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and Mundell - Fleming

Lecture : Dias Satria SE., M.App.Ec.

Faculty Of Economy

Economic Development Major

University Of Brawijaya Malang

A. Natural Disasters Impacting a Macroeconomics Model with

Endogenous Dynamics

RESUME

Natural disaster might depend on the pre-existing economic situation. The

recovery eﬀect from the additional activity due to reconstruction might, in fact, have

compensated, at least partly, the direct damages of the disaster. Investigating this

problem requires one to model economic ﬂuctuations, and macroeconomists are still

quite divided on how best to do this. The dominant one today is known as real

business cycle (RBC) theory and is implemented within Stochastic Dynamic General

Equilibrium models. It originates from embedded into the general equilibrium

framework with rational expectations. This theory assumes that economic ﬂuctuations

arise from exogenous shocks and that the economic system is otherwise stable. The

second one is Endogenous Business Cycle (EnBC) theory, which proposes that

economic ﬂuctuations are due to intrinsic processes that endogenously destabilize the

economic system. The existence of these two alternative theories of economic

ﬂuctuations is a signiﬁcant obstacle in attempting to assess the economic cost of

natural disasters. Overcoming the controversy between the RBC and EnBC theories

and achieving a constructive synthesis between the two would thus reduce in a

signiﬁcant manner uncertainties in the assessment of disaster and policy costs. On the

other hand, investigating the consequences of exogenous shocks, like natural

disasters, can also provide useful insights into economic behavior in general and help

achieve a uniﬁed theory of business cycles.

reproduce several realistic features of the historical data which natural disasters

destroy the productive capital through the use of a modiﬁed production function and in

which reconstruction investments are explicitly represented. NEDyM to show that the

particular phase of a business cycle matters greatly in assessing the economic impacts

of natural disasters. In our EnBC model, this impact is enhanced by internal economic

processes when the shock occurs during an expansion phase, while the opposite is

the case during a recession. The NEDyM investment ﬂexibility summarizes many

characteristics of an economy, and diﬀerences in can arise from many factors:

a. Investing more requires producing more investment goods, and this cannot be

done instantaneously.

b. What is true for the productive capital is also valid for human capital.

investment ﬂexibility at the ﬁrm level , also making a diﬀerence between

developed and developing countries.

situation, we apply the same loss of productive capital at diﬀerent points in time along

the models business cycle. To assess the total GDP loss, we use the diﬀerence

between the 20-year total production in a baseline scenario, with no disaster, and the

20-year total production in the disaster scenario; no discounting was applied in

assessing this diﬀerence.

CHAPTER 1

INTRODUCTION

Benson and Clay (2004), among others, have suggested that the overall cost of

a natural disaster might depend on the pre-existing economic situation. The recovery

eﬀects from the additional activity due to reconstruction might, in fact, have

compensated, at least partly, the direct damages of the disaster. Investigating this

problem requires one to model economic ﬂuctuations, and macroeconomists are still

quite divided on how best to do this. Two main theories have attempted, over the

years, to explain the causes and characteristics of business cycles. The dominant

one today is known as real business cycle (RBC) theory and is implemented within

Stochastic Dynamic General Equilibrium models with rational expectations. This

theory assumes that economic ﬂuctuations arise from exogenous shocks and that the

economic system is otherwise stable. The second one is Endogenous Business Cycle

(EnBC) theory, which proposes that economic ﬂuctuations are due to intrinsic

processes that endogenously destabilize the economic system Both theories have

their successes and shortcomings, but it is RBC theory that garners consensus in the

current economic literature.

signiﬁcant obstacle in attempting to assess the economic cost of natural disasters,

such as hurricanes or earthquakes, or of other exogenous shocks, e.g., the

implementation of climate policies aimed at reducing the emissions of greenhouse

gases. Indeed, to carry out such an assessment, one has to decide ﬁrst within which

macroeconomic setting to work, as the underlying economic hypotheses can strongly

inﬂuence the results. Overcoming the controversy between the RBC and EnBC

theories and achieving a constructive synthesis between the two would thus reduce in

a signiﬁcant manner uncertainties in the assessment of disaster and policy costs. On

the other hand, investigating the consequences of exogenous shocks, like natural

disasters, can also provide useful insights into economic behavior in general and help

