2010 premium ppt macroprinc-ch35-

1、35C H A P T E RTheShort-Run Trade-off Between Inflation and UnemploymentEcP RoI N nC I PoL E mSO FicsN. Gregory MankiwPremium PowerPoint Slides by Ron Cronovich 2010 South-Western, a part of Cengage Learning, all rights reserved2010updateIn this chapter,look for the answers to these questions:How ar

2、e inflation and unemployment related in theshort run?In the long run?What factors alter this relationship?What is the short-run cost of reducing inflation?Why were U.S. inflation and unemployment both so low in the 1990s?1IntroductionIn the long run, inflation & unemployment are unrelated: The infla

3、tion rate depends mainly on growth in the money supply. Unemployment (the “natural rate”) depends on the minimum wage, the market power of unions, efficiency wages, and the process of job search.One of the Ten Principles:In the short run, society faces a trade-off between inflation and unemployment.

4、2THE SHORT-RUN TRADE-OFFThe Phillips CurvePhillips curve:shows the short-run trade-offbetween inflation and unemployment1958:A.W. Phillips showed thatnominal wage growth was negativelycorrelated with unemployment in the U.K.1960:Paul Samuelson & Robert Solow founda negative correlation between U.S.

5、inflation& unemployment, named it “the Phillips Curve.”3THE SHORT-RUN TRADE-OFFDeriving the Phillips CurveSuppose P = 100 this year.The following graphs show two possible outcomes for next year:A. Agg demand low,small increase in P (i.e., low inflation), low output, high unemployment.B. Agg demand h

6、igh,big increase in P (i.e., high inflation), high output, low unemployment.4THE SHORT-RUN TRADE-OFFDeriving the Phillips Curve A.Low agg demand, low inflation, high u-rateinflationPS5%1051033%6%Y1Y2Y4%u-rate B.High agg demand, high inflation, low u-rateTHE SHORT-RUN TRADE-OFF5SRABAAD2 AD1BAPCThe Ph

7、illips Curve:A Policy Menu?Since fiscal and mon policy affect agg demand, the PC appeared to offer policymakers a menu of choices: low unemployment with high inflation low inflation with high unemployment anything in between1960s:U.S. data supported the Phillips curve.Many believed the PC was stable

8、 and reliable.6THE SHORT-RUN TRADE-OFFEvidence for the Phillips Curve?Inflation rate (% per year)During the 1960s,U.S. policymakers opted for reducingunemployment at the expense ofhigher inflation1086684666762265641961630Unemployment0246810rate (%)7THE SHORT-RUN TRADE-OFFThe Vertical Long-Run Philli

9、ps Curve1968:Milton Friedman and Edmund Phelpsargued that the tradeoff was temporary.Natural-rate hypothesis:the claim thatunemployment eventually returns to its normal or “natural” rate, regardless of the inflation rateBased on the classical dichotomy and the vertical LRAS curve8THE SHORT-RUN TRADE

10、-OFFThe Vertical Long-Run Phillips CurveinflationPLRASLRPChigh infla- tionP2P1AD2AD1low infla- tionYu-rateNatural rate of output9Natural rate of unemploymentIn the long run, faster money growth only causes faster inflation.Reconciling Theory and EvidenceEvidence (from 60s):PC slopes downward.Theory

11、(Friedman and Phelps):PC is vertical in the long run.To bridge the gap between theory and evidence, Friedman and Phelps introduced a new variable: expected inflation a measure of how much people expect the price level to change.10THE SHORT-RUN TRADE-OFFThe Phillips Curve EquationNatural rate of unem

12、p.Unemp. rateActual inflationExpected inflationa=Short runFed can reduce u-rate below the natural u-rate by making inflation greater than expected.Long runExpectations catch up to reality,u-rate goes back to natural u-rate whether inflation is high or low.11THE SHORT-RUN TRADE-OFFHow Expected Inflat

13、ion Shifts the PCInitially, expected & actual inflation = 3%,inflationunemployment = natural rate (6%).Fed makes inflation2% higher than expected, u-rate falls to 4%.In the long run, expected inflation increases to 5%, PC shifts upward,unemployment returns to its natural rate.THE SHORT-RUN TRADE-OFF

14、LRPC5%3%2u-rate4%6%12BC APC PC1L E A R N I N G1A C T I V E A numerical exampleNatural rate of unemployment = 5% Expected inflation = 2%In PC equation, a = 0.5A. Plot the long-run Phillips curve.B. Find the u-rate for each of these values of actualinflation:0%, 6%.Sketch the short-run PC.C. Suppose e

15、xpected inflation rises to 4%. Repeat part B.D. Instead, suppose the natural rate falls to 4%. Draw the new long-run Phillips curve,then repeat part B.131A C T I V EL E A R N I N GLRPCDAnswersPCBLRPCA7An increase in expected inflation shifts PC tothe right.654PCD3PCCA fall in the natural rate shifts

