Chapter 11: Inflation, ln activity, and Money Growtl 9111: Output, Unemployment, and Inflation ●11-2: The medium run o11-3: Disinflation a First Pass .11-4: Expectations, Credibility, and Nominal Contracts e11-5: The U.s. Disinflation 1979 to 1985 2003-7-28
2003-7-28 1 Chapter 11: Inflation, activity, and Money Growth 11-1: Output, Unemployment, and Inflation 11-2: The Medium Run 11-3: Disinflation: A First Pass 11-4: Expectations, Credibility, and Nominal Contracts 11-5: The U.S. Disinflation, 1979 to 1985
11-1: Output, Unemployment, and Inflation e In thinking about the interactions between output unemployment, and inflation, you must keep in mind three relations o 1.okun's law, which relates the change in unemployment to the deviation of output growth from normal o 2. The phillips curve, which relates the change in inflation to the deviation of unemployment from natural rate 3. The aggregate demand relation, which relates output growth to the rate of growth of nominal money minus the rate of inflation 2003-7-28
2003-7-28 2 11-1: Output, Unemployment, and Inflation In thinking about the interactions between output, unemployment, and inflation, you must keep in mind three relations: ⚫ 1.Okun’s law, which relates the change in unemployment to the deviation of output growth from normal. ⚫ 2.The Phillips curve, which relates the change in inflation to the deviation of unemployment from natural rate. ⚫ 3.The aggregate demand relation, which relates output growth to the rate of growth of nominal money minus the rate of inflation
okuns lawHoutput growth and changes in unemployment We assumed that output and employment moved together, so change in output led to equal changes in employment. And we assumed the labor force was constant, so changes in employment were reflected one for one in opposite changes in unemployment. Let gw denote the growth rate of output. Then, under these two assumptions the following relation should hold ue-u -gyt continue 2003-7-28 3
2003-7-28 3 Okun’s law:output growth and changes in unemployment We assumed that output and employment moved together, so change in output led to equal changes in employment. And we assumed the labor force was constant, so changes in employment were reflected one for one in opposite changes in unemployment. Let gyt denote the growth rate of output. Then, under these two assumptions ,the following relation should hold: ut –ut-1=-gyt (11.1) continue
okuns law:output growth and changes in unemployment e According to the experience, the relation actually should be 0.4(gyt-3%) (11.2) e Equation(11.2) differs in two ways from equation(11.1) o Annual output growth has to be at least 3% to prevent the unemployment rate from rising The coefficient on the deviation of output growth from the normal growth rate is-0. 4 in equation(11.2), not.0 in equation (11.1) To continue 2003-7-28
2003-7-28 4 Okun’s law:output growth and changes in unemployment According to the experience, the relation actually should be: ut –ut-1= -0.4(gyt – 3%) (11.2) Equation (11.2) differs in two ways from equation (11.1) ⚫ Annual output growth has to be at least 3% to prevent the unemployment rate from rising ⚫ The coefficient on the deviation of output growth from the normal growth rate is –0.4 in equation (11.2), not –1.0 in equation (11.1). To continue
okuns law:output growth and changes in unemployment e There are two reasons why e 1. Firm adjust employment less than one for one in response to deviations of output growth from the normal growth rate More specifically, output growth that is 1% above normal for one year leads to only a 0.6% increase in the employment rate 2. An increase in the employment rate does not lead to a one for one decrease in the unemployment rate. More specifically, a 0.6%increase in the employment rate leads to only a0.4% decrease in the unemployment rate To continue 2003-7-28 5
2003-7-28 5 Okun’s law:output growth and changes in unemployment There are two reasons why: ⚫ 1.Firm adjust employment less than one for one in response to deviations of output growth from the normal growth rate. More specifically, output growth that is 1% above normal for one year leads to only a 0.6% increase in the employment rate. ⚫ 2.An increase in the employment rate does not lead to a one for one decrease in the unemployment rate. More specifically, a 0.6% increase in the employment rate leads to only a 0.4% decrease in the unemployment rate. To continue
