Chapter 10 Review Questions

Transcription

1 Chaptr 0 Rviw Qstios. How ca o accot for a short-r trad-off btw iflatio ad mploymt? What is th diffrc btw th atral rat of mploymt ad th NAIRU? Th NAIRU is dtrmid as th qilibrim lvl of mploymt i th imprfct comptitio modl. This rprsts a bargai ovr th lvl of ral wags, whr firms st prics ad workrs st omial wags. w w RW w BRW air Th wag sttig rlatio is W ( Z β) = whr is th xpctd pric lvl, Z a st of factors dtrmiig th bargaiig powr of labor, ad th rat of mploymt. W rics ar st as a mark-p ovr margial costs, = ( + μ ), whr μ is th markp, W th omial wag ad L th lvl of labor L prodctivity. Th NAIRU is dfid as th poit whr th ral wag dmads of both sids of th bargai ar cosistt with ach othr. At this qilibrim positio thr is o prssr o ithr prics or wags to chag. If mploymt fll blow th NAIRU, th workrs will attmpt to icras th ral wag by bargaiig for highr omial wags. This howvr will th fd ito th firm s pric sttig rlatioship, ladig to a icras i prics if th mark-p ad labor prodctivity rmai chagd. Likwis, if mploymt ros abov th NAIRU, th workrs will modrat ral wag claims by rdcig th omial wagwhich shold th fd ito prics throgh th pric-sttig rlatioship.

2 Hc, prics rspod positivly to th dviatio of mploymt from th NAIRU. ΔW = = f air W ( ) This givs ris to a trad-off btw mploymt ad iflatio dscribd by th hillips crv. 0 = α( air ) = α( r ) r air Th NAIRU ad th atral rat of mploymt ar oft sd itrchagably, althogh thr is a sbtl diffrc. Th atral rat is th qilibrim mploymt rat is a comptitiv labor markt, whras th NAIRU rfrs to a imprfctly comptitiv o. Th atral rat of mploymt lis blow th NAIRU. This is bcas i comptitiv markts th pric lvl is qal to th margial cost, whr imprfct comptitio lads to a wdg btw margial costs ad prics. Bcas of th highr pric lvl, th fasibl ral wag that firms ca afford at ach lvl of mploymt is lowr, hc qilibrim i th labor markt rqirs a highr rat of mploymt, air > r. Imprfct comptitio lads to th prsc of a iflatio wdg i th hillip crv. This is th lvl of iflatio that wold aris if a coomy charactrisd by imprfct comptitio tris to assrt th atral rat of mploymt.

3 Iflatio wdg = α( ) =. air r. Th hillips crv is writt as: t t ( 0. ) = a. What is th atral rat of mploymt? Th atral rat of mploymt is whr iflatio is costat, Δ t = t t = 0. ( ) = = 0 t t = 0.05 or 5%. r b. Graph th rlatioship btw iflatio ad mploymt; graph th rlatioship btw th acclratio i iflatio ad mploymt. t t t t ( 0. ) = Th hillips crv, wh mploymt is qal to th atral rat iflatio rmais chagd at its prvios lvl. Th rat of iflatio riss at ay lvl of mploymt blow 5%, ad falls at ay rat of mploymt blow 5%.

4 Th acclratio i iflatio roghly corrspods to th chag i iflatio, which qals: t t t ( 0. ) Δ = = Δ t ( 0. ) Δ t = Th plot of th acclratioist hillips crv highlights that th rat of iflatio is oly costat wh mploymt is at its atral rat of 5%. If mploymt wr to xcd this rat th iflatio wold dclrat, if mploymt wr to fall blow 5% iflatio wold acclrat. c. What lvl of mploymt is rqird to rdc iflatio by 3%? From th acclratioist hillips crv w rqir = 0. 03, hc ( 0. ) 0.03 = Δ t 0.03 = = = = or 8.75%. 0.8

