20121125 mankiw economics chapter35

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  • 1. Principles of Economics Chap35   The  short-­‐run  trade  off  between   Infla7on  and  Unemployment 1
  • 2. What we have learned 
 in macroeconomics 2 Chap 25 Chap 26 Chap 27 Chap 28 Chap 29 Chap 30 The level and growth of productivity and real GDP How the financial system works and How the real interest rate adjusts to balance saving and investment Why there is always some unemployment in the economy The monetary system and how changes in the money supply affect the price level,the inflation rate, and the nominal interest rate Chap 31 Chap 32 Extension of this analysis to open economies to explain the trade balance and the exchange rate. GDP Financial system Unemployment Monetary system Open Economy Chapter Key words Contents Chap 33 .Discussing some of the important facts about short run fluctuations in economic activity and introducing a basic model to explain those fluctuations. Aggregate demand and aggregate supply Chap 34 ・How monetary policy influences aggregate demand.   ・How fiscal policy influences aggregate demand Aggregate demand and aggregate supply
  • 3. The  long  run  determinants  of   unemployment  rate  and  infla7on 3 Unemployment Inflation Labor Makers -minimum wage laws -the market power of union -the role of efficiency wages Monetary Markets -growth in the money supply -a nation’s central bank controls Largely unrelated problems in the long run
  • 4. Ten Principles of Economics Ⅰ.How People Make Decisions. 1:People Face Trade-offs. 2:The Cost of Something Is What You Give Up to Get It. 3:Rational People Think at the Margin. 4:People Respond to Incentives. Ⅱ.How People Interact. 5:Trade Can Make Everyone Better Off. 6:Markets Are Usually a Goodway to Organize Economic Activity. 7:Governments Can Sometimes Improve Market Outcomes. Ⅲ.How the Economy as a Whole Works 8:A Country's Standard of Living Depends on its Ability to Produce Goods and Services. 9:Prices Rise When the Government Prints Too Much Money. 10:Society Faces a Short-Run Trade-off between Inflation and Unemployment. 4
  • 5. 5 Probably the single most important macroeconomics relationship is the Phillips curve
  • 6. Origins  of  the  Phillips  Curve 6 p  Phillips showed the negative correlation between the rate of unemployment and the rate of inflation based on date for the United Kingdom through publishing article in 1958. p  Paul Samuelson and Robert Solow also showed a similar negative correlation between the rate of unemployment and the rate of inflation in data for United States. p  According to Samuelson and Solow, policy makers face a trade off between inflation and unemployment, and the Phillips curve illustrates that trade-off. Unemployment rate(%) Inflation rate (% year) 4% 7% 6% 2%
  • 7. Aggregate  demand  and  aggregate  supply,     and  the  Phillips  Curve 7 p  The Phillips curve shows the combinations of inflation and unemployment that arise in the short run as shifts in the aggregate-demand curve move the economy along the short-run aggregate-supply curve. p  Because monetary and fiscal policy can shifts the aggregate demand curve, they can move an economy along the Phillips curve. p  The Phillips curve offers policymakers a menu of combination of inflation and unemployment. Unemployment rate(%) Inflation rate (% year) Quantity of output Price level 7% 4% 6% 2% A B 106 102 Unemployment Is 7% Unemployment Is 4% The  Phillips  Curve The  model  of  aggregate  demand   and  aggregate  supply
  • 8. The  Phillips  curve  seems  to  offer  policy   maker  a  menu  of  possible  infla7on   unemployment  outcome.      But  does  this  menu  of  choices  remain  the   same  over7me? 8
  • 9. The  long-­‐run  Phillips  curve 9 p  According to Friedman and Phelps, there is no trade-off between inflation and unemployment in the long run. p  Growth in the money supply determines inflation rate. Regardless of the inflation rate, the unemployment rate gravitates toward its natural rate. As a result, the long-run Phillips curve is vertical. Unemployment rate(%) Inflation rate (% year) Quantity Of output Price level Natural rate Of return B A B A P2 P1 The  Phillips  Curve The  model  of  aggregate  demand   and  aggregate  supply
  • 10. How  to  reduce  natural  rate  of   unemployment   •  Policy  makers  should  look  to  policies  that   improve  the  func7oning  of  the  labor  market   – Minimum  wage  laws   – Collec7ve  bargaining  laws   – Unemployment  insurance   – Job  training  program 10
  • 11. The  short  run  Phillips  curve 11 Unemployment rate = Natural rat of Unemployment a Actual inflation Expected inflation In  the  short-­‐run In  the  long-­‐run People  come  to  expect  whatever  infla7on  the  Fed   produces  ,  so  actual  infla7on  equals  expected   infla7on  ,  and  unemployment  is  at  its  natural  rate. Expected  infla7on  is  given,  so  higher  actual  infla7on   rate  is  associated  with  lower  unemployment  rate - -
  • 12. The  natural  experiment  for     the  Natural-­‐rate  hypothesis 12 Unemployment rate(%) Inflation rate (% year) p  Friedman and Phelps had made a bold prediction in 1968. p  If policy maker try to take advantage of the Phillips curve by choosing higher inflation to reduce unemployment, they will succeed at reducing unemployment only temporarily. Natural rate of unemployment B A C The  long  run  Phillips  Curve
  • 13. [case]data  from  1961  to  1968   The  Phillips  curve  in  the  1960s 13 p This figure uses annual data from 1961 to 1968 on the employment rate and on the inflation to show the negative relationship between inflation and unemployment.
