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BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 1 MACROECONOMICS BGSE/UPF LECTURE SLIDES SET 4 Professor Antonio Ciccone.

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Presentation on theme: "BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 1 MACROECONOMICS BGSE/UPF LECTURE SLIDES SET 4 Professor Antonio Ciccone."— Presentation transcript:

1 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 1 MACROECONOMICS BGSE/UPF LECTURE SLIDES SET 4 Professor Antonio Ciccone

2 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 2 3. Applications of the Ramsey- Cass-Koopmans (RCK) model 3.1 Government spending, consumption, and interest rates 3.2 Bond versus tax financed government spending

3 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 3 3.1 Government spending, consumption, and interest rates - Comparative “dynamics” in the RCK model - Permanent, surprise drop in output - Temporary, surprise drop in output - Wars, government expenditures and interest rates - The role of expectations - Permanent, anticipated drop in output - Temporary, anticipated drop in output

4 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 4 k c k-ISOCLINE: NO CAPITAL GROWTH c-ISOCLINE: NO CONSUMPTION GROWTH k* 0 The RCK model

5 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 5 k c k-ISOCLINE: NO CAPITAL GROWTH c-ISOCLINE: NO CONSUMPTION GROWTH k* 0

6 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 6 k c NEW k-ISOCLINE: NO CAPITAL GROWTH c-ISOCLINE: NO CONSUMPTION GROWTH k* 0 Permanent, surprise fall in output for given k

7 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 7 time Permanent, surprise fall in output Evolution of consumption

8 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 8 time Permanent, surprise fall in output Evolution of capital intensity

9 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 9 -- consumption can JUMP at the time new information arrives -- but consumption must be smooth (follow the first-order condition) from than onward:  There CANNOT BE an ANTICIPATED jump in consumption

10 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 10 k c NEW k-ISOCLINE: NO CAPITAL GROWTH c-ISOCLINE: NO CONSUMPTION GROWTH k* 0 Temporary, surprise fall in output for given k: PART I k-ISOCLINE: NO CAPITAL GROWTH

11 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 11 k c k-ISOCLINE: NO CAPITAL GROWTH c-ISOCLINE: NO CONSUMPTION GROWTH k* 0 Temporary, surprise fall in output for given k: PART II

12 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 12 k c NEW k-ISOCLINE: NO CAPITAL GROWTH c-ISOCLINE: NO CONSUMPTION GROWTH k* 0 Temporary,surprise fall in output: Equilibrium response

13 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 13 k c k-ISOCLINE: NO CAPITAL GROWTH c-ISOCLINE: NO CONSUMPTION GROWTH k* 0 Temporary,surprise fall in output: Equilibrium response

14 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 14 time START of Temp fall in output END of Temp fall in output Evolution of the capital intensity

15 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 15 time START of Temp fall in output END of Temp fall in output Evolution of real interest rate

16 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 16 time START of Temp fall in output Evolution of consumption END of Temp fall in output

17 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 17 Wars and real interest rates -- Suppose government expenditures associated with wars are surprise, temporary events -- Study the dynamic response of: capital, interest rates, and consumption to wars -- Government expenditures associated with wars decrease output available for consumption and investment  INCREASE G  Same effect as temporary fall in output

18 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 18 time START of War END of War Evolution of real interest rate

19 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 19

20 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 20 - The role of expectations - Permanent, anticipated drop in output - Temporary, anticipated drop in output

21 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 21 k c k-ISOCLINE: NO CAPITAL GROWTH c-ISOCLINE: NO CONSUMPTION GROWTH k* 0 Permanent, anticipated fall in output: PART I

22 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 22 k c NEW k-ISOCLINE: NO CAPITAL GROWTH c-ISOCLINE: NO CONSUMPTION GROWTH k* 0 Permanent, anticipated fall in output: PART II

23 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 23 k c NEW k-ISOCLINE: NO CAPITAL GROWTH c-ISOCLINE: NO CONSUMPTION GROWTH k* 0 Permanent, anticipated fall in output: Equilibrium response

24 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 24 time INFO of permanent FUTURE fall in output Evolution of capital intensity Output actually falls

25 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 25 time INFO of permanent FUTURE fall in output Evolution of consumption Output actually falls

26 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 26 - The role of expectations - Permanent, anticipated drop in output - Temporary, anticipated drop in output

27 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 27 k c k-ISOCLINE: NO CAPITAL GROWTH c-ISOCLINE: NO CONSUMPTION GROWTH k* 0 Temporary, anticipated fall in output for given k: PART I

28 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 28 k c NEW k-ISOCLINE: NO CAPITAL GROWTH c-ISOCLINE: NO CONSUMPTION GROWTH k* 0 Temporary, anticipated fall in output for given k: PART II

29 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 29 k c k-ISOCLINE: NO CAPITAL GROWTH c-ISOCLINE: NO CONSUMPTION GROWTH k* 0 Temporary, anticipated fall in output for given k: PART III

30 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 30 k c k-ISOCLINE: NO CAPITAL GROWTH c-ISOCLINE: NO CONSUMPTION GROWTH k* 0 Temporary, anticipated fall in output: Equilibrium response

31 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 31 k c k-ISOCLINE: NO CAPITAL GROWTH c-ISOCLINE: NO CONSUMPTION GROWTH k* 0 Temporary, anticipated fall in output: Equilibrium response

32 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 32 time INFO of FUTURE Temp fall in output END of Temp fall in output Evolution of the capital intensity START of FUTURE Temp fall in output

33 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 33 time Evolution of consumption INFO of FUTURE Temp fall in output END of Temp fall in output START of FUTURE Temp fall in output

34 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 34 3. Application of the Ramsey- Cass-Koopmans (RCK) model 3.1 Government spending, consumption, and interest rates 3.2 Bond versus tax financed government spending

35 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 35 Government expenditures and taxes Government intertemporal budget constraint

36 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 36 -- Suppose that households believe in government budget constraint -- The government cut taxes at time t -- But there is no indication that the government cuts expenditures -- WHAT HAPPENS TO DISCOUNTED FLOW OF TAXES?

37 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 37 Nothing, because: and the right-hand side of this equation has not changed.  Government will have to compensate current tax cut by tax increase sometime in the future.

38 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 38 Now let’s look at household intertemporal budget constraint: -- current tax cut does NOT affect this constraint at all as only the DISCOUNTERD PRESENT VALUE OF TAXES MATTERS -- and present value of taxes remains constant if expenditures do not change

39 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 39 -- TAX CUT DOES NOT CHANGE HH CONSUMPTION -- AS A RESULT IT DOES NOT CHANGE THE NATIONAL SAVINGS RATE: -- DOES NOT AFFECT: - INVESTMENT(!) - AND INTEREST RATES (!) -- HH SAVINGS INCREASES, BUT IS OFFSET BY AN INCREASE IN GOVERNMENT DEFICIT:

40 BGSE/UPF Macroeconomics, 2008-09 SLIDE SET 4 SLIDE 40 Hence, government cuts taxes  Has to issue debt (government bonds)  Government ensures that real interest rate on bond mimics market interest rate (before issue of new bonds)  Households buy these new bonds with their tax savings Hence,  Household use to buy government bonds what they “save” in current taxes

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