1、CHAPTER 10Investment,Net Exports,and Interest Rates1Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Questions How are the determinants of investment different in a sticky-price than in a flexible-price model?How are the determinants of net exports different in a sticky-price than
2、 in a flexible-price model?How do changes in interest rates affect the equilibrium level of production and income in a sticky-price model?2Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Questions What is the“IS Curve”?What use is it?What determines the equilibrium level of real
3、GDP when the central banks policy is to keep the real interest rate constant?3Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Importance of Investment Changes in investment are the driving force behind the business cyclereductions in investment have played a powerful role in
4、every recession and depressionincreases in investment have spurred every boom4Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Importance of Investment Understanding the causes and consequences of changes in investment will help us to understand business cycles5Copyright 2002
5、by The McGraw-Hill Companies,Inc.All rights reserved.Figure 10.1-Investment as a Share of Real GDP,1970-20006Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Role of Investment In the flexible-price model,the real interest rate is a market-clearing priceit is pushed up or down
6、 by supply and demand to equate the flow of savings to the flow of investment7Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Role of Investment In the sticky-price model,the interest rate is not set in the loanable funds marketit is set directly by the central bank or indire
7、ctly by the combination of the stock of money and the liquidity preferences of households and businessesbusinesses match the quantity they produce to aggregate demand automatically creates balance in the financial market8Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Fluctuation
8、s in Investment Fluctuations in investment have two sourceschanges in the real interest rateshifts in investors expectations about future growth,profits,and riskrI-IIr09Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Investment and theInterest Rate The opportunity cost of an inve
9、stment project is the real interest ratethe higher the interest rate,the lower the number and value of investment projects that will return more than their current cost and the lower the level of investment spending10Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Investment and
10、theInterest Rate The interest rate that is relevant for determining investment spending is a long-term interest ratewhen considering an investment project,a manager must compare the potential profits of the project to the opportunity to make money from a long-term commitment of the funds elsewhere11
11、Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Investment and theInterest Rate Long-term and short-term interest rates are different and do not always move in steplong-term interest rates are usually higher than short-term interest ratesthe term premium is the premium in the int
12、erest rate that the market charges on long-term loans vis-vis short term loans12Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 10.2-Bond Yield Curves13Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Investment and theInterest Rate The interest rate tha
13、t is relevant for investment spending decisions is the real interest rate14Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 10.3-Gaps between Real and Nominal Interest Rates15Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Investment and theInterest Rate
14、 The interest rate that a firm faces is the interest rate charged to risky borrowersthe premium that lenders charge for loans to companies rather than to safe government borrowers is called the risk premium16Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 10.4-The Risk Pre
15、mium:Safe and Risky Interest Rates17Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Investment and theInterest Rate In the investment function the relevant interest rate(r)is the long-term,real,risky interest rate As r rises,the level of investment spending will declinerI-IIr018C
16、opyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 10.5-Investment as a Decreasing Function of the Long-Term,Real,Risky Interest Rate19Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Exports and Autonomous Spending Gross exports depend onforeign total incom
17、es(Yf)the real exchange rate()the real exchange rate depends on the domestic real interest rate(r)Like investment,gross exports are affected by changes in the real interest rate20Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Exports and Autonomous Spending A higher interest rat
18、e reduces autonomous spending(A)by reducing exports(Xr r)as well as by reducing investment(Ir r)rX-)rXXY(XGr)I-I(CArfrffr00021Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Exports and theInterest Rate A higher real interest rate reduces gross exportsinvesting in the home countr
19、y is more attractive foreign exchange speculators shift their portfolio holdings to include more home currency-denominated assetsthe exchange rate falls exports are more expensive to foreigners22Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 10.6-From the Real Interest Ra
20、te to the Change in Exports23Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Autonomous Spending and the Real Interest Rate A one-percentage-point increase in the real interest rate(r)reduces autonomous spending by(Ir+Xr)r)X(I-)rXXY(XGICArrfrff00024Copyright 2002 by The McGraw-Hi
21、ll Companies,Inc.All rights reserved.Figure 10.7-Autonomous Spending as a Function of the Real Interest Rate25Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Investment-Saving(IS)Curve Because a change in the real interest rate changes autonomous spending,it will change the e
22、quilibrium level of real GDPthe effect will be equal to the interest sensitivity of autonomous spending (Ir+Xr)times the multiplier26Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Investment-Saving(IS)Curve The relationship between the level of the real interest rate and the
23、 equilibrium level of real GDP is the IS curveIS stands for“Investment-Saving”27Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Investment-Saving(IS)Curve To find a point on the IS curve:pick a value for the real interest rate and determine the level of autonomous spending at
24、 that interest rateuse the income-expenditure diagram to determine the equilibrium level of real GDP Repeat this procedure to find other points on the IS curve28Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 10.8-The IS Curve29Copyright 2002 by The McGraw-Hill Companies,I
25、nc.All rights reserved.The IS Curve Define baseline autonomous spending(A0)to include the determinants of autonomous spending that do not depend on the real interest rater)X(I-)rXXY(XGICArrfrff000)rXXY(XGICAfrff0000r)X(I-AArr030Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The