16、 bothcurves210to the left.012345678unemployment rate14inflation rateion.The Breakdown of the Phillips CurveInflation rate (% per year)Early 1970s:unemployment increased,10despite higher inflat Friedman &Phelps8explanation: expectations were catchingup with reality.73706716968472666762265641961630Une

17、mployment0246810rate (%)15THE SHORT-RUN TRADE-OFFAnother PCShifter:Supply ShocksSupply shock:an event that directly alters firms costs and prices, shifting the AS and PC curvesExample:large increase in oil prices16THE SHORT-RUN TRADE-OFFHow an Adverse Supply Shock Shifts the PC SRAS shifts left, pri

18、ces rise, output & employment fall.inflationP1BP2P1APC2PC1Y2Y1Yu-rate Inflation & u-rate both increase as the PC shifts upward.THE SHORT-RUN TRADE-OFF17SRAS2BSRASAADThe 1970s Oil Price ShocksThe Fed chose to accommodate the first shock in 1973with faster money growth.Result:Higher expected inflation

19、, which further shifted PC.1979:Oil prices surged again, worsening the Feds tradeoff.18THE SHORT-RUN TRADE-OFFOil price per barrel1/1973$ 3.561/197410.111/197914.851/198032.501/198138.00The 1970s Oil Price ShocksInflation rate (% per year)Supply shocks & rising expected inflation worsened the PCtrad

20、eoff.10817574808797867773764197220Unemployment0246810rate (%)19THE SHORT-RUN TRADE-OFFThe Cost of Reducing InflationDisinflation:a reduction in the inflation rateTo reduce inflation,Fed must slow the rate of money growth, which reduces agg demand.Short run:Output falls and unemployment rises.Long ru

21、n:Output & unemployment return to their natural rates.20THE SHORT-RUN TRADE-OFFDisinflationary Monetary PolicyContractionary monetary policy moves economyinflationLRPCfrom A to B.Over time,expected inflation falls,PC shifts downward.In the long run, point C:the natural rateof unemployment, lower inf

22、lation.1e21THE SHORT-RUN TRADE-OFFCABPC PC2u-ratnatural rate of unemploymentThe Cost of Reducing InflationDisinflation requires enduring a period of high unemployment and low output.Sacrifice ratio:percentage points of annual output lostper 1 percentage point reduction in inflationTypical estimate o

23、f the sacrifice ratio: To reduce inflation rate 1%,5must sacrifice 5% of a years output.Can spread cost over time, e.g.To reduce inflation by 6%, can either sacrifice 30% of GDP for one year sacrifice 10% of GDP for three years22THE SHORT-RUN TRADE-OFFRational Expectations, Costless Disinflation?Rat

24、ional expectations:a theory according towhich people optimally use all the information they have, including info about govt policies, when forecasting the futureEarly proponents:Robert Lucas, Thomas Sargent, Robert BarroImplied that disinflation could be much less costly23THE SHORT-RUN TRADE-OFFRati

25、onal Expectations, Costless Disinflation?Suppose the Fed convinces everyone it is committed to reducing inflation.Then, expected inflation falls,the short-run PC shifts downward.Result:Disinflations can cause less unemployment than the traditional sacrifice ratio predicts.24THE SHORT-RUN TRADE-OFFTh

26、e Volcker DisinflationFed Chairman Paul Volcker Appointed in late 1979 under high inflation & unemployment Changed Fed policy to disinflation1981-1984: Fiscal policy was expansionary,so Fed policy had to be very contractionaryto reduce inflation. Success:Inflation fell from 10% to 4%,but at the cost

27、 of high unemployment25THE SHORT-RUN TRADE-OFFThe Volcker DisinflationInflation rate (% per year)Disinflation turned out to be very costlyu-rate near 10%in 1982-83108180197988268448385872860Unemployment0246810rate (%)26THE SHORT-RUN TRADE-OFFThe Greenspan Era1986:Oil prices fell 50%.1989-90:Unemploy

28、ment fell, inflation rose. Fed raised interest rates, caused a mild recession.1990s:Unemployment and inflation fell.Alan GreenspanChair of FOMC, Aug 1987 Jan 20062001:Negative demand shockscreated the first recession in a decade.Policymakers responded with expansionary monetary and fiscal policy.27T

29、HE SHORT-RUN TRADE-OFFThe Greenspan EraInflation rate (% per year)Inflation and unemployment were low during most of Alan Greenspans yearsas Fed Chairman.108690050641987922000202 9496980Unemployment0246810rate (%)28THE SHORT-RUN TRADE-OFFBen Bernankes challengesAggregate demand shocks: Subprime mort

30、gage crisis, falling housing prices, widespread foreclosures, financial sector troubles.Aggregate supply shocks: Rising prices of food/agricultural commodities, e.g.,Corn per bushel: Rising oil prices$2.10 in 2005-06, $5.76 in 5/2008Oil per barrel:$35 in 2/2004, $134 in 6/2008From 6/2007 to 9/2009, unemployment rose from 4.6% to 10.0%29THE SHORT-RUN TRADE-OFFCONCLUSIONThe theories in this chapter come from some of the greatest economists of the 20th cen