Download Sec 6, Mod 32, 33, 34

Old CHAPTER 32
Labor Markets, Unemployment and
Inflation
READ Krugman Section 6 Module 31-36
Mankiw Ch 28,35
DO Morton Unit 5
PowerPoint® Slides
by Can Erbil
© 2005 Worth Publishers, all rights reserved
What you will learn in this chapter:
The meaning of the natural rate of unemployment, and why it
isn’t zero
Why cyclical unemployment changes over the business cycle
How factors such as a minimum wage and efficiency wages can
lead to structural unemployment
The reasons that unemployment can be higher or lower than
the natural rate for extended periods
The existence of a short-run trade-off between unemployment
and inflation, called the short-run Phillips curve, that disappears
in the long run
Why the NAIRU, the nonaccelerating inflation rate of
unemployment, is an important measure for policy-making
2
The Nature of Unemployment
Workers who spend time looking for
employment are engaged in job search.
Frictional unemployment is unemployment
due to the time workers spend in job search.
Structural unemployment is
unemployment that results when there are
more people seeking jobs in a labor market
than there are jobs available at the current
wage.
3
Distribution of the Unemployed
by Duration of Unemployment, 2000
4
The Effect of a Minimum Wage on the Labor
Market
5
Causes of Structural Unemployment
Minimum wages
Unions
Efficiency wages
Side effects of government policies
6
The Natural Rate of Unemployment
The natural rate of unemployment
Cyclical unemployment
7
The Changing Makeup of the U.S. Labor Force
8
Changes in the Natural Rate of
Unemployment
Changes in Labor Force Characteristics
Changes in Labor Market Institutions
Changes in Government Policies
Changes in Productivity
OUTPUT GAP: The percentage difference between the actual level
of real GDP and potential output.
OKUN’s LAW: Each additional percentage point of output gap
reduces the unemployment rate by less than 1 percentage point.
9
The Actual Unemployment Rate Fluctuates
Around the Natural Rate
10
These Fluctuations Correspond to the
Output Gap
11
Okun’s Law
Each additional percentage point of output
gap reduces the unemployment rate by
less than 1 percentage point.
Unemployment rate = Natural rate of
unemployment – (0.5 x Output gap)
For example:
Suppose that the natural rate of unemployment is 5.2% and that
the economy is currently producing only 98% of potential output.
In that case, the output gap is -2% and Okun’s Law predicts an
unemployment rate of 5.2% - (0.5 x (-2%)) = 6.2%
12
Unemployment and Inflation, 1961–1990
13
CHAPTER 33
Inflation, Disinflation, and Deflation
PowerPoint® Slides
by Can Erbil
© 2005 Worth Publishers, all rights reserved
What you will learn in this chapter:
Why efforts to collect an inflation tax by printing money can
lead to high rates of inflation
How high inflation can spiral into hyperinflation as the public
tries to avoid paying the inflation tax
The economy-wide costs of inflation and disinflation, and the
debate over the optimal rate of inflation
Why even moderate levels of inflation can be hard to end
Why deflation is a problem for economic policy
15
Money and Prices
According to the classical model of the price level, the real
quantity of money is always at its long-run equilibrium level.
16
Money Supply Growth and Inflation
in Brazil
17
The Inflation Tax and Hyperinflation
The inflation tax is the reduction in the real value of money
held by the public caused by inflation, equal to the inflation rate
times the money supply, on those who hold money.
The real value of resources captured by the government is
reflected by the real inflation tax, the inflation rate times the
real money supply.
A vicious circle of a shrinking real money supply and a rising
rate of inflation, leads to hyperinflation and a fiscal crisis.
18
Money and Prices in Brazil, 1985–1995
19
According to the
FISHER EFFECT, an increase in
expected inflation drives up the nominal interest rate,
leaving the expected real interest rate unchanged.
(Krugman)
The 1 for 1 adjustment of the nominal interest rate to
the inflation rate. (Mankiw)
Real Interest Rate = Nominal interest rate – inflation rate
20
The Fisher Effect
21
The Costs of Inflation
Shoe-leather costs of inflation
The increased costs of making transactions that arise from
the public’s efforts to avoid the inflation tax. (using more
money to buy the same product)
Menu costs
Small costs associated with the act of changing prices.