26、IS Curve Recall that real GDP is equal to autonomous spending(A)divided by(1-MPE)Substituting,we getMPE-1r)X(I-AYrr0r)IM-t)-(1(C-1)X(I-)IM-t)-(1(C-1)rXXY(XGICYyyrryyfrff00031Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The IS Curve The term on the left is the horizontal interc
27、ept of the IS curvethe value of equilibrium real GDP if the real interest rate was equal to zero The term on the right is the slope of the IS curvethe responsiveness of real GDP to changes in the interest rater)IM-t)-(1(C-1)X(I-)IM-t)-(1(C-1)rXXY(XGICYyyrryyfrff00032Copyright 2002 by The McGraw-Hill
28、 Companies,Inc.All rights reserved.Figure 10.9-The IS Curve33Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Slope of the IS Curve The first term is the multiplier (1/1-MPE)The second term shows how large a change in investment or exports is generated by a change in the real
29、interest rate)X(I)IM-t)-(1(C-11slope ISrryy34Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The Position of the IS Curve The position of the IS curve depends on the baseline level of autonomous spending times the multiplier Changes in any of these determinants will shift the pos
30、ition of the IS curve)IM-t)-(1(C-1)rXXY(XGICMPE-1Ayyfrff000035Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 10.10-A Change in Fiscal Policy and the Position of the IS Curve36Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Changes in the Interest Rate
31、To calculate how much a change in the interest rate will shift the equilibrium level of real GDP,you need to know four things:the marginal propensity to spend(MPE)the interest sensitivity of investment(Ir)the interest sensitivity of the exchange rate(r)the exchange rate sensitivity of exports(X)37Co
32、pyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Moving to the IS Curve If the economy is above the IS curve:real GDP planned expenditure inventories rise firms cut production employment,real GDP,and national income fall If the economy is below the IS curve:planned expenditure real
33、GDP inventories fall firms expand production employment,real GDP,and national income rise38Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 10.11-Off of the IS Curve39Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Shifting the IS Curve Two kinds of gove
34、rnment policies directly affect the position of the IS curvea shift in tax rates changes both the position and the slope of the IS curvea change in the level of government purchases changes the position of the IS curve40Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Shifting the
35、 IS Curve Example-an increase in government spendingG=$200 billionMPE=0.5Ir=$0.11Xr=$0.015r=4%rMPE-1XI-MPE-1AYrr0trillion$0.400.5-1$0.015$0.11-0.5-10.2$Y41Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Moving along the IS Curve Changes in the real interest rate will move the eco
36、nomy along the IS curvea higher real interest rate will produce a lower level of aggregate demand and equilibrium real GDPa lower real interest rate will produce a higher level of aggregate demand and equilibrium real GDP42Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Moving al
37、ong the IS Curve Example-cutting interest rates to boost equilibrium real GDP by$500 billionMPE=0.5Ir=$0.11X=5%r=$0.003trillion$0.250.5-1$0.003)5($0.11MPE-1XIslope ISrr To boost real GDP by$500 billion,the real interest rate must fall by 2 percentage points43Copyright 2002 by The McGraw-Hill Compani
38、es,Inc.All rights reserved.Figure 10.12-Cutting Target Interest Rates and Raising Real GDP44Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Changing Interest Rates The Federal Reserve controls interest rates through open market operationsbuying and selling short-term government b
39、onds for cash45Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Open Market Operations When the Federal Reserve buys government bondsthe total cash in the hands of the public and bank reserves increaseshouseholds,businesses,and banks find that they are holding more money than they
40、 would like use the money to buy assets(such as bonds)bond prices rise and interest rates fall46Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Open Market Operations When the Federal Reserve sells government bondsthe total cash in the hands of the public and bank reserves decrea
41、seshouseholds,businesses,and banks find that they are holding less money than they would like try to get money by selling assets(such as bonds)bond prices fall and interest rates rise47Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 10.13-Open Market Operations48Copyright
42、2002 by The McGraw-Hill Companies,Inc.All rights reserved.Difficulties Our knowledge of the structure of the economy is imperfect Even when policies have their expected effects,these effects do not necessarily arrive on schedule The interest rates the Federal Reserve can control are short-term,nomin
43、al,safe interest rates49Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The IS Curve of the 1960s In the 1960s,there was a rightward shift in the IS curveincreased optimism on the part of businessesa cut in income taxesextra government expenditures(Vietnam War)50Copyright 2002 by
44、 The McGraw-Hill Companies,Inc.All rights reserved.Figure 10.14-Real GDP and the Interest Rate,1960-199951Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The IS Curve of the 1960s In the late 1960s,there was a movement down along the IS curve as real interest rates declinedthe dr
45、op in real interest rates was caused(in part)by an increase in inflation52Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 10.15-Shifting Out and Moving along the IS Curve,1960s53Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The IS Curve of theLate 197
46、0s From 1977 to 1979,the U.S.economy moved down and to the right of the IS curvethe expansion toward potential output was accompanied by high and rising inflation In 1979,the Federal Reserve began fighting inflationraised real interest rates from 1979 to 198254Copyright 2002 by The McGraw-Hill Compa
47、nies,Inc.All rights reserved.Figure 10.16-Moving along the IS Curve,Late 1970s55Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The IS Curve of the 1980s The 1980s began with a large outward shift in the IS curvean increase in military spendinga cut in income taxesan increase in
48、investor optimism The Federal Reserve responded to this shift by raising real interest rates56Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 10.17-Shifting the IS Curve Out,Early 1980s57Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The IS Curve of th
49、e 1980s As inflation remained low through the mid-and late-1980s,Federal Reserve policymakers gained confidencebegan reducing real interest rates causing a movement along the IS curve58Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.Figure 10.18-Moving along the IS Curve,Late 198
50、0s59Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.The IS Curve of the 1990s In the second half of 1990,there was a leftward shift of the IS curvea drop in investment as firms worried about the price of oil after the Iraqi invasion of Kuwait The Federal Reserve took no steps to
