Macroeconomics Tutorial Study Notes: Monetary Policy, IS-LM Model, Labour Market, Phillips Curve, Growth, and Open Economy

Monetary Policy and Central Banking

Current Monetary Policy and the Role of the Reserve Bank of Australia (RBA)

Monetary policy refers to the actions undertaken by a nation's central bank to control money supply and achieve macroeconomic objectives such as controlling inflation, consumption, growth, and liquidity. In Australia, the RBA is responsible for setting the policy interest rate.

• Monetary Policy Decision: The RBA meets regularly to decide on the policy interest rate, which influences borrowing, spending, and investment in the economy.

• Factors Considered: Inflation, unemployment, economic growth, and global economic conditions are key factors in the RBA's decision-making process.

• Example: If inflation is above target, the RBA may increase interest rates to cool the economy; if unemployment is high, it may lower rates to stimulate growth.

The Goods Market and IS-LM Model

Goods Market Equilibrium

The goods market is where final goods and services are bought and sold. Equilibrium occurs when aggregate demand equals output (Y).

• Consumption Function: $C = c_0 + c_1(Y - T)$, where $c_0$ is autonomous consumption, $c_1$ is the marginal propensity to consume, $Y$ is income, and $T$ is taxes.

• Investment (I), Government Spending (G), and Taxes (T): These are exogenous in the basic model.

• Equilibrium Condition: $Y = C + I + G$

• Example: Given $C = 100 + 0.8(Y - 50)$, $I = 110$, $G = 100$, $T = 50$, solve for equilibrium output.

The IS-LM Model

The IS-LM model combines the goods market (IS curve) and the money market (LM curve) to determine equilibrium output and interest rates.

• IS Curve: Represents equilibrium in the goods market. Downward sloping; higher interest rates reduce investment and output.

• LM Curve: Represents equilibrium in the money market. Upward sloping; higher income increases demand for money, raising interest rates.

• Equations:

  • IS: $Y = C(Y - T) + I(r) + G$

  • LM: $M/P = L(Y, r)$

• Example: Analyze the effect of an increase in taxes on output using the IS curve.

Labour Market and Unemployment

Wage-Setting and Price-Setting

The labour market determines the equilibrium wage and employment level. The wage-setting (WS) and price-setting (PS) relations are central to understanding unemployment.

• Wage Equation: $W = P^e F(u, z)$, where $W$ is nominal wage, $P^e$ is expected price level, $u$ is unemployment rate, $z$ is other factors (e.g., unemployment benefits).

• Price Equation: $P = (1 + m)W$, where $m$ is the markup over costs.

• Natural Rate of Unemployment: The rate at which the real wage set by wage bargaining equals the real wage implied by price setting.

• Example: If the markup increases, the natural rate of unemployment rises.

The Phillips Curve and Inflation

Expectations-Augmented Phillips Curve

The Phillips Curve describes the relationship between inflation and unemployment. The expectations-augmented version incorporates expected inflation.

• Equation: $\pi_t = \pi_t^e + 0.1 - 2u_t$, where $\pi_t$ is inflation, $\pi_t^e$ is expected inflation, $u_t$ is unemployment rate.

• Implications: Lower unemployment can lead to higher inflation if expectations are adaptive.

• Example: If expected inflation rises, the short-run Phillips Curve shifts upward.

Economic Growth: The Solow Model

Solow Growth Model

The Solow model explains long-run economic growth based on capital accumulation, labor or population growth, and technological progress.

• Production Function: $Y = F(K, L)$, often $Y = K^\alpha L^{1-\alpha}$

• Capital Accumulation: $\Delta K = sY - \delta K$, where $s$ is the saving rate, $\delta$ is depreciation.

• Steady State: The economy converges to a steady state where capital per worker and output per worker are constant.

• Golden Rule Level: The saving rate that maximizes steady-state consumption per worker.

• Example: If the saving rate is halved, steady-state capital and output per worker decrease.

Expectations, Yield Curve, and Consumption

Yield Curve and Expectations

The yield curve plots interest rates of bonds with different maturities. It reflects market expectations of future interest rates and economic conditions.

• Upward Slope: Indicates expectations of rising interest rates or inflation.

• Downward Slope (Inverted): May signal expectations of economic slowdown.

• Example: Central bank announcements can shift the yield curve by changing expectations.

Intertemporal Consumption

Consumers allocate consumption over time based on preferences, income, and interest rates.

• Present Value: $PV = \frac{C_1}{1 + r} + \frac{C_2}{(1 + r)^2} + ...$

• Consumption Smoothing: Households borrow or save to maintain stable consumption.

• Example: A temporary income increase may be saved rather than spent.

Open Economy and Exchange Rates

Trade, Tariffs, and Exchange Rate Regimes

Open economy macroeconomics studies interactions with the rest of the world, including trade, capital flows, and exchange rates.

• Tariffs: Taxes on imports that can affect domestic prices, output, and employment.

• Exchange Rate Regimes: Fixed vs. floating exchange rates impact monetary policy autonomy.

• Example: Higher tariffs may reduce imports but can provoke retaliation and reduce overall welfare.

Technological Progress and Labour Market Dynamics

Impact of AI and Technological Change

Technological progress, such as AI, affects productivity, employment, and income distribution.

• Solow Model with Technological Progress: $Y = F(K, AL)$, where $A$ is technology.

• Labour Market Effects: Some jobs may be automated, but new jobs can also be created.

• Example: Doubling the rate of technological progress increases steady-state output per worker.

Summary Table: Key Macroeconomic Models and Concepts

Model/Concept	Main Equation	Key Variables	Application
IS-LM Model	$Y = C(Y-T) + I(r) + G$ $M/P = L(Y, r)$	Y, r, M, P, C, I, G, T	Short-run output and interest rate determination
Phillips Curve	$\pi_t = \pi_t^e + \alpha (u_n - u_t)$	Inflation, expected inflation, unemployment	Inflation-unemployment trade-off
Solow Growth Model	$Y = K^\alpha L^{1-\alpha}$	K, L, s, δ, n, g	Long-run growth and steady state
Wage-Setting/Price-Setting	$W = P^e F(u, z)$ $P = (1 + m)W$	W, P, u, z, m	Natural rate of unemployment

Additional info:

• Some context and explanations have been expanded for clarity and completeness.

• Examples and equations are based on standard macroeconomics textbook models.