"Do we really want to commit ourselves ex ante for reasons of pure theory
to a model in which:
1) each 1% change in expected real GDP next period
induces a corresponding 1% change in real GDP this period
2) each 1% point change in the one period ahead real interest rate induces
a corresponding change in the opposite direction
equal to the inverse of the average and representative household's
coefficient of relative risk aversion
3)the trend growth of output is equal to the average and representative household's
pure rate of time discount divided by
its coefficient of relative risk aversion;
"The answer is: NO!!"
shlock NK's :
"throw (3) over the side immediately:
"we suppress the constant term"."
"(1) is embarrassing, in that it means that when the main equation system
is iterated forward it forces aggregate demand to depend
only on the real consol interest rate
(with shorter-term interest rates affecting aggregate demand
only to the extent that they affect the console rate).
"(1) and (2) together impose a rigid proportionality
--depending on the average and representative household's
coefficient of relative risk aversion--
between
expected business-cycle movements in output
and in the consol rate which usually get immediately
thrown over the side
by bringing in (unmodeled) fluctuations in business investment and net exports."
The bottom line? We have a new Keynesian IS curve that is "in contrast to the traditional IS curve… derived from microeconomic foundations".
"But we don't believe what the NK IS curve's derivation tells us."
" We don't believe what it tells us about:
(a) which interest rate aggregate demand depends on
(b) the quantitative relationship between expected future output and current output
(c) the relationship between the responsiveness of aggregate demand
and the average representative household's coefficient of risk aversion
or
(d) the dependence of the trend growth rate of the economy on the average representative household's pure rate of time preference and coefficient of relative risk aversion."
"What do we keep from the derivation? Two things.
First, that it "implies an inverse relationship between" the real interest rate (not the real consol rate, mind you) and aggregate demand
and
second, that for each Old Keynesian conclusion there is a set of (almost surely wrong) microfoundations that gets you into the neighborhood of that conclusion"
----------------------------
brad goes socratic
"Why keep this implication of the microfoundations while rejecting the others?
Why is there an inverse relationship between the real interest rate and aggregate demand? "
" The answers I get tend to be:
Because if the average representative household is following an optimal consumption plan over time, it must plan for its marginal utility of consumption to fall at a pace. equal to the difference between the real interest rate and the pure rate of time discount, which means it must plan for consumption to rise by an amount proportional to the difference between the real interest rate and the pure rate of time discount. Thus when the interest rate is high, the average representative household must be planning to raise its consumption rapidly, which means its spending must be low. "" if I am mean, I ask:
"So if the interest rate goes up, people think that they are making too much utility this period and that their marginal utility of consumption is too low, and so they decide to make themselves poorer and less happy today by not working?".
"schloch NKs often seem confused "
----------------------------------------------------------
"The right way is to say:
- that production is demand determined,
- that production is equal to income,
- that households today plan to take their income and spend it on (a) consumption goods and (b) adding to their stock of financial assets,
- that planned financial asset accumulations are a positive function of both the real interest rate r and the level of income Y,
- that if the interest rate r goes up everybody tries to cut back on their consumption spending in order to boost their holdings of financial assets--and so production and incomes fall until Y is low enough that there is no desired net accumulation of extra financial assets which are not there to be accumulated."
that drives the economy toward S-I=0 "
and
"that creates a downward-sloping relationship between r and Y
anywhere and anywhen
that economy-wide net financial asset accumulation
depends positively on Y and r."
"It is, I think much less powerful when presented as the mysterious dictates of necessity: that Y and C "must" be equal and that the Euler equation "must" be satisfied"
"But in what I regard as the relatively weak and confusing way to teach it,
it has microfoundations
"microfoundations that happen not to describe the world we live in terribly well"
