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Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
Chapter 11
Market-Clearing Models of the Business Cycle
Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 11-2
Study Three Market-Clearing Business Cycle Models
• Real Business Cycle Model
• Segmented Markets Model
• Keynesian Coordination Failure Model
Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 11-3
Real Business Cycle Model
• Business cycles are caused by fluctuations in total factor productivity.
• There is no role for the government in smoothing business cycles – cycles are just optimal responses to the technology shocks.
• Model fits the data well.
Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 11-4
Figure 11.1 Solow Residuals and GDP
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Figure 11.2 Effects of a Persistent Increase in Total Factor Productivity in the Real Business Cycle Model
Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 11-6
Figure 11.3 Average Labor Productivity with Total Factor Productivity Shocks
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Table 11.1 Data Versus Predictions of the Real Business Cycle Model with Productivity Shocks
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Figure 11.4 Procyclical Money Supply in the Real Business Cycle Model with Endogenous Money
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Equation 11.1
Cobb-Douglas production function, with labor share of output of 64%:
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Segmented Markets Model
• Business cycles can be caused in this model by unanticipated shocks to the money supply.
• Model exhibits a liquidity effect – the interest rate falls in the short run when the money supply increases.
• Monetary policy can only improve the functioning of the economy if the central bank has an informational advantage over the private sector.
• Fit to the data is not as good as with the real business cycle model.
Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 11-11
Figure 11.5 Effects of an Unanticipated Increase in the Money Supply in the Segmented Markets Model
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Table 11.2 Data Versus Predictions of the Segmented Markets Model with Monetary Shocks
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Figure 11.6 A Welfare-Improving Role for Active Monetary Policy
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Figure 11.7 Percentage Deviations from Trend in Money Supply and GDP
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Figure 11.8 Real and Nominal Interest Rates
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Figure 11.9 Relative Price of Energy
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Keynesian Coordination Failure Model
• Strategic complementarities imply that the aggregate production function has increasing returns to scale, and the labor demand function can be upward sloping.
• There can be multiple equilibria.• In an example, the model fits the data as well as the real
business cycle model.• GDP fluctuates in the model because of self-fulfilling
waves of optimism and pessimism.
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Figure 11.10 A Production Function with Increasing Returns to Scale
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Figure 11.11 Aggregate Labor Demand with Sufficient Increasing Returns to Scale
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Figure 11.12 The Labor Market in the Coordination Failure Model
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Figure 11.13 The Output Supply Curve in the Coordination Failure Model
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Figure 11.14 Multiple Equilibria in the Coordination Failure Model
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Table 11.3 Data Versus Predictions of the Coordination Failure Model
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Figure 11.15 Average Labor Productivity in the Keynesian Coordination Failure Model
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Figure 11.16 Procyclical Money Supply in the Coordination Failure Model
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Figure 11.17 Stabilizing Fiscal Policy in the Coordination Failure Model