Monetary policy and business fluctuations
Seminar problems, Spring 2007
Seminar 1
i)What are business cycles? Compare the definition of Burns and Mitchell (1946) with that of Lucas (1977).
ii)What is meant by “business cycle facts”? Describe some important stylized facts of business cycles that are common in most countries.
iii)What is meant by leading and lagging indicators? What kind of data would you look at if you want to make forecasts?
iv)What is a spurious relationship?
v)Describe briefly the structure of the basic Real Business Cycle model. What are the key differences with a traditional Keynesian empirical model? What was the rationale for developing RBC models?
vi)Describe the key assumptions that are necessary for an RBC model to have a steady state path. Explain why one ensures that the models have a steady state path.
vii)Show that the utility function U(C, L) = log (C) + ν log (L), where C is consumption and L is leisure, is consistent with steady state growth
Seminar 2
i)Consider the “high substitution economy” described by King and Rebelo. Explain briefly the main features that lie behind this characteristic, and the motivation for choosing them.
ii)Derive the optimal capacity utilization of a representative firm, and interpret the result.
iii)Discuss the effect of the size of ξ, the elasticity of the derivative of the depreciation rate with respect to the rate of capital utilization, Dδ(zt).
iv)Describe briefly Gali’s empirical evidence suggesting that a positive technology shock has a negative impact on firm’s use of labour input, and discuss the relevance of this finding for the basic RBC model with shocks to total factor productivity.
v)What are the effects of a temporary increase in government consumption on output and private consumption in a standard RBC model? Compare with the effect within a traditional Keynesian model.
Seminar 3
Consider the paper by Gali, Gertler and Lopez-Salido, and the paper by Gali.
i)Explain briefly the following concepts
- wage markup
- price markup
- inefficiency gap
ii)What is the basis for GGL-S’s argument that some form of wage rigidity is central to business fluctuations?
iii)Based on GGL-S and G, discuss the merits of using fiscal policy to stabilize the economy. Try also to include additional arguments, in both directions, that are not included in their analysis.
iv)What is the basis for Gali’s argument that “there appears to be a global trend towards more countercyclical fiscal policies”. How would Norway fit into this picture? (In Norwegian, consider e.g. the National budget 2007, 3.2.3. In English, consider e.g. the Inflation report 3/2006, figure 3.17).
Seminar 4
A A simplified RBC model with additive technology shocks
Consider an economy consisting of a constant population of infinitely lived individuals. The representative individual maximizes the expected value of
The instantaneous utility function u(Ct), is u(Ct) = Ct – θCt2, θ > 0. Assume that Ct is always in the range where u’(Ct) is positive.
Output is linear in capital, plus an additive disturbance: Yt = AKt + et. There is no depreciation, so Kt+1 = Kt + Yt – Ct, and the interest rate is A. Assume that A = ρ. Furthermore, assume that the disturbance follows a first-order autoregressive process:
et = φet-1 + εt, where -1 < φ < 1 and where the εt’s are mean-zero, i.i.d shocks.
(i)Find the first-order condition (Euler equation) relating Ct and expectations of Ct+1. (Tip: use the informal perturbation method where you suppose the individual reduces period-t consumption by ΔC. He then uses the greater wealth in period t+1 to increase consumption above what it otherwise have been.)
(ii)Guess that consumption takes the form Ct = α + βKt + γet. Given this guess, what is Kt+1 as a function of Kt and et?
(iii)What values must the parameters α, β and γ have for the first-order condition in part (i) to be satisfied for all values of Kt and et?
(iv)What are the effects of a one-time shock to ε on the paths of Y, K and C?
BConsider a basic RBC (e.g. as in King and Rebelo)
i)How does a productivity shock affect the economy?
ii)Explain the difference between temporary, persistent and permanent productivity shocks, and the difference in their effects on the economy. Why do King and Rebelo argue that productivity shocks must be persistent?
iii)Why cannot the productivity shocks be replaced by other types of shock?
Seminar 5
A A simplified RBC model with additive taste shocks
This follows the setup in problem 4A, but the technology shocks are replaced by taste shocks.
Consider an economy consisting of a constant population of infinitely lived individuals. The representative individual maximizes the expected value of
The instantaneous utility function u(Ct), is u(Ct) = Ct – θ(Ct + νt)2, θ > 0. The νt’s are taste shocks, assumed to be mean-zero, i.i.d shocks. Furthermore, we assume that Ct is always in the range where u’(Ct) is positive.
Output is linear in capital: Yt = AKt, there is no depreciation, so Kt+1 = Kt + Yt – Ct, and the interest rate is A. Assume that A = ρ.
(i)Find the first-order condition (Euler equation) relating Ct and expectations of Ct+1.
(ii)Guess that consumption takes the form Ct = α + βKt + γνt. Given this guess, what is Kt+1 as a function of Kt and νt?
(iii)What values must the parameters α, β and γ have for the first-order condition in part (i) to be satisfied for all values of Kt and νt?
(iv)What are the effects of a one-time shock to ν on the paths of Y, K and C?
BAggregate demand and long-run unemployment
(i)Describe the empirical basis for Ball’s conclusion that passive monetary policy during a recession can lead to permanently higher unemployment
(ii)Explain briefly the economic mechanisms that Ball argues may explain his result.
(iii)Discuss alternative explanations for Ball’s results, and the possible policy conclusions we can draw from this.