Transcript Chapter 16 - Central Web Server 2

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Macroeconomics: Principles, Applications, and Tools
O’Sullivan, Sheffrin, Perez
6/e.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.
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Macroeconomics: Principles, Applications, and Tools
O’Sullivan, Sheffrin, Perez
6/e.
6/e.
O’Sullivan, Sheffrin, Perez
Macroeconomics: Principles, Applications, and Tools
The Dynamics of Inflation
and Unemployment
In a restaurant, we use tips
to evaluate and reward the
performance of the servers.
PREPARED BY
FERNANDO QUIJANO, YVONN QUIJANO,
AND XIAO XUAN XU
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16.1
MONEY GROWTH, INFLATION, AND
INTEREST RATES
Macroeconomics: Principles, Applications, and Tools
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C H A P T E R 16
The Dynamics of Inflation
and Unemployment
Inflation in a Steady State
● nominal wages
Wages expressed in current dollars.
● real wages
Wage rates paid to employees adjusted
for changes in the price level.
● money illusion
Confusion of real and nominal
magnitudes.
● expectations of inflation
The beliefs held by the public about the
likely path of inflation in the future.
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16.1
MONEY GROWTH, INFLATION, AND
INTEREST RATES
Macroeconomics: Principles, Applications, and Tools
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C H A P T E R 16
The Dynamics of Inflation
and Unemployment
Inflation in a Steady State
INFLATION EXPECTATIONS AND INTEREST RATES
When the public expects inflation, real and nominal rates of interest will differ
because we need to account for inflation in calculating the real return from
lending and borrowing.
INFLATION EXPECTATIONS AND MONEY DEMAND
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16.1
MONEY GROWTH, INFLATION, AND
INTEREST RATES
How Changes in the Growth Rate of Money Affect the Steady State
Macroeconomics: Principles, Applications, and Tools
O’Sullivan, Sheffrin, Perez
6/e.
C H A P T E R 16
The Dynamics of Inflation
and Unemployment
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Original Phillips Curve
Macroeconomics: Principles, Applications, and Tools
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C H A P T E R 16
The Dynamics of Inflation
and Unemployment
• A. W. Phillips (1958), “The Relation Between
Unemployment and the Rate of Change of
Money Wage Rates in the United Kingdom,
1861-1957”, Economica.
• Wage inflation vs. Unemployment
• New Zealander at London School of
Economics
• Missing Equation of Keynesian economics?
7
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C H A P T E R 16
The Dynamics of Inflation
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Macroeconomics: Principles, Applications, and Tools
O’Sullivan, Sheffrin, Perez
5½ % = zero inflation
8
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C H A P T E R 16
The Dynamics of Inflation
and Unemployment
5½ %
9
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C H A P T E R 16
The Dynamics of Inflation
and Unemployment
Macroeconomics: Principles, Applications, and Tools
O’Sullivan, Sheffrin, Perez
6/e.
Friedman-Phelps
Expectations-Augmented Phillips Curve
inflation
LRPC
Short run
Phillips curves
e=1
U1
U*
e=0
Unemployment
Natural Rate of Unemployment
10
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16.2
UNDERSTANDING THE EXPECTATIONS
PHILLIPS CURVE: THE RELATIONSHIP
BETWEEN UNEMPLOYMENT AND INFLATION
● expectations Phillips curve
The relationship between unemployment
and inflation when taking into account
expectations of inflation.
Macroeconomics: Principles, Applications, and Tools
O’Sullivan, Sheffrin, Perez
6/e.
C H A P T E R 16
The Dynamics of Inflation
and Unemployment
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C H A P T E R 16
The Dynamics of Inflation
and Unemployment
16.2
UNDERSTANDING THE EXPECTATIONS
PHILLIPS CURVE: THE RELATIONSHIP
BETWEEN UNEMPLOYMENT AND INFLATION
Are the Public’s Expectations About Inflation Rational?
● rational expectations
The economic theory that analyzes how
the public forms expectations in such a
manner that, on average, they forecast
the future correctly.
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Macroeconomics: Principles, Applications, and Tools
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C H A P T E R 16
The Dynamics of Inflation
and Unemployment
16.2
UNDERSTANDING THE EXPECTATIONS
PHILLIPS CURVE: THE RELATIONSHIP
BETWEEN UNEMPLOYMENT AND INFLATION
U.S. Inflation and Unemployment in the 1980s
 FIGURE 16.1
The Dynamics of Inflation and
Unemployment, 1986–1993
Inflation rose and the
unemployment rate fell below
the natural rate. Inflation later
fell as unemployment exceeded
the natural rate.
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Macroeconomics: Principles, Applications, and Tools
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C H A P T E R 16
The Dynamics of Inflation
and Unemployment
16.2
UNDERSTANDING THE EXPECTATIONS
PHILLIPS CURVE: THE RELATIONSHIP
BETWEEN UNEMPLOYMENT AND INFLATION
Shifts in the Natural Rate of Unemployment in the 1990s
What factors can shift the natural rate of unemployment?
• Demographics
• Institutional changes
• The recent history of the economy
• Changes in growth of labor productivity
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C H A P T E R 16
The Dynamics of Inflation
and Unemployment
APPLICATION
1
REGIONAL DIFFERENCES IN UNEMPLOYMENT INCREASE
THE NATURAL RATE
APPLYING THE CONCEPTS #1: Do regional differences in
unemployment affect the natural rate of unemployment?
Some regions of a country may experience difficulties while others prosper. Does this
matter when it comes to understanding the behavior of inflation and unemployment?
• When unemployment is low, firms compete for workers and bid up wages sharply.
• When unemployment is high, it is more difficult for firms to cut wages because
workers tend to resist wage cuts.