5 To rdc iflatio by 3% a tmporary icras i mploymt to 8.75% is rqird. d. What policis ca th govrmt s to achiv a 3% fall i iflatio? Umploymt ca b raisd by 3.75% throgh a dmad cotractio ithr tightig motary policy by icrasig itrst rats or limitig crdit cratio, or throgh fiscal policy by raisig taxs or cttig govrmt spdig. This cotractio is oly rqird for o priod, as oc iflatio has fall to its rqird lvl it ca b hld thr by movig mploymt back to th atral rat. If this dos t happ iflatio will coti to fall by this rat ach priod. A short sharp cotractio will thrfor hit th iflatio targt. If thogh th govrmt wishd th iflatio adjstmt to b lss svr it cold hav achiv th sam targt throgh a smallr bt mor protractd cotractio. For xampl, if mploymt was raisd to 6% th iflatio wold fall by 0.8% pr yar. This is ddcd from th hilips crv: ( ) Δ = = t Hc, at this rat iflatio will hav fall by 3% withi 0.03/0.008 = 3.75 priods. Altrativly, iflatio ca b lowrd by rdcig th atral rat of mploymt by 3.75% to.5%. Howvr, aftr o priod th coomy ca b xpadd to kp mploymt at this lvl othrwis iflatio will coti to dclrat frthr. Thr ar svral spply-sid policis that might b sd to achiv this, bt all ar coctd with ithr improvig th prodctivity or fficicy of labor ad capital, or by icrasig th total spply throgh ictivs to work or ivst. Covtioal wisdom thogh args that spply-sid (shiftig th log r aggrgat spply crv of th coomy) is part of logr-trm policy makig. 3. Sppos a govrmt ovrstimats th NAIRU ad attmpts to prvt iflatio from risig by cotractig aggrgat dmad. Show th likly otcom of this policy i th short r ad th log r. This dscribs a sitatio whr th coomy is at th NAIRU, bt th govrmt mistakly blivs that th NAIRU is i fact highr. Th coomy is actally at poit a, bt if th govrmt prcivs th NAIRU to b at thy bliv th coomy will mov to a poit sch as c. Bcas crrt mploymt is blow th prcivd NAIRU, iflatio wold acclrat. I ordr to prvt this thy may drtak a cotractioary policy with th viw of movig th coomy to poit b. Umploymt will rtr to th stimatd NAIRU, bt iflatio will b prvtd from acclratig.

6 Log R hillips Crv c a b d ( ) = α + 3 ( ) = α + ( ) 3 = α + If th govrmt blivs th NAIRU to b at. th poit b is a stabl qilibrim i th coomy. Bt bcas thy ar wrog i thir stimats of th NAIRU, th coomy was actally i a stabl positio at th origial poit a. Th policy of icrasig mploymt to prvt th acclratio of iflatio jst movs th coomy ito a rcssio with mploymt xcdig th NAIRU. At poit b, th ris i mploymt, via a rdctio i omial wag growth will lad to a rdctio i iflatio. As iflatio xpctatios ar pdatd this will lad to a frthr dclratio i wag ad pric iflatio. Th coomy will rtr to th NAIRU, bt with lowr qilibrim iflatio at poit d. Umploymt falls bcas as log as th actal rat of mploymt xcds th NAIRU, th ral wag dmadd by workrs will fall blow th fasibl ral wag affordd by firms giv labor prodctivity ad prodct markt coditios. 4. Udr what circmstacs is it possibl to rdc iflatio withot icrasig mploymt? Th hillips crv posits a short r trad-off btw iflatio ad mploymt, so iflatio ca oly b rdcd by icrasig mploymt abov th NAIRU. Howvr, th log r hillips crv is vrtical at th NAIRU ad args that ( ) thr is o log-r trad-off btw iflatio ad mploymt. Each poit o th log r hillips crv plots mploymt at th NAIRU, bt th prvailig rat of iflatio dpds o iflatio xpctatios.

