Larig objctivs thr modls of aggrgat supply i which output dpds positivly o th pric lvl i th short ru th short-ru tradoff btw iflatio ad umploymt kow as th Phillips curv Aggrgat Supply slid 1 Thr modls of aggrgat supply 1. Th sticky-wag modl 2. Th imprfct-iformatio modl 3. Th sticky-pric modl All thr modls imply: agg. output atural rat of output Y = Y + α ( P P a positiv paramtr th actual pric lvl th xpctd pric lvl Aggrgat Supply slid 2 1
Th sticky-wag modl Assums that firms ad workrs gotiat cotracts ad fix th omial wag bfor thy kow what th pric lvl will tur out to b. Th omial wag, W, thy st is th product of a targt ral wag, ω, ad th xpctd pric lvl: W = ω P W P = ω P P Aggrgat Supply slid 3 Th sticky-wag modl W P = ω P P If it turs out that P = P P > P P < P th umploymt ad output ar at thir atural rats Ral wag is lss tha its targt, so firms hir mor workrs ad output riss abov its atural rat Ral wag xcds its targt, so firms hir fwr workrs ad output falls blow its atural rat Aggrgat Supply slid 4 2
Aggrgat Supply slid 5 Th sticky-wag modl Implis that th ral wag should b coutrcyclical, it should mov i th opposit dirctio as output ovr th cours of busiss cycls: I booms, wh P typically riss, th ral wag should fall. I rcssios, wh P typically falls, th ral wag should ris. This prdictio dos ot com tru i th ral world: Aggrgat Supply slid 6 3
Th cyclical bhavior of th ral wag Prctag chag i ral4 wag 3 2 1 1960 1998 1997 1999 1972 1965 0-1 -2 1982 1991 1975 1970 1990 1993 1992 1996 2000 1984-3 1974 1979-4 1980-5 -3-2 -1 0 1 2 3 4 5 6 7 8 Prctag chag i ral GDP Aggrgat Supply slid 7 Th imprfct-iformatio iformatio modl Assumptios: all wags ad prics prfctly flxibl, all markts clar ach supplir producs o good, cosums may goods ach supplir kows th omial pric of th good sh producs, but dos ot kow th ovrall pric lvl Aggrgat Supply slid 8 4
Th imprfct-iformatio iformatio modl Supply of ach good dpds o its rlativ pric: th omial pric of th good dividd by th ovrall pric lvl. Supplir dos t kow pric lvl at th tim sh maks hr productio dcisio, so uss th xpctd pric lvl, P. Suppos P riss but P dos ot. Th supplir thiks hr rlativ pric has ris, so sh producs mor. With may producrs thikig this way, Y will ris whvr P riss abov P. Aggrgat Supply slid 9 Th sticky-pric modl Rasos for sticky prics: log-trm cotracts btw firms ad customrs mu costs firms do ot wish to aoy customrs with frqut pric chags Assumptio: Firms st thir ow prics (.g. as i moopolistic comptitio Aggrgat Supply slid 10 5
Th sticky-pric modl A idividual firm s dsird pric is p = P + a ( Y Y whr a > 0. Suppos two typs of firms: firms with flxibl prics, st prics as abov firms with sticky prics, must st thir pric bfor thy kow how P ad Y will tur out: p = P + a ( Y Y Aggrgat Supply slid 11 Th sticky-pric modl p = P + a ( Y Y Assum firms w/ sticky prics xpct that output will qual its atural rat. Th, p = P To driv th aggrgat supply curv, w first fid a xprssio for th ovrall pric lvl. Lt s dot th fractio of firms with sticky prics. Th, w ca writ th ovrall pric lvl as Aggrgat Supply slid 12 6
Th sticky-pric modl P = s P + (1 s[ P + a( Y Y ] pric st by sticky pric firms pric st by flxibl pric firms Subtract (1 s P from both sids: sp = s P + (1 s [ a( Y Y ] Divid both sids by s : (1 s a P = P + ( Y Y s Aggrgat Supply slid 13 Th sticky-pric modl (1 s a P = P + ( Y Y s High P High P If firms xpct high prics, th firms who must st prics i advac will st thm high. Othr firms rspod by sttig high prics. High Y High P Wh icom is high, th dmad for goods is high. Firms with flxibl prics st high prics. Th gratr th fractio of flxibl pric firms, th smallr is s ad th biggr is th ffct of ΔY o P. Aggrgat Supply slid 14 7
