The Economic Models - Coursework Example

IS-LM model describes a framework used by economic policy makers to analyze implications of alternative policies used in solving economic problems such as how employment can be regulated of how inflation can be fought. It is representative of the workings of the economy as two curves’ interaction. On one hand is the IS curve, which shows different combinations of real rates of interest (r) and real out-put (Y) result into goods market equilibrium while on the other hand is the LM curve, which shows different combinations of real rates of interest and real output resulting into money market equilibrium. In essence, the IS-LM model is a macro-economic tool demonstrating the relationship between interest rates and real out-put in the goods and services market and the money market. It is a combination of goods market and money-market equilibriums. The aggregate model describes general equilibrium situation in macro-economy. IS-LM model is based on assumption of fixed price level. This implies that general price level will not abruptly adjust when economic conditions alter. Suppose there is an increase in demand. Given supply, the increase in demand should produce an increase in price level (and in quantity exchanged within market). The period within which it stays unaltered is short run. Time series The time series traits of variables using three tests reveal most of variables are stationary with intercept. This captures non-zero mean under alternative hypothesis. Nonetheless, many variables are non-stationary with constant and deterministic time trends. This captures deterministic trends under this alternative. The variables may therefore be regarded as stationary and does not require differencing. The IS Curve is representative of the equilibrium points in goods market, that is, the combinations of r and Y for which investments (I) are equal to savings (S). It is important to remember that investment is negatively related to real interest rate and is non-dependent on level of real output/income. Saving has a positive relationship to real interest rate and further increases with income. For shifts in IS curve, The IS line will shift to the right when:  Expected future income increases: S  Wealth increases: S  Taxes decrease: S  Government expenditure increases: S  Net Exports increase: NX  MPK increases: I  Taxes on capital decrease: I The IS line will shift to the left when:  Expected future income decreases: S  Wealth decreases: S  Taxes increase: S  Government expenditure decreases: S  Net Exports decrease: NX  MPK decreases: I  Taxes on capital increase: I The LM Curve The LM curve represents the equilibrium points in the money market: the combinations of r and Y for which money demand (Md) is equal to money supply (M). Remember that: Money demand is negatively related to the real interest rate and depends on the level of real output / income (because we use money for transaction purposes.) Money supply is determined by the Fed, independently of real interest rate and real income. (Plotting that: see Money market diagram ) The LM curve will then be upward sloping. Shifts in the LM curve: The LM line shifts right if:  Money supply increases: M.  Prices decrease: Md.  Inflationary expectations increase: Md. The LM line shifts left if:  Money supply decreases: M.  Prices increase: Md.  Inflationary expectations decrease: Md. REGRESSION OUTPUT regress netborowwings m1 Source | SS df MS Number of obs = 108 -------------+------------------------------ F (2, 105) = 1289.265 Model | 8.912E11 2 4.456E11 Prob > F = 0.0000 Residual | 3.629E10 105 3.456E8 R-squared = 0.961 -------------+------------------------------ Adj R-squared = 0.960 Total | 9.275E11 107 Root MSE = 7.1482 ------------------------------------------------------------------------------ gdp | Coef. Std. Err. t P>|t| [95% Conf. Interval] ---------------+------------------------------------------------------------- netborowwings | .773 .206 3.749 0.000 .364 1.182 m1 | .272 .006 42.052 0.000 .259 .285 cons | 116644.909 3201.346 36.436 0.000 110297.233 122992.586 18.62364 ------------------------------------------------------------------------------ Anova Table Sourcea | SSb dfc MSd -------------+------------------------------ Model | 8.912E11 2 4.456E11 Residual | 3.629E10 105 3.456E8 -------------+------------------------------ Total | 9.275E11 107 regress netborowwings m1 Source | SS df MS Number of obs = 108 -------------+------------------------------ F (2, 106) = 110.538 Model | 1000.890 2 500.445 Prob > F = 0.0000 Residual | 479.898 106 4.527 R-squared = 0.676 -------------+------------------------------ Adj R-squared = 0.670 Total | 1480.788 108 504.972 Root MSE = 7.1482 ----------------------------------------------------------------------------- rate | Coef. Std. Err. t P>|t| [95% Conf. Interval] ---------------+------------------------------------------------------------- netborowwings | 4.746E-5 .000 2.019 0.046 .000 0.000 m1 |-7.453E-6 .000 -10.105 0.000 .000 0.000 cons | 9.941 .365 27.263 0.000 9.218 10.664 ----------------------------------------------------------------------------- Anova Table Sourcea | SSb dfc MSd -------------+------------------------------ Model | 1000.890 2 500.445 Residual | 479.898 106 4.527 -------------+------------------------------ Total | 1480.788 108 504.972 REGRESSION 2 OUTPUT regress netborowwingsreal m1real Source | SS df MS Number of obs = 108 -------------+------------------------------ F (2, 105) = 1289.265 Model | 8.912E11 2 4.456E11 Prob > F = 0.0000 Residual | 3.629E10 105 3.456E8 R-squared = 0.961 -------------+------------------------------ Adj R-squared = 0.960 Total | 9.275E11 107 Root MSE = 7.1482 ------------------------------------------------------------------------------ gdp | Coef. Std. Err. t P>|t| [95% Conf. Interval] ---------------+------------------------------------------------------------- netborowwings | .773 .206 3.749 0.000 .364 1.182 m1 | .272 .006 42.052 0.000 .259 .285 cons | 116644.909 3201.346 36.436 0.000 110297.233 122992.586 18.62364 ------------------------------------------------------------------------------ Anova Table Sourcea | SSb dfc MSd -------------+------------------------------ Model | 8.912E11 2 4.456E11 Residual | 3.629E10 105 