7 A pailss iflatio, i trms of ot icrasig mploymt abov th NAIRU, ca b achivd if iflatio xpctatios ca b rdcd. This simply lads to a dowward shift i th short r hillips crv, ad th rat of iflatio, whilst stayig o th log r hillips crv. No icras i mploymt is rqird. A drstadig of th importac of xpctatios ca b s from th itractio of th wag-sttig ad pric-sttig modls W = ( Z β) A icras i pric xpctatios lads to a icras i omial wag dmads. = W ( + μ) L A icras i omial wag dmads fds dirctly ito a icras i prics. Thrfor thr is a chai likig pric xpctatios to actal prics i this bargaiig framwork. ΔW W Log R hillips Crv ( ) = α + ( ) = α + A fall i iflatio xpctatios simply acts to rdc actal iflatio from. Thr is a ititiv whilst mploymt rmais at th NAIRU ( )

8 raso as to why th NAIRU rmais chagd. Bcas wags ad prics ar growig at th sam rat, th ral wag i th coomy ( w = W/ ) rmais chagd. Thrfor, thr is o chag i or movmt alog ithr th RW or th BRW schdls so th labor markt rmais i qilibrim. This also accots for how thr ca b a costat ral wag at th NAIRU, bt still a positiv bt stabl rat of iflatio. If wags ad prics icras i th sam proportios th th ral wag will rmai costat. If workrs bliv pric iflatio to hav slowd, th maitaiig th sam ral wag will rqir a smallr icras i th rat of growth of omial wags- which th fd throgh ito actal pric iflatio. If this xpctatios rot dos ot work, th policy-makrs will hav to iflc omial wag growth dirctly throgh mploymt. From th wag sttig schdl, a icras i mploymt wold lad to workrs cttig omial ad ral wags. Lowr omial wags will th fd throgh to pric sttig. This procss highlights two importat factors cocrig iflatio xpctatios. First, if xpctatios ar pdatd slowly i a backward-lookig procss it will b impossibl to rdc iflatio withot icrasig mploymt. Scod, v if xpctatios adjst qickly th prsc of omial rigiditis prvtig th rapid adjstmt of wags ad prics might prvt iflatio from fallig. Mor advacd problms 5. What wold b th ffcts o iflatio ad mploymt of: a. A sbstatial ris i oil prics. LRC LR C

9 W If th bargaid ral wag is BRW = = Z β ad th pric dtrmid ral wag W L is RW = =, th th NAIRU ca b fod whr BRW = RW. + μ Z β = = Z β L ( + μ ) ( ) L ( + μ ) Thrfor a fall i labor prodctivity idcd by a ris i oil prics implis a ris i th NAIRU. This will shift th log r hillips crv to th right so crrt mploymt ow lis blow th w NAIRU. At th crrt lvl of iflatio xpctatios, th ris i th NAIRU will idc acclratig iflatio to th rat. Iflatio will coti to ris as log as th mploymt rat rmais blow th NAIRU, ad that iflatio xpctatios ar adjstd pwards i li with actal iflatio. Th w qilibrim positio i th coomy will b whr mploymt qals th NAIRU, ad iflatio xpctatios ar cosistt with actal iflatio at th rat. b. a major improvmt i prodctivity This wold hav tirly th opposit impact as that dscribd i part a. LR C LRC

10 A improvmt i prodctivity will rdc th NAIRU. Thrfor, at th crrt rat of iflatio xpctatios thr wold b a fall i th rat of iflatio, rflctig th fact that mploymt is abov its w NAIRU. Iflatio will coti to dclrat as log as iflatio xpctatios ar adjstd dowwards, ad that mploymt rmais abov th w NAIRU. Th w qilibrim positio will xhibit both lowr mploymt ad iflatio. c. A rform of labor markt istittios This wold b xpctd to hav th sam cosqcs as a ris i labor prodctivity. By rdcig th bargaiig strgth of labor, dirctly throgh rglatio o trad ios powr tc. or idirctly throgh attmpts to icras comptitio, th bargaid ral wag will fall at all lvls of mploymt. Hc th log r NAIRU will also fall. Giv that workrs ow targt lowr ral wags at ach lvl of mploymt, firms ca afford to hir mor labor giv th lvls of th mark-p ad prodctivity. ric iflatio will fall bcas workrs will psh for a lowr rat of omial wag growth i ordr to rdc th ral wag, ad also bcas iflatio xpctatios will fall. 6. Th govrmt ca do othig abot th NAIRU, so shold jst targt iflatio ad lt mploymt sttl at th lowst rat possibl? I I TC = α( )