Result: Even if the total unemployment rate in the country appears to be at the natural
rate of unemployment, there could still be upwards inflation pressure if wages increase
faster in the low-unemployment regions than they fall in the high-unemployment regions.
Economists studied how regional differences in unemployment have varied over time.
• Variations were relatively high during the 1980s but fell sharply in the 1990s.
• The U.S. labor market operated more like a truly national than a regional market
in the 1990s.
• The natural rate of unemployment fell in the 1990s.
Economists estimated the effect was large and that the natural rate fell by about 2%.
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16.3
HOW THE CREDIBILITY OF A NATION’S
CENTRAL BANK AFFECTS INFLATION
Macroeconomics: Principles, Applications, and Tools
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C H A P T E R 16
The Dynamics of Inflation
and Unemployment
 FIGURE 16.2
Choices of the Fed: Recession
or Inflation
If workers push up their nominal
wages, the aggregate supply curve
will shift from AS0 to AS1.
If the Fed keeps aggregate demand
constant at AD0, a recession will
occur at point a, and the economy
will eventually return to full
employment at point c.
If the Fed increases aggregate
demand, the economy remains at
full employment at b, but with a
higher price level.
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16.3
HOW THE CREDIBILITY OF A NATION’S
CENTRAL BANK AFFECTS INFLATION
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C H A P T E R 16
The Dynamics of Inflation
and Unemployment
Macroeconomics: Principles, Applications, and Tools
 FIGURE 16.3
How Central Bank
Independence Affects Inflation
Countries in which central banks
are more independent from the
rest of the government have, on
average, lower inflation rates.
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C H A P T E R 16
The Dynamics of Inflation
and Unemployment
APPLICATION
2
INCREASED POLITICAL INDEPENDENCE FOR THE BANK
OF ENGLAND LOWERED INFLATION EXPECTATIONS
APPLYING THE CONCEPTS #2: Can changes in the way
central banks are governed affect inflation expectations?
A major change in monetary policy allowed the Bank of England to be free to pursue
its policy goals without direct political control.
An economist studied how the British bond market reacted to the policy change by
comparing the interest rates changes on two types of long-term bonds: bonds that
are automatically adjusted (or indexed) for inflation and bonds that are not.
• The difference between the two interest rates primarily reflects expectations of
inflation.
• If the gap narrowed following the policy announcement, this would be
evidence that the new policy reduced expectations of inflation.
• If it did not, the announced policy would have had no effect on inflation
expectations.
Result: After the announcement, the gap narrowed.
Conclusion: The announcement did cause expectations about inflation to fall by
about half a percentage.
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16.4
INFLATION AND THE VELOCITY OF MONEY
● velocity of money
The rate at which money turns over during
the year. It is calculated as nominal GDP
divided by the money supply.
Macroeconomics: Principles, Applications, and Tools
O’Sullivan, Sheffrin, Perez
6/e.
C H A P T E R 16
The Dynamics of Inflation
and Unemployment
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16.4
INFLATION AND THE VELOCITY OF MONEY
Macroeconomics: Principles, Applications, and Tools
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C H A P T E R 16
The Dynamics of Inflation
and Unemployment
or
● quantity equation
The equation that links money, velocity,
prices, and real output. In symbols, we have
M × V = P × y.
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16.4
INFLATION AND THE VELOCITY OF MONEY
Macroeconomics: Principles, Applications, and Tools
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6/e.
C H A P T E R 16
The Dynamics of Inflation
and Unemployment
 FIGURE 16.4
The Velocity of M2, 1959–2007
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16.4
INFLATION AND THE VELOCITY OF MONEY
Macroeconomics: Principles, Applications, and Tools
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6/e.
C H A P T E R 16
The Dynamics of Inflation
and Unemployment
growth rate of money + growth rate of velocity
= growth rate of prices + growth rate of real output
● growth version of the quantity equation
An equation that links the growth rates of
money, velocity, prices, and real output.
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16.5
HYPERINFLATION
● hyperinflation
An inflation rate exceeding 50 percent per month.
Macroeconomics: Principles, Applications, and Tools
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6/e.
C H A P T E R 16
The Dynamics of Inflation
and Unemployment
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16.5
HYPERINFLATION
Macroeconomics: Principles, Applications, and Tools
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6/e.
C H A P T E R 16
The Dynamics of Inflation
and Unemployment
How Budget Deficits Lead to Hyperinflation
● seignorage
Revenue raised from money creation.
government deficit = new borrowing from the public + new money created
● monetarists
Economists who emphasize the role that the
supply of money plays in determining nominal
income and inflation.
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and Unemployment
APPLICATION
3
HYPERINFLATION IN ZIMBABWE
APPLYING THE CONCEPTS #3: What caused a severe
hyperinflation to emerge recently in Zimbabwe?
In June 2008, the consumer price index in Zimbabwe was 8 million
percent higher than it was a year before.
What caused Zimbabwe to suffer from this crippling hyperinflation?
The simple answer is that the political and economic system began
to self-destruct.
Zimbabwe has been ruled since 1980 by the dictator Robert Mugabe, whose
policies to intervene militarily in African conflicts and expropriate white-owned
farms had the cumulative effect of crippling the economy.
• As the economy deteriorated, tax revenues declined.
• Mugabe and his central bank simply resorted to printing new banknotes.
Result: Hyperinflation and further deterioration of the economy as the financial
system collapsed.
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KEY TERMS
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C H A P T E R 16
The Dynamics of Inflation
and Unemployment
expectations of inflation
expectations Phillips curve
growth version of the quantity equation
hyperinflation
monetarists
money illusion
nominal wages
quantity equation
rational expectations
real wages
seignorage
velocity of money
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