3.456E8 -------------+------------------------------ Total | 9.275E11 107 regress netborowwings m1 Source | SS df MS Number of obs = 108 -------------+------------------------------ F (2, 106) = 110.538 Model | 1000.890 2 500.445 Prob > F = 0.0000 Residual | 479.898 106 4.527 R-squared = 0.676 -------------+------------------------------ Adj R-squared = 0.670 Total | 1480.788 108 504.972 Root MSE = 7.1482 ----------------------------------------------------------------------------- rate | Coef. Std. Err. t P>|t| [95% Conf. Interval] ---------------+------------------------------------------------------------- netborowwings | 4.746E-5 .000 2.019 0.046 .000 0.000 m1 |-7.453E-6 .000 -10.105 0.000 .000 0.000 cons | 9.941 .365 27.263 0.000 9.218 10.664 ----------------------------------------------------------------------------- regress netborowwings m1 Source | SS df MS Number of obs = 108 -------------+------------------------------ F (2, 106) = 110.538 Model | 1000.890 2 500.445 Prob > F = 0.0000 Residual | 479.898 106 4.527 R-squared = 0.676 -------------+------------------------------ Adj R-squared = 0.670 Total | 1480.788 108 504.972 Root MSE = 7.1482 ----------------------------------------------------------------------------- rate | Coef. Std. Err. t P>|t| [95% Conf. Interval] ---------------+------------------------------------------------------------- netborowwings | 4.746E-5 .000 2.019 0.046 .000 0.000 m1 |-7.453E-6 .000 -10.105 0.000 .000 0.000 cons | 9.941 .365 27.263 0.000 9.218 10.664 ----------------------------------------------------------------------------- Anova Table Sourcea | SSb dfc MSd -------------+------------------------------ Model | 1000.890 2 500.445 Residual | 479.898 106 4.527 -------------+------------------------------ Total | 1480.788 108 504.972 Notably, there is no difference when real and nominal values are used in analysis. Various scholars have argued that the European sovereign debt crisis is traceable to the nineties whereby the 15 member states then, deliberated on the benefits of establishment of a common regional currency (Sgherri & Zoli, 2009). Despite agreeing on certain debt targets, there are many instances where member states out-rightly failed to adhere to the ceiling limits. Despite this obvious violation, no financial sanctions were imposed on the member states and as such no evident mechanisms were present to discourage member states from running into excessive debts. Ultimately, the poor economic management in respective nations was exposed by the unfolding events. With the soaring bond yields, the respective nations found themselves ill-prepared to deal with the massive debts accrued (Schuknecht, Hagen, & Wolswijk, 2008). Government budgets as well as finances deteriorated drastically as the global financial crisis took toll. Europe like many other regions was not spared. Various nations were forced to make use of public expenditure to offer stability as well as stimulus packages. In a similar response, Eurozone countries met their own constituent of the financial crisis as a result of the huge borrowing acts, asset bubbles, as well as the high end lifestyle. According to Schuknecht, Hagen, & Wolswijk (2008) ease of access to loan facilities further aggravated the situation give that it resulted into overreliance on externally sources credit facilities as a means of funding their domestic debts. In addition, the interdependence, both financially and commercially developed between Europe and foreign nations increased its susceptibility to economic volatility as a result of domino effect in cases where other parts of the globe are faced with financial challenges (De Broeck & Anastasia, 2011). Back in 1997, having recognized the inherent crisis risk as a result of the common currency, the Europe union set up the Stability and Growth Pact to establish a budgetary deficit ceiling, set at 3% of GDP as well as an external debt ceiling, set at 60% of GDP. This measure was aimed at ensuring that the member states engaged in disciplined budgeting as a means of diminishing systemic risks faced and in the process encourage monetary stability. Additionally, the pact called for enhanced monetary and economic policy coordination in order to lower national sovereignty degree as well as provide a clout for various member states. However, the crisis revealed some level of incompleteness of the policies put in place. According to Haugh, Ollivaud &Turner (2009) there was a clear indication that regulation based policy framework resulted into an excessive procedural deficit and additionally, the Stability and Growth Pact was not sufficient to eliminate or minimize a debt crisis regardless of the emphasis it placed on maintaining public sector deficit at low levels and forward looking budget strengthening. Additionally, after occurrence of the crisis, it agitated the financial markets making it obvious that the European Monetary Union lacked sufficient policies for management and resolution of monetary crises (Copeland & Jones, 2001). Despite the belated ad hoc agreement to bail out and hence stabilize Greece, through creation of the European Financial Stability Facility which somehow calmed the markets, the measure still lacks the threshold to keep minimal or eliminate future debt crises. In essence, an insufficient policy framework was one of the key contributors to the development of the European sovereign debt crisis. In general, the key contributors to the crisis affecting various European nations were ineffective frameworks to monitor government spending deficits within the Eurozone as well as inadequate enforcement regulations. However, in some cases, for instance Spain, the problem was a product of recession rather than irresponsible budgeting. The problem was therefore a result of combination of both irresponsible behavior and bad luck. However, it was worsened by the inability of respective countries with the Eurozone to use their independent monetary policies to deal with the problem. According to Goldman (2009) if the nations had their independent currencies, they would have responded by adjusting the currency value to offset the negative impacts either by elevating of taxes or reducing spending to deal with the deficit. This option was unfortunately not available. Read More