11/11/2018. Chapter 14 8 th and 9 th edition. Aggregate Supply and the Short-run Tradeoff Between Inflation and Unemployment.

Transcription

1 Chaptr 14 8 th and 9 th dition Aggrgat Supply and th Short-run Tradoff Btwn Inflation and Unmploymnt W covr modls of aggrgat supply in which output dpnds positivly on th pric lvl in th short run. th short-run tradoff btwn inflation and unmploymnt known as th Phillips curv. Discuss th Phillips curv formulation prsntd in Chaptr 15. Mor ralistic SRAS P LRAS All wags and prics flxibl Y Y ( P P ) P P SRAS Som wags and prics flxibl VSRAS: P = P Y SRAS in btwn th two xtrm assumptions w considrd bfor. Y All wags and prics fixd 1

2 Thr modls of aggrgat supply - 2 modls prsntd in th book 1. Th sticky-pric modl 2. Th imprfct-information modl 3. Th sticky-wag modl (not in th book) All thr modls imply: agg. output natural rat of output Y Y ( P P ) a positiv paramtr th actual pric lvl th xpctd pric lvl How th SRAS quation works P LRAS Y Y ( P P ) P P P P SRAS P P Y Y is full mploymnt output from chaptr 3 assuming prfct comptition and flxibl wags and prics. Y Th sticky-wag modl (not in th book) but convys a lsson skip th nxt group of slids on sticky wag, sticky P and mis-prcptions this smstr. I will summariz in class. Assums that firms and workrs ngotiat contracts and fix th nominal wag (W) bfor thy know what th pric lvl (P) will turn out to b. Th nominal wag, W, thy st is basd on a targt ral wag and th xpctd pric lvl: W w P 2

3 Th sticky-wag modl If it turns out that P P P P P P thn Unmploymnt and output ar at thir natural rats. Actual ral wag is lss than th targt, firms hir mor workrs and output riss abov its natural rat. Actual ral wag xcds its targt, so firms hir fwr workrs and output falls blow its natural rat. Th sticky-wag modl Implis that th ral wag should b countr-cyclical, should mov in th opposit dirction as output during businss cycls: In booms, whn P typically riss, ral wag should fall. In rcssions, whn P typically falls, ral wag should ris. This prdiction dos not com tru in th ral world which is why Mankiw droppd th thory from th book. 3

4 Prcntag chang in ral wag 11/11/2018 Th cyclical bhavior of th ral wag. Th ral wag is pro-cyclical Prcntag chang in ral GDP So What s Going ON? Sticky wag modl assum labor dmand curv dos not shift ovr th businss cycl. Th prvious slid is consistnt with dmand for labor changing ovr th businss cycl. Th quilibrium ral wag Units of output Labor supply quilibrium ral wag Labor dmand L Units of labor, L 4

5 Th imprfct-information/misprcptions modl skip this smstr Assumptions: All wags and prics ar prfctly flxibl, all markts ar clar. (drops th assumption of imprfct comptition) Each supplir producs on good and consums a lot of othrs. Each supplir knows th nominal pric of hr own good, but not all of th othr goods - dos not know th ovrall pric lvl. What shifts th curvs? R-writ in dviation form Y Y ( P P ) Y Y ( P P ) Chang in pric xpctations (P ) shifts th SAS: P = P => Y = Y P > P => Y < Y, incras in P shifts SAS up to th lft. P < P => Y > Y, dcras in P shifts SAS down to th right. 5

6 Summary & implications Suppos a positiv AD shock movs output abov its natural rat (to Y2) and P riss to P2, abov th lvl popl had xpctd. SRAS quation: Y Y ( P P ) P LRAS P3 P3 As th pric lvl P riss, ovr tim, 2 P riss. P2 P1 P1 E Th SRAS shifts up, and output rturns to its natural rat. Y3 Y1 Y H F Y 2 SRAS 2 SRAS 1 AD 2 AD 1 Y Imprfct Information - Misprcptions Thory and th Non-nutrality of Mony unanticipatd montary policy has ral ffcts; but anticipatd montary policy has no ral ffcts bcaus thr ar no misprcptions Th prvious slid showd th ffct of an unanticipatd dmand shock. For xampl, and unanticipatd chang in th mony supply. Th Misprcptions Thory and th Nonnutrality of Mony Anticipatd changs in th mony supply If popl anticipat th chang in th mony supply and thus in th pric lvl, thy arn't foold, thr ar no misprcption, and th SRAS curv shifts immdiatly to its highr lvl So anticipatd montary is nutral in both th short run and th long run 6