11 Th govrmt has prfrcs ovr iflatio ad mploymt that ca b rprstd by a sit of idiffrc crvs (I). Bcas iflatio ad mploymt both giv distility, ths ar cocav to th origi ad wlfar is hacd by movig oto lowr crvs. Th NAIRU dtrmis th lvl of mploymt whr th rat of iflatio is costat. Ay positio away from this lvl ca oly b hld tmporally, ad adjstmt back to th NAIRU will lad to a prmat chag i th lvl of iflatio. This dtrmis th positio of th log r hillips crv. Thrfor, i th log r it is likly that th govrmt shold maximis tility sbjct to this costrait. This will ivariably lad to a otcom of tryig to mov th coomy to a poit towards th bottom of th log r hillips crv. I th short r a prfrrd positio ca b achivd by xploitig th short-r hillips crv trad-off. This abls mploymt to b tradd off for highr iflatio, bt oly i th short r. Rdcig mploymt blow th NAIRU will idc a acclratio i iflatio that wold lad to a wors log r positio, i.. highr p th log r hillips crv. For this raso, th govrmt may b bst advisd to allow mploymt to sttl at th NAIRU ad th jst targt a low rat of iflatio. Howvr, i th log r th govrmt ca prmatly mov to a lowr idiffrc crv by shiftig th log r hillips crv to th lft. This howvr wold rqir policis to rdc th NAIRU throgh spply sid policis. From qstio 5, th NAIRU is dfid as: = Z β L ( + μ ) Hc a rdctio i th NAIRU ca b achivd by: Icrasig β : This raiss th ssitivity of ral wag aspiratios to th lvl of mploymt. Thrfor th bargaid ral wag crv will pivot dowwards ad th NAIRU will fall. This cold b achivd throgh policis to icras th job sarch itsity of mployd workrs. Th log-trm mployd ar spcifically pro to los motivatio ad sffr aliatio. Attmpt to icras labor mobility may also act to crb isidr powr i labor markts, maig that mployd workrs ca compt mor ffctivly with xistig mployd workrs. Rdcig μ : A lowr mark-p abls a highr pric dtrmid ral wag ad a fall i th NAIRU. This cold b achivd by icrasig comptitio i prodct markts, prhaps throgh comptitio policy.

12 Icras L: Highr labor prodctivity also icrass th pric dtrmid ral wag schdl, ablig a highr lvl of ral wags to b paid i th coomy. Thrfor mor workrs ca b hird withot placig pward prssr o prics. Typical policis to improv prodctivity may cosist of coragig ivstmt i skills ad iovatio. Rdc Z: This is a catch-all variabl that picks p factors affctig th bargaiig powr of labor. A lowr Z rdcs ral wag aspiratios, ad thrfor mploymt ca xpad withot idcig iflatio. olicis that might achiv cold icld dirct cotrols o labor powr sch as trad io rform; rdctios i th altrativ wag which is affctd by th grosity of mploymt bfits, rddacy paymts ad lowr miimm wags; ad by makig th labor markt mor comptitiv- both domstically ad itratioally. 7. Explai how a rcssio might rais th NAIRU. Hystrsis rfrs to th cas whr tmporary or short r movmts i th NAIRU ca b propagatd ito mdim or log trm ffcts. As a rslt, chags i mploymt that aris i th short r ca bcom vry prsistt or v prmat. LRC LR C w (a) RW w RW BRW (b) SRC w RW BRW BRW For xampl, th coomy starts off at th NAIRU, bt followig a rcssio mploymt riss to. If th sal dyamics play ot, th coomy will rtr to th NAIRU bt iflatio will dclrat. This is bcas at high mploymt ral wag aspiratios of workrs fall, which both prics thm back ito mploymt bt also throgh a wag-pric spiral lowrs th xpctd ad actal rat of iflatio prvailig i th coomy.

