Lecture 4
Keynes-Hicks-Samuelson-Mundell-Fleming Models for Analysis
of Macroeconomic Fluctuations (Demand Side)
Keshab Bhattarai
Business School
University of Hull, Hu6 7RX, UK
Blog: http://economics-and-economic-modellingcom.blogspot.com/
URL: http://www.hull.ac.uk/php/ecskrb
Macroeconomic modelling
Market is always in equilibrium: Demand = Supply both in goods and factor markets;
No excess demand or no excess supply can persist.
See http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/
Labour market imbalance: rigid labour market, nominal wages not flexible
upwards
unemployment may persist for a long period if the deficiency in demand
continues. Loss of welfare
Active fiscal and monetary policy can fine tune the economy
In time of massive unemployment dig holes and fill them to create jobs and
income
C+I+G
C+I
C
450
Y: Output
EM: KB, 2007: HUBS.
Y_Supply
Spending =Demand
C+I+G+X-M
Y_D
Y = C+I+G X-M
450
YF
EM: KB, 2007: HUBS.
Output
6
Interest rate
IS Curve
h
A(y1, i1)
i1
. Excess supply
of goods
B(y2,i2)
i2
IS
I1
Investment I2
y1
e
S1
Equilibrium
S=I
S2
y2
Y: Outpu
c
d
Saving Function: S(Y)
Saving
EM: KB, 2007: HUBS.
Excess Supply
Excess Demand
C = C 0 + a(Y T )
I = b dr
Z = mY
Y = C + I +G+ X Z
Numerical Example
I = 100 200(0.05)
Z = 0.2Y
C 0 aT + b dr + G + X
Y=
1 a + m
Model Solutions
Y = 900
C = 840
I = 90
T=G= 100;X=50
M = 180
X-M = -130
S=Y-T-C=-40
S-I=-40-90=-130
I = 100 200(0.05)
Z = 0.2Y
Macro Balance:
Income = Expenditure
C+S+T = Y = C+I+G+X-M
(S - I) +(T-G) = (X-M)
-130 + 0 = -130
10
r1<r0
AD
I(r) =S(y)
r0
r1
y1
y2
IS
y1
y2
11
i2
MD(y2,i)
i1
MD(y1,i)
i0
MD(y0,i)
EM: KB, 2007: HUBS.
MS
y0
y1
y2
12
LM
i2
Excess supply of Money
i1
i0
y1
y2
y3
13
LM (i,Y)
i*
ESG, EDM
Excess DG
Excess SM
EDG, EDM
IS(i,Y)
Y*
EM: KB, 2007: HUBS.
14
c
i2
b
i1
a
IS2
i0
IS1
IS0
EM: KB, 2007: HUBS.
y0
y1
y2
15
LM1
i0
LM2
b
i1
c
i3
IS
0
EM: KB, 2007: HUBS.
y0
y1
y2
16
c
i2
b
i1
a
IS2
i0
IS1
IS0
0
EM: KB, 2007: HUBS.
y0
y1
y2
17
Interest
rate
Y1
Y2
Y1 Y2
Income
Monetary policy is effective (Flat LM) and
Small output effect of Monetary policy (Steep IS)
18
r2
LM0
LM1
rate
r2
r1
r1
IS2
IS
IS1
Y1
Y2
Y1
Y2
Income
Monetary policy is effective (Steep LM) and
Large output small interest rate effect of monetary
policy (FLAT IS)
19
IS
LM(P1)
r1
r2
r3
Y1
Y2
Y3
Price Level
P1
P2
P3
AD
Y1
Y2
Y3
20
(12)
(13)
Investment:
(14)
I = 200 25 r
Balanced budget: T = G = 100
(15)
Derive IS curve:
Y = 250 + 0.75(Y T ) + 200 25r + 100
Y = 1900 100r
y
= 100
:
a negatively sloped IS curve
EM: KB, 2007: HUBS.
r
(16)
(17)
21
(18)
1000 = Y 100 r
Or r = 10 + 0.01Y
r
= 0.01 > 0
=> y
(19)
(20)
22
2900
Y=
2
Y = 1450
(21)
r = 10 + 0.01Y =>
23
(16)
Y = 3100 Y
3100
Y=
= 1550
r = 10 + 0.01Y
r = 10 + 0.01(1550)
r = 5.5%
24
1450
1550
y2
25
LM1
a
b
3%
IS
0
EM: KB, 2007: HUBS.
