Core Macroeconomics, Hilary Term 2014

Week 4: A Keynesian closed-economy model

This week's focus is the closed economy model that Carlin & Soskice present in Chapter 3, which is built up from three components: an IS-LM demand side; a supply side derived from the imperfectly competitive labour market model; and a monetary policy rule for the central bank. We will use the model to discuss the economy's response to various shocks, and the implementation of monetary policy. We will also look in a bit more detail at how monetary policy works. We are probably getting a bit out of step with lectures from this point, following what I think is a more natural way to organise the material.

We will not discuss in any detail, this week, the New Keynesian effort to build models featuring rational expectations and optimising decisions by households and firms ("microfoundations"), in which aggregate demand, more particularly money, nonetheless has a persistent impact on the economy. We will discuss this topic later in term.


The primary reading for this week is C&S Chapters 2 (AS/AD), 3 (the 3-eqn model), and 5 (monetary policy).

The following readings are relevant for the essay topics.
On the transmission mechanism for monetary policy, as a starting point see the Autumn 1995 (vol. 9, no. 4) special issue of the Journal of Economic Perspectives, especially the article by Ben Bernanke and Mark Gertler, "Inside the Black Box: The Credit Channel of Monetary Policy Transmission" (pp. 27-48).

Also useful is Krugman, P., K. Dominguez, and K. Rogoff, "It's Baaack: Japan's Slump and the Return of the Liqudity Trap", Brookings Papers on Economic Activity, vol. 1998 no. 2, pp. 137-205.

On central bank responses to inflation, see:
Ball, L. "What Determines the Sacrifce Ratio?" available in working paper version on line or published in Monetary Policy N.G. Mankiw, ed. (U. of Chicago Press, 1994).
Temple, J. "Openness, Inflation, and the Phillips Curve: A Puzzle," Journal of Money, Credit and Banking vol. 34, no. 2 (May 2002), pp. 450-68.
Caporale, B. and T. Caporale, "Political Regimes and the Cost of Disinflation" JMCB, vol. 40 no. 7 (Oct. 2008), pp. 1541-54.


Please write an essay on one of the following topics. Whichever you choose, you should make an effort to incorporate evidence - which might be one or more case studies of particular episodes, or might be more systematic, quantitative data - in addition to an exposition of the theoretical issues.

1. What determines the degree to which the monetary authorities should respond to a rise in inflation above the target rate?

2. How important is the "credit channel" in transmitting changes in monetary policy to the economy?

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