Unit-of-account costs
Costs arising from the way inflation makes money a less
reliable unit of measurement.
22
Inflation and Nominal Interest Rates in the
U.S.
23
Module 32
Money,
Output, and
Prices in the Long Run
KRUGMAN'S
MACROECONOMICS
Margaret Ray and David Anderson
for AP*
What you will learn
in this Module:
•
The effects of an inappropriate monetary
policy
•
The concept of monetary neutrality and
its relationship to the long-term
economic effects of monetary policy
Short-Run and Long-Run Effects of
an Increase in the Money Supply
Increases in
the money
supply initially
lead to an
increase in
output,
but in the long
run increased
nominal wages
reduce SRAS
and lead only
to an
increased
price level.
Money Neutrality
Changes in the
money supply
have no real
effects in the
economy. In
the long run,
the only effect
of an increase in
the money
supply is to raise
the aggregate
price level.
Money is
neutral in
the long
run.
Changes in the Money Supply and
the Interest Rate in the Long Run
2) But in the long
run, higher prices
lead to greater
Mdem, raising the
IR to original level
1) An
increase in
the MS
lowers the IR
in the short
run
33
Module
Types of
Inflation, Disinflation,
and Deflation
KRUGMAN’S
MACROECONOMICS for
AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
•
The classical model of the price level
•
Why efforts to collect an inflation tax by
printing money can lead to high rates of
inflation and even hyperinflation
•
The types of inflation: cost-push and
demand-pull
The Classical Model of Money
and Prices
Increase in MS shifts demand
rightward (AD1 to AD2). Creates
new SR equilibrium at E2 and
higher PL at P2.
In LR, nominal wages adjust
upward and push the SRAS curve
leftward to SRAS2.
The total percent change in PL
from P1 to P2 is equal to the
percent increase in MS.
In the classical model of the price level, we ignore the transition
period and think of the price level as rising to P3 immediately.
This is a good approximation under conditions of high inflation.
The Classical Model of Money
and Prices
• %∆ M = %∆ PL
• Classical Model of the Price
Level (E to E’’)...Good
assumption given high inflation
•Classical Model ignores shortrun changes ( E to E’)... Poor
assumption given low inflation.
The Inflation Tax
•Independent central banks issue fiat money
•Monetizing the debt (turning the debt (bonds)
into money)
•Seignorage (revenue generated by the FEDs
right to print money)
•Inflation Tax (financial loss of value suffered by
holders of cash and fixed-rate bonds, as well those
on fixed income (not indexed to inflation), due to
the effects of inflation)
The Treasury issues debt to finance the
government’s purchases of goods and services.
The FED monetizes the debt by creating money
and buying the debt back from the public through
open-market purchases of Treasury Bills.
In effect, the government can and does raise
revenue by printing money.
Seignorage =
M
Real Seignorage =
Real Seignorage = (
M = Money Supply
= monthly change in
M/P
M/M) x (M/P)
The Logic of Hyperinflation
•Impact of inflation tax on people’s
decision to hold money
•Why print large sums of money?
•Taxi analogy (if gov taxes taxi rides,
people will find substitutes, and gov will have
to raise taxes on taxi rides to gain more
revenue)
In the 1920s, hyperinflation made
German currency worth so little
that children made kites from the
banknotes.
•Substituting commodities for
currency
Moderate Inflation and
Disinflation
•
Cost-push inflation (inflation
caused by an increase in the price
of inputs)
•
Demand-pull inflation
(inflation caused by an increase in
aggregate demand)
•
Politically motivated
inflation (policies that produce a
booming economy may also
increase inflation)
•
Disinflation?