achieve a uniﬁed theory of business cycles. The validation of RBC and EnBC models

against 3the history of past disasters could provide evidence in support of such a

uniﬁed theory. To do so, we apply the Non-Equilibrium Dynamic Model (NEDyM) of

Hallegatte et al., which exhibits business cycles that reproduce several realistic

features of the historical data. We introduce into this model the disaster-modeling

scheme of Hallegatte et al, in which natural disasters destroy the productive capital

through the use of a modiﬁed production function and in which reconstruction

investments are explicitly represented. In the latter paper, however, disasters were

investigated in an economy initially at equilibrium. The main contribution of the

present article is to consider a ﬂuctuating economy, and to investigate the sensitivity

of the economic consequences of natural disasters with respect to the phase of the

business cycle. From this, we summarize the main features of NEDyM emphasizing

the role of investment ﬂexibility in the model solutions’ behavior.

CHAPTER 2

RESEARCH QUESTION

1. Why endogenous dynamic in macroeconomics model impacting by

natural disaster?

exogenous shocks?

processes within developing countries which structure the impact of natural

disasters, rather than at disasters as unforeseen events requiring large scale

intervention?

CHAPTER 3

METHODS FROM MACROECONOMICS JOURNAL

1. The main changes applied to the basic Solow model, starting with its core set of

equations where Y is production, K is productive capital, L is labor, A is total

productivity, C is consumption, S is consumer savings, I is investment,

is the investment (or, equivalently, saving) ratio, ,, is the depreciation time, and

is the labor at full employment:

2. Goods market: A goods inventory H is introduced, opening the possibility of

temporary imbalances between production and demand, instead of a market

clearing at each point in time. Thus

This inventory can be either positive or negative and it encompasses all sources of

delay in the adjustment between supply and demand, including technical lags in

producing, transporting and distributing goods. Its situation aﬀects price

movements:

market clearing conditions are veriﬁed only over the long term.

3. Labor market : The producer sets the optimal labor demand that maximizes

proﬁts, as a function of real wage and marginal labor productivity:

But full employment is not guaranteed at each point in time, because (i) institutional

and technical constraints create a delay between a change in the optimal labor

demand and the corresponding change in the number of actually employed workers:

and (ii) wages are partially rigid over the short term; they progressively restore the full

employment rate by increasing if labor demand is higher than and decreasing

when it is lower:

4. Household behavior : Like the Solow model, NEDyM uses a constant saving ratio but it

makes the tradeoﬀ between consumption and saving more sophisticated by

considering that households (i) consume (ii) make their savings available for investment

through the savings, and (iii) hoard up a stock of money that is not immediately

available for investment.

NEDyM describes an investment behavior “`” It introduces a stock of liquid assets F

held by banksand companies, which is ﬁlled by the diﬀerence between sales p(C+I)

and wages wL, and by the savings S received from consumers. Theseassets are used

to redistribute share dividends. Div and to invest in the amount pI. This formulation

creates a wedge between investment and savings, reﬂected by changes in F:

The dynamics of the system is governed by an investment ratio that allocates these

assets between productive investments and share dividends:

The producer’s net proﬁt follows the accounting deﬁnition of proﬁt that is gross

proﬁts minus capital depreciation:

The distribution between dividends and investment depends on the expected net proﬁts

per capital unit compared with a standard of profitability ν. If the expected net proﬁt

per capital unit is higher than this standard, the producer increases his/her

physical investments; if, on the contrary, the expected proﬁt is lower than ν, investments

are reduced. Assuming that observed values are the best guess of expected values at

each point in time leads to:

Eﬀective capital is K = ξK

is the potential productive capital, which is the stock of capital in the absence of any

disaster.

With this new function, a destruction of x% of the productive capital reduces production

by x%. The replacement of the productive capital K by the two new variables K0 and ξK

makes it necessary to modify the modeling of investment and to introduce the

distinction between regular investments, carried out to increase the production capacity,

and reconstruction investments that follow a disaster. To capture how these constraints

may impact the pathways back to equilibrium, we bounded by the fraction of total

investment that reconstruction can mobilize.