7 With an anticipatd incras in th mony supply, go dirctly from P1 to P3, dirctly from point E to H. Th AD and SRAS curvs shift simultanously. Notic: thr is no SR quilibrium point F. Th conomy gos dirctly from E to H P P P 2 SRAS quation: Y Y ( P P ) P P 3 3 P 1 1 LRAS Y Y Y 3 1 E H SRAS 2 SRAS 1 AD 2 AD 1 Y Inflation, Unmploymnt, and th Phillips Curv 5½ % = zro inflation 23 7

8 5½ % 24 Unmploymnt and Inflation: Is Thr a Trad-off? Som conomist think thr is a trad-off btwn inflation and unmploymnt In th 1960 s such a trad-off xistd. This suggstd that policymakrs could choos th combination of unmploymnt and inflation thy most dsird But th rlationship fll apart in th following thr dcads Th 1970s wr a particularly bad priod, with both high inflation and high unmploymnt, inconsistnt with th Phillips curv What happnd? 26 8

9 Inflation Rat 11/11/2018 Supply-Sid Inflation Inflation Advrs supply shocks Oil pric incrass: , Costs incras, prics ris, output falls, unmploymnt incrass 27 Th Phillips Curv: A Historical Prspctiv 1960 s and s 12% Unmploymnt Rat in Prcnt Supply-sid Inflation , favorabl supply shocks Lowr oil prics, advancs in tchnology Both aggrgat dmand and supply incras But aggrgat supply shiftd mor Rapid growth, lowr unmploymnt, and lowr inflation 29 9

10 Favorabl Supply Shock 30 What th Phillips Curv Is and Is Not Is a statistical rlationship btwn inflation and unmploymnt Holds if businss cycl fluctuations aris mainly from dmand with AS stabl During 1970s, 1980s, AS was not stabl. If AS shifts, th Phillips curv shifts 31 Th Phillips Curv is Not Stabl Slf-corrcting mchanism shifts th AS curv Rfrs to th way mony wags rspond to rcssionary or xpansionary gaps Wag changs shift th aggrgat supply curv Effcting quilibrium ral GDP and th pric lvl Th Phillips curv shifts 32 10

11 Inflation, Unmploymnt, and th Augmntd Phillips curv Th Phillips curv stats that π dpnds on: xpctd inflation, Eπ cyclical unmploymnt: th dviation of th actual rat of unmploymnt from th natural rat supply shocks, (Grk lttr nu ). E ( u u n ) whr β > 0 is an xognous constant. Driving th Phillips curv from SRAS (1) Y Y ( P EP) (2) P EP (1 )( Y Y ) (3) P EP (1 )( Y Y) (4) ( P P ) ( EP P ) (1 )( Y Y ) 1 1 (5) E (1 )( Y Y) n (6) (1 )( Y Y) ( u u ) Okun s Law n (7) E ( u u ) Chaptr 15 stops at quation (5) Comparing SRAS and th Phillips curv Phillips curv: SRAS: Y Y ( P EP) E ( u u n ) SRAS curv: Output is rlatd to unxpctd movmnts in th pric lvl. Phillips curv: Unmploymnt is rlatd to unxpctd movmnts in th inflation rat. 11

12 Adaptiv xpctations Adaptiv xpctations: an approach that assums popl form thir xpctations of futur inflation basd on rcntly obsrvd inflation. A simpl vrsion: Expctd inflation = last yar s actual inflation E 1 Thn, Phillips curv quation bcoms n 1 ( u u ) Inflation inrtia n 1 ( u u ) In this form, th Phillips curv implis that inflation has inrtia: In th absnc of supply shocks or cyclical unmploymnt, inflation will continu indfinitly at its currnt rat: π = π -1 Past inflation influncs xpctations of currnt inflation, which in turn influncs th wags & prics that popl st. Two causs of rising & falling inflation n 1 ( u u ) cost-push inflation: inflation rsulting from supply shocks Advrs supply shocks typically rais production costs and induc firms to rais prics, pushing inflation up. dmand-pull inflation: inflation rsulting from dmand shocks Positiv shocks to aggrgat dmand caus unmploymnt to fall blow its natural rat, which pulls th inflation rat up. 12

