Recession depression and despair

1. Recession, Depression, and Despair:
Business Cycles and Their Tragic Effects
7

2. https://www.brookings.edu/wp-content/uploads/2017/08/casetextsp17bpea.pdf
https://www.brookings.edu/bpea-articles/mortality-and-morbidity-in-the-21st-century/

4. Drugs of Despair
 Drug use from despair or addiction
 Recessions  Unemployment and Despair
 Unemployment Insurance runs out  Disability /
medications, etc.
 Attempt to crack down on pill mills raised price
of prescription opioids  substitutes
 Markets will meet demand…
10

6. 12
Classical Economics
 Until Now:
 Been thinking long run - “Eventually”
Prices adjust and markets clear
Increases in money  inflation
 Short run (couple years):
 Can have recessions
 Changes in money can have an influence on
output
 We need another (new) model!

7. Fidget Spinners
14

8. Super Bowl Tickets
15

9. AD/AS Preview
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10. Aggregate Demand
 AD curve: the quantity of “ALL” g&s demanded
at any given price level.
 AD = C + I + G + NX
 Assume G fixed by govt policy.
 Slope of AD
 must determine how a change in P affects C, I,
and NX.
19

11. Aggregate Demand
 Aggregate Demand = C + I + G + NX
 Suppose the price level increases:
 Wealth Effect
 Real value of money falls
 Consumers are poorer, purchase less (C)
 Interest Rate Effect
 Requires more “dollars”
 Less saved  interest rate increases
 Less investment (I)
 Exchange Rate Effect
 Increase in price level, less sold abroad (NX)
 Downward sloping

12. Wealth and I-Rate Effects
21

13. Shifters of AD
23

14. C H A P T E R
Moving on to the Aggregate Supply
20

15. Aggregate Supply
 AS curve - total quantity of g&s produced at any
given price level.
 Two versions:
Long Run
Short Run
31

16. Why the Slope of AS Matters
32

17. Why the Slope of SRAS Matters
In the long run,
prices increase
(by more than in
the short run) and
output is
unchanged (it
reverts back to
long-run levels of
output
In the short
run, prices
AND output
increase

18. Why LRAS Is Vertical

19. 35
Why the LRAS Curve Might Shift

20. Three Theories of SR
Aggregate Supply

21. Three Theories of Aggregate Supply
 Decisions based on expectations
 Expectations of price, PE
 Expectations are incorrect  output deviates
from LRAS
If P>PE  Output greater than LRAS
If P<PE  Output less than LRAS

22. If P>PE, Produce More
39

23.  Move to NYC and don’t ask for a high enough
wage
 Company sells at NYC prices
 Company pays you Wilmington wages
 NYC Prices – Wilmington Wages = Big Profits!
 Takes time for wage to adjust
43

24. Three Theories of Aggregate Supply
 Decisions based on expectations
 Including expectations of price, PE
 If expectations are incorrect, output deviates
until corrections are made
1. Sticky Wages
P>PE, low wages, high retail price, produce more
2. Sticky Prices
P>PE, high menu costs, for some firms, slow
corrections, more sold because prices at some
firms are too low
3. Misperceptions
Hard to tell inflation from changes in demand
 All three cause SRAS to slope upward

25. 45
SRAS and LRAS
 Imperfections are temporary, eventually:
 sticky wages and prices become flexible
 misperceptions are corrected
 In the LR,
 PE = P
 AS curve is vertical

26. Short Run Aggregate Supply
 Shifters of SRAS
 Everything that shifts LRAS also shifts SRAS
 AND change in expected prices (input prices)
46

27. Using the Model
Economic Fluctuations

28. 50
Economic Fluctuations

29. Stock Market Crash
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30. Stock Market Crash
53

31.  Use AD/AS to analyze the US Economy
 Suppose a boom occurs in Canada.
 What happens to P? Y?
 In Short Run?
 In Long Run?
Working with the model
56

32. Answers

33. 59
John Maynard Keynes, 1883-1946
The long run is a misleading guide
to current affairs. In the long run,
we are all dead.

34. Short Run Policies
 Monetary Policy – the setting of the money
supply by policymakers in the central bank
 Fiscal Policy – the setting of the level of
government spending and taxation by
policymakers
61

35. 62
Fiscal Policy and Aggregate Demand
 Expansionary fiscal policy
 Increase in G and/or decrease in T
 shifts AD right
 Contractionary fiscal policy
 a decrease in G and/or increase in T
 shifts AD left
 Fiscal policy has two effects on AD...