Long-term averaged GDP losses due to the distribution of natural disasters for

diﬀerent types of economic dynamics of the table) or very low (not shown), the

economy is incapable of responding to the natural disasters through investment

increases aimed at reconstruction. Total production losses, therefore, are very large,

amounting to 0.15% of GDP when the ﬂexibility is null. Such an economy behaves

according to a pure Solow growth model, where the savings, and therefore the

investment, ratio is constant.

economy, i.e. when αinv is non-null but still lower than 1.39, the economy has a new

degree of freedom to improve its situation and respond to productive capital shocks.

Such an economy is much more resilient to disasters, because it can adjust its level

of investment in the disaster’s aftermath: for αinv = 1.0 (second row of the table),

GDP losses are as low as 0.01% of GDP, a decrease by a factor of 15 with respect to

a constant investment ratio, thanks to the added investment ﬂexibility.

CHAPTER 4

PREVIOUS STUDIES OR REFERENCES

A). 1. TITLE

Charlotte Benson and Edward J. Clay

policy?

that governments undertake mitigation and preparedness measures?

disasters risk in the future?

3. METHODS

regression analysis, the use of charts to examine movement around trends,

and “before-and-after” comparison of disaster impacts and of forecast and

actual economic performance. The implied null hypothesis is that there is no

direct link between disaster shocks and the relevant aspect of economic

performance. Such analysis cannot always be definitive, but the results at

least provide a basis for further reflection and investigation. If impacts are not

apparent at an aggregate level, the analysis moves on to consider possible

effects within the composition of the relevant economic indicator. A qualitative

political-economic analysis is also employed in a complementary way to

place quantitative results within the specific economic and social policy

context of each case study country. Where similar qualitative results

repeatedly emerge from previous and current studies, this is taken to be

preliminary evidence of a more general finding about the economic

consequences of natural disasters.

reduce instantaneously the total productive capital K by an amount ∆K. To

avoid underestimating natural disaster impacts because of decreasing returns

in the production function the Cobb-Douglas production function by

introducing a term ξK, which is the proportion of capital that was not

destroyed. This new variable ξK is such that the eﬀective capital is K = ξK ·

K0, where K0 is the potential productive capital, which is the stock of capital

in the absence of any disaster. Instead of replacing K by ξK ·K0 in Eq. (A-2),

we introduce the new production function:

With this new function, a destruction of x% of the productive capital reduces

production by x%. The replacement of the productive capital K by the two

new variables K0 and ξK makes it necessary to modify the modeling of

investment and to introduce the distinction between regular investments,

carried out to increase the production capacity, and reconstruction

investments that follow a disaster. Denoting by In the investments that

increase the potential capital K0, and by the reconstruction investments

that increase ξK, we have:

4. RESULT

Hypotheses:

HA is true. Look at the p value or sig value (based on a t statistic).

public policy which impacting by natural disaster)

relationship between variables in a target population.

• Consider Y = β0 + β1 X + ε.

• Unless, of course, β1 = 0.

• : β1 ≠ 0 (Y does depend on X)

A Priori Considerations

Sign tests:

model, the regression may be worthless.

regressor seem unbelievably large (or small).

Regression standard error

Forecast errors:

between actual and values predicted by the estimated equation).

• Small values indicate that the estimated model fits the observed

data closely (min SE = 0).

The smaller the value of SE of the regression, the better is the fit of the

regression line.

significant.

Student’s

t-table

one. N < 30

Eﬀective capital is K = ξK

absence of any disaster.

reduces production by x%. The replacement of the productive capital K by

the two new variables K0 and ξK makes it necessary to modify the

modeling of investment and to introduce the distinction between

regular investments, carried out to increase the production capacity,

and reconstruction investments that follow a disaster.

B)

1. TITLE

Sebastián Galiani, Ilan Noy, and Juan Pantano

one?

2. What is the path of gross domestic product (GDP) of the affected country in

the absence of natural disasters and to assess the disaster’s impact by

comparing the counterfactual to the actual path observed?

respect to output dynamics?

studies?

and the relationship with vector of post-disaster outcomes for the exposed

country and matrix of post-disaster outcomes for the potential control

countries?

