1 Great Moderation a Time during the 1980 s 1990 s with stable inflation and stable unemployment 2 Calibration a Plug in and Guess and Check numbers to an equation and check the results b Look at actual equation and predicted equation c Calibration is when you start increasing decreasing the numbers d Problem Parts of equation may not represent what s actually there 3 Reagan Thatcher revolution a Emphasis on aggregate supply side vs aggregate demand b Emphasis on growth instead of stability c Deregulation and Privatization 4 Short vs long term interest rate rate a Long term interest rates are typically higher because they hold more risk b Investors need to be compensated for this risk or they will never be invested in c 3 theories that show relationship between short and long term a Market segmentation b Expectation theory i no relationship between long and short term interest rates i Long term interest rates contain a prediction of short term interest rates c Expectations Theory Liquidity Premium i Expectations theory premium paid on illiquid assets 5 Financial intermediation and borrowers a Channeling of funds through financial intermediaries to facilitate transactions between lenders 6 Laffer curve If you increase taxes business goes down which leads to less income which leads to less taxes paid a b Can only tax so much until there is nothing 7 Schumpeter s theory of growth and its developments in the American economy Innovation leads to changes in equilibrium which leads to growth a b Recent innovations causing our economy to grow Internet cell phones etc c If there aren t any fluctuations it is impossible to grow Need to hurt to grow d Also innovators need money to keep growing That s where banks play a role e Too much competition causes a saturated field and economy goes down 8 Endogenous growth model of Paul Romer a Growth seems to come from outside of the system b There is an investment that comes in and then the economy grows c Process of innovation was from inside the system that created a need for outside investment d Therefore we need a system that promotes endogenous growth 9 Government s response to current economic recession Other things that they could have implemented a Expanded monetary policy to increase government spending b Beyond conventional things by buying QE and pouring money into the economy c Cut taxes social security payments decreased d Like Reagan Should have provided an environment where businesses feel secure and optimistic about future and pour money into the economy 10 Central bank independence a Central bank is part of government in foreign countries b Money Supply goes up in foreign countries because President says to print money and then inflation goes crazy c President is seen as nice but inflation is crazy d Making them independent prevents inflation from happening a Central banking policy that revolves around meeting preset publicly displayed targets for the 11 Inflation Targeting annual rate of inflation 12 Ricardian equivalence a When government tries to stimulate demand by increasing government spending demand b This is because people will save excess money to pay for future tax increases used to pay off remains unchanged debt 13 Connection between government expenditures and inflation in a developing country a G T Change Borrowing from public Change Money Supply borrow from fed b Most countries don t trust government and don t buy gov t bonds c In developing countries only option is to increase money supply d If you increase money supply you will increase inflation 14 Crowding out effect 15 Globalization a Suppose government sells bonds and collects money b If government starts taking out interest rate goes out and some people cannot borrow c Those at the margin can t borrow and are kicked out of the market a Leads to innovation Can t do anything about it b Will benefit everyone If it didn t happen production would not increase 16 Diversification reduces risk a See supplement documents from Dadkhah 17 Asset backed securities collateralized debt obligations and credit default swaps a Asset backed securities estate and mortgage backed securities b Collateralized Debt Obligations i Financial security backed by a loan lease or receivables against assets other than real i Pools together cash flow generating assets and repackages this asset pool into tranches ii Pooled assets mortgages bonds and loans are debt obligations that serve as collateral that can be sold to investors for the CDO c Credit Default Swaps A swap designed to transfer the credit exposure of fixed income products between parties Essentially a transfer of default risk to a third party 18 Effect of NAFTA on the US economy a NAFTA passes thought there would be a loss of manufacturing in beginning But that s not the case Increased exporting b Has benefitted all three countries and has not had a bad effect c d International Exporting jobs get paid 20 than domestic exporting jobs e Increased income which increases spending and helped the economy 19 Sovereign fund and U S policy vis a vis these funds a Government getting foreign income b If put in Central Bank it causes inflation c Form investment fund around the world This protects invests wealth and no problem caused in economy d U S doesn t need to worry but needs to be vigilant because things can go wrong 20 Based on the balance sheet of the central bank See supplement from Dadkhah 21 Federal Reserve System mandate a b c Low unemployment Moderate Long Term Interest Rates Price stabilization control inflation