okun's law:output growth and changes in unemployment e Using letters rather than numbers let us write the relation between output growth and the change in the unemployment rate as t-1 b(gyt gy (113) Where g, is the normal growth rate of the economy(about 3% for the United States), and B tells us how growth in excess of normal growth translates into decrease in the unemployment rate 2003-7-28 6
2003-7-28 6 Okun’s law:output growth and changes in unemployment Using letters rather than numbers, let us write the relation between output growth and the change in the unemployment rate as: ut –ut-1= -β(gyt - gy ) (11.3) ⚫ Where gy is the normal growth rate of the economy (about 3% for the United States), and β tells us how growth in excess of normal growth translates into decrease in the unemployment rate
The Phillips curve: Unemployment and the change in inflation e We derived in chapter 10 the following relation (11.4) If expected inflation be well approximated by last year's inflation, so that we can replace s t by J 1 then it should hold J4—兀 (11.5) 2003-7-28 7
2003-7-28 7 The Phillips curve:Unemployment and the change in inflation We derived in chapter 10 the following relation: πt -πt e = -α(ut - un ) (11.4) If expected inflation be well approximated by last year’s inflation, so that we can replace πt e by πt-1 , then it should hold: πt -πt-1 = -α(ut - un ) (11.5)
The aggregate demand relation: Money Growth Inflation and Output Growth e In chapter 9, we have the following relation Y=Y(MP,G、T (92) e n order to focus on the relation between the real money stock and output, we shall ignore changes in factors other than real money here, and write the aggregate demand relation simply as Y+=r(M /Pt) (11.6) e You should keep in mind, however, that behind this elation hides the set of steps we saw in the IS-LM model To continue 2003-7-28 8
2003-7-28 8 The aggregate demand relation: Money Growth, Inflation, and Output Growth In chapter 9,we have the following relation: Y=Y(M/P, G, T) (9.2) ( + , + , - ) In order to focus on the relation between the real money stock and output, we shall ignore changes in factors other than real money here, and write the aggregate demand relation simply as: Yt =γ(Mt /Pt ) (11.6) You should keep in mind, however, that behind this relation hides the set of steps we saw in the IS-LM model: To continue
The aggregate demand relation: Money Growth Inflation and Output Growth e An increase in the real money stock leads to a decrease in the interest rate o The decrease in the interest rate leads to an increase in the demand for goods and, to an increase in output e Let gt be the growth rate of output. Let gmt be the growth rate of nominal money, and let J be the growth rate of prices the rate of inflation. Then equation(11.6), it follows that 令 g mt -JT g (11.7) 2003-7-28 9
2003-7-28 9 The aggregate demand relation: Money Growth, Inflation, and Output Growth ⚫ An increase in the real money stock leads to a decrease in the interest rate. ⚫ The decrease in the interest rate leads to an increase in the demand for goods and, to an increase in output. Let gyt be the growth rate of output. Let gmt be the growth rate of nominal money, and let πt be the growth rate of prices—the rate of inflation. Then equation (11.6), it follows that gyt = gmt -πt (11.7)
112: The Medium run By far, we have already got the following three relation 阝(9t-9 yt a(ut gvt= gmt Our task is now to see what these three relation imply for the effects of money growth on output, unemployment and inflation. We can go some way already. Take for example a decrease in money growth From the aggregate demand relation, given inflation, lower money growth implies a decrease in output growth From Okun's law, this decrease in growth leads to an increase in unemployment From the Phillips curve, higher unemployment implies a decrease in inflation 2003-7-28 10
2003-7-28 10 11-2: The Medium Run By far, we have already got the following three relation: ut –ut-1= -β(gyt - gy ) πt -πt-1= -α(ut - un ) gyt = gmt -πt Our task is now to see what these three relation imply for the effects of money growth on output, unemployment and inflation. We can go some way already. Take for example a decrease in money growth: •From the aggregate demand relation,given inflation, lower money growth implies a decrease in output growth. •From Okun’s law, this decrease in growth leads to an increase in unemployment •From the Phillips curve, higher unemployment implies a decrease in inflation