3. METHODS

1. be the GDP per capita that would be observed for country i at time t in

the absence of the disaster, for countries i = 1……,J + 1, and time periods =

1………T . be the number of periods before the disaster, with

. be the outcome that would be observed for country i at time t if country i

is exposed to the disaster and its aftermath from period . Of course,

to

the extent that the occurrence of a large disaster is unpredictable, it has no

effect on the outcome before the intervention, so for t

we have that

country i is exposed to the intervention in periods

Note that we allow this effect to potentially vary over time. Again, the

intervention, in our context, is the disaster and its aftermath. Therefore:

Let be an indicator that takes value one if country i is exposed to the

intervention at time t and value zero otherwise. The observed output per

capita for country i at time t is :

3. Because only the ﬁrst country (country “one”) is exposed to the intervention

and only after period

causal effect of the catastrophic event on the outcome of interest

4. The outcome variable of interest, say GDP per capita, is observed for T

periods for the country affected by the catastrophic event

countries. Let the deﬁne a linear

combination of pre-disaster outcomes:

4. RESULT

One obvious choice for the set of linear combinations of pre-disaster outcomes

would be :

C) 1. TITLE

1. Why the interaction of the propensity to save and the productivity of capital

can lead to growth cycles that exhibit the wandering, in case not coverage to

a cycle of any regular periodic?

parameters or initial conditions?

3. METHODS

Lorenz. A formal definition of chaos and sufficient conditions for chaotic

transectories.

application of overlapping generations model and forth coming study of the

classical growth model

equation in capital labor ratio

4. RESULT

In which s is the saving ratio, f the per capita production function, and the

natural rate of population growth. Aggregate output is of course given by the

aggregate production function, where the aggregate

capital stock is and the supply of labor is = . The saving ratio

may dependence income, wealth, and the interest rate, but using y = f(k) and

the real interest rate , it reduces to a dependence on k alone.

CHAPTER 5

RESULT MACROECONOMICS JOURNAL

Hypotheses:

true. Look at the p value or sig value (based on a t statistic).

policy which impacting by natural disaster)

Remember that we have a small sample and are trying to estimate a relationship

between variables in a target population.

• Consider Y = β0 + β1 X + ε.

• Unless, of course, β1 = 0.

• : β1 ≠ 0 (Y does depend on X)

A Priori Considerations

Sign tests:

• If the a priori signs do not agree with those in the estimated model, the

regression may be worthless.

unbelievably large (or small).

Forecast errors:

between actual and values predicted by the estimated equation).

• Small values indicate that the estimated model fits the observed

data closely (min SE = 0).

The smaller the value of SE of the regression, the better is the fit of the regression

line.

• t-table

1. The main changes applied to the basic Solow model, starting with its core set of

equations where Y is production, K is productive capital, L is labor, A is total

productivity, C is consumption, S is consumer savings, I is investment,

is the investment (or, equivalently, saving) ratio, ,, is the depreciation time, and

is the labor at full employment:

temporary imbalances between production and demand, instead of a market

clearing at each point in time. Thus

This inventory can be either positive or negative and it encompasses all sources of

delay in the adjustment between supply and demand, including technical lags in

producing, transporting and distributing goods. Its situation aﬀects price

movements:

market clearing conditions are veriﬁed only over the long term.

3. Labor market : The producer sets the optimal labor demand that maximizes

proﬁts, as a function of real wage and marginal labor productivity:

But full employment is not guaranteed at each point in time, because (i) institutional

and technical constraints create a delay between a change in the optimal labor

demand and the corresponding change in the number of actually employed workers:

and (ii) wages are partially rigid over the short term; they progressively restore the full

employment rate by increasing if labor demand is higher than and decreasing

when it is lower:

4. Household behavior : Like the Solow model, NEDyM uses a constant saving ratio but it

makes the tradeoﬀ between consumption and saving more sophisticated by

considering that households (i) consume (ii) make their savings available for investment

through the savings, and (iii) hoard up a stock of money that is not immediately

available for investment.

