Transcript sticky wages

CHAPTER 14 The Labor Market In the Macroeconomy
Eco 106 W8B
Contrasting Views of
Inflation and Unemployment
Case-Fair Ch 14
1.
2.
Unemployment Types and Flows
Classical and Keynesian views of the
Labor Market
3. The Phillips Curve
1. Inflation expectations
2. US supply and demand shocks
4. Okun’s Law
5. The Taylor Rule and the FAIR model
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The Labor Market: Basic Concepts
The labor force (LF) is the number of employed
plus unemployed:
CHAPTER 14 The Labor Market In the Macroeconomy
LF = E + U
unemployment rate The number of people
unemployed as a percentage of the labor force.
Unemployment rate = U/LF
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CHAPTER 14 The Labor Market In the Macroeconomy
The Labor Market: Basic Concepts
frictional unemployment The portion of
unemployment that is due to the normal working of
the labor market; used to denote short-run job/skill
matching problems.
structural unemployment The portion of
unemployment that is due to changes in the
structure of the economy that result in a significant
loss of jobs in certain industries.
cyclical unemployment The increase in
unemployment that occurs during recessions and
depressions.
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Ue Duration
CHAPTER 14 The Labor Market In the Macroeconomy
Most spells are short but at any moment in time the
Unemployed population is dominated by longer term
Unemployed. For example suppose:
2 mo. Spells, 60m spells for the year, 10m at any time
1 yr spells, 20m spells, 20m at any time
Average spell= (60/80)2 mo+(20/80)12mo=4.5
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CHAPTER 14 The Labor Market In the Macroeconomy
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Change in employment status in a typical month
CHAPTER 14 The Labor Market In the Macroeconomy
The US labor market has huge “churn” relative to the net change in employment.
Net Change in Employment here is -0.36,
that is 1/5th of one percent of the Employed
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CHAPTER 14 The Labor Market In the Macroeconomy
Employment Situation
Has both Household and Establishment Data
Household survey has been showing more
job growth.
Changes are small in comparison to totals
The Employment Situation from the BLS
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CHAPTER 14 The Labor Market In the Macroeconomy
BLS retrieved 10 Jan 2009, http://www.bls.gov/LAU
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CHAPTER 14 The Labor Market In the Macroeconomy
BLS retrieved 10 Jan 2009, http://www.bls.gov/LAU
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CHAPTER 14 The Labor Market In the Macroeconomy
Big Numbers
2.4 million jobs lost (reduction in employment)
over 2008.
1.9m in last 4 months of year (post panic from
Lehman Brothers collapse.)
2.6m long term unemployed (27 weeks or
more). (Table A-12, Current Employment
Situation, Friday Jan 9 2009)
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CHAPTER 14 The Labor Market In the Macroeconomy
2 sources of employment data
household
establishment
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CHAPTER 14 The Labor Market In the Macroeconomy
2 Classical vs Keynesian Views of the
Labor Market
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The Classical View of the Labor Market
CHAPTER 14 The Labor Market In the Macroeconomy
labor demand curve A graph that illustrates the
amount of labor that firms want to employ at each
given wage rate.
labor supply curve A graph that illustrates the
amount of labor that households want to supply at
each given wage rate.
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CHAPTER 14 The Labor Market In the Macroeconomy
The Classical View of the Labor Market
 FIGURE 14.1 The Classical Labor Market
Classical economists believe that the labor market always clears. If the demand for labor shifts from D0 to D1,
the equilibrium wage will fall from W0 to W1. Anyone who wants a job at W1 will have one.
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The Classical View of the Labor Market
CHAPTER 14 The Labor Market In the Macroeconomy
The Classical Labor Market and the Aggregate Supply Curve
The classical idea that wages adjust to clear the
labor market is consistent with the view that wages
respond quickly to price changes. This means that
the AS curve is vertical.
When the AS curve is vertical, monetary and fiscal
policy cannot affect the level of output and
employment in the economy.
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Sticky Wages vs Market Clearing
W
CHAPTER 14 The Labor Market In the Macroeconomy
With a perfectly functioning
market an adverse supply
shock will lower wages
and employment.
S
D
D’
N
With “sticky wages” that shock
would cause a greater fall
in employment as well as
unemployment rather than
a falling real wage.
