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Fundamental Analysis

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Keynesian Analysis. Prices are fixed in the short run ... Classical Analysis ... Classical Analysis. Suppose that, initially trade was balances at the global ... – PowerPoint PPT presentation

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Title: Fundamental Analysis


1
Fundamental Analysis
  • Classical vs. Keynesian

2
Similarities
  • Both the classical approach and the Keynesian
    approach are macro models and, hence, examine the
    interaction between asset, money, and labor
    markets.
  • Both models depend on the fundamentals (GDP,
    price levels, etc)

3
Differences
  • Classical Analysis
  • Keynesian Analysis

4
Differences
  • Classical Analysis
  • Prices are flexible, markets clear
  • Money is Neutral
  • Emphasis on Relative Prices
  • Asset markets play a minor role
  • Emphasis on Technology rather that policy (Supply
    side)
  • Keynesian Analysis

5
Differences
  • Classical Analysis
  • Prices are flexible, markets clear
  • Money is Neutral
  • Emphasis on Relative Prices
  • Asset markets play a minor role
  • Emphasis on Technology rather that policy (Supply
    side)
  • Keynesian Analysis
  • Prices are fixed in the short run
  • Money can influence output in the short run
    (Phillips curve)
  • Asset markets play a pivotal role
  • Emphasis on policy rather than technology (demand
    side)

6
Example The Productivity Slowdown
  • During the Mid 1970s, productivity growth
    dropped from its long run average of 1.5 to
    -.27.

7
Classical Analysis
  • How would this drop in productivity influence
    capital markets?

8
Classical Analysis
  • How would this drop in productivity influence
    capital markets?
  • Investment demand would most likely drop as
    firms face lower profit expectations.

9
Classical Analysis
  • How would this drop in productivity influence
    capital markets?
  • Investment demand would most likely drop as
    firms face lower profit expectations.
  • Lower productivity ,means shrinking personal
    income. What happens to personal savings?

10
Classical Analysis
  • How would this drop in productivity influence
    capital markets?
  • Investment demand would most likely drop as
    firms face lower profit expectations.
  • Lower productivity ,means shrinking personal
    income. What happens to personal savings?
  • Temporary drop in income tends to lower savings
  • Permanent declines in income tend to lower
    consumption

11
Classical Analysis
  • Recall that at a (fixed) global interest rate,
    the current account balance is the difference
    between domestic savings and domestic borrowing
    (public and private)

12
Classical Analysis
  • Suppose that, initially trade was balances at the
    global interest rate of 10.

13
Classical Analysis
  • Suppose that, initially trade was balances at the
    global interest rate of 10.
  • A drop in investment demand in a closed economy
    would lower the domestic interest rate
  • In an open economy, the economy runs a trade
    surplus

14
Classical Analysis
  • How would this drop in productivity influence
    money markets?

15
Classical Analysis
  • How would this drop in productivity influence
    money markets?
  • Recall, the demand for money is equal to
  • M kPY
  • A drop in income (Y) without a corresponding drop
    in money supply creates rising prices

16
Classical Analysis
  • What happens to real/nominal exchange rates?

17
Classical Analysis
  • What happens to real/nominal exchange rates?
  • Recall, PeP (PPP)
  • Assuming no change in the foreign price level, a
    rise in the domestic price level causes an equal
    rise (depreciation) in the nominal exchange rate
  • PPP implies a constant real exchange rate

18
Summary
  • Current account improves
  • No change in domestic (real) interest rates
  • A rise in the domestic price level
  • A depreciation in the nominal exchange rate
  • A constant real exchange rate

19
Keynesian Analysis
  • As before, begin in capital markets.
  • Investment drops while savings remains constant
  • With excess demand for credit, interest rates
    fall and income falls (lower income lowers
    savings) IS shifts left

20
Keynesian Analysis
  • The shift in IS reflects two opposing forces in
    the balance of payments

21
Keynesian Analysis
  • Lower income improves the current account, but
    lower interest rates worsen the capital account

22
Keynesian Analysis
  • With a high rate of capital mobility, the
    interest rate effect dominates and a BOP deficit
    results
  • A BOP deficit forces a currency depreciation

23
Keynesian Analysis
  • We know that the long run impact is a currency
    depreciation
  • However, lower domestic interest rates imply a
    future currency appreciation (Interest Parity)

24
Keynesian Analysis
  • We know that the long run impact is a currency
    depreciation
  • However, lower domestic interest rates imply a
    future currency appreciation (Interest Parity)
  • Therefore, the initial currency depreciation must
    be larger than the long run result (overshooting)

25
Summary
  • Current account improves (by more in the short
    run due to the sharp depreciation)
  • Domestic real interest rates fall
  • No change in domestic prices
  • A sharp depreciation (both real and nominal)
    followed by an appreciation

26
Savings 1970-1980

27
Consumption 1970-1980

28
Investment 1970-1980

29
Interest Rates 1970-1980

30
Current Account 1970-1980

31
GDP 1970-1980

32
Prices 1970-1980

33
Exchange Rate 1970-1980

34
Example Government Deficits
  • Currently, the US deficit is around 500B dollars
    (projected to be 550B in 2004)

35
Classical Analysis
  • Suppose that the government runs a 500B deficit

36
Classical Analysis
  • Suppose that the government runs a 500B deficit
  • A rise in demand for loanable funds increases the
    interest rate

37
Classical Analysis
  • Suppose that the government runs a 500B deficit
  • However, with higher anticipated future taxes,
    households increase their savings

38
Classical Analysis
  • Suppose that the government runs a 500B deficit
  • These two effects offset each other, leaving
    savings, investment, and the interest rate
    unchanged.

39
Summary
  • The current account is unaffected as are domestic
    interest rates
  • Assuming that the deficit has no effect on GDP,
    money markets are unaffected leaving prices and
    exchange rates (real and nominal) unchanged.

40
Keynesian Analysis
  • Suppose that the government deficit increases.
  • The long run impact should be zero.

41
Keynesian Analysis
  • However, in the short run, the IS curve shifts
    right output increases and interest rates rise.
  • In this example, the worsening of the trade
    deficit is more than offset by higher interest
    rates attracting foreign capital. A balance of
    payments surplus is created.

42
Summary
  • In the short run, a BOP surplus is created
    causing a currency appreciation
  • However, interest parity suggests that higher
    domestic interest rates imply a currency
    depreciation
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