NEDyM describes an investment behavior “`” It introduces a stock of liquid assets F

held by banksand companies, which is ﬁlled by the diﬀerence between sales p(C+I)

and wages wL, and by the savings S received from consumers. Theseassets are used

to redistribute share dividends. Div and to invest in the amount pI. This formulation

creates a wedge between investment and savings, reﬂected by changes in F:

The dynamics of the system is governed by an investment ratio that allocates these

assets between productive investments and share dividends:

The producer’s net proﬁt follows the accounting deﬁnition of proﬁt that is gross

proﬁts minus capital depreciation:

The distribution between dividends and investment depends on the expected net proﬁts

per capital unit compared with a standard of profitability ν. If the expected net proﬁt

per capital unit is higher than this standard, the producer increases his/her

physical investments; if, on the contrary, the expected proﬁt is lower than ν, investments

are reduced. Assuming that observed values are the best guess of expected values at

each point in time leads to:

Eﬀective capital is K = ξK

is the potential productive capital, which is the stock of capital in the absence of any

disaster.

With this new function, a destruction of x% of the productive capital reduces production

by x%. The replacement of the productive capital K by the two new variables K0 and ξK

makes it necessary to modify the modeling of investment and to introduce the

distinction between regular investments, carried out to increase the production capacity,

and reconstruction investments that follow a disaster. To capture how these constraints

may impact the pathways back to equilibrium, we bounded by the fraction of total

investment that reconstruction can mobilize.

Long-term averaged GDP losses due to the distribution of natural disasters for

diﬀerent types of economic dynamics of the table) or very low (not shown), the

economy is incapable of responding to the natural disasters through investment

increases aimed at reconstruction. Total production losses, therefore, are very large,

amounting to 0.15% of GDP when the ﬂexibility is null. Such an economy behaves

according to a pure Solow growth model, where the savings, and therefore the

investment, ratio is constant.

economy, i.e. when αinv is non-null but still lower than 1.39, the economy has a new

degree of freedom to improve its situation and respond to productive capital shocks.

Such an economy is much more resilient to disasters, because it can adjust its level

of investment in the disaster’s aftermath: for αinv = 1.0 (second row of the table),

GDP losses are as low as 0.01% of GDP, a decrease by a factor of 15 with respect to

a constant investment ratio, thanks to the added investment ﬂexibility.

One obvious choice for the set of linear combinations of pre-disaster outcomes

would be :

In which s is the saving ratio, f the per capita production function, and the natural rate

of population growth. Aggregate output is of course given by the aggregate production

function, where the aggregate capital stock is and the

supply of labor is = . The saving ratio may dependence income, wealth,

and the interest rate, but using y = f(k) and the real interest rate , it reduces to

a dependence on k alone.

Policy Implications

The findings from the study have implications for national development and

macroeconomic policies, public finance, the generation and use of information, and the

financing of disaster costs. A precondition for improvement in all these areas is good

governance. National Development Policy and the Macroeconomic Natural hazards

warrant more serious consideration in the formulation of national economic policies and

strategies. Risk assessments should be made from a broad macroeconomic standpoint,

exploring areas of both sensitivity and resilience. Assessments should seek to

understand the underlying factors determining vulnerability, including the potentially

complex and dynamic interlink ages between various influences and the scope for risk

reduction. Vulnerability has to be assessed according to the particular type of hazard.

strategies are appropriate. From a macroeconomic perspective, vulnerability can

shift quickly, particularly in countries experiencing rapid growth and socio economic

change, including urbanization.

2. For geographically large countries, where nation wide disasters are rare, regional

analysis is potentially more appropriate than country-level analysis for understanding

vulnerability and designing relevant policies.

3. Risk management necessarily involves the private sector and civil society, as well as

the public sector. The private sector should be encouraged and supported in

enhancing its understanding of natural hazard risks and adopting appropriate risk

management tools. Both structural and nonstructural measures may be required.

exploit potential organizational, technological, and other improvements that could be

made in rebuilding an economy while keeping priority development objectives on

track.

programs on the basis of disaster scenarios and, within that, identifying critical

projects that should receive priority in post disaster funding. There is a case for

exploring economic policy options through disaster scenarios that include the likely

effects of fiscal changes and monetary measures in order to develop guidelines for

policymakers in responding to disasters (see “Public Finance,” below).

