Transcript Econ 309 July 20th

Econ 309: Savings and Social
Security
Keynesianism: The IS-LM Model
• Keynes wrote The General Theory of Employment,
Interest, and Money in 1936
• The IS-LM model was developed by John Hicks for
the Econometric Conference at Oxford,
September, 1936
• One of many attempts to make the General
Theory more accessible, formal
– Hicks later became disillusioned with IS-LM and was
ambivalent about receiving the Nobel Prize for it in
1972
Keynesianism: The IS-LM Model
P
LM
Ymax
IS2
IS1
• IS curve: Y = C(Y-T) + I(r) + G
• LM curve: M/P = L(r, Y)
Q
Keynesianism: IS-LM curve
• IS curve: Y = C(Y-T) + I(r) + G
– Assumption: Consumption is a functional of
“disposable income” (marginal propensity to
consume) and nothing else
– Assumption: Investment is a function of interest rates
(though it can be exogenously shifted by “animal
spirits”)
– Government spending does not affect either
investment or consumption directly
• LM curve: M/P = L(r, Y)
– People have a liquidity preference, demanding more
money and less
Keynesianism: The IS-LM Model
• Implications for policy
– Fiscal policy: An increase in government spending
pushes the IS curve outward and raises GDP (if Y<Ymax)
– Monetary policy: An increase in the money supply
pushes LM outward and raises GDP
• “Crowding out”: expansionary fiscal policy drives
up interest rates and causes a fall in investment
that partially offsets its effects
• Question: What if Y=Ymax?
Savings in Keynes
• IS curve: Y = C(Y-T) + I(r) + G
– Consumption, C, is a function of disposable
income, Y-T
– Savings is the residual of disposal income after
consumption, i.e. S = Y – T - C(Y-T)
– Savings behavior does not involve any thought for
the future!
• What is the effect of a fall in the savings rate?
C rises, and GDP rises
Basic Monetarism
• The equation of exchange: MV=PT, where
–
–
–
–
M = money supply
V = velocity of money
P = price level
T = volume of real transactions (i.e., real GDP)
• If V is constant (a major assumption), then:
– Monetary policy (interpreted as raising M) can increase
real GDP, but might only increase inflation
– No obvious interpretation for fiscal policy
• “The triumph of monetarism”: in recent years (until
2009), economists have usually advocated monetary
policy rather than fiscal policy
The Solow Model of Long-Run Growth
y=f(k)
Y
(n+d)k
sy
K
• Yt = f(Kt), dY/dK > 0, d2Y/dK2 < 0
• Kt+1 = (1-n-d)Kt + sYt
Savings in Solow
• As in the standard Keynesian model, savings is
exogenously fixed
• What is the effect of a fall in the savings rate?
The long-run growth rate falls
• IS-LM plus Solow: Savings are bad in the
“short run,” good in the “long run”???
Digression: Ethics and discount rates
• Economists assume that people “discount the future”
• Revealed preference says:
– The future really is worth less than the present, if people
systematically treat it so
– It is not irrational to discount the future
– Ordinary people find this view hard to accept
• Exponential vs. hyperbolic discounting:
– If discounting is exponential, people’s behavior is “timeconsistent”
– If discounting is hyperbolic, people have time-inconsistent
preferences
• Given economic growth, is it clear that people really do
discount the future?
Gokhale: Social Security and Savings
• Gokhale’s explanations for the decline in the
savings rate:
1. Government redistribution of income from
younger cohorts to older cohorts
2. A rise in the consumption propensities of older
cohorts due to annuitization of incomes
The decline in US savings rates
• (go to Gokhale, p. 7/320)
• Between 1950 and 1995, savings rate dropped
from 11.5% to 3.4%
• Continued falling after that, to 0% or less,
before rising sharply in 2008/09
US savings rates, 2000-2009
http://www.bea.gov/briefrm/saving.htm
Net national savings rate
St
Ct Gt
 1 
Yt
Yt Yt
Savings rate equals one minus consumption rate
minus government spending rate