1、,CHAPTER 10,Investment,Net Exports,and Interest Rates,1,Copyright 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
2、 than in a flexible-price model?How do changes in interest rates affect the equilibrium level of production and income in a sticky-price model?,2,Copyright 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
3、of real GDP when the central banks policy is to keep the real interest rate constant?,3,Copyright 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 powerf
4、ul role in every recession and depressionincreases in investment have spurred every boom,4,Copyright 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 cycles,5
5、,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Figure 10.1-Investment as a Share of Real GDP,1970-2000,6,Copyright 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
6、is pushed up or down by supply and demand to equate the flow of savings to the flow of investment,7,Copyright 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
7、 central bank or indirectly by the combination of the stock of money and the liquidity preferences of households and businessesbusinesses match the quantity they produce to aggregate demandautomatically creates balance in the financial market,8,Copyright 2002 by The McGraw-Hill Companies,Inc.All rig
8、hts reserved.,Fluctuations in Investment,Fluctuations in investment have two sourceschanges in the real interest rateshifts in investors expectations about future growth,profits,and risk,9,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Investment and theInterest Rate,The opport
9、unity cost of an investment 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 spending,10,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights r
10、eserved.,Investment and 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
11、of the funds elsewhere,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 premiu
12、m is the premium in the interest rate that the market charges on long-term loans vis-vis short term loans,12,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Figure 10.2-Bond Yield Curves,13,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Investment and theIn
13、terest Rate,The interest rate that is relevant for investment spending decisions is the real interest rate,14,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Figure 10.3-Gaps between Real and Nominal Interest Rates,15,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights re
14、served.,Investment and theInterest Rate,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 premium,16,Copyright 2002 by The McGraw-Hill Companies,Inc.All
15、 rights reserved.,Figure 10.4-The Risk Premium:Safe and Risky Interest Rates,17,Copyright 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 rateAs r rises,the level o
16、f investment spending will decline,18,Copyright 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 Rate,19,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Exports and Autonomous Spending
17、,Gross exports depend onforeign total incomes(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 rate,20,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Exports
18、 and Autonomous Spending,A higher interest rate reduces autonomous spending(A)by reducing exports(Xr r)as well as by reducing investment(Ir r),21,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Exports and theInterest Rate,A higher real interest rate reduces gross exportsinvesti
19、ng in the home country is more attractiveforeign exchange speculators shift their portfolio holdings to include more home currency-denominated assetsthe exchange rate fallsexports are more expensive to foreigners,22,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Figure 10.6-Fro
20、m the Real Interest Rate to the Change in Exports,23,Copyright 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),24,Copyright 2002 by The McGraw-H
21、ill Companies,Inc.All rights reserved.,Figure 10.7-Autonomous Spending as a Function of the Real Interest Rate,25,Copyright 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
22、the equilibrium level of real GDPthe effect will be equal to the interest sensitivity of autonomous spending(Ir+Xr)times the multiplier,26,Copyright 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
23、and the equilibrium level of real GDP is the IS curveIS stands for“Investment-Saving”,27,Copyright 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 s
24、pending at that interest rateuse the income-expenditure diagram to determine the equilibrium level of real GDPRepeat this procedure to find other points on the IS curve,28,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Figure 10.8-The IS Curve,29,Copyright 2002 by The McGraw-Hi
25、ll Companies,Inc.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 rate,30,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,The IS Curve,Recall that real GDP is equal
26、 to autonomous spending(A)divided by(1-MPE),Substituting,we get,31,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,The IS Curve,The term on the left is the horizontal intercept of the IS curvethe value of equilibrium real GDP if the real interest rate was equal to zeroThe term o
27、n the right is the slope of the IS curvethe responsiveness of real GDP to changes in the interest rate,32,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Figure 10.9-The IS Curve,33,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,The Slope of the IS Curve,Th
28、e 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 interest rate,34,Copyright 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
29、 baseline level of autonomous spending times the multiplier,Changes in any of these determinants will shift the position of the IS curve,35,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Figure 10.10-A Change in Fiscal Policy and the Position of the IS Curve,36,Copyright 2002 b
30、y The McGraw-Hill Companies,Inc.All rights reserved.,Changes in the Interest Rate,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
31、sensitivity of the exchange rate(r)the exchange rate sensitivity of exports(X),37,Copyright 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 expenditureinventories risefirms cut productionemployment,real GDP,and n
32、ational income fallIf the economy is below the IS curve:planned expenditure real GDPinventories fallfirms expand productionemployment,real GDP,and national income rise,38,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Figure 10.11-Off of the IS Curve,39,Copyright 2002 by The Mc
33、Graw-Hill Companies,Inc.All rights reserved.,Shifting the IS Curve,Two kinds of government 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 curve,40,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Shifting the IS Curve,Exa