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W
S
D
D’
N
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CHAPTER 14 The Labor Market In the Macroeconomy
Keynesian vs Classical View of Ue
K view: shocks to labor demand come from both
the supply side (productivity and oil prices)
and the demand side (C+I+G+X-IM).
sticky wages cause labor demand shocks to
become unemployment rather than lower wages.
C view: shocks to labor demand come essentially
from productivity shocks.
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The Classical View of the Labor Market
CHAPTER 14 The Labor Market In the Macroeconomy
The Unemployment Rate and the Classical View
The unemployment rate is not necessarily an
accurate indicator of whether the labor market is
working properly.
The measured unemployment rate may
sometimes seem high even though the labor
market is working well.
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Explaining the Existence of Unemployment
Sticky Wages
CHAPTER 14 The Labor Market In the Macroeconomy
sticky wages The downward rigidity of wages as
an explanation for the existence of unemployment.
 FIGURE 14.2 Sticky Wages
If wages “stick” at W0 instead of
falling to the new equilibrium wage
of W* following a shift of demand
from D0 to D1, the result will be
unemployment equal to L0 - L1.
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Explaining the Existence of Unemployment
Sticky Wages
CHAPTER 14 The Labor Market In the Macroeconomy
Social, or Implicit, Contracts
social, or implicit, contracts Unspoken
agreements between workers and firms that firms
will not cut wages.
relative-wage explanation of unemployment
An explanation for sticky wages (and therefore
unemployment): If workers are concerned about
their wages relative to other workers in other firms
and industries, they may be unwilling to accept a
wage cut unless they know that all other workers
are receiving similar cuts.
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Explaining the Existence of Unemployment
Sticky Wages
CHAPTER 14 The Labor Market In the Macroeconomy
Explicit Contracts
explicit contracts Employment contracts that
stipulate workers’ wages, usually for a period of 1
to 3 years.
cost-of-living adjustments (COLAs) Contract
provisions that tie wages to changes in the cost of
living. The greater the inflation rate, the more
wages are raised.
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Explaining the Existence of Unemployment
Sticky Wages
CHAPTER 14 The Labor Market In the Macroeconomy
Explicit Contracts
Graduate School
Applications in
Recessions
Graduate School Offers
Relief During Economic
Recession
Oklahoma Daily
(U. Oklahoma)
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Explaining the Existence of Unemployment
CHAPTER 14 The Labor Market In the Macroeconomy
Efficiency Wage Theory
efficiency wage theory An explanation for
unemployment that holds that the productivity of
workers increases with the wage rate. If this is so,
firms may have an incentive to pay wages above
the market-clearing rate.
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Explaining the Existence of Unemployment
CHAPTER 14 The Labor Market In the Macroeconomy
Imperfect Information
Firms may not have enough information at their
disposal to know what the market-clearing wage
is. In this case, firms are said to have imperfect
information.
If firms have imperfect or incomplete information,
they may set wages wrong—wages that do not
clear the labor market.
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Explaining the Existence of Unemployment
CHAPTER 14 The Labor Market In the Macroeconomy
Minimum Wage Laws
minimum wage laws Laws that set a floor for
wage rates—that is, a minimum hourly rate for any
kind of labor.
An Open Question
The aggregate labor market is very complicated,
and there are no simple answers to why there is
unemployment.
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CHAPTER 14 The Labor Market In the Macroeconomy
3 The Phillips Curve
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The Short-Run Relationship Between
the Unemployment Rate and Inflation
CHAPTER 14 The Labor Market In the Macroeconomy
In the short run, the unemployment rate (U) and
aggregate output (income) (Y) are negatively
related.
 FIGURE 14.3 The Aggregate
Supply Curve
The AS curve shows a positive
relationship between the price
level (P) and aggregate output
(income) (Y).
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CHAPTER 14 The Labor Market In the Macroeconomy
The Short-Run Relationship Between
the Unemployment Rate and Inflation
This curve shows a
negative relationship
between the price
level (P) and the
unemployment rate
(U). As the
unemployment rate
declines in response
to the economy’s
moving closer and
closer to capacity
output, the price
level rises more and
more.