Th sticky-pric modl (1 s a P = P + ( Y Y s Fially, driv AS quatio by solvig for Y : Y = Y + α ( P P, whr α = s (1 s a Aggrgat Supply slid 15 Th sticky-pric modl I cotrast to th sticky-wag modl, th stickypric modl implis a procyclical ral wag: Suppos aggrgat output/icom falls. Th, Firms s a fall i dmad for thir products. Firms with sticky prics rduc productio, ad hc rduc thir dmad for labor. Th lftward shift i labor dmad causs th ral wag to fall. Aggrgat Supply slid 16 8
Summary & implicatios P LRAS Y = Y + α ( P P P > P P = P P < P Y SRAS Y Each of th thr modls of agg. supply imply th rlatioship summarizd by th SRAS curv & quatio Aggrgat Supply slid 17 Suppos a positiv AD shock movs output abov its atural rat ad P abov th lvl popl had xpctd. Summary & implicatios Ovr tim, P riss, SRAS shifts up, P 2 = ad output rturs to its atural rat. SRAS quatio: Y = Y + α ( P P P = P P = P P 3 3 P 2 1 1 LRAS SRAS 2 SRAS 1 AD 2 AD 1 Y 3 = 1 Aggrgat Supply slid 18 Y = Y Y 2 Y 9
Iflatio, Umploymt, ad th Phillips Curv Th Phillips curv stats that π dpds o xpctd iflatio, π cyclical umploymt: th dviatio of th actual rat of umploymt from th atural rat supply shocks, ν π = π β( u u + ν whr β > 0 is a xogous costat. Aggrgat Supply slid 19 Drivig th Phillips Curv from SRAS (1 Y = Y + α ( P P (2 P = P + (1 α ( Y Y (3 P = P + (1 α ( Y Y + ν (4 ( P P = ( P P + (1 α ( Y Y + ν 1 1 (5 π = π + (1 α( Y Y + ν (6 (1 α( Y Y = β( u u (7 π = π β( u u + ν Aggrgat Supply slid 20 10
Th Phillips Curv ad SRAS SRAS: Y = Y + α ( P P Phillips curv: π = π β( u u + ν SRAS curv: output is rlatd to uxpctd movmts i th pric lvl Phillips curv: umploymt is rlatd to uxpctd movmts i th iflatio rat Aggrgat Supply slid 21 Adaptiv xpctatios Adaptiv xpctatios: a approach that assums popl form thir xpctatios of futur iflatio basd o rctly obsrvd iflatio. A simpl xampl: Expctd iflatio = last yar s actual iflatio π π 1 Th, th P.C. bcoms = π = π 1 β( u u + ν Aggrgat Supply slid 22 11
Iflatio irtia π = π 1 β( u u + ν I this form, th Phillips curv implis that iflatio has irtia: I th absc of supply shocks or cyclical umploymt, iflatio will cotiu idfiitly at its currt rat. Past iflatio iflucs xpctatios of currt iflatio, which i tur iflucs th wags & prics that popl st. Aggrgat Supply slid 23 Two causs of risig & fallig iflatio π = π 1 β( u u + ν cost-push iflatio: iflatio rsultig from supply shocks. Advrs supply shocks typically rais productio costs ad iduc firms to rais prics, pushig iflatio up. dmad-pull iflatio: iflatio rsultig from dmad shocks. Positiv shocks to aggrgat dmad caus umploymt to fall blow its atural rat, which pulls th iflatio rat up. Aggrgat Supply slid 24 12
Graphig th Phillips curv I th short ru, policymakrs fac a trad- off btw π ad u. π + ν π π = π β( u u + ν β 1 Th short-ru Phillips Curv u u Aggrgat Supply slid 25 Shiftig th Phillips curv Popl adjust thir xpctatios ovr tim, so th tradoff oly holds i th short ru. π π 2 1 + ν + ν π π = π β( u u + ν E.g., a icras i π shifts th short- ru P.C. upward. u u Aggrgat Supply slid 26 13
