DADDAS MODEL notes PDF

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lecture notes about the DADDAS model...

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DAD DAS model Introduction

We develop a complimentary model to the ISMP model. It is another ‘lens’ on the economy. This model allows us to think about the effects of shocks in the medium to longer return as well.

Dynamic Aggregate Demand/ Dynamic Aggregate Supply

You can use impulse response functions to model how variables are affected by shocks.

Underpinning the framework are 3 equations, just like the ISMP. IS PC Taylor Rule

DADDAS has the same underlying models.

DAD curve AKA ADI Curve It captures the central banks behaviour. It incorporates the inflation-rate targeting behaviour of the central bank. How does AD vary with changes with the rate of inflation? Real interest rates (not nominal interest rates) are key in influencing Aggregate demand. Investors care about this. What is the other factor that can affect an investment decision? The real rate of interest will only become evident in a years time. You need to know the expected rate of inflation over the next 12 months. While investors know the nominal rate, what they don’t know is what happens to the economies price level between now and the next year. What will the inflation rate look like in a years’ time?

The Ex ante real interest rate. We assume that people form their judgement based on the current rate of inflation. This is not unreasonable when we have inflation rate targets. However, inflation is volatile in some countries. we can use the current rate of inflation to assume what will happen to prices over the next 12 months. ADAPTIVE EXPECTATIONS backward looking

Perhaps peoples inflation expectations are constant. ANCHORED What could help anchor expectations in a country like Britain? Inflation rate target. Central bank independence gives people the confidence they wont be cheated in. increasing confidence that the inflation rate will be delivered around the target. Expectations therefore become anchored too.

The bottom axis is the same as an AD curve. Assume the target is 2%. Inflation target line.

Monetary policy transition mechanism- how AD is affected Raising real interest rates will curve Ad by how much depends on the MPT^

This is what a DAD curve looks like. Examiner doesn’t matter if its linear,steeper,flatter.

The more weight the CB places on stabilising inflation, the more it will respond to the increase in inflation e.g commodity price inflation, the more impact it will have on aggregate demand. Tariffs can cause inflation. When there is a negative supply shock, inflation and output move in the opposite direction.

The IS curve was affected by the multiplier and interest responsiveness. This is the same with the DAD curve.

Could the DAD curve look different in a less evolved financial system? Yes The larger the multiplier, the flatter the IS curve.

Positive shocks will move the curve to the right, negative shocks will move the curve to the left....