt in all the "surplus" (polite) / mercantilist (impolite) nations.
China's new "currency basket" management approach to external sector has changed trends in all currencies since it was announced.
More rapid than expected fall in US oil production, will drag down overall growth as NX falls all else being equal.