6. National or economy wide disaster impacts, including total financial losses, should

be reassessed as a matter of course 12 to 18 months after an event. This task might

be undertaken as part of an end-of-project report for a recovery loan or in a paper for

consideration at an annual consortium or roundtable meeting.

crisis

RESUME

Interest rates near zero, money and government bonds are nearly perfect

substitutes, especially for the banks and ﬁnancial institutions at the center of economic

events. Conventional monetary policy analysis aimed at the split of government debt

holdings between “monetary” and “debt” assets seems rather irrelevant; the big events

seem to be the huge demand for both kinds of government debt, and the large interest

rate spreads that have opened up between government and non-government debt. The

massive ﬁscal deﬁcits, credit guarantees, and Federal Reserve purchases of risky

private assets raises the question of the ﬁscal limits of monetary policy. All analyses of

monetary policy operate against a ﬁscal backdrop. At some point the ﬁscal constraints

of monetary policy must take hold. The ﬁscal price equilibrating mechanism feels

exactly like “aggregate demand.” Suppose the price level is too low. Then the value of

debt is higher than expected future surpluses. People try to get rid of government debt,

buying goods and services instead. This extra demand raises the price level to its

equilibrium level. More deeply, “aggregate demand” is really just the mirror image of

demand for government debt. The household budget constraint says that after-tax

income must be consumed, invested, or result in purchase of government debt. The

only way to consume or invest more is to hold less government debt.

raise, so at some point any monetary policy runs into its ﬁscal limit. At some point, the

government cannot run a “Ricardian” regime, and inﬂation results no matter what the

government attempts regarding the split of its liabilities between money and bonds.

Argentina has found that limit. So far, the US may has not — if the ﬁscal theory governs

our price level, it is by choice. But there is some limit, some point where the government

simply cannot raise the present value of future surpluses, and US economists may be

rudely surprised when it arrives. In addition, interest rates on government bonds fell to

dramatic lows, including some negative rates. In combination with reserves paying

interest, the distinction between government bonds and money (reserves) was a third-

order issue for ﬁnancial institutions, especially compared to the very high interest rates,

lack of collateralizability, and dramatic illiquidity of any instrument that carried a whiﬀ of

credit risk. In short, ﬁnancial institutions didn’t want more money and less bonds. They

wanted more of both, and less of other assets, and in massive quantities. The “special”

or “liquidity” services we usually associate with money applied with nearly equal force to

all government debt to these actors. The asset pricing literature has concluded that

time-varying discount rates account for essentially all stock market price ﬂuctuations.

This event suggests that we might similarly account for “aggregate demand”

ﬂuctuations by changes in the discount rate for government debt rather than (or as well

as) changes in expectations of future surpluses. People ﬂy to quality quite generally in

recessions. Perhaps this ﬂight is a crucial part of lower “aggregate demand.” MV = PY

with constant velocity (“stable money demand”) and long and variable lags seems a

likely casualty. The Fed has pretty clearly accommodated a large shift in money

demand. When that shift reverses, the Fed can (subject to a ﬁscal limit) reverse course

and soak up that money. Simply looking at current aggregates is not a serious sign of

future inﬂation.

CHAPTER 1

INTRODUCTION

The ﬁscal theory oﬀers an attractive perspective. First, with interest rates near

zero, money and government bonds are nearly perfect substitutes, especially for the

banks and ﬁnancial institutions at the center of economic events. Conventional

monetary policy analysis aimed at the split of government debt holdings between

“monetary” and “debt” assets seems rather irrelevant; the big events seem to be the

huge demand for both kinds of government debt, and the large interest rate spreads

that have opened up between government and non-government debt. Second, the

massive ﬁscal deﬁcits, credit guarantees, and Federal Reserve purchases of risky

private assets raises the question of the ﬁscal limits of monetary policy. All analyses of

monetary policy operate against a ﬁscal backdrop. At some point the ﬁscal constraints

of monetary policy must take hold. That point may be coming faster than we think.

1. Fall 2008 saw a large increase in demand for both money and government debt.

This makes sense in the ﬁscal theory as a deﬂationary decrease in the discount

rate for government debt. Many of the Government’s innovative policies can be

understood as ways to accommodate this demand, which a conventional swap of

money for government debt does not address.