1550
1575
26
r = 10 + 0.01Y
7%
r
4.5%
Y = 1900 100r
1200
1450
Y
27
28
C t = 0 + 1 (Yt Tt )
I t = 0 + 1 Rt + Yt 1
Tt = t 0 + t1Yt
M t = m0 + m1Yt + m2 t
C t + Tt + S t = Yt = C t + I t + Gt + X t M t
(Tt Gt ) + ( S t I t ) = ( X t M t )
0 1 c 0 + 0 m 0 + Gt + X t
1 Rt
Yt 1
Yt =
+
+
1 1 + 1t1 + m1
1 1 + 1t1 + m1 1 1 + 1t1 + m1
EM: KB, 2007: HUBS.
29
Base
Case
Tax
cut
Spending MPC
High
T &G X
High
I
MMM
200
200
200
400
200
400
200
200
200
100
100
100
100
100
100
300
100
100
0.1
0.1
0.1
0.1
0.1
0.1
0.1
0.1
0.1
C0
300
300
300
300
300
300
300
300
300
0.8
0.8
0.8
0.8
0.9
0.8
0.8
0.8
0.8
I0
50
50
50
50
50
50
50
200
50
10
10
10
10
10
10
10
10
10
t0
30
30
30
30
30
30
30
30
30
0.3
0.3
0.2
0.2
0.3
0.2
0.3
0.3
0.3
m0
20
20
20
20
20
20
20
20
20
m1
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.4
30
T
876.8
991.8
1166.7
971.0
1319.7
1166.7
1094.2
720.2
293.0
228.4
380.0
767.0
910.8
929.3
321.3
884.7
293.9
1120.
6
380.0
358.3
246.1
929.3
888.8
679.3
G
49.0
49.0
49.0
49.0
49.0
49.0
199.0
49.0
200.0
200.0
400.0
200.0
400.0
200.0
200.0
200.0
X
100.0
100.0
100.0
100.0
100.0
300.0
100.0
100.0
239.2
183.2
268.0
147.3
311.7
142.7
262.7
T-G
X-M
S-I
Bal
93.0
139.2
232.2
139.2
28.4
168.0
196.3
168.0
-20.0
211.7
191.7
211.7
235.0
121.3
162.7
284.0
162.7
349.9
-94.9
106.1
249.9
143.9
249.9
311.7
142.7
180.0
-11.7
191.7
-11.7
293.6
152.8
158.3
193.6
351.8
193.6
308.1
205.2
46.1
208.1
254.2
208.1
31
= b0 + b1Yt b2 Rt
P
b0 1 MM
Rt =
b2 b2 P
Y =
t
b t + m + G + X
t
t
10
0
0
2 0
b
R
b2
b2
+ t
11
MM
P t
+ m b
1 2
b1
b2
b
11
b
2
+ t
11
b1
+ Yt
b
2
t
t 1
+ m b
1 2
b0
+
b
1 + t + m b b b 2
11
1
11
1 2
11
b ( t + m + G + X )
b Y
t 1
2
2 0 10 0 0 t t +
1 1 + 1t1 + m1 b2 1b1 1 1 + 1t1 + m1 b2 1b1
b
2
b
+
+ t +
11
m b
1 2
b
1 1
MM
b P
2
t
b0
b2
MM
P t
32
10000
10000
10000
10000
10000
10000
10000
10000
10000
10000
22114.16
beta1
0.9
0.9
0.9
0.9
0.9
0.9
0.9
0.9
0.6
0.9
0.459078
mu0
500
500
500
500
500
500
1000
500
500
500
105457
m0
100
100
100
100
100
100
100
100
100
100
-65167
t0
200
500
200
500
200
200
200
200
200
200
-201384
t1
0.3
0.3
0.3
0.3
0.3
0.3
0.3
0.3
0.3
0.3
0.476403
m1
0.2
0.2
0.2
0.2
0.2
0.2
0.2
0.2
0.2
0.3
1.387408
1000
1000
1000
1000
1000
1000
1000
1000
1000
1000
1720.051
0.6
0.6
0.6
