The purpose of this article is to introduce you to the model and to discuss the main results that can be expected with this approach. As a policy maker, I am always looking for ways to improve my policies, especially when they deal with the economic cycle. One of my main concerns is that interest rates do not remain level for long periods of time. In short, we want to make sure our central banks do everything possible to keep long-term interest rates low, which is an essential tool to avoid deflation.
One of the questions I receive quite often in The International Macroeconomics Association (IMA) is about the so-called Phillips Curve. This is named after its creator, Dr. Albert Phillips. In his model, inflation occurs when there is deviation from a perfect market, otherwise known as a zero lower bound. With this deviation, demand for goods and services outstrips supply. Dr. Phillips believes that this process should be repeated over again until equilibrium is reached, which he calls the Target Rate.
If we take Dr. Phillips’ model as the factual basis for the validity of my IMAP policy, we would find that there are four specifications of this theoretical concept. These are (I) a lower bound on aggregate demand; (ii) a zero lower bound on effective supply; (iii) a positive relationship between investment and output; and (iv) depreciation. With these four specifications, you can see that there is a perfect, or nearly perfect correlation between policy and monetary variables. With this said, I would like to take my international macro economics policy evidence quiz for you, along with my macroeconomic model, and see if I am indeed correct in my assumption that these theories are in fact true.
First, let us take my theory: that there is a zero correlation between investment and output. I think we can all agree that this is a non-trivial and not entirely valid result. This theory could certainly be shown untrue, however, it is not my purpose to do so. Second, let us take my second hypothesis: that a positive effect of investment should be shown on overall economic activity. I think that, based on my experience with investment, it is very likely that my hypothesis is correct one.
To support my first hypothesis, let us look at investment rates as a function of the current international monetary environment. Investment is most often considered to be a monetary or banking policy function; however, it can also be a policy function stemming from national central bank policy, technological advancement, or even just the nature of an economy. With this in mind, let us examine a situation where one country has an extremely high and low investment rate relative to another. In this case, one might expect that the low investment rate would decrease overall economic activity, while the high investment rate increases the value of the dollar relative to other currencies. While this example illustrates the power of monetary policy to affect investment, let’s look at an alternate possibility; where the two countries have a very low and high investment rate respectively.
Let us now use these assumptions to examine the results of my theory. The results suggest that my assumption (i.e., that there is a significant relationship between investment and macroeconomic performance) fails to meet the standards of a robust macroeconomic theory. On the other hand, it does seem to make sense that there is some correlation between the two. Since an increasing investment means increasing overall output and employment (and decreasing employment and output in the case of a decreasing investment), it is easy to see why an increase in investment would lead to increased employment and output. Also, since most policies are implemented with a view toward maintaining competitiveness, it seems that an increase in investment would reduce the gap between the U.S. and foreign economies as it would mean more products made by the United States that are able to sell for a higher price on the domestic market.
In conclusion, I do believe that it is important for people to consider my theory in regards to the effects of foreign trade on the US economy. In particular, if you want to take my international macroeconomics policy evidence quiz for me, the first question that you should ask is “do foreign trade policies affect the U.S. economy?” The second question that you should answer is “How does foreign trade influence the performance of the U.S. economy?” In conclusion, I have tried to make my case for these questions in this article, but in the end you are the one who has to decide what your beliefs are about these issues.
