Macroeconomics -- Seventh Unit

Inflation

Declined as unemployment rose from 2006 to 2009. Expectations of _____ remained consistent after Recession and Phillips Curve did not shift rightward. People trusted the Fed.

Government Spending

During recessions, it is said that _____ can restore demand needed for full employment, in part because of the multiplier effect. Case against is that people will respond to this by saving money and creating deadweight loss.

19th Century

During the _____, debt was taken out to build canals, roads, and the industrial base.

2019

Economy in _____ disproves the Phillips Curve, as there was low unemployment and inflation.

New Zealand

Established 0-2% inflation target in 1989. Effective in restraining inflation -- which went from 7.6% in 1989 to 2% in 1991. Changed expectations and allowed for constant wages and prices.

A. W. Phillips

Established the inverse relationship between unemployment and inflation. All data; no theory.

Supply Shock

Event that increases a firm's costs of production. Leads to less supply, higher prices, and higher unemployment because of fewer workers being needed for a limited output.

Politics

Explains why the U.S. has run deficits for 46 of the past 50 years, as nobody wants to raise taxes.

MV = PQ

Expresses contention that monetary policy only impacts nominal variables/counting devices (e.g., money stability) and not real variables. Classical dichotomy/neutrality of money.

Political Business Cycle

Fed allies with politicians and bases policy of off electoral calendar. Occurred in 1972 with Nixon and Arthur Burns -- who boosted money supply. Also, politicians and their debt spending leads to economic fluctuations.

Active Rule

For example, Fed boosting money growth by 1 percentage point for every percentage point in unemployment.

Expenditures

Government _____ result from wars, recessions, and political expediency (i.e., politicians appealing to base without cost-benefit analysis).

1990s

Greenspan era. Low unemployment under George H. W. Bush led to interest-rate hike, diminished demand, and 1991-92 recession. Rest of decade had low inflation and unemployment, and limited variability.

Government

Has a funding source as long as the economy is growing. Thus, spending that makes the economy grow is OK. Top three expenditures are transfer payments, defense, and interest on the national debt.

Inflation

Has six costs -- shoe-leather, menu, relative-price variability, changes in tax liabilities, confusion (because money ceases to be unit of account), and arbitrary wealth redistribution.

Reduction of Inflation

Has temporary costs and permanent benefits, as expectations change and there's no long-run tradeoff.

Government

Has to strike balance between waste and expediency when considering programs to boost aggregate supply, given lag. Tax cuts decentralize these decisions and allow households to decide how to allocate money. Production will follow.

Sanderson

He is less concerned about where the government gets its money from, and more about how the money is spent. Should be used to boost growth and equity. Sees attempts to focus on where money comes from as magic -- the art of misdirection. Better to spend money on new restaurant than at Vegas -- cost-benefit test.

Phillips Curve

In Friedman's view, this shows the economy's response to unexpected inflation -- i.e., unanticipated fluctuations in nominal prices caused by an augmentation of the money supply. Output and employment are boosted in the short run, but not the long run.

Long Run

In the _____, actual inflation minus expected inflation is zero -- so the economy will settle at the natural rate of unemployment.

Late 1960s

In the _____, fiscal policy boosted aggregate demand and the Fed held down interest rates by expanding money supply. Unemployment dropped throughout, until people came to expect inflation in early 1970s.

Vertical

In the long term, the Phillips Curve is _____ -- just like the long-run aggregate supply curve. In short, nominal variables controlled by the Fed do not influence real ones.

Unemployment and Inflation

In the short run, these variables are arguably intertwined. In the long run, they are unrelated.

Money Contraction

In times of inflation, _____ leads to more unemployment but diminishes inflation expectations. Leads to a leftward shift in the short-run Phillips Curve.

Deficits

Lead to deduction from national saving and an uptick in interest rates, and a decline in investment, a lower capital stock, and lower incomes. When they are lower, national saving is higher and so is investment and growth.

Ninja Loans

Loans to people with no income, job, or assets. Encouraged by federal policy and moral hazard.

1960s

Low unemployment led to high inflation.

Market Madness

Question: Who was most responsible for the Great Recession? Choices: Yoyos, indifferences, PROGS, distavores, moral hazards, excesses, bailouts, feeding frenzies, big MACs, foreclosures, Malthusians, stuff happens, invisible hands, HurriKeynes, no bells, and watchdogs. Winner: "Indifferences" -- Bush administration, which limited regulation and ran profligate budgets. Based on poll of UChicago alumni and friends.

Classical Economics

Recessions sprout from supply-side issues, and inflation results from expansion of money supply. Focus was on loanable funds equilibrium -- where the real interest rate coordinates supply and demand of loanable funds. Unemployment and money stock were not connected, partly because money stock grew at constant pace.