2. Surpluses can generate inﬂation (the same thing as “stimulate” here) if people do

not expect future taxes. However, no irrationality or market failure is required for

this expectation. prospective deﬁcits are just as “stimulative” as current deﬁcits, the

Government’s announcements can be read both ways, and I show that we can

measure the state of private expectations in the bond market.

3. Credit guarantees make matters much worse than actual deﬁcits suggest. I also

point out that since the present value of deﬁcits matters, if taxes have any eﬀect on

growth, the ‘Laﬀer limit’ of taxation may come much sooner than static analysis

suggests.

4. Fiscal inﬂations, and in particular inﬂations that come from collapsing expectations

of deﬁcits, may have quite diﬀerent output eﬀects. Thus a ﬁscal inﬂation, an event

outside recent US experience, may well lead to stagﬂation, not recovery.

CHAPTER 2

RESEARCH QUESTION

1. Why ﬁscal theory of the price level focuses on the valuation equation for

government debt?

3. Why “aggregate demand” is really just the mirror image of demand for

government debt?

5. Describe the two effects in credit guarantees which most obviously, having to

make good on these guarantees on top of large budget deﬁcits can be the piece of

poor surplus news that kicks us against the ﬁscal limit and nominal credit

guarantees mean that government ﬁnances are much worse if the price level goes

down, and much better if there is inﬂation?

6. What is the measure of fiscal limit which determine by the price level in the

dynamic laffer curve?

CHAPTER 3

METHODS FROM FISCAL POLICY JOURNAL

1. The ﬁscal theory of the price level focuses on the valuation equation for government

debt,

where is the real stochastic discount factor, which we can also think of as a

discount rate are real primary surpluses. This

equation is an equilibrium condition, not a budget constraint. It operates just like the

standard asset pricing equation for valuing a stock as the present value of its

dividend payments. The Government may choose a “Ricardian regime” in which it

adjusts taxes and spending ex-post so this equation holds for any price level Pt, but

no budget constraint logic forces it to do so. Analogously, no constraint forces

Microsoft to raise earnings in response to an “oﬀ-equilibrium” or “bubble” in its stock

price.

2. More deeply, “aggregate demand” is really just the mirror image of demand for

government debt. The household budget constraint says that after-tax income must

be consumed, invested, or result in purchase of government debt,

3. The valuation equation (1) can determine the price level even in a frictionless

economy with . But to understand monetary policy with we also

need a money demand function, that captures the “special” nature of money,

4. The timing of the ﬁscal equation (1) is quite diﬀerent with long-term debt. For

example, if debt consists of a constant coupon c that is redeemed each period, with

no other debt purchases and sales, then we have

5. Each period. Equation (1) still holds, but the market value of long term debt

ﬂuctuates overtime as well as the price level. However, most US debt is rolled over

every few years, so if we take a time interval of a few years we will not go too far

wrong in the qualitative analysis

recognizing that the discount rate for government debt declined dramatically.

In our ﬁscal framework, R declined in

7. In our ﬁscal framework, let Dt denote private debt owned by the government in

exchange for additional Treasury debt. Our ﬁscal equation becomes

10.

11. Real revenue from debt sales are

14. We also know from past ﬁscally - induced currency collapses that the turning point

comes suddenly and irretrievably, as do stock market collapses.

15. Nominal credit guarantees mean that government ﬁnances are much worse if the

price level goes down, and much better if there is inﬂation. Surpluses are not

independent of the price level. Our equation is really

We are used to thinking of the static Laﬀer curve, in which tax revenue T is

generated by a tax rate τ from income Y as and The marginal revenue generated

from an increase in taxes is

CHAPTER 4

PREVIOUS STUDIES OR REFERENCES

A).1. TITLE

Prospective Deficits and the Asian Currency Crisis by Craig Burnside, Martin

Enchenbaum, and Sergio Rebelo.

policy?

3. What is the model of Asian currency crisis from continuous time, perfect

foresight endowment economy populated by infinitely lived representative

agent and government?

4. How to characterize the time at which the fixed exchange rate regime

collapses, and the post - crisis behavior economy.

calibrated for analyze the nature of optimal monetary policy in our model?