0.6
0.6
0.6
0.6
0.6
0.6
0.6
0.6
20000
20000
25000
25000
20000
20000
20000
20000
20000
20000
155880
8000
8000
8000
8000
8000
8000
8000
10000
10000
8000
289225
y0
500
500
500
500
500
500
500
500
500
500
500
b0
800
800
800
800
800
800
800
800
800
800
-78809
b1
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.333992
b2
300000
300000
300000
30000
0
300000
600000
300000
300000
300000
300000
-1829.75
M4
10000
10000
10000
10000
15000
10000
10000
10000
10000
10000
10000
mu1
phi
33
X-M
S-I
T-G
Base case
0.0251
66901
51968
525
20000
20270
13480
8000
-5337
-5480
-5862
270
More Tax
0.024
65640
50453
524
20000
20692
13228
8000
-5505
-5228
-6029
692
More Spending
0.0324
75660
57486
532
25000
22898
15232
8000
-4724
-7232
-5256
-2102
0.032
75187
56918
532
25000
23056
15137
8000
-4787
-7137
-5319
-1944
0.0084
66872
51949
508
20000
20262
13474
8000
-5339
-5474
-5847
262
More Sensitive
Asset demand
0.0126
66977
52015
513
20000
20293
13495
8000
-5332
-5495
-5844
293
More investment
0.026
67777
52519
1026
20000
20533
13655
8000
-5276
-5655
-6301
533
More Exports
0.028
70405
54175
528
20000
21321
14181
10000
-5092
-4181
-5620
1321
Low MPC
0.01
48985
30454
510
20000
14896
9897
8000
3636
-1897
3126
-5104
High MPM
0.017
56928
45685
517
20000
17278
17178
8000
-6035
-9178
-6552
-2722
34
Market Clearing
Consumption
Investment
Equilibrium
Steady State
Yt = Yt1 = Yt 2 = Y
EM: KB, 2007: HUBS.
Yt = C t + I t + G0
Ct = Yt1
0 < <1
I t = (Ct Ct1 )
>0
Yt = (1 + )Yt1 Yt 2 + G0
G0
G0
=
Y =
1 (1 + ) + 1
35
Yt (1 + )Y t1 + Y t 2 = 0
Assume
Yt = Ab t
Ab
t 1
t 2
(
)
1 + Ab + Ab = 0
b t + 2 (1 + )b t +1 + b t = 0
b1 , b2 =
(1 + ) 2 (1 + )2 4
Yt = A1b1t + A2 b2t
Three cases:
Distinct real roots:
(1 + ) > 4
2
No cycle
(1 + ) = 4
Complex root:
(1 + ) < 4
No cycle
Fluctuation, cycles
36
37
0<b<1
b >1
Y_SS
Y_SS
Time
Time
Y
Y
b=1
b = -1
Y_SS
Y_SS
No Cycle no fluctuation
Regular Cycle
Time
Time
-1 < b < 0
b < -1
Y_ss
Time
Convergent Cycle
Time
38
Divergence
No cycle
=1
Cycle
O
C
Accelerator
4
(1 + )2
= 1
Convergence
O
2 (1 + )2 = 4
=
4
39
What is the link between budget deficit and trade imbalance and
money supply?
How do fiscal, monetary and the exchange rate policies affect output
and employment in an economy?