Disinflation

Reduction of the rate of inflation. Policy of Paul Volcker. Amount of pain caused by this policy is contingent on how quickly inflation expectations change in response to its implementation.

Federal Reserve

Responded to 1970s supply shock, caused by OPEC, by increasing rate of money supply growth. Goal was to boost aggregate demand and prevent falling output. Led to smaller recession but catalyzed inflation -- was 9% by 1980.

Deficit

Sanderson proposes that people think of this in terms of a country's GDP or a country's history.

Housing Sector

Sanderson says it is most responsible for 2008 recession, as everyone was trying to game the system.

Rational Expectations

School of Lucas, Sargent, and Barro. They believe people use all the information they have, including knowledge of government policies, to forecast the future, and that people do not systematically make mistakes. Believe also that Phillips Curve would shift to left amid expectations of disinflation -- leading to decline in inflation and unemployment. Furthered the Friedman and Phelps view of expected inflation. Affirmed by less-than-expected uptick in unemployment resulting from Volcker's policies.

Homeowners

Always have to pay their debts as income will eventually go to $0 and they will die. Conversely, government and companies have immortal flow so they can continue to refinance.

1977

Amendment to Federal Reserve Act passed in _____ gives Fed triple mandate: maximum employment, stable prices, and moderate long-term interest rates.

Barack Obama

Based on assertion that tax cuts boost GDP by 99c per dollar and spending boosts GDP by $1.59 per dollar, he implemented shovel-ready projects (public works), federal aid to state and local governments, and transfer payments.

Stagflation

Because fewer workers are needed due to diminished output, the Phillips Curve shifts right and upward -- more unemployment and higher price level. Ends with higher unemployment or higher inflation no matter what. Duration of either is contingent on expectations.

Stock

The national debt, or the accumulation of previous years' deficits, is a _____.

Debt-to-GDP

This ratio is a stock-to-flow comparison. Now more than 1:1.

Price Stability

To achieve this, the growth of the money supply should be equal to the growth in real GDP -- as GDP is tantamount to money demand.

Mistakes

Tradeoff between inflation and employment is contingent on people making _____ -- sticky wages and prices. There ceases to be a tradeoff once people adapt their expectations.

Debt Clock

Turned off on 9/11, in times of surplus, and once the debt crossed $10 trillion.

Full Employment

Under the Keynesian view, the absence of this is an invitation for government to boost spending, cut taxes, and expand money supply.

Recessions

Under the Keynesian view, these are pure waste -- people are out of work and factories are idle. Thus, government should stabilize aggregate demand to maintain production and unemployment.

Classical Macroeconomics

Under the framework of _____, inflation does not affect real variables -- it just increases prices and wages proportionately. Friedman affirmed this by contending that Fed does not affect real variables when it targets nominal factors.

Misery Index

Unemployment plus inflation.

Paul Volcker

Wanted inflation to be 0%.

Deficit

Was 15% of GDP in 2020, because G was roughly $6.5 trillion and T was only $3.5 trillion. Sanderson estimates that it will be $5 trillion in 2020, or 20% of GDP -- unprecedented since WWII.

Alan Greenspan

Was content with low inflation as long as it didn't affect business decisions. Cut interest rates to 1% in early 2000s.

Leftward

When people expect inflation to decrease, there is a _____ shift in the Phillips Curve.

Rightward

When people expect inflation to increase, there is a _____ shift in the Phillips Curve.

Interest

When the government pays this, it is not necessarily a bad thing -- can be compared to mortgage or tuition payments.

Tax Cuts

They increase disposable income and alter incentives so that aggregate demand is boosted and also so that people are more willing to work (since they get to keep more of their money).

Sargent

Called into question the sacrifice ratio, as people will cease to make inflationary bargains given government commitment to disinflation. Affirmed by 1980s disinflation, as expectations of inflation dropped by less than what was actually the case -- suggesting that there would have been smaller sacrifice ratio had people's expectations adapted quicker.

Disinflation

Can induce recessions, smaller capital stock, and loss of job skills.

Moral Hazard

"Can I get away with doing something stupid?" Manifested in 2000s, as banks loaned money to unqualified homeowners with expectation that homes would increase in value. Banks thought they'd just be able to foreclose and take home the profit. Aggravated by Fed bailouts.

0% Target

Could lead to decline in output because of sacrifice ratio, and penalty for those who can least afford.

Inflation

Allows for a decline in real wages without cuts in nominal wages and incentivizes spending/investment at low interest rates (stimulative effect). A head cold, whereas unemployment is a lobotomy.

Unemployment Rate

According to Friedman and Phelps, it