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Macroeconomics: Energy Price Shocks + Inflation
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Macroeconomics: Energy Price Shocks + Inflation


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  • G (up) = IS shifts right I (up)= i (up) = y (up) When i (up)= private investment (down)
  • if tax rate (x-axis) increases constantly substitution effect sets in causes tax revenue to decrease Laffer curve shifts orientation from demand-side towards the supply-side as AS moves right downwards, price decreases and income increases simultaneously
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    • 1. Energy Price Shocks & Inflation European University Macroeconomics Spring Semester 2010 Ziegler, RuschkeMacroeconomics Presentation 21.03.2010
    • 2. Contents 1 Introduction 2 Pre 1970 Keynesianism 2.1 1970s Economy Turndown 2.2 1973s Yom Kippur War 3 Classical School of Thought 3.1 1970s and 1980s Stagflation 3.2 Crowding-Out Effect and the Phillips Curve 3.3 Laffer Curve 4 Alternative Views 4.1 Demand-Pull Inflation 4.2 Cost-Push Inflation 5 ConclusionMacroeconomics Presentation 21.03.2010 2
    • 3. 1 Introduction “Neoclassical economics is replacing Keynesianism and the fiscal policy as the Philips curve is substituted by the Laffer curve.”  Postwar Keynesian and monetarist views:  Fiscal policy determines government spending  Neoclassical economics:  Stagnation and inflation are two separate entities  Affect aggregate supply (AS) and aggregate demand (AD) curve  Stagflation= Stagnation + Inflation  Reasons for stagflation in 1970’s and 1980’s:  Expensive government expenditure policy= demand-pull inflation with time leg  Supply-side shocks (such as oil price shocks)  Inflationary expectations which led to the increase in wage level, interest rates and rentsMacroeconomics Presentation 21.03.2010 3
    • 4. 2 Pre 1970 Keynesianism  Based upon early 20th Century theories of John Keynes.  IS-LM Curve of John Hicks  Relationship between Investment and Spending  Equivalent to Aggregate Demand Curve  Aggregate Supply – LM Curve (Interest & Output)  Phillips Curve  Decreased unemployment implied inflation.  Keynes predicted lower unemployment would cause higher price, not higher inflation.  Economists could use IS-LM model to predict  ↑Money Supply = ↑Output +↑EmploymentMacroeconomics Presentation John Maynard Keynes- 1946 21.03.2010 4
    • 5. 2.1 1970s Economy Turndown  1973 Oil Shock was first big show of power by OPEC.  1971 Withdrawal from Bratton Woods Accord (Gold Exchange Standard)  U.S. Dollar “floats” along with other currencies, they increase currency reserves.  OPEC receives less income from Oil.  So begins the decline of U.S. EconomyMacroeconomics Presentation 21.03.2010 5
    • 6. 2.2 1973s Yom Kippur War August ’73: King  October 19, 1973: Faisal mentions “Oil Nixon requests $2.2 Weapon” Billion in Support for Israel, initiating October 6, 1973: Syria Embargo by Syria & Egypt attack Israel settlements  October 26, 1973: Yom Kippur War ends. October 12, 1973: U.S. begins arms support  November 5, 1973: for Israel in Re: Soviet OPEC announces 25% arms support. reduction in production. October 17, 1973: OPEC agrees to use  Oil Price quadrupled “Oil as a Weapon” from $3/barrel to $12/ against supporters of barrel. Yom Kippur War, recommending an  In Re: Central Banks Embargo reduced interest rate to increase growth, intiating stagflation Macroeconomics Presentation 21.03.2010 6
    • 7. 3 Classical School of Thought  Originated in the 1980’s:  no more Government intervention in the economy  rejects the idea that monetary policy can have real effects  real economic quantities: -output -employment determined by real factors -unemploymentMacroeconomics Presentation 21.03.2010 7
    • 8. 3 Classical School of Thought  Separate explanations:  Stagnation: low growth, high unemployment, due to inefficient government regulations, or effects of the business cycle such that any decrease in labour productivity makes it efficient to work less  Inflation: due to too high increase of money supply by monetary authorities  aggregate supply curve (AS), the y-axis, is effected by real factors  aggreate demand curve (AD), the x-axis, is effected by nominal factors that determine inflationMacroeconomics Presentation 21.03.2010 8
    • 9. 3.1 Stagflation  Stagflation: Y= C+I+G+(X-M)  Where: i) demand increases, price increases ii) AS increases= price increases= Output/ Income sameMacroeconomics Presentation 21.03.2010 9
    • 10. 3.2 Crowding-Out Effect  Phillips Curve: shows trade-off between inflation and unemployment (1960) in terms of GNP and GDP inflator  unemployment increases= inflation decreases  inflation increases= unemployment decreases  The Phillips = smooth curve= negative relationship between increasing inflation rate and decreasing unemployment rateMacroeconomics Presentation 21.03.2010 10
    • 11. 3.2 Crowding-Out Effect  increasing government spending= expensive fiscal policy (T-G)  interest rate increases, private investment (I) decreases  government spending (G) crowds out private investment in order to reach a new equilibriumMacroeconomics Presentation 21.03.2010 11
    • 12. 3.3 Laffer Curve  shows the relationship between tax rate and tax revenue  explains prolonged stagflation as the effect of inappropriate government policies i) excessive regulation of product markets and labour markets lead to long run stagnation ii) excessive growth of the money supply result in inflationMacroeconomics Presentation 21.03.2010 12
    • 13. 4 Alternative Views  Two types of inflationary pressure: 1. Demand – Pull: describes the situation in which price levels rise because of an imbalance in the aggregate supply and demand 2. Cost – Push: occurs when there are increases in the costs of wages and raw materials, therefore the prices are going up as wellMacroeconomics Presentation 21.03.2010 13
    • 14. 4.1 Demand-Pull Inflation  Aggregate Demand increases= right upwards  Price increases simultaneously  Needed labour and wages increaseMacroeconomics Presentation 21.03.2010 14
    • 15. 4.1 Labour Market  Relationship between wage and labour needed  As AS increases, labour needed increases simultaneously= moving right upwardsMacroeconomics Presentation 21.03.2010 15
    • 16. 4.2 Cost - Push Inflation  Aggregate Supply increases= left upwards  Aggregate demand decreases as price increases  Labour needed decreases as wellMacroeconomics Presentation 21.03.2010 16
    • 17. 5 Conclusion  Energy price shocks lead to stagflation  Crowding out effect: government spending increase and crowds out prtivate investement which decreases  As result (pre-1970) Philips Curve: hows the trade-off between infaltion and unemployment  Philips Curve is replaced by Laffer Curve by the substitution effect  as AS moves to the right/ decreases=price decreases= income and private investment increases  Cost pull inflation (ex. Oil price shocks)  economic stagflation  income (demand) stays the same but inflation rises (price)  Energy price shocks lead to stagflationMacroeconomics Presentation 21.03.2010 17
    • 18. Thank You…Macroeconomics Presentation 21.03.2010 18