ec6012 lecture 7
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EC6012 Lecture 7
Stephen Kinsella
Notation
ReviewEquation SystemSteady StateSolutions
Portfolio Choicewith ExpectationsPuzzling Results fromthe modelReal WorldApplications
EC6012 Lecture 7Government Money with Portfolio Choice II
Stephen Kinsella
January 24, 2008
EC6012 Lecture 7
Stephen Kinsella
Notation
ReviewEquation SystemSteady StateSolutions
Portfolio Choicewith ExpectationsPuzzling Results fromthe modelReal WorldApplications
Objectives today
Notation
ReviewEquation SystemSteady State Solutions
Portfolio Choice with ExpectationsPuzzling Results from the modelReal World Applications
Notation
Symbol MeaningG Pure government expenditures in nominal termsY National Income in Nominal TermsC Consumption of goods supply by households, in nominal termsT Taxes! Personal Income Tax Rate
YD Disposable Income of Households"1 Propensity to consume out of regular (present) income"2 Propensity to consume out of past wealth
!Hs Change in cash money supplied by the central bank!Hh Cash money held by households
H,H!1 High Powered cash money today, and yesterday (!1)V Wealth of Households, in nominal terms
Bh,cb Bills held by households, central banks.
Review
Households Production Government Central Bank!
Money +H !H 0Bills +Bh !B +Bcb 0
Balance (net worth) -V +V 0!0 0 0 0
Table: Balance Sheet for PC.
Transactions Matrix
Central Bank
Households Production Government Current Capital!
Consumption - C + C 0Govt. Expenditures + G -G 0
Income = GDP +Y -Y 0Interest Payments +r!1 · Bh!1 !r!1 · B!1 +r!1 · Bcb!1 0
Central Bank Profits +r!1 · Bcb!1 !r!1 · Bcb!1 0Taxes -T +T 0
Change in Money !!H +!H 0Change in Bills !!Bh +!B !!Bcb 0!
0 0 0 0 0 0
Table: Transactions matrix for PC.
Equation Systems
Y = G + C (1)
YD = Y ! T + r!1 · Bh!1 (2)
T = ! · (Y + r!1 · Bh!1) (3)
V = V!1 + (YD ! C ) (4)
C = "1 · YD + "2 · V!1, 0 < "1 < "2 < 1 (5)
Hh
V= (1! #0)! #1 · r + #2 ·
"YD
V
#(6)
Bh
V= #0 + #1 · r ! #2 ·
"YD
V
#(7)
Hh = V ! Bh (8)
!Bs = Bs ! Bs!1 = (G + r!1 · Bs!1)! (T + r!1 · Bcb!1)(9)
!Hs = Hs ! Hs!1 = !Bcb (10)
Bcb = Bs ! Bh (11)
r = r (12)
EC6012 Lecture 7
Stephen Kinsella
Notation
ReviewEquation SystemSteady StateSolutions
Portfolio Choicewith ExpectationsPuzzling Results fromthe modelReal WorldApplications
Steady States
"3 = "2 · (1! "1)/"2 (13)
!V = "2 · ("3 ! V!1) (14)V "
YD" = "3 (15)
r" =B"
h · r
V " (16)
EC6012 Lecture 7
Stephen Kinsella
Notation
ReviewEquation SystemSteady StateSolutions
Portfolio Choicewith ExpectationsPuzzling Results fromthe modelReal WorldApplications
PCEX
Introducing expectations into PC is done through includingan expectation on disposable income, YDe . This changesthe consumption function to
C = "1 · YDe + "2 · V!1. (17)
EC6012 Lecture 7
Stephen Kinsella
Notation
ReviewEquation SystemSteady StateSolutions
Portfolio Choicewith ExpectationsPuzzling Results fromthe modelReal WorldApplications
Expectation-Augmented Modeling
Bd
V e= #0 + #1 · r ! #2 ·
"YDe
V e
#(18)
Hd
V e= (1! #0)! #1 · r + #2 ·
"YDe
V e
#(19)
Hd = V e ! Bd (20)
V e = V!1 + (YDe ! C ) (21)
EC6012 Lecture 7
Stephen Kinsella
Notation
ReviewEquation SystemSteady StateSolutions
Portfolio Choicewith ExpectationsPuzzling Results fromthe modelReal WorldApplications
Puzzling Results from the Model
! " G #" YD, !YD!
!G < 0
! " r #" YD, !YD!
!r > 0
! " #0 # Govt. taking Bills #" Y . So dropping liquiditypreference implies increasing Y in PCEX.
! " "3 #" Y (Paradox of Thrift?)
EC6012 Lecture 7
Stephen Kinsella
Notation
ReviewEquation SystemSteady StateSolutions
Portfolio Choicewith ExpectationsPuzzling Results fromthe modelReal WorldApplications
Real World Applications
Application 1PCEX implies that targeting debt to income ratios will havea positive e"ect on the fortunes of the country, if thegovernment does the targeting in a credible way. Inparticular, PCEX gives us a targeting rule of
V "
Y " ="3
1 +$
"1!"
%· r · [(#0 + #1 · r) · "3 ! #2]
. (22)
EC6012 Lecture 7
Stephen Kinsella
Notation
ReviewEquation SystemSteady StateSolutions
Portfolio Choicewith ExpectationsPuzzling Results fromthe modelReal WorldApplications
Debt/GDP
Figure: Debt/GDP Ratio in Ireland, 1990-2006
EC6012 Lecture 7
Stephen Kinsella
Notation
ReviewEquation SystemSteady StateSolutions
Portfolio Choicewith ExpectationsPuzzling Results fromthe modelReal WorldApplications
Interest Cost
Figure: Interest Cost Trend
EC6012 Lecture 7
Stephen Kinsella
Notation
ReviewEquation SystemSteady StateSolutions
Portfolio Choicewith ExpectationsPuzzling Results fromthe modelReal WorldApplications
Other Oddities
Application 2PCEX also implies that knowing "3 is important inforecasting behaviour. What does today’s news about thepercentage of SSIA money actually spent imply about thelevel of "3 in the Irish economy at present?According to yesterday’s Sunday Times, only three billion ofthe estimated ten billion to be paid out in the SSIAs hasbeen spent, leaving seven billion sitting in banks. Why doyou think this is?
EC6012 Lecture 7
Stephen Kinsella
Notation
ReviewEquation SystemSteady StateSolutions
Portfolio Choicewith ExpectationsPuzzling Results fromthe modelReal WorldApplications
Next Time
! Presentations $ Check Site.
! Read Godley, Chapter 6
! Read Expectations In Economics by Lachman (Link onSite, be in college)
! The Open Economy!