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The Short-Run Relationship Between
the Unemployment Rate and Inflation
CHAPTER 14 The Labor Market In the Macroeconomy
inflation rate The percentage change in the price
level.
Phillips Curve A curve showing the relationship
between the inflation rate and the unemployment
rate.
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CHAPTER 14 The Labor Market In the Macroeconomy
The Short-Run Relationship Between
the Unemployment Rate and Inflation
The Phillips
Curve shows
the relationship
between the
inflation rate
and the
unemployment
rate.
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The Short-Run Relationship Between
the Unemployment Rate and Inflation
CHAPTER 14 The Labor Market In the Macroeconomy
The Phillips Curve: A Historical Perspective
During the
1960s, there
seemed to be an
obvious trade-off
between inflation
and
unemployment.
Policy debates
during the period
revolved around
this apparent
trade-off.
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CHAPTER 14 The Labor Market In the Macroeconomy
In the 1950’s 60’s and 70’s the two political
parties were associated with different
preferences regarding where the economy
should operate on the Phillips curve
I
n
f
l
a
t
i
o
n
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Unemployment
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The Short-Run Relationship Between
the Unemployment Rate and Inflation
CHAPTER 14 The Labor Market In the Macroeconomy
The Phillips Curve: A Historical Perspective
From the 1970s
on, it became
clear that the
relationship
between
unemployment
and inflation was
anything but
simple.
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The Short-Run Relationship Between
the Unemployment Rate and Inflation
CHAPTER 14 The Labor Market In the Macroeconomy
Aggregate Supply and Aggregate Demand Analysis and the
Phillips Curve
 FIGURE 14.8 Changes in the Price Level and Aggregate Output Depend on Shifts in Both
Aggregate Demand and Aggregate Supply
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CHAPTER 14 The Labor Market In the Macroeconomy
In the 1960’s the Phillips curve was viewed as a stable trade off
Between inflation and unemployment. It is a menu, we thought.
Just pick which point you like best.
Able and Bernanke Figure 12.01
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2009 Pearson
Education,
Inc. Publishing
PrenticeU.S.
Hall Principles
of Macroeconomics
9e by
Case,1960s
Fair and Oster
The
Phillips
curve
andas the
economy
during
the
US 1942-68
USA Phillips Curve Data 1948-1959
20
10
Inflation
CHAPTER 14 The Labor Market In the Macroeconomy
15
5
0
0
1
2
3
4
5
6
7
-5
-10
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Unemployment
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Demand Pull then Supply Push
Pi is the inflation rate.
There is a special point
on any Phillips curve
that shows the
natural rate of
unemployment and
the expected rate of
inflation.
CHAPTER 14 The Labor Market In the Macroeconomy

Unemployment rate
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Demand Pull then Supply Push
CHAPTER 14 The Labor Market In the Macroeconomy

In the late 60’ the economy stayed above
expected inflation and so inflation
expectations rose.
Late 60’s
Phillips Curve of 1970’s
Phillips Curve of 1960’s
Unemployment rate
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The Short-Run Relationship Between
the Unemployment Rate and Inflation
CHAPTER 14 The Labor Market In the Macroeconomy
Expectations and the Phillips Curve
Expectations are self-fulfilling. This
means that wage inflation is affected
by expectations of future price
inflation.
Price expectations that affect wage
contracts eventually affect prices
themselves.
Inflationary expectations shift the
Phillips Curve up and to the right.
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USA 1970s
14
12
inflation
CHAPTER 14 The Labor Market In the Macroeconomy
10
8
6
4
2
0
0
1
2
3
4
5
6
7
8
9
unemployment
Late 1960’s Demand Pull Inflation
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The Short-Run Relationship Between
the Unemployment Rate and Inflation
CHAPTER 14 The Labor Market In the Macroeconomy
Aggregate Supply and Aggregate Demand Analysis and the
Phillips Curve
The Role of Import Prices
 FIGURE 14.9 The Price of Imports, 1960 I–2007 IV
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USA 1980's
12
10
2nd Oil Shock
inflation
CHAPTER 14 The Labor Market In the Macroeconomy
8
6
4
2
0
0
2
4
6
8
10
unemployment
1979 Oil Shock and After
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USA 1990-2000
5
4.5
4
3.5
inflation
CHAPTER 14 The Labor Market In the Macroeconomy
3
2.5
2
1.5
1
0.5
0
0
1
2
3
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5
6
7
8
unemployment
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Why Can’t I Draw?