13 Graphing th Phillips curv In th short run, policymakrs fac a tradoff btwn and u. E E ( u u n ) 1 Th short-run Phillips curv n u u Hr, th short run is th priod until popl adjust thir xpctations of inflation Shifting th Phillips curv Popl adjust thir xpctations ovr tim, so th tradoff only holds in th short run. E 2 E 1 E ( u u n ) E.g., an incras in E shifts th short-run P.C. upward. n u u currnt inflation Chaptr 15 - Th Phillips Curv t Et 1 t ( Yt Yt ) t prviously xpctd inflation 0 indicats how much inflation rsponds whn output fluctuats around its natural lvl supply shock, random and zro on avrag At full mploymnt, actual inflation = xpctd. As Y riss abov full mploymnt, inflation riss. As Y falls blow full mploymnt, inflation falls. 13

14 Th Dynamic Aggrgat Supply Curv (DAS) Th DAS curv shows a rlation btwn output and inflation that coms from th Phillips Curv and Adaptiv Expctations: t t 1 ( Yt Yt ) t (DAS) Th Dynamic Aggrgat Supply Curv π t t 1 ( Yt Yt ) t DAS t DAS slops upward: high lvls of output ar associatd with high inflation dmand pull inflation. Y DAS shifts in rspons to changs in prvious priod s inflation, th natural lvl of output, and supply shocks. Th Dynamic Aggrgat Supply Curv π Y t π t = t-1 A DAS t Y t =Y Y 14

15 THE COST OF REDUCING INFLATION To rduc inflation, policy makrs can contract aggrgat dmand, causing unmploymnt to ris abov th natural lvl. Th conomy must ndur a priod of high unmploymnt and low output. Whn th Fd combats inflation, th conomy movs down th short-run Phillips curv. Th conomy xprincs lowr inflation but at th cost of highr unmploymnt. Exampl: Considr an conomy in which inflation has bn stady at 13 prcnt pr yar for svral yars. Assum firms and housholds form thir xpctations on th basis of past xprinc (adaptiv or backward-looking xpctations) vryon will xpct inflation for th coming yar to b 13 prcnt. Thus, labor ngotiations will nsur a 13 prcnt ris in wags. Firms xpct thir input costs to ris by 13 prcnt so thy will rais thir prics by 13 prcnt as wll. Th Fd must b incrasing th mony supply 13 prcnt pr yar as wll. Exampl In this scnario, at full mploymnt with 13% inflation. Now, suppos th Fd wishs to brak this cost-pric spiral and bring down th rat of inflation. Th only way to induc firms to rais prics by lss than 13 prcnt is to crat a situation whr thy ar unabl to sll thir output at currntly plannd prics. 15

16 Exampl: Similarly, th only way to induc workrs to accpt lss than a 13 prcnt ris in thir wags is to crat xcss supply in th labor markt, so that comptition for scarc jobs will lad to a slowr rat of wag growth. Crat a rcssion!!! To crat th rcssion, th Fd simply nds to cut th growth rat of th mony supply blow prcnt. Initially, with prics still rising at 13 prcnt, th dmand for mony will b rising fastr than th supply of mony causing th intrst rat to ris and invstmnt to fall. Th rsult is a dclin in aggrgat xpnditur and a dclin in output, togthr with a slowing down of wag and pric incrass. Th Volckr Disinflation Whn Paul Volckr bcam Fd chairman in 1979, inflation was widly viwd as on of th nation s formost problms. Volckr succdd in rducing inflation (from 10 prcnt to 4 prcnt), but at th cost of high mploymnt (about 10 prcnt in 1983). U.S. Inflation Rat 16

17 Th Volckr Disinflation: Inflation Rat (prcnt pr yar) 10 8 A C 1986 B Unmploymnt Rat (prcnt) Copyright 2004 South-Wstrn Th Volckr Disinflation Inflation Rat (prcnt pr yar) 10 8 A 1979 LRPC SRPC C 1986 B 1983 SRPC3 SRPC2 SRPC Unmploymnt Rat (prcnt) Copyright 2004 South-Wstrn Th Grnspan Era Alan Grnspan s trm as Fd chairman (1987) bgan with a favorabl supply shock. In 1986, OPEC mmbrs abandond thir agrmnt to rstrict supply. This ld to falling inflation and falling unmploymnt. 17

