Macroeconomics by Ix4g2Jd9

VIEWS: 34 PAGES: 24

									  Macroeconomics

          Lecture 5
Inflation and unemployment
                Outline
• Empirical facts

• The dynamic AD-AS model (the Phillips
  Curve Model).

• Using the Phillips Curve Model to make
  sense of the 70ies, 80ies and 90ies.
 Unemployment as a % of the labour force,
       United Kingdom, 1960-1997

                  12
   Unemployment




                  10
                   8
                   6
                   4
                   2
                   0
                   1950   1960   1970   1980   1990   2000


OECE, Main indicators.                                80s 70s
              Inflation, GDP deflator (annual, %)
                    United Kingdom, 1961-96

              30
              25
              20
  Inflation




              15
              10
               5
               0
               1950   1960   1970   1980   1990     2000


OECD. Main indicators.
Inflation and unemployment in
   the UK is the early 1980s
    20
    15
%




    10
     5
     0
         79

               80

                     81

                           82

                                  83

                                        84

                                              85

                                                    86
    19

              19

                    19

                          19

                                 19

                                       19

                                             19

                                                   19
                     Inflation         Unemployment
Inflation and unemployment in
         the short-run
    Static model         Dynamic model
                         Inflation and
    P and Y
                         unemployment

Aggregate demand      Dynamic Aggregate
      (AD)              demand (DAD)

Short-run aggregate   Short-run Phillips Curve
   supply (SAS)                (SPC)

Long-run aggregate     Long-run Phillips
  supply (LAC)           curve (LAC)
           The Phillips Curve
Aggregate supply:       Y  Y   (P  P )e



    Rewrite:            P  P   (Y  Y )
                              e       1



  Subtract P-1:     P  P1  P  P1   (Y  Y )
                                  e     1




              (Y  Y )
                    e     1

       Inflation
               Okun’s law

The deviation of output from its equilibrium level
     is inversely related to the deviation of
    unemployment from its equilibrium level



       (Y  Y )    (u  u )         N
            Slope
       of the Phillips                Random
            curve                   supply shocks


                  
     (u  u )  
            e
                  
                                N


Expected
inflation                   Cyclical
                         unemployment
               
          (u  u )  
           e
               
                       N


     
  1
 e
 1
                          
                           e
                           1
                                    e
                                    0

                         1   0
 0  0
  e


                      SPC ( 1e , 1 )

                    SPC ( ,  0 )
                            e
                            0
                                 U
               UN
P         The static AD curve


                   M up




    (G - T) up
                      AD0       AD1
                                 Y
Dynamic Aggregate demand
         (DAD)
Growth in real            Growth in government
money supply                  deficit (G-T)

  Y  Y   (m   )  BDg
                      S



               Dynamic multipliers

   m   (Y  Y )  BDg
           S      1             
                                
              Use Okun’s Law

             Slope              Growth
         of the DAD         of government
            curve               deficit

                
  m  (u  u )  BDg 
          S
                
                           N       
                                   

Money                                  Demand
growth                 Cyclical         shock
                    unemployment
                 
   m  (u  u )  BDg 
             S
                 
                     N    
                          

         
                                   S           1
                          DAD(m , BD )
                                   1           g



m  BD
s
1
     
     
         1
         g
                                       S
                              DAD(m , BD )
                                       0
                                                   0
                                                   g




m  BD
 s
 0
     
     
         0
         g




                                           U
                     UN
       Long-run equilibrium

       Steady state equilibrium

•   Stable (constant) inflation.
•   Expectations are fulfilled.
•   The growth of the deficit is zero.
•   No shocks.
    Characterization of long-run
           equilibrium
        e
                                  u u    N


               Non-accelerating inflation rate of
  Real            unemployment (NAIRU)
rigidity
           = the structural rate of unemployment
Nominal
rigidity       The natural rate of unemployment
Characterization of long-run
       equilibrium



BDg  0            m   S
        Short-run analysis
           The model in action

• Stagflation in the 70ies (high inflation
  and unemployment in response to supply
  shocks).
• Disinflation in the 80ies.
• Central bank independence in the 90ies.
               LPC

                     DAD(m , BDg  0)
                            s




                A
   m
    e       s
                           Long-run
                          equilibrium

                        SPC ( 0 ,  0  0)
                               e

                                        U
                UN
 • Negative supply shock leading to stagflation in the 70ies
 • Accommodating economics policy

          
                                                      d
                             LPC
                                            DAD1 (m1s )

          1
                                                     s
                                   C        DAD 0 ( m0 )

                                        B
                             A
   m
      e     s
            0

                                              SPC ( 0 ,  1 )
                                                     e



                                       SPC ( ,  0  0)
                                                  e
                                                  0
                                                     U
                              UN       u1
         Dis-inflation in the beginning of the 1980s


          
                                                         d
                              LPC

                                          DAD ( m1s )
                  SPC ( )
                        e                                s
                        1
                                                DAD ( m )2
                                 C
           1
          B                                B

 1   1e  m2
              s
                                C           SPC ( 0 )
                                                   e


                                                         U
                               UN      UB
 u



uN
     Time

 
0          Fig




1
     Time
       The cost of disinflation

               Credibility
            Adjustment speed

 • Does the private sector believe the
• How fast do expectations adjust (rational
    government will go through with the
  versus adaptive expectations)?
    plan.
• How fast do changes in expectations get
 • Institutions and ideology
  locked into nominal wage contracts?
            What is next?


• Stabilization policy in a closed economy.

• Fiscal and monetary policy.

								
To top