What are the golden rules of fiscal, monetary and exchange rate
policies?
40
National income
*
f
eP
e
)
Y = C (Y T ) + I (Y , i ) + G + NX (Y ,Y ,
P
Money market:
M
= L(i, Y )
P
= r + (3)
eP *
=
P
*
NX
=
KF
r
r
Balance of payment:
e
(
)
Y
=
Y
+
P
Aggregate supply:
(2)
e
(1)
(4)
(5)
(6)
(7)
41
Y, i, r, , P, e
Exogenous Variables
e
P
= foreign income = expected domestic
42
Y = C (Y T ) + I (i ) + G + NX Y , Y ,
C = 200 + 0.8(Y T )
I = 50 200(i )
T =100 G = 100
NX = 10 + 0.3Y 0.1Y 20
f
EP *
=
P
M
= 200 50i + 0.5Y
P
EM: KB, 2007: HUBS.
i = i = 5%
*
= 0.03
43
I = 50 20(0.05 0.03 )
NX = 10 + 150 128 40 = 8
(100 100) + (36 44) = 8
(T G ) + (S I ) = NX
EM: KB, 2007: HUBS.
44
1e6
500000
200000
150000
100000
500000
250000
1960
400000
1980
2000
2020
1980
2000
20
1980
2000
2020
1960
1980
2000
400000
1960
1980
2000
2020
M4
1960
1980
2000
Inflation
20
10
2020
S-I
150000
1960
1980
2000
2020
T-G
200000
100000
30000
1980
2000
2020
Lbforce
1960
1980
2000
2020
Employed
25000
2000
2020
1980
2000
X-M
2020
2020
1980
2000
2020
1980
2000
2020
2000
2020
1980
2000
2020
2000
2020
1960
K-Flow
-200000
1960
1980
2000
2020
1960
3
Unrate
1980
dlrpnd
5
1960
1960
-300000
10
22500
1980
1960
-50000
27500
1960
2020
200000
0
1960
2000
250000
10
2000
1980
200000
2e6
1980
1960
250000
1960
2020
500000
500000
1960
2020
750000
DY
750000
200000
100000
50000
1960
150000
1960
1980
2000
2020
1960
1980
45
Investment function:
Tax Reveneu:
Import function:
Interest rate:
46
Fitted
150000
500000
400000
Fitted
100000
300000
200000
50000
1960
400000
1970
T
1980
1990
2000
Fitted
1960
M
300000
300000
200000
200000
100000
100000
1970
1980
1990
2000
1980
1990
2000
Fitted
0
1960
20
1970
i
1980
1990
2000
1960
1970
Fitted
15
10
5
EM: KB, 2007: HUBS.
1960
1970
1980
47
1990
2000
250000
Forecasts
225000
700000
200000
175000
600000
150000
2000
600000
Forecasts
2005
2010
2000
500000
Forecasts
2005
2010
2005
2010
2005
2010
500000
400000
400000
2000
10
Forecasts
2005
2010
2000
1.6e6
Forecasts
1.4e6
0
1.2e6
-5
2000
2005
2010
2000
48
Y = Yn + 10 P P e Yn + 10 e
Keynesian Supply
P=P
AD
0
EM: KB, 2007: HUBS.
Y = Yn
Output
49
Economic Growth: Models and Global Evidence, Research Memorandum no. 40 Business School, University of Hull.
Keynesian Models for Analysis of Macroeconomic Policy, Paper presented in Cassino Macroeconomic Conference, 2005, Italy.
Unemployment-inflation Trade-off in OECD Countries: Lessons from Panel data and Theories of Unemployment, Paper Presented in
Atlantic Economic Association Conference, Berlin, Germany
REVIEW OF MACROECONOMETRIC MODELS FOR ANALYSIS AND FORECASTING, Memio, Hull.
Interest Determination Rule four UK and Other Four Major Industrial Economies a Research Memorandum no. 42 Business School,
University of Hull, forthcoming in Applied Financial Economics.
50