18 Th Grnspan Era Inflation Rat (prcnt pr yar) Unmploymnt Rat (prcnt) Copyright 2004 South-Wstrn Rational xpctations Ways of modling th formation of xpctations: adaptiv xpctations: Popl bas thir xpctations of futur inflation on rcntly obsrvd inflation. rational xpctations: Popl bas thir xpctations on all availabl information, including information about currnt and prospctiv futur policis. Expctations adjust quickly. Th trad-off btwn inflation and unmploymnt disappars quickly. Painlss disinflation? Proponnts of rational xpctations bliv that th cost of rducing inflation may b vry small: Suppos u = u n and = = 6%, and suppos th Fd announcs that it will do whatvr is ncssary to rduc inflation from 6 to 2 prcnt as soon as possibl. If th announcmnt is crdibl, thn will fall, prhaps by th full 4 points. Thn, can fall without an incras in u. 18

19 Th natural rat hypothsis Th analysis of th costs of disinflation, and of conomic fluctuations in th prcding chaptrs, is basd on th natural rat hypothsis: Changs in aggrgat dmand affct output and mploymnt only in th short run. In th long run, th conomy rturns to th lvls of output, mploymnt, and unmploymnt dscribd by th classical modl (Chap. 3). Allows conomist to study SR and LR sparatly. An altrnativ hypothsis: Hystrsis Rad th first or 5 pags of th Ylln Prsntation Hystrsis: th long-lasting influnc of history on variabls such as th natural rat of unmploymnt. A rcssion (ngativ dmand shock) may incras u n, so conomy may not fully rcovr. Hystrsis: Why ngativ shocks may incras th natural rat Th skills of cyclically unmployd workrs may dtriorat whil unmployd, and thy may not find a job whn th rcssion nds. Cyclically unmployd workrs may los thir influnc on wag-stting; thn, insidrs (mployd workrs) may bargain for highr wags for thmslvs. Rsult: Th cyclically unmployd outsidrs may bcom structurally unmployd whn th rcssion nds. 19

20 Mankiw NYT Articl 11/23/13 Th most arrsting pic of conomic data is in th numbr of wks th avrag unmployd prson has bn looking for work statistics that hav bn compild sinc Until rcntly, th largst such figur was 22 wks, in th aftrmath of th dp rcssion of In th most rcnt rcssion, howvr, th avrag rachd about 41 wks, and it still stands at mor than 36 wks (Oct 2014 at 32.7; Oct 2015 at 28.9). In othr words, aftr mor than four yars of rcovry, th conomy still has an unprcdntd numbr of longtrm unmployd. Mankiw NYT Articl 11/23/13 Som conomists bliv that long-trm unmploymnt lavs prmannt scars on th conomy a thory calld hystrsis. On possibl rason for hystrsis is that th long-trm unmployd los valuabl job skills and, ovr tim, bcom lss committd to th labor markt. In som ways, prhaps, thy should b thought of as ffctivly out of th labor forc. If this thory is right, th labor markt today may hav lss slack than th unmploymnt rat and th mploymnt-to-population ratio suggst. Policy makrs at th Fd may hav to accpt that lowr mploymnt is th nw normal. highr unmploymnt is th nw normal. 20

21 Chaptr Summary 1. Thr modls of aggrgat supply in th short run: sticky-wag modl imprfct-information modl sticky-pric modl All thr modls imply that output riss abov its natural rat whn th pric lvl riss abov th xpctd pric lvl. Chaptr Summary 2. Phillips curv drivd from th SRAS curv stats that inflation dpnds on xpctd inflation cyclical unmploymnt supply shocks prsnts policymakrs with a short-run tradoff btwn inflation and unmploymnt Chaptr Summary 3. How popl form xpctations of inflation adaptiv xpctations basd on rcntly obsrvd inflation implis inrtia rational xpctations basd on all availabl information implis that disinflation may b painlss 21

22 Chaptr Summary 4. Th natural rat hypothsis and hystrsis th natural rat hypothss stats that changs in aggrgat dmand can only affct output and mploymnt in th short run hystrsis stats that aggrgat dmand can hav prmannt ffcts on output and mploymnt 22