13 This mchaism thogh will b sht off if th NAIRU also icrass to. Bcas bargaid ad pric dtrmid ral wags ar ow cosistt at this lvl of mploymt, thr will b o frthr prssr o ithr mploymt or iflatio to fall. A hystrsis mchaism is aythig that lads to a tmporary chag i mploymt bcomig prmat. This wold aris throgh somthig iflcig th compots of th wag bargaiig procss. For xampl, (s pal (a)) a ris i mploymt may act to rdc labor prodctivity ad shift th pric dtrmid ral wag pwards. This cold b th rslt of skill dgradatio from mploymt, or lowr capital ivstmt d to a dprssd coomy. Altrativly, th bargaid ral wag may shift or pivot pwards (s pal (b)). Thr ar mros ffcts which may cas this to happ. A icras i mploymt may rais th lvl of log-trm mployd ad rdc th sarch itsity of mployd workrs, so ral wags bcom lss ssitiv to mploymt. If powrfl isidr-otsidr ffcts occr a similar sitatio wold aris if th highr mploymt displacs prvios isidrs ito th pool of otsidrs- who hav littl powr to iflc th wag bargai. 8. What ar th costs of iflatio? Dos th cotrol of iflatio dsrv its prmit positio i policy circls? If iflatio is aticipatd, th it may grat rdistribtio ffcts if cotracts ar ot sfficitly flxibl. A xpctd ris i iflatio will most sigificatly rdistribt from savrs/ldrs to borrowr. This is bcas th ral itrst rat o dbt is rdcd, bt also highr iflatio rods th val of omial liabilitis. It also bfits pric-sttrs (firms) ovr wag-sttrs (wags) by rdcig th ral wag. Fiscal drag occrs wh omial wags ar pdatd for iflatio, bt icom tax thrsholds rmai chagd. This has th tdcy to drag hosholds ito highr tax brackts- thrfor gratig rdistribtio from tax payrs to govrmt. Also, thos o fixd icoms, which ar prdomiatly thos that liv o social scrity paymts, may s th ral val of this icom dcli. Almost all of ths r-distribtiv ffcts cold b cotrd by spcifyig cotracts that tak accot of iflatio. If ths variabls wr idxd, so adjst atomatically to iflatio, th th ral val of ths variabls cold b maitaid v if iflatio was xpctd. Wh iflatio is aticipatd it ca still prodc m ad sho lathr costs. Ths ar th ral rsorcs that ar cosmd i dalig with chags i prics. M costs rfr to th costs of rpritig ms- bt cold apply to ay rcord of sals prics sch as brochrs tc. If prics ris, th mor moy is rqird to drtak th

14 sam trasactios. h cost of dalig with this is kow as sho-lathr costs, bcas it is symbolisd with popl havig to mak mor trips to th bak. Sic th 970s coomic policy-makig has shiftd away from th targt of fll mploymt towards maitaiig pric stability, or low ad stabl iflatio. This chag i thos partly rflcts th poor prformac of dmad-maagmt programs dsigd to maitai fll mploymt- bt largly rsposibl for stop-go cycls i th coomy. Also, prior to th 970s high ad prsistt iflatio was ot a fatr of dvlopd cotris, ad thrfor th cotrol of iflatio was t a major macrocoomic policy objctiv. Th ris of iflatio was dmd to crat istabilitis i th coomy that might b dtrimtal to its log trm growth prospcts. Sharp flctatios i prics mak it difficlt for firms to valat th ral val of ftr cash flows. ric stability is also likly to b trasmittd ito omial ad ral itrst rat istability. Thrfor, i a ra of iflatio, policy-makrs saw thir rsposibility as cratig a stabl macrocoomic viromt charactrisd by low iflatio ad prdictabl itrst rats. This chag i mphasis has ld to motary policy risig i sigificac to fiscal policy. I trms of maitaiig iflatio targts fiscal policy is hamprd by a lack of flxibility (it ca oly b adjstd from tim to tim), ad is also affctd by Lcas critiq isss, as wll as havig th addd complicatio of affctig th compositio as wll as th lvl of otpt. 9. olicymakrs wold bttr attai thir macrocoomic objctivs if thy had thir discrtio tak away from thm. Discss TC I TC ( ) = α + TC I ( ) = α + I

