ECON CH20

financial shocks

Any change in borrowing conditions that changes the real interest rate at which people can borrow. ____ ____ shift the MP curve-whether due to the Federal Reserve shifting the federal funds rate, or changes in financial markets shifting the risk premium. EX) banking system collapses. A high interest rate --> shifts MP curve up --> Higher interest rate --> lower output gap --> lower inflation. If real interest changes that's evidence that the economy has been hit by a ___ ___.

A new Federal Reserve chair, determined to reduce inflation, raised the federal funds rate sharply

Shift MP curve upward -> higher real interest rate, lower output, and lower inflation

rapid economic growth in China led to an increase in demand for American-made goods

shift IS curve to the right -> unchanged real interest rate, higher output, and higher inflation

Three steps for analyzing macroeconomic shocks

1. Identify the shock and shift the curve 2. Find the output gap 3. Assess inflation

stagflation

A combination of economic stagnation-or falling output-combined with high inflation. A supply shock can cause not only higher inflation, but also short-run _____. It's a reminded that when you account for the effects of a supply shock, realize that the shock can lower output by lower potential output even if the output gap remains unaffected

supply shocks

Any change in production costs that leads suppliers to change the prices they charge at any given level of output. ___ ____ shift the Phillips curve. An increase in production costs shifts the Phillips curve up. A decrease in production costs shifts the Phillips curve down. Common ____ ____ include changes in input prices, productivity, and the exchange rate (a depreciating U.S. dollar leads imported inputs to become more expensive and makes foreign competitors less competitive, both of which lead domestic prices to rise, shifting the Phillips curve up and a appreciating dollar shifts it down). HIGH production costs --> Phillips curve shifts up -> No change in real interest rate --> No change in output gap --> Higher inflation. If inflation rises/falls in a strong/weak economy it is a ____ ____. EX) oil prices skyrocket -> ____ ___ can reduce both actual and potential output because businesses would shift from being energy intensive to become more energy efficient, we'd need more hybrid cars and fewer SUV'S and we'd shift from energy-intensive manufacturing toward more energy-efficient services, in the short-run, this transition creates severe disruptions, as existing factories that were profitable when oil prices were low are rendered unprofitable once they're high, leading these factories to close and both actual and potential output fall, and production will only return to its earlier levels once more energy efficient factories have been built. As a result, this may lead to stagflation

Fed model

The framework that uses the IS curve, the MP curve, and the Phillips curve to link interest rates, the output gap and inflation. Businesses, economists, and policy makers use it to understand the ups and downs of the business cycle/economy. Intersection of the IS and MP curves determines the output gap and Phillips curve illustrates the role the output gap plays in shaping inflation. Real federal funds rate=MP CURVE -->Real interest rate=IS CURVE --> Output gap=Phillips CURVE --> Unexpected inflation

spending shocks

any change in aggregate expenditure at a given real interest rate and level of income. ____ ____ shift the IS curve-whether due to consumption (changes in wealth, consumer confidence, government assistance, taxes, or inequality), planned investment (changes in response to changes in future economic growth, business confidence, investment tax credits, corporate taxes, lending standards, cash reserves, or uncertainty), government expenditure (reflects the governments fiscal policy, and the operation of automatic stabilizers), or net exports (economic growth among our trading partners, trade policy, and exchange rates). EX) plummeting consumer confidence leads to a decrease in consumption. lower spending -> IS curve shifts left -> no change in real interest rate -> lower output gap -> lower inflation. If output gap has shifted without much movement in the real interest rate it is a ____ _____.

As the bargaining power of workers eroded, their nominal wages unexpectedly fell

shift Phillips curve down -> unchanged real interest rate, unchanged output gap, and lower inflation

improvements in fracking technology led the price of energy to decline

shift Phillips curve down -> unchanged real interest rate, unchanged output gap, and lower inflation