  • 14. [case]data  from  1961  to  1973   The  break  down  of  the  Phillips  curve 14 p  The Phillips curve of the 1960s breaks down in the early 1970s, just as Friedman and Phelps had predicted. p  Notice that the points labeled A, B, and C in this figure correspond roughly to the points in figure of page 12.
  • 15. Shi[  in  the  Phillips  curve   The  role  of  supply  shock 15 Quantity Of output Price level Unemployment rate(%) Inflation rate (% year) B A P2 P1 B A AS1 AS2 p In 1974, OPEC began to exert its market power as a cartel in the world oil market to increase its member’s profits. p A large increase in the world price of oil is an example of oil is an example of a supply shock. A supply shock is an event that directly affects firm’s costs of production and thus the prices they charge; it shifts the economy’s aggregate supply curve and, as a result the Phillips curve. p Confronted with such an adverse shifts in the Phillips curve, policy makers face a difficult choice between fighting inflation and unemployment further. p Faced with such an adverse shifts in the Phillips curve, policy makers will ask whether the shift is temporary or permanent. The answer depends on how people adjust their expectations of inflation. Y1 Y2 The  Phillips  Curve The  model  of  aggregate  demand   and  aggregate  supply
  • 16. [case]  data  from  1972  to  1981      the  period  1973-­‐1975  and  1978-­‐1981   The  supply  shock  of  the  1970s 16 p In the period 1973-1975 and 1978-1981, increases in world oil prices led to higher inflation and higher unemployment.
  • 17. Disinfla7onary  monetary  policy     in  the  short  run  and  long  run 17 Unemployment rate(%) Inflation rate (% year) Long  run    Phillips  Curve A C B Natural rate of Unemployment Short  run  Phillips  curve   with  high  expected   infla7on. Short  run  Phillips  curve   with  low    expected  infla7on. p  If a nation wants to reduce inflation, it must endure a period of high unemployment and low input. p  When the Fed pursues contractionary monetary policy to reduce inflation, the economy moves along a short run Phillips curve from point A to B. p  Over time ,expected inflation falls, and the short run Phillips curve shifts downward. p  When the economy reaches point C, unemployment is back at its natural rate.
  • 18. Sacrifice  ra7o •  The  sacrifice  ra7o  is  the  number  of  percentage   points  if  annual  output  lost  in  the  process  of   reducing  infla7on  by  1%  point.   •  A  typical  es7mate  of  sacrifice  ra7o  is  5. 18
  • 19. [case]from  1979  to  1987   The  Volcker  disinfla7on 19 p The reduction in inflation during this period came at the cost of very high unemployment in 1982 and 1983. p Note that the points labeled A, B, and C in this figure correspond roughly to the the points in page 17.
  • 20. [case]  data  from  1984  to  2005   The  Greenspan  Era 20 p During most of this period, Alan Greenspan was chairman of the Federal Reserve. p Fluctuations in inflation and unemployment were relatively small.
  • 21. [case]data  from  2006  to  2009   The  Phillips  curve  during  the  financial  crisis 21 p A financial crisis caused aggregate demand to plummet, leading to much higher unemployment and pushing inflation down to a very low level.