15 olicy-makrs fac difficltis bcas low iflatio aocmts ar timicosistt. Sppos iflatio was at its tim cosistt lvl, TC, yt th govrmt wishd to rdc iflatio to a targt of. O aocmt, if this targt was crdibl th privat sctor wold rdc thir iflatio xpctatios to this lvl ad th coomy wold xpric a pailss disiflatio. Howvr, this policy is likly to work. If th privat sctor sts iflatio xpctatios qal to th govrmt facs a ictiv to lash a iflatio srpris, ad trad-off highr iflatio for lowr mploymt. This is bcas th govrmt ca mov oto a lowr idiffrc crv as a rslt. I fact, th lowst lvl of iflatio whr this ictiv dos ot xist is TC - this wold b a tim cosistt iflatio aocmt. Th difficlty, i trms of crdibility, ariss bcas th govrmt has prfrcs for both low iflatio ad mploymt ad might b prpard to xploit a short r hillips crv trad-off. If motary policy is dlgatd to a body that has o prfrc for mploymt, th th tim icosistcy problm disappars. Thr ar howvr som costs to dlgatig motary policy to a body sch as a idpdt ctral bak. First, th govrmt loss cotrol of a lvr it cold othrwis s to cotrol th coomy, so dlgatio may ivolv stabilisatio costs for otpt. Scodly, if motary ad fiscal policis hav comptig objctivs, th a lack of coordiatio cold sr that pshs th coomy towards a ifrior qilibrim positio. 0. Wold a dcras i th ctral bak s iflatio targt affct th lvl of mploymt? If motary policy is crdibl, th low iflatio aocmts wold lad dirctly to a rdctio i iflatio xpctatios. Ths will th fd throgh th pric-sttig procss ito actal iflatio. As a rslt thr is a pailss disiflatio to th w targt. For policy to b crdibl, th privat sctor has to bliv that th ctral bak wold b prpard to rais itrst rats ad psh mploymt abov th NAIRU to forc iflatio dow to targt- if cssary. Thrfor, th privat sctor wold ot s fit to try ad call th blff of th ctral bakrs. If ctral bakrs wr cocrd abot iflatio, th a ris i mploymt wold lad to a shift o a highr idiffrc crv. Udr ths coditios th rsolv of th ctral bakrs to actally tak th paifl policy actio if rqird may b wak. Thrfor, th privat sctor may b prpard to qstio whthr th w iflatio targt will b forcd.

16 I I ( ) = α + ( ) = α + Crdibility ovr iflatio aocmts thrfor ariss from th sigl-middss of ctral bakrs to targt iflatio ad igor othr possibl macrocoomic objctivs. Thr ar varios ways i which crdibility ca b achivd: - dlgatio of policy to a idpdt ctral bakr with a strog rptatio for big iflatio advrs. - dsigig cotracts to corag ctral bakrs to bhav i a particlar way - allowig th ctral bak to bild a rptatio for big togh o iflatio ovr tim.. Drig World War II, both Grmay ad Britai pritd larg amots of th othrs crrcy. Why might droppig this o a my city cas mor damag tha high xplosivs? Th basic ratioal is rlatd to th qatity thory of moy. A dramatic icras i th moy spply wold grat high lvls of iflatio, which may drmi th domstic crrcy as a mdim of xchag. This cold th lad to coomic ad political disrptio. If th crrcy bcoms worthlss th agts may hav o othr choic bt to bartr.

17 . Explai th rols of motary ad fiscal policy is dig hypriflatio. A priod of hypriflatio oft ariss wh a govrmt rs a larg dbt which is pays for by pritig moy. It ca do this by sllig bods to th ctral baks which prit moy to pay for thm- th govrmt th spds th procds. Sigorag, or th iflatio tax, rprsts th ral rsorcs accrd to th govrmt by gratig iflatio. Howvr, raisig a giv amot of sigorag rv wold rqir highr ad highr iflatio which cold lad to hypriflatio. O way to d th priod of hypriflatio is to rplac th iflatio tax with othr taxs, or throgh a rdctio i govrmt spdig. This will stabilis th lvl of dbt ad thrfor th d to motaris it. I trms of motary policy, th govrmt ds to mak a crdibl commitmt ot to fiac dficit spdig by pritig moy. Thr ar a mbr of ways i which this crdibility might b achivd. Th ctral bak cold b prvtd from byig govrmt bods. Th omial xchag rat cold b pggd to a low iflatio crrcy- a attmpt to achor xpctatios ad import disiflatio. Altrativly, th govrmt cold dollaris- thrfor ay sigorag rvs wold prtai to th US so thr is o ictiv to motaris fiscal dficits.