36. Policy to Increase AD
65
AD = C + I + G + NX
Monetary Policy (Federal Reserve)
Increase MS  i-rates↓  Inv.↑
Fiscal Policy
1. Increase G  G
2. C↑ (multiplier)
Fiscal Policy (Gov’t)
1. Increase G  G
Fiscal Policy
1. Increase G  G
2. C↑ (multiplier)
3. I ↓ (crowding-out)
Fiscal Policy
Increases G and C (multiplier)
Decreases I (crowding-out)

37. Fiscal Policy

38. 1. Multiplier Effect
$12
$9
$6
$3
∆Y = $12 + $9 + $6 + $3 +...
1. Multiplier effect -
additional shifts in AD
that result when fiscal
policy increases
income and thereby
increases consumer
spending

39. 77
2. The Crowding-Out Effect
 Problem: Money from somewhere!
 Crowding-Out Effect
 Works in the opposite direction of multiplier
 A fiscal expansion:
 reduces savings
 raises interest rates,
 reduces investment
 reduces the net increase in agg. demand

40. 78
2. Crowding Out
P
Y
AD AD2 AD3 AD4AD5
Net Effect
AD  AD5
= multiplier
= crowding out

41. For each of the events below,
- determine the short-run effects on output
- determine how the Fed and/or Federal
Government should react
A. A recession takes hold in Europe
B. A stock market boom increases household
wealth.
Stabilization Policy
88

42. Stabilization Policy
89

43. 101
The Case for Active Stabilization Policy
 Keynes: “Animal spirits” cause waves of
pessimism and optimism, shifting AD
 Other factors:
 booms and recessions abroad
 stock market booms and crashes
 Fluctuations are destabilizing → Policymakers
should do something

44. 102
The Case Against Active Stabilization Policy
 Long lags means policies hit too late
 Fiscal policy requires “an act of congress”
 Monetary policy may take 6 months to affect
output
 Active Stabilization Policy messes up price
signals businesses and consumers rely on.
 Policymakers should focus on long-run goals like
economic growth and low inflation.

45. 103
Automatic Stabilizers
 Automatic stabilizers:
changes in fiscal policy that stimulate
agg demand without policymakers having to take
any deliberate action
 Tax System – taxes fall automatically as
incomes fall
 Gov’t spending – public assistance increases as
more people apply, stimulating economy

46. Dear Economist…
104
I believe that my trade war has caused other countries to implement retaliatory
tariffs and our net exports have fallen as a result. In addition, policy uncertainty
has caused business investment to fall. But I am committed to remaking global
trade and plan to continue my policies. Can you help me understand the
economics and suggest some policies to respond?
~Donald J. Trump
• Use the Model of AD/AS to model out the scenario presented
• Suggest a policy that can be undertaken by the Fed to keep AD from
shifting
• What is the Fed’s policy tool/action?
• How does it affect interest rates?
• How does that translate through to AD?
• Suggest a policy than can be undertaken by the Federal Government to
keep AD from shifting
• What are its two effects?
• Would Keynes support the above policies? Does that make Trump a
Keynesian?
• How would Hayek respond?

47. Stabilization Policy
105
Answers – try to work on your own first and then check…
TheFederalReserve(orFed)can:
•buybondsincreasingexcessreservesinbankingsystemreducingtheinterest
rate(fedfundsrateotherrates)encouraginginvestment
•Reducetheinterestratetheypaybanksonexcessreservesleadstoareductionin
thefederalfundsrateandthenotherratesencouraginginvestment
TheFederalGovernmentcan:
•Increasespending(G)whichalso(1.)increasesCthoughthemultipliereffectbut(2.)
reducesIbecauseofcrowdingoutsincethemoneyhastocomefromsomewhere
•Note:wedidn’tdiscussmuchinclassbutthegovernmentcanalsoreducetaxesto
encouragemorespendingasCincreaseswhentaxesdecrease.Notethatmultiplier
effectandcrowdingoutbothstilloccur.
•Keyneswouldargueinfavorofanyofthefouractionsaboveashebelivedpolicies
shouldbeusedtostabilizeAD.(Ifyoubelievesomeofhistweetsandpressstatements,
TrumpisaKeynesian;believingintheideasofKeynes)
•Hayekwouldpointoutthatthelastreductionintheinterestrateledtoahousingbubble
andcrashandthatgovernmentspendingispoorlytargeted,corruptandoftenwasteful.
Inaddition,hewouldarguethatthefourpoliciessuggestedabovemessuppricesignals
andmarketsandmaymakearecessionlongeraspeopletrytofigureoutthenewrules
oftheeconomyandpricesignals

48. 106

49. Keynes vs. Hayek
107

50. 108