Former Federal Reserve Chairman, Alan
Greenspan
The Output Gap and the
Unemployment Rate
•Output Gap
•Actual Output = Potential Output .:
Actual Unemployment = Natural
Rate of Unemployment
•Actual Output > Potential Output .:
Actual Unemployment < Natural
Rate of Unemployment
•Actual Output < Potential Output .:
Actual Unemployment > Natural
Rate of Unemployment
34
Module
Inflation and
Unemployment:
The Phillips Curve
KRUGMAN’S
MACROECONOMICS for
AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
•
What the Phillips curve is and the nature of
the short-run trade-off between inflation and
unemployment
•
Why there is no long-run trade-off between
inflation and unemployment
•
Why expansionary policies are limited due to
the effects of expected inflation
•
Why even moderate levels of inflation can
be hard to end
•
Why deflation is a problem for economic
policy and leads policy makers to prefer a
low but positive inflation rate
Why Doesn’t the Labor Market Move Quickly to
Equilibrium?
Misperceptions
Sticky Wages
Menu Costs
41
The Short-Run Phillips Curve
•Phillips Curve
•Short-Run Phillips Curve
(negative short-run
relationship between inflation
and unemployment)
•The role of supply shocks
•Friedman and Phelps:
(1968) crucial hypothesis:
expectations about future
inflation directly influences
the present inflation rate.
Today this is the most
important factor affecting
inflation (other than the
unemployment rate).
Unemployment and Inflation in the 1960s
43
Inflation Expectations and the
Short-Run Phillips Curve
•Expected Inflation
•Relationship between
actual and expected
inflation
•What determines
expected inflation?
•Why was expected
inflation not included
initially?
Unemployment and Inflation: The Phillips Curve
Hypothetically…..
45
Expected Inflation and the Short-Run Phillips
Curve
46
Inflation and Unemployment in
the Long Run
•
The SRPC of the 1960s
(click)
•
The experience of the
1970s (if inflation is consistently
high, then people will expect more
of the same)
•
The trade-off between
inflation and unemployment
Most economists believe there is no
long-run tradeoff……
The Long-Run Phillips Curve
The
unemployment
rate at which
inflation does
NOT change
over time…..
LRPC =
5% or
NAIRU (nonaccelerating
inflation rate of
unemployment)
…..keeping the
Infl Rate below
5% leads to
ever-accelerating
inflation and
cannot be
•The
maintained.
short run and long run effects of expansionary
policies
The NAIRU and the Long-Run Phillips Curve
NAIRU: nonaccelerating inflation
rate for unemployment.
***the unemployment
rate at which inflation
does not change over
time.
49
The Long-Run Phillips Curve
•NAIRU = 5% (nonaccelerating inflation rate for
unemployment)
•LRPC = 5%
•Natural Rate Hypothesis–
another name for the NAIRU
•Natural Rate = NAIRU
The Costs of Disinflation
The Great Disinflation of the 1980s
52
Stock Market Crash of 1987 (Oct 19) BLACK MONDAY. DJIA dropped
by 508 points to 1738.74 (22.61%).
Potential causes for the decline include program trading,
overvaluation, illiquidity, and market psychology.
In program trading,
computers perform
rapid stock executions
based on external
inputs, such as the
price of related
securities. Common
strategies implemented
by program trading
involve an attempt to
engage in arbitrage
and portfolio insurance
strategies.
Program trading
(LTCM) was also
responsible for the
crash in 2007.
53
Deflation
•
•
Deflation: falling price level
Debt Deflation: borrowers—
short of cash—forced to cut
spending….result is decrease in
AD.
•
Effects of Expected
Deflation: Lenders gain;
borrowers lose
•
Zero Bound: IR very low—can’t
go below zero
•
Liquidity Trap: when
conventional monetary policy can’t
be used because nominal IR are up
against zero bound
Effects of Deflation
Effects of Unexpected Deflation:
-Debt
deflation
-**The
reduction in AD arising from the increase in the real burden of
outstanding debt caused by deflation.
Effects of Expected Deflation:
-Zero
bound
-**on
the nominal interest rate; it cannot go below zero.
-Liquidity
trap
-**a
situation in which monetary policy can’t be used because the nominal
interest rates cannot fall below zero
55
Japan’s Trap
56