79
CHAPTER 14 The Labor Market In the Macroeconomy
inf
Early 80’s
73
End
60’s
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Late 90’s
Ue
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The Short-Run Relationship Between
the Unemployment Rate and Inflation
CHAPTER 14 The Labor Market In the Macroeconomy
Is There a Short-Run Trade-Off between Inflation and
Unemployment?
There is a short-run trade-off between
inflation and unemployment, but other
factors besides unemployment affect
inflation. Policy involves more than
simply choosing a point along a nice
smooth curve.
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CHAPTER 14 The Labor Market In the Macroeconomy
The Long-Run Aggregate Supply Curve, Potential Output, and the
Natural Rate of Unemployment
 FIGURE 14.10 The Long-Run Phillips Curve: The Natural Rate of Unemployment
If the AS curve is vertical in the long run, so is the Phillips Curve. In the long run, the Phillips Curve
corresponds to the natural rate of unemployment—that is, the unemployment rate that is consistent
with the notion of a fixed long-run output at potential output. U* is the natural rate of unemployment.
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CHAPTER 14 The Labor Market In the Macroeconomy
The Long-Run Aggregate Supply Curve, Potential Output, and the
Natural Rate of Unemployment
natural rate of unemployment The
unemployment that occurs as a
normal part of the functioning of the
economy. Sometimes taken as the
sum of frictional unemployment and
structural unemployment.
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The Long-Run Aggregate Supply Curve, Potential Output, and the
Natural Rate of Unemployment
CHAPTER 14 The Labor Market In the Macroeconomy
The Nonaccelerating Inflation Rate of Unemployment (NAIRU)
To the left of the
NAIRU, the price level
is accelerating
(positive changes in
the inflation rate); to
the right of the NAIRU,
the price level is
decelerating (negative
changes in the
inflation rate).
Only at the NAIRU is
inflation constant.
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CHAPTER 14 The Labor Market In the Macroeconomy
4 Okun’s Law
Only mentioned in passing by Fair,
useful for your paper!
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Okun’s law
CHAPTER 14 The Labor Market In the Macroeconomy
How does unemployment vary with output.
How does unemployment vary in response to the
Growth rate of output?
What is the potential growth rate of the economy?
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CHAPTER 14 The Labor Market In the Macroeconomy
Arthur Okun’s Level Law
When real GDP is 2 percentage
points below the full-employment level
of GDP the unemployment rate will exceed
the natural rate of unemployment (The
NAIRU) by 1 %.
The level version as an equation:
%GDP gap = 2(u – u natural),
where u is measured in percentage points,
i.e., u = 5.5%, not .055.
http://www.amherst.edu/~econ53/Okun.PDF
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CHAPTER 14 The Labor Market In the Macroeconomy
Okun’s Growth Rate Law
II. The basic idea underlying the growth rate version is that when
output grows more slowly than full employment output,
unemployment will rise (i.e., the utilization of productive factors will
be falling). This version of Okun’s Law is particularly useful for
forecasting:
For every 2 percentage points that the rate of growth of real GDP
exceeds the rate of growth of full-employment GDP over the
course of a year, the unemployment rate will fall by one percentage
point.
