Why do I feel bad for the Spaniards, but not the Greeks?

[Zoetstofzoetje]

you forgot ´retard´ by the way.

[KrazyHorse]

Please, do tell what conference you attended and what capacity you were there in. Also, what is your PhD in, and what do you do for a living?

[giblets]

I don't understand the traditional IS model. It seems to me as though the slope of the IS curve is arbitrary (depending on circumstances). I particularly don't understand the classical IR mechanism's explanation for why the IS curve slopes downward. I wish somebody could explain it to me in a way which doesn't blatantly contradict ratex and an inflation targeting cb, and which doesn't require more than a page of math.

I'm serious about this. Nobody has yet managed to do so, despite my most sincere attempts to understand this.

I'm not sure what the problem is...? A lower interest rate makes investment cheaper, so firms want to do more of it. As the interest rate falls, people decide to buy more stuff in the present so output increases.

[KrazyHorse]

That is pretty much the extent of the explanation I've found, and if you think about it for more than 5 seconds you should realize why it's idiotic, not to mention blatantly contradictory to empirical evidence.

[Kuciwalker]

Why did the (real) interest rate fall? Remember that it is the interest rate that equlibriates lending and borrowing.

e.g. if interest rates fell because economic growth was expected to be poor in the future, that might not spur investment.

[giblets]

If you take rational expectations into account, it wouldn't make sense to assume that the IS curve isn't affected by monetary policy which is what macroeconomics textbooks seem to do.

[Kuciwalker]

I think you are subtly conflating rational expectations with the idea that the Fed can't do anything unanticipated (a peculiar sort of anti-free will argument!)

[KrazyHorse]

If you take rational expectations into account, it wouldn't make sense to assume that the IS curve isn't affected by monetary policy which is what macroeconomics textbooks seem to do.

Argh. No. No, no, no.

The CB is not perfect. If it was, and was expected to be perfect then IS wouldn't move at all. However, there is uncertainty about the CB's intentions. That's the whole point.

[KrazyHorse]

Question: what happened to the following variables in the runup to QE2 (from the point where the market didn't really expect it, circa Aug-Sep 2010 to the point where it was known to be planned Nov 3 2010)
1) Nominal interest rates
2) Real interest rates
3) Expected inflation
4) Equity prices (proxy for future economic activity)

EDIT: equity prices, not asset prices

[giblets]

Argh. No. No, no, no.

The CB is not perfect. If it was, and was expected to be perfect then IS wouldn't move at all. However, there is uncertainty about the CB's intentions. That's the whole point.

So there's a hypothetical IS curve representing the relationship between interest rate and willingness to buy things in the present if the CB were perfect, and there's no reason for this to move because with a perfect CB, AD would always be at the right level. Then there's the IS curve that exists given current expectations of demand for things that firms want to sell in the future. If firms expect low demand, the actual IS curve would be to the left of the IS curve that would exist under ideal conditions.

[KrazyHorse]

I think you should sit back and think a bit before you post any more. In your world where people can always foresee exactly what the CB will do out to infinite time horizons there wouldn't exist an IS curve at all because there would be no external agency to manipulate the interest rate; it would be purely endogenous. The IS curve is only meaningful insofar as there can be surprises in monetary policy. However, under any reasonable model of how much people CAN foresee, there is absolutely no reason for them to say "the CB has lowered interest rates for the next 6 weeks, therefore the CB will lower interest rates relative to our expectations for all future times!". That is insane, but that is the standard reasoning given for the transmission policy IR->real variables

[giblets]

No, but people might say "the central bank has lowered interest rates for the next six weeks so it's cheaper to make investments in the next six weeks". Also, if the CB announces an unanticipated expansionary policy I don't see why this couldn't raise expectations of future AD, making firms more willing to invest.

[Kuciwalker]

No, but people might say "the central bank has lowered interest rates for the next six weeks so it's cheaper to make investments in the next six weeks".

Investments with maturity of the next six weeks. Precious few real investments do.

[KrazyHorse]

No, but people might say "the central bank has lowered interest rates for the next six weeks so it's cheaper to make investments in the next six weeks". Also, if the CB announces an unanticipated expansionary policy I don't see why this couldn't raise expectations of future AD, making firms more willing to invest.

1) "The next six weeks"? WTF investment is complete and paid back in the next six weeks? That is ridiculous
2) I completely agree with the second statement. That is one (actually, two) of the transmission mechanisms I explicitly mentioned earlier. In no way does this have anything to do with interest rates (except that the CB signals monetary policy with interest rates at the extreme short end). Interest rates serve only as the language they use to communicate, not the transmission mechanism. And the only interes rates they work with (again, in normal times) are the short rates, not the rates companies/people actually care about.

[KrazyHorse]

I feel like we are close to making another convert...