Second Generation Models and the ERM Crisis

Although first-generation models can account for many features of Latin American crises in the 1970s and 1980s, they cannot shed any light on the currency crisis that hit the European Exchange Rate Mechanism (ERM) in 1992. The ERM was a system of fixed exchange rates among European countries. Each currency had a central exchange rate around which its value could vary within certain specified bands. Governments could either buy and sell foreign exchange reserves to keep exchange rates within...

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(Section 18.1) Assume short-term interest rates are set in the way outlined in question 5. Investment expenditure is sensitive to yields on five-year bonds. For every 1 (100 basis points) rise in yields, investment expenditure falls by 0.5 . Consumption expenditure is also sensitive to yields. For every 1 rise in yields on five-year bonds, consumption falls by 0.25 . Government expenditure is unaffected by changes in yields. Initially investment spending and government spending are each 20 of...

One interpretation of a low dividend yield is that people became more optimistic about longrun economic growth and the

Either of these forces could account for a decline in the dividend yield during the 1990s. We will consider the risk premium issues in more detail shortly. But another explanation is that stock prices were just far ahead of their fundamental value by the end of the 1990s for some reason, share prices had become higher than would be predicted by companies' earnings. In the light of the large falls in stock prices in 2001 and 2002, this now looks more likely.

The Frisch Slutsky Paradigm

We have already implicitly discussed the main ideas behind the Frisch-Slutsky paradigm when we drew an analogy between business cycles and reservoirs.6 The Frisch-Slutsky paradigm identifies three components in business cycle fluctuations as shown in Figure 14.10. The first component is an impulse or a shock that triggers business cycle fluctuations. In terms of our metaphor, the impulse is the pebble or automobile that is thrown into the reservoir. However, as in our metaphor, the fluctuations...

What Is Macroeconomics

What Macroeconomics

In this chapter we show you what macroeconomics is about by looking at some of the big questions that macro-economists ask Why do some countries enjoy a standard of living many times greater than others How does growth in productivity evolve over time Why does the economy fluctuate between expansions and contractions What impact do changes in interest rates or in oil prices have upon the economy We draw out what is distinctive about macroeconomics and contrast it with microeconomics, and...