The growth rate version as an equation:
D%Y = 3 - 2Du
http://www.amherst.edu/~econ53/Okun.PDF
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CHAPTER 14 The Labor Market In the Macroeconomy
From Level to Growth Form of Okun’s law (an approximation)
Y Y 
   (u  u )
100 * 
 Y 
if we start from a full employment
situation then initially Y  Y
and as an approximation we can write
DY
DY
100 *
 100 *
  (Du )
Y
Y
%DY  %DY   (Du )
 %DY  %DY   (Du )
%DY  %DY   (Du )
%DY     (Du )
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CHAPTER 14 The Labor Market In the Macroeconomy
Okun’s law in the United States: 1954-1998
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US Annual Data 1974-95
8.0
Y: GDP Growth Rate in Percent
CHAPTER 14 The Labor Market In the Macroeconomy
6.0
4.0
Y
2.0
Predicted Y
0.0
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
-2.0
-4.0
X: Change in Percent Unem ploym ent Rate
In 1974-95 annual data alpha (2.39, 2.86, 3.34) beta (-1.28, -1.84, -1.4)
From BEA data
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US Data 1980-90
8.0
Y: Percent Growth of GDP
CHAPTER 14 The Labor Market In the Macroeconomy
6.0
4.0
Y
2.0
Predicted Y
0.0
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
-2.0
-4.0
X: Change in Unem ploym ent rate
In 1980-90 annual data alpha (2.4, 2.87, 3.32) beta (-2.57, -2.11, -1.7)
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CHAPTER 14 The Labor Market In the Macroeconomy
DeLong on Okun’s Law
J. Bradford DeLong, 2000 Macroeconomics.
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Economagic Okun’s Law
CHAPTER 14 The Labor Market In the Macroeconomy
11 data points: to 2001
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Paul Krugman, ‘How
Fast Can The US
Economy Grow? HBR
July/Aug 1997
CHAPTER 14 The Labor Market In the Macroeconomy
2.4% Potential Growth
Rate
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%DY  2.4  2(Du )
%DY  %DY p  2(Du )
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CHAPTER 14 The Labor Market In the Macroeconomy
5 The Taylor Rule and Fair Model
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Taylor Rule
CHAPTER 14 The Labor Market In the Macroeconomy
Is a “rule” describing rather than prescribing FRB action.
i    0.02  0.5 y  0.5(   target )
y is the gdp gap in percent
 is the rate of inf lation.
0.02 is the long term real interest rate.
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CHAPTER 14 The Labor Market In the Macroeconomy
Interest rate targeting
Fairmodel:
Central bank can
Target only 1:
a) Interest rate
b) Money supply
c) Gov Debt
They target (a)
Able and Bernanke Ch 14
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CHAPTER 14 The Labor Market In the Macroeconomy
Figure 14.05 The discount rate and the Fed funds rate
The discount rate and the Fed funds rate
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FAIR MODEL
CHAPTER 14 The Labor Market In the Macroeconomy
Fair Model http://fairmodel.econ.yale.edu
We will look at some of the equations in the Faimodel
Which are found in Appendix A (pdf) of the US model.
It contains
Table A.1 the 6 sectors of the model.
Table A.2 the variables in Alphabetical Order
Table A.3 the equations of the model
Table A1-Equations 1-30 then follow
(this ought to be Table A.4)
Table A.5 Sources of raw data
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FAIR MODEL
CHAPTER 14 The Labor Market In the Macroeconomy
We will look at Appendix A, Table
3, FairModel’s Equations
1) Spending Behavior
equations 1-3 cons/eq
4housing/eq 12 investment
2) Price and Output Behavior
eq10 and eq12
3) FRB Behavior eq 30
Then we will look at the Forecast Memo
http://fairmodel.econ.yale.edu/memo/index.htm
After that we will run one experiment with the FairModel
by how much will lower interest rates increase inflation?
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
CHAPTER 14 The Labor Market In the Macroeconomy
FAIR MODEL
Then we will look at the Forecast Memo
http://fairmodel.econ.yale.edu/memo/index.htm
After that we will run one experiment with the FairModel:
by how much will lower interest rates increase inflation?
Start by naming a data base and copying the base data
http://fairmodel.econ.yale.edu/usmodel/index.htm
Then pick option 2: monetary policy options
allow the interest rate to be exogenous
Pushes us to a screen where we put in a new value for
the interest rate for future quarters. Hit enter and see the
changes on the screen. Then click “commit to changes”.
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
CHAPTER 14 The Labor Market In the Macroeconomy
FAIR MODEL
Now solve the model (option 8) and examine the results.
Graph 1:
pick graph one per variable
pick the comparison dataset UseBase option
select the 5 main variables from the US variable list:
GDPR, GDPD, RS, M1, UR, SGP
Graph 2:
GDPD percentage change
Graph3:
Y, YS (full employment output by firm sector)
(In Fairmodel Y and YS referr only to the firm sector.)
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
CHAPTER 14 The Labor Market In the Macroeconomy
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
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