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Chapter 16
Expectations and
Macroeconomics
Nominal wage inflation
rate (percent)
10
The Trade–Off Between Inflation
and Unemployment
1949 - 1959
8
6
4
2
2.4%
5.8%
0
Figure 16.1
0
2
4
6
8 10
Unemployment rate (percent)
2
©1999 South-Western College Publishing
0% of GDP
20
15
10
5
0
-5
6
4
2
0
-2
-4
2% per year
Percentage of GDP
Percentage per year
Money Growth and Debt
Creation in the Postwar Period
1950 ’55 ’60 ’65 ’70 ’75 ’80 ’85 ’90 ’95
Rate of money creation (left scale)
Government budget deficit (right scale)
3
Figure 16.2
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(
Dw - g
w
(
DM - g
M
(
(
(
(
(
Dw - g
=
w
DM - g
M
LRAS
(
Inflation rate (DP/P)
Fixing the Position of the Aggregate
Demand and Supply Curves
AD
SRAS
DY/Y = g
Growth rate of output (DY/Y)
Figure 16.3
4
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Inflation rate (DP/P)
Short Run Effects of an Increase in the
Rate of Money Creation
LRAS
SRAS
(DP/P)1
(DP/P)0
AD1
AD0
(DY/Y)0 = g
(DY/Y)1
Growth rate of output (DY/Y)
Figure 16.4
5
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Inflation rate (DP/P)
Short Run Effects of an Increase in the
Rate of Money Creation
SRAS2
(DP/P)2
(DP/P)1
SRAS1
B
A
AD1
(DY/Y)2 = g
(DY/Y)1
Growth rate of output (DY/Y)
6
Figure 16.5
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Inflation rate (DP/P)
Determining Inflation When Expected
Inflation Is Too Low
AD1
AD2
SRAS
(DP/P)3
(DP/P)2
(DP/P)E = (DP/P)1
C
B
A
g
Growth rate of output (DY/Y)
7
Figure 16.6
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Determining Inflation When Expected
Inflation Is Too High
Inflation rate (DP/P)
(DP/P)E
Figure 16.7
SRAS
D
= (DP/P)4
(DP/P)5
(DP/P)6
E
F
AD2
AD1
g
Growth rate of output (DY/Y)
8
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The Rational Expectation of Inflation
DP
AD2
(P 8
SRAS
AD
DM
( M -g
AD1
H
DP E DP
G
( =(
(
(
(
DP
P 9
The rational
expectation of price
inflation is equal to
Figure 16.8
Inflation rate (DP/P)
(
7
(
(
=
P
DM
g
M
(
(
P
I
g
Growth rate of output (DY/Y)
9
©1999 South-Western College Publishing
Removing Inflation from the Economy
Panel A: Money Growth Rate
Percentage per year
10
9
8
7
6
5
4
1977
Figure 16.10A
’78
’79
’80
’81
’82
’83
10
©1999 South-Western College Publishing
Percentage per year
16
Removing Inflation from the Economy
Panel B: Interest Rate
14
12
10
8
6
4
1977
Figure 16.10B
’78
’79
’80
’81
’82
’83
11
©1999 South-Western College Publishing
Percentage per year
6
Removing Inflation from the Economy
Panel C: GDP Growth Rate
4
2
0
-2
-4
1977
Figure 16.10C
’78
’79
’80
’81
’82
’83
12
©1999 South-Western College Publishing
Removing Inflation from the Economy
Panel D: Inflation Rate
Percentage per year
10
9
8
7
6
5
4
1977
Figure 16.10D
’78
’79
’80
’81
’82
’83
13
©1999 South-Western College Publishing
END