Advanced Modern MacroeconomicsGroup 3 :

Assignment 1Rutger van Wesel 290155

Filmon Kidane266309


Question 1

a)Underneath you see the graph for the output gaps in reference to Belgian GDP figures taken from the OECD outlook database. The two approaches used yield clear differences for which we seek explanation.

With the annual data for Belgian GDP, taken from the OECD outlook database, we have counted the HP cycle for B(t) and for L(t). An indication for in a five year interval is giving in table 1.1.

Annual / HP Bt Cycle / HP Lt Cycle
1960 / -0.0088 / -0.0001
1965 / 0.0030 / 0.0053
1970 / 0.0126 / -0.0052
1975 / -0.0118 / 0.0006
1980 / 0.0169 / 0.0086
1985 / -0.0131 / -0.0076
1990 / 0.0243 / -0.0030
1995 / -0.0053 / 0.0016
2000 / 0.0226 / -0.0016
2005 / -0.0046 / -0.0013

The cyclical component of total factor productivity accounts for a large fraction of the output gap at business cycle peaks and troughs. The GDP approach seems to have a bigger amplitude, showing higher positive and lower negative signs. This might imply that work intensity and capacity utilization are unusually low in recessions and unusually high in boom periods. Furthermore, the production function theory is much more subjective to own restrictions, since you try to calculate the output gap by combining various components, whereas in the case of the GDP approach you simply take the log of the GDP. HP filtering of the real GDP series is therefore a quick way to see a first estimation for the output gap, but when we want to find the difference in influence that the different production factors have on the gap, we should actually use the second way, the production function method. In real life, international organizations such as the OECD, the IMF and the EC work with this approach rather than the quick and easy way. In our case there is a large difference in the two approaches. One assumption which may apply in the Belgian caseis made in the book of Sörensen. He argues that capital could fully utilized, which is hardly a strong case for real life. We therefore have to assume that in our case the estimations are subject to different interpretations and since the data is officially published by the OECD, we tend to believe that the Cobb-Douglas approach used by us in this exercise is not sufficient enough to explain the full scope of the business cycles.

Question 2:

a)


b)The respective values for the three variables in their long run equilibrium without a shock are:

H(t) / Ph(t) / I(t)
345.7147376 / 1.2396678 / 6.914294753

They do not change over time because this is the long-run equilibrium in which the values stay equal. They are shown in the small graphs besides the large graphs that portray the effect of the price shock and the converging equilibrium lines for the three variables. After the shock (P=1,05 for us) the following three graphs appear.

We can clearly see that the shock has significant effect on the different variables, However the charts also make clear that all three converge after the shock to their new long-run equilibrium that are:

H(t) / Ph(t) / I(t)
Old equilibrium / 345.7147376 / 1.2396678 / 6.914294753
New convergence equilibrium / 330.8628246 / 1.2953145 / 6.61718816

Judging from the graph 2.4 we conclude that there is a lag in the adjustment H(t) is converging to 330. The PH(t) settles after an initial lag to a higher convergence of 1,30 and I(t) converges to a lower standard, after the initial shock was seen smashing it downward, of 6,6. In words; the amount of houses offered on the market decreases which in turn has an upward pressure on the average price levels because demand will stay stable. Because the house prices are higher the investment quote will be lower; there is simply less money to invest.

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