Inflation, Unemployment, and Stabilization Policies
Inflation, Unemployment, and Stabilization Policies
Inflation, Unemployment, and Stabilization Policies
Unemployment,
and Stabilization
Policies
Budget Balance
http://www.usdebtclock.org/
1) Crowding out
2) Todays deficits, by increasing the governments
debts, place financial pressure on future budgets.
Monetary Policy
Taylor Rule
Inflation Targeting
Zimbab
we
Summer of 2008
achieved the worlds
highest inflation rate: 11
million percent a year
Hyperinflation
Cost-Push Inflation
Demand-Pull Inflation
Inflation and
In the long
Unemployment
run, inflation & unemployment
are unrelated:
Aggregate Demand,
Aggregate Supply, and the
The Phillips
curve shows
the combination
Philips
Curve
P
SRAS
105
103
5%
A
AD2
3%
PC
AD1
Y1
Y2
4%
6%
u-rate
Aggregate Demand,
Aggregate Supply, and the
Given that monetary and fiscal policy can
Phillips Curve
both shift the aggregate demand curve,
both shift the aggregate demand curve,
these types of policies can move the
economy along the Philips curve.
U.S.
U.S. policymakers
policymakers
opted
opted for
for reducing
reducing
unemployment
unemployment
at
at the
the expense
expense of
of
higher
higher inflation
inflation
inflation
LRAS
LRPC
high
inflation
P2
P1
AD2
AD1
natural rate
of output
low
inflation
natural rate of
unemployment
u-rate
Short run
Fed can reduce u-rate below the
natural u-rate by making inflation
greater than expected.
Long run
Expectations catch up to reality,
u-rate goes back to natural u-rate
whether inflation is high or low.
inflation
5%
LRPC
C
A
3%
PC2
PC1
4%
6%
u-rate
LRPC
5%
C
A
3%
PC2
PC1
4%
6%
u-rate
Nonaccelerating inflation
rate of unemployment
(NAIRU)
The figure on the next slide shows the unemployment rate and inflation
rate. It is easy to see the inverse relationship between these variables.
Beginning in the late 1960s, the government followed policies that
increased aggregate demand.
Government spending rose because of Vietnam War.
The Fed increased the money supply to try to keep interest rates
down.
As a result of these policies, the inflation rate remained fairly high.
However, even though inflation remained high, unemployment did not
remain low.
The simple inverse relationship between the two variables began to
disappear in 1970.
This occurred because peoples inflation expectations adjusted to the
higher rate of inflation and the unemployment rate returned to its
natural rate of around 5 to 6 percent.
Government can NOT keep the unemployment rate low, it should try to
keep it stable at the natural rate.
unemployment
unemployment increased,
increased,
despite
despite higher
higher inflation.
inflation.
Friedman
Friedman &
& Phelps
Phelps
explanation:
explanation:
expectations
expectations were
were
catching
catching up
up with
with
reality.
reality.
P
SRAS2
P2
SRAS1
P1
AD
Y2
Y1
PC2
PC1
u-rate
Supply
Supply shocks
shocks &
& rising
rising expected
expected
inflation
inflation worsened
worsened the
the PC
PC tradeoff.
tradeoff.
Disinflationary Monetary
Policy
Contractionary
inflation
monetary policy moves
economy from A to B.
Over time,
expected inflation falls,
PC shifts downward.
In the long run,
point C:the natural rate
of unemployment,
and lower inflation.
LRPC
A
B
C
PC1
PC2
u-rate
natural rate of
unemployment
A
B
C
PC1
PC2
u-rate
natural rate of
unemployment
u-rate
u-rate near
near
10%
10% in
in
1982-83
1982-83
Deflation
Effects of Expected
Deflation
Main Approaches to
Macroeconomics
Classical Economics
Keynesian Economics
Keynesian Economics
Keynesian Economics
Keynesian Economics
Monetari
sm
Monetarism
Monetarism
Hypothesis of Economics
Neoclassical Economics
Rational Expectations
New Keynesian
Economics
2001:
George W Bush pushed for a
tax cut that helped the economy
recover from a recession that
had just begun.
Automatic Stabilizers
Automatic Stabilizers