Th sacrific ratio To rduc iflatio, policymakrs ca cotract agg. dmad, causig umploymt to ris abov th atural rat. Th sacrific ratio masurs th prctag of a yar s ral GDP that must b forgo to rduc iflatio by 1 prctag poit. Estimats vary, but a typical o is 5. Aggrgat Supply slid 27 Th sacrific ratio Suppos policymakrs wish to rduc iflatio from 6 to 2 prct. If th sacrific ratio is 5, th rducig iflatio by 4 poits rquirs a loss of 4 5 = 20 prct of o yar s GDP. This could b achivd svral ways,.g. rduc GDP by 20% for o yar rduc GDP by 10% for ach of two yars rduc GDP by 5% for ach of four yars Th cost of disiflatio is lost GDP. O could us Oku s law to traslat this cost ito umploymt. Aggrgat Supply slid 28 14
Ratioal xpctatios Ways of modlig th formatio of xpctatios: adaptiv xpctatios: Popl bas thir xpctatios of futur iflatio o rctly obsrvd iflatio. ratioal xpctatios: Popl bas thir xpctatios o all availabl iformatio, icludig iformatio about currt ad prospctiv futur policis. Aggrgat Supply slid 29 Pailss disiflatio? Propots of ratioal xpctatios bliv that th sacrific ratio may b vry small: Suppos u = u ad π = π = 6%, ad suppos th Fd aoucs that it will do whatvr is cssary to rduc iflatio from 6 to 2 prct as soo as possibl. If th aoucmt is crdibl, th π will fall, prhaps by th full 4 poits. Th, π ca fall without a icras i u. Aggrgat Supply slid 30 15
Th sacrific ratio for th Volckr disiflatio 1981: π = 9.7% 1985: π = 3.0% Total disiflatio = 6.7% yar u u u u 1982 9.5% 6.0% 3.5% 1983 9.5 6.0 3.5 1984 7.4 6.0 1.4 1985 7.1 6.0 1.1 Total 9.5% Aggrgat Supply slid 31 Th sacrific ratio for th Volckr disiflatio Prvious slid: iflatio fll by 6.7% total of 9.5% of cyclical umploymt Oku s law: ach 1 prctag poit of umploymt implis lost output of 2 prctag poits. So, th 9.5% cyclical umploymt traslats to 19.0% of a yar s ral GDP. Sacrific ratio = (lost GDP/(total disiflatio = 19/6.7 = 2.8 prctag poits of GDP wr lost for ach 1 prctag poit rductio i iflatio. Aggrgat Supply slid 32 16
Th atural rat hypothsis Our aalysis of th costs of disiflatio, ad of coomic fluctuatios i th prcdig chaptrs, is basd o th atural rat hypothsis: Chags i i aggrgat dmad affct output ad ad mploymt oly oly i i th th short ru. ru. I I th th log log ru, ru, th th coomy rturs to to th th lvls of of output, mploymt, ad ad umploymt dscribd by by th th classical modl (chaptrs 3-8. 3 Aggrgat Supply slid 33 A altrativ hypothsis: hystrsis Hystrsis: th log- lastig ifluc of history o variabls such as th atural rat of umploymt. Ngativ shocks may icras u, so coomy may ot fully rcovr: Th skills of cyclically umployd workrs dtriorat whil umployd, ad thy caot fid a job wh th rcssio ds. Cyclically umployd workrs may los thir ifluc o wag- sttig; isidrs (mployd workrs may th bargai for highr wags for thmslvs. Th, th cyclically umployd outsidrs may bcom structurally umployd wh th rcssio ds. Aggrgat Supply slid 34 17
Chaptr summary 1. Thr modls of aggrgat supply i th short ru: sticky-wag modl imprfct-iformatio modl sticky-pric modl All thr modls imply that output riss abov its atural rat wh th pric lvl falls blow th xpctd pric lvl. Aggrgat Supply slid 35 Chaptr summary 2. Phillips curv drivd from th SRAS curv stats that iflatio dpds o xpctd iflatio cyclical umploymt supply shocks prsts policymakrs with a short-ru tradoff btw iflatio ad umploymt Aggrgat Supply slid 36 18
Chaptr summary 3. How popl form xpctatios of iflatio adaptiv xpctatios basd o rctly obsrvd iflatio implis irtia ratioal xpctatios basd o all availabl iformatio implis that disiflatio may b pailss Aggrgat Supply slid 37 Chaptr summary 4. Th atural rat hypothsis ad hystrsis th atural rat hypothss stats that chags i aggrgat dmad ca oly affct output ad mploymt i th short ru hystrsis stats that agg. dmad ca hav prmat ffcts o output ad mploymt Aggrgat Supply slid 38 19
Aggrgat Supply slid 39 20