3. METHODS

4. RESULT

1. The ﬁscal theory of the price level focuses on the valuation equation for government

debt,

where is the real stochastic discount factor, which we can also think of as a

discount rate are real primary surpluses. This

equation is an equilibrium condition, not a budget constraint. It operates just like the

standard asset pricing equation for valuing a stock as the present value of its

dividend payments. The Government may choose a “Ricardian regime” in which it

adjusts taxes and spending ex-post so this equation holds for any price level Pt, but

no budget constraint logic forces it to do so. Analogously, no constraint forces

Microsoft to raise earnings in response to an “oﬀ-equilibrium” or “bubble” in its stock

price.

2. More deeply, “aggregate demand” is really just the mirror image of demand for

government debt. The household budget constraint says that after-tax income must

be consumed, invested, or result in purchase of government debt,

3. The valuation equation (1) can determine the price level even in a frictionless

economy with . But to understand monetary policy with we also

need a money demand function, that captures the “special” nature of money,

4. The timing of the ﬁscal equation (1) is quite diﬀerent with long-term debt. For

example, if debt consists of a constant coupon c that is redeemed each period, with

no other debt purchases and sales, then we have

5. Each period. Equation (1) still holds, but the market value of long term debt

ﬂuctuates overtime as well as the price level. However, most US debt is rolled over

every few years, so if we take a time interval of a few years we will not go too far

wrong in the qualitative analysis

recognizing that the discount rate for government debt declined dramatically.

In our ﬁscal framework, R declined in

7. In our ﬁscal framework, let Dt denote private debt owned by the government in

exchange for additional Treasury debt. Our ﬁscal equation becomes

10.

14. We also know from past ﬁscally - induced currency collapses that the turning point

comes suddenly and irretrievably, as do stock market collapses.

15. Nominal credit guarantees mean that government ﬁnances are much worse if the

price level goes down, and much better if there is inﬂation. Surpluses are not

independent of the price level. Our equation is really

We are used to thinking of the static Laﬀer curve, in which tax revenue T is

generated by a tax rate τ from income Y as and The marginal revenue generated

from an increase in taxes is

C. Mundell–Fleming model

RESUME

The Mundell-Fleming model is an economic model first set forth by Robert

Mundell and Marcus Fleming. The model is an extension of the IS-LM model. Whereas

the traditional IS-LM Model deals with economy under autarky (or a closed economy),

the Mundell-Fleming model tries to describe an open economy. Typically, the Mundell-

Fleming model portrays the relationship between the nominal exchange rate and an M

economy's output (unlike the relationship between interest rate and the output in the IS-

LM model) in the short run.The Mundell-Fleming model has been used to argue that an

economy cannot simultaneously maintain a fixed exchange rate, free capital movement,

and an independent monetary policy. This principle is frequently called "the Unholy

Trinity," the "Irreconcilable Trinity," the "Inconsistent trinity" or the Mundell-Fleming

"trilemma."

reduces the local interest rate and in turn forces the local interest rate lower than the

global interest rate. This depreciates the exchange rate of local currency through capital

outflow. (Hot money flows out to take advantage of higher interest rate abroad and

hence currency depreciates.) The depreciation makes local goods cheaper compared

to foreign goods and increases export and decreases import. Increased net export

leads to the shifting of the IS curve (which is Y = C + I + G + NX) to the right to the point

where the local interest rate equalizes with the global rate. At the same time, the BoP is

supposed to shift too, as to reflect(1)depreciation of home currency and (2)an increase

in current account or in other word, the increase in net export.

An increase in government expenditure shifts the IS curve to the right. The shift causes

the local interest rate to go above the global rate. The increase in local interest causes

capital inflow, and the inflow makes the local currency stronger compared to foreign

currencies. Strong exchange rate also makes foreign goods cheaper compared to local

goods. The level of income of the local economy stays the same. The LM curve is not

at all affected. A decrease in government expenditure reverses the process.

An increase in the global interest rate causes an upward pressure on the local interest

rate. The pressure subsides as

the local rate closes in on the global rate. When a positive differential between the

global and the local rate occurs,

holding the LM curve constant, capital flows out of the local economy. This depreciates

the local currency and helps

boost net export. Increasing net export shifts the IS to the right. This shift continues to

the right until the local

interest rate becomes as high as the global rate. A decrease in global interest rate

causes the reverse to occur.

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