Chapter 27

What did Milton Friedman argue?

He argued that the Phillips curve had no permanent trade-off btw u.e. and inflation

Is it possible to buy a permanently lower u.e rte at the cost of a permanently high infl rte?

No it's not

True or False: No trade-off btw u.e. and infl in the l.r b/c the l.r Phillips curve is vertical rather than downward sloping

True

True/False: actual u.e rte will fluctuate in the s.r. but will come back to the natural rte in the l.r.

True

perm low infl rte possible w/

a perm high u.e. rte

the gap between actual and expected infl rates

actual real wage to fall below the expected real wage, pushing the u.e. rte below the natural rte

actual inflation < expected inflation

actual real wages increase more than expected; many firms will hire fewer workers (u.e. rte will rise)

actual inflation > expected inflation

actual real wages will be < expected real wages; many firms will hire fewer workers (u.e. rte will fall)

if wages + prices adjust slowly then even if workers and firms have rat'l expectations,

an expans monetary policy may reduce u.e. in the short-run

what kind of relationship exists between unemployment and inflation?

an inverse relationship

what is the structural relationship dependent upon?

basic behavior of consumers and firms and remains unchanged over long periods

slow growth in a.d. leads to

both higher unemployment and lower inflation

what are tech shocks?

changes to the economy that make it possible to produce either more output or less output w/ the same # of workers, machines, and other inputs

what are rational expectations?

expectations formed by using all available info abt an economic variable

what are adaptive expectations?

future rates of inflation will follow the pattern of rates of inflation in the recent past

what is a Phillips curve?

graph showing short-run relationship between unemployment rate and the inflation rate

workers/firms adjust their expectations of inflation depending on

how high the infl rte is

the fed uses expansionary monetary policy

if workers ignore infl or form adaptive expectations policy will cause the actual infl rte to be higher than the expected infl rte s.r equilibrium will move form A > B on the s.r p.c

increased infl rte > increased unemployment (and lower u.e.) only if the

increase in the infl rte is unexpected

there is a temporary trade-off btw

inflation and u.e.

if worker/firm have rational expectations, they will use all available info including...

knowledge of the effects of the Fed reserve policy

He said that the Phillips curve couldn't be downward sloping in the

long-run

what are the three reasons that workers/firms adjust their expectations?

low inflation, moderate but stable inflation, and high and unstable inflation

an expansionary monetary policy cannot

make the act infl rte > expected infl rte

what does contractionary policy do to the S.r equilibrium curve?

moves the curve to a point where the u.e. rte is higher than the n.r (infl rte would be lower)

l.r. Phillips curve is vertical at

nat rte of u.e.

at potential GDP, firms will operate at

normal level of capacity

in the l.r. the Fed reserve can affect the infl rte

not the u.e. rte

level of real GDP in the long-run is aka

potential GDP

l.r. a.s.c is vertical at

potential real GDP

how does expansionary monetary policy affect the s.r equilibrium?

pushes s.r equilibrium to a point where U.E rate is lower than the n.r (movement up the s.r. phillips curve w/ increasing infl)

an expansionary monetary policy would not work when using _______________ expectations

rational

workers/firms formed expectations

rationally

fluctuations like tech shocks explain deviations of _______ from its potential level

real GDP

In the 60's many economics viewed the Phillips curve to have a _____________relationship

structural

at potential GDP everyone except the _________________ has a job

structurally and frictionally employed

nat u.e. rte occurs when

the economy is at potential GDP

when a bank makes a loan, it is interested in

the real interest rate on the loan

the low u.e rte was possible due to

the real wage rate being unexpectedly low

if s.r equilibrium remained higher for the n.r long enough,

the s.r. phillips curve would shift downward as workers and firms adjusted to the new, lower infl rte

non acccelerating infl rte of u.e:

the u.e rate at which the infl rte has no tendency to go up or down

in the l.r. a higher or lower infl rte will have no effect on the u.e rte b/c

the u.e rte = n.r. in the l.r.

Diff btw the expected infl rte and the actual infl rte could lead

the u.e. rte to increase or decrease below the n.r.

if policymakers were willing to accept a permanently increases infl rte,

they could keep the u.e. rte perm down

expan monet policy would cause the

u.e rate to go down b/c workers/firms would be taken by surprise and their expectations of infl would be too low

the infl rate is stable only when

u.e rte = nat rte

under the expansionary monetary policy,

u.e rte won't fall below the nat rte

During the 60's it was seen as a trade-off between

u.e. and inflation

there is a short-run tradeoff between

u.e. and inflation

temporary trade-off comes from

unanticipated infl

what are the two macroeconomic problems?

unemployment and inflation

When a.d. increases, what happens to unemployment?

unemployment falls and inflation goes up

expansionary monetary and fiscal policies had moved the short-run equilibrium

up the short-run Phillips curve to an infl rte of 4.5% and a u.e rte of 3.5%

what is the structural relationship useful for?

useful in forming economic policy, relationships are constant, relationships won't change due to changes in policy

Friedman claimed that the long-run a.s.c. was

vertical

why might some ppl think the s.r. Phillips curve isn't vertical?

workers may not have rational expectations; rational adjustment of wages/prices needed for s.r. p.c to be vertical will not actually take place

in low inflation,

workers tend to ignore it. Ex: if the infl rte is low, a restaurant may not want to pay for printing new menus that would show slightly higher prices

s.r trade off existed b/c

workers/firms expected the infl rte to be higher or lower than it turned out to be

high and unstable inflation

workers/firms that failed to correctly predict the fluctuations in inflation during these yrs could experience substantial declines in real wages and profits

if s.r equilibrium remained lower than n.r. long enough, the short-run Phillips curve

would shift up as workers and firms adjusted to the new, higher infl rte