8. a comprehensive business cycle model* ) isolated state („viking village“) => thünen...

8. A comprehensive business cycle model*)

• isolated state („Viking village“) => Thünen paradigm

• Corn = consumption and investment => Ricardo paradigm

1U. van Suntum, Lecture KuB

Improved version of the model in CAWM Discussion Paper No 24 (2009): Economic Confidence, Neagtive Interest Rates, and Liquidity: Towards Keynesianism 2.0 (Ulrich van Suntum)

U van Suntum, Lecture KuB 1

Stylized facts of the recent crisis (I):banks hoard money at central bank

(Source: council of economic advisors JG 2008)

© Ulrich van Suntum© U.van Suntum, CAWM 2U. van Suntum, Lecture KuBU van Suntum, Lecture KuB 2

© U.van Suntum, CAWM

Stylized facts of the recent crisis (II):sharp decline in money growth rates

(Source: spring report on business cycle 2009)

3U. van Suntum, Lecture KuBU van Suntum, Lecture KuB 3

© U.van Suntum, CAWM

Stylized facts of the recent crisis (III):high capital-market interest rate(Source: spring report on business cycle 2009)


Shortcomings of conventional textbook Keynesianism

• only one single interest rate

•Financial sector is not explicitly incorporated

•Psychological elements widely missing

•Missing link between savings and capital stock

5U. van Suntum, Lecture KuBU van Suntum, Vorlesung KuB 5

The Viking Village model: Five non-standard features

1. production function with degree of homogeneity less than 1

2. savings S derived from a (reduced) wealth optimization approach

3. credit money with private banking system

4. money market interest rate distinguished from capital market interest rate

5. confidence q an explicit (and endogenous) variable in the model


Assumptions in more detail

• seed is the only commodity

• depreciation rate = 1 => (gross) saving S = capital stock K

• Paper money M for transaction and liquidity reserves

• Three kinds of wealth: real capital K, currency L, deposits D

• stationary economy (no technical progress)

• population = labor force N (perfectly elastic)

• real wage rate is fixed exogenously


The model at a glance

FirmsPrivate

Households

Private BanksCentral Bank

Government

HCGC

HDMD

GpK

CapitalMarket

BpK

HpKFpK

L

M

MpK

Y


The supply side

sublinear production function

exp1)9(

tF Y

idK

1 )6( FKNY

1)7(YF Pure profits > 0

Labor demand of farmsexp

/)8( tYpwN

Capital (seed) demand of farms


The demand side: household behavior

),(

qiLL

),(

qiKK MHH

,

.

),(

qiVV

q = confidence, i = capital market interest rate, iM = money market interest rate

total wealth

liquidity

real capital

exp* VVSH HHH SYC YYH )1(


p

L

p

DEKV HHHH )1(


Capital market equilibrium

Demand of real capital Supply of real capital

MBHFG KKKKK

• Generally, the equlibrium interest rate i must be calculated numerically

• With neatly chosen parameters, an analytical solution can be derived (see below)


Additional capital supply from central bank

Additional capital demand from governmentGG

MM

KK

KK


Monetary Equlibrium and Nominal Income

BHMM LLpKDMM

Money supply: Money demand:

** ))1(()14( nomYxlvlM

MKxlvlY

Mp

))1(()20(

**


Equilibrium interest rate

15,05,0

)19(1

3

2

1

2

1

2*

H

H

H

H

H

Hi

With H being complex, but exogenous auxiliary variable


Dynamic simulations

• Adaptive expectations for both the price level p and total icome Y

• labor input depends on expectation of Y for period t

• capital input depends on expectation of Y for period t+1


Results at a glance


..\..\..\work in progress und sonstige Desktop-Dateien\confidence model VI.xlsx

Table of Results i: dynamicsShort Term Responses

Impulses (permanent) Y N p Yp i KF M M/p pEH

confidence q (-) - - +/- +/- + - - + -fiat money M (+) + + + + + + + -base rate iM (-) + + - + - + + + -

central bank credits KM (+) + + - + - + + + -public debt KG (+) + + + + + - + +/- +

income tax rate τ (-) - - - - - - - - +/-real wage rate w/p (+) - - + - - - -

Table of Results ii: steady stateLong Term Responses

Impulses (permanent) Y N p Yp i KF M M/p pEH

confidence q (-) - - - - + - - - -fiat money M (+) + + + +base rate iM (-) + + + + - + + + +

central bank credits KM (+) + + + + - + + + +public debt KG (+) - - + + + - + - +

income tax rate τ (-) + + - +/- - + - + -real wage rate w/p (+) - - + +/- - - +/-


Results: short term

• decline in economic confidence q: roughly equal to long term results

• increase in public deficit spending g: real income increases because of rising consumption and rising expected income

• increase in fiat money : real income increases because of real balance effect

• increasing central bank credits Km: real income increases because of increase in capital supply and real balance effect

• decreasing money market interest rate im: like increasing KM

• rise in real wage rate: real income and employment decrease

• tax rate cut: real income decreases because of Haavelmo-effect (increase in liquidity demand)

M




Results : long term

• decline in economic confidence q: real income decreases due to increasing preference for liquidity and decreasing supply of real capital

• increase in public deficit spending g: real income decreases because of crowding out effect and decreasing government consumption

• increase in fiat money : real income unchanged, price level increases

• increasing central bank credits Km: real income increases because of increase in capital supply, price level eventually increases

• decreasing money market interest rate im: like increasing Km

• rise in real wage rate: real income and employment decrease

• tax rate cut: real income increases because of increased savings

M




Some General Conclusions

• Keynesian results in the short term, monetaristic results in the long term • model fits stylized facts during the recession quite well

• long run effect of monetary policy on real income depends on how it is done

• short run effects of monetary policy are limited by zero lower bound on interest rates

• direct central bank credits to firms could help

• the latter are only inflationary, however, if they increase the amount of public debt


8. a comprehensive business cycle model* ) isolated state („viking village“) => thünen...

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