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September 28, 2006
Interest Rate Parity
Interest rate parity establishes a relation between the interest rates in two countries and the exchange rate between their currencies.
We first do a quick overview of arbitrage pricing.
It might be possible to generate arbitrage profits by trading in the two countries' bond markets.
The interest rate parity condition rules out these arbitrage profits.
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September 26, 2006
Midterm 1
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September 21, 2006
The Natural Rate of Unemployment
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Monetarism
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Aggregate Demand and Monetary Policy
When we take into account the aggregate supply curve, things get really complicated because the change in prices induces an additional change in M/P. EconModel can handle this simulation, but the chalkboard version hits its limit.
Posted by bparke at 04:03 AM | Comments (0)
September 19, 2006
The Term Structure of Interest Rates
The IS/LM diagram assumes that the short-term and long-term interest rates are the same.
The forward rate:
The forward rate and the expectations hypothesis share some algebra:
Arbitrage pricing establishes the present value formula.
There should be a risk premium separating long-term and short-term bond yields because long-term bonds are inherently riskier.
Posted by bparke at 04:11 AM | Comments (0)
September 14, 2006
IS/LM with Flexible Prices
Monetary policy:
Changes in the price level generate the AD curve:
An increase in M shifts the AD curve.
Fiscal policy:
Fiscal policy shifts the AD curve.
The classical view (assuming that unemployment is possible):
Posted by bparke at 03:58 AM | Comments (0)
September 12, 2006
LM - the other curve
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September 05, 2006
A View of Failure to Sell Output
Keynes challenged Say's Law, which states that production creates its own demand. How could we depict a failure to sell the equilibrium output in a classical model?
If A cannot be attained because demand for output is insufficient, then we may be producing at point B. The demand for labor will be a vertical line to the left of A. An interesting question is whether the real wage will decline so that labor hired is still on the labor supply curve. An alternative is that the real wage rate does not change and the labor hired is less than the labor supplied. In that case, we have unemployment.
Posted by bparke at 04:07 AM | Comments (0)
IS -- the heart of the Keynesian concept
The IS Curve is the element common to all the Keynesian models. It establishes the role of the interest rate in determining the level of output.
Economics lectures typically reflect decades of refinement in presentation. Students are often shown the best presentation without even a mention of alternatives.
For example, if the quantity demanded is a function of price and income, there are two ways to depict that function on a two-dimensional blackboard. On the left is the standard demand curve, which shifts when income changes. On the right is a graph of quanity vs. income, which shifts when the price changes. The alternative on the left is preferred for a variety of reasons, but depicting any function with two arguments presents a similar choice.
This point is relevant here because the Simple Keynesian Model and the IS Curve bear a similar relationship. We consider these in turn.
The Simple Keynesian Model
Step 1
Step 2
An algebraic view
Derive an IS Curve from the Simple Keynesian Model
Derive an IS Curve from the supply and demand for loanable funds
Conclusion
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