THE KEYNESIAN MODEL

Lecture 4: Introduction to Keynesian Model:Derivation; National Saving Identity.

Lecture 5: Multipliers for spending & exports; the transfer problem.

Lecture 6: Large-country model; International transmission under fixed vs. floating exchange rates

Lecture 7: Adjustment of a CA deficit via expenditure-reducing vs. expenditure-switching policies

Lecture 8: Monetary factors

Imports & exports depend on income:

Y

TB

+ 0 -

),( YEMM d *),( YEXX dmYM X

)( mYMXTB

as does consumption: Keynesian consumption function cYCC

assuming E & Y* fixed, for now.

where slope = -m ≡ - marginal propensity to import

TB falls in expansions…

…and rises in contractions

API-120 - Professor Jeffrey Frankel, Harvard University

Trade balance rises in recessions,

API-120 - Professor Jeffrey Frankel, Harvard University

falls in expansions

Determination of equilibrium incomein open-economy Keynesian model

TBAY )()( MXGIC

)()( mYMXGIcYC

MXGICmYcYY

mc

MXGICY

1

ms

MXAY

GICA cs 1where and

Now solve:

API-120 - Professor Jeffrey Frankel, Harvard University

API-120 - Professor Jeffrey Frankel, Harvard University

Derivation of National Saving Identity

Income ≡ Output (assuming no transfers)

Y ≡ GDP

S + (T-G) ≡ I + X – M / /

NS ≡ S + BS ≡ I + TB

NationalSavingIdentity

C + S + T ≡ C + I + G + X -M

API-120 - Professor Jeffrey Frankel, Harvard University

US National Saving, Investment, & Current Account as Shares of GDP, 1949-2019

Trend:Gap widened,

as NS fellrelative to I

API-120 - Professor Jeffrey Frankel, Harvard University

Keynesian Consumption Function: dYc CC

)cY C( -Y C - Y S ddd

} I

or, expressed as a saving function:

where s ≡ 1 – c . dY s C-

API-120 - Professor Jeffrey Frankel, Harvard University

Closed economy: NS – I = 0

Fiscal Expansion

1 < Closed-economy multiplier 1/s < ∞

Imports: for simplicity

mY Mor , Y)(E,MM d

API-120 - Professor Jeffrey Frankel, Harvard University

Open economy: NS – I = TB = X – M

Exports: for simplicity Xor ),Y(E,XX *d

)( mYMXTB

API-120 - Professor Jeffrey Frankel, Harvard University

Fiscal Expansion

Gms

Y

1

G

slope = s

Open economy

Gs

1

API-120 - Professor Jeffrey Frankel, Harvard University

End of Lecture 4: Introduction to the Keynesian Model

Bussière, Callegari, Ghironi, Sestieri & Yamano, 2013, "Estimating Trade Elasticities: Demand Composition and the Trade Collapse of 2008-2009."

Appendix -- Puzzle: Why did global trade collapse

in the 2008-09 global recession?(more than usual)

2009

API-120 - Professor Jeffrey Frankel, Harvard University Bussière, Callegari, Ghironi, Sestieri & Yamano, 2013,

"Estimating Trade Elasticities: Demand Composition and the Trade Collapse of 2008-2009."

One answer: There is a marginal propensity to import out of investment, greater than the marginal propensity to import by consumers.

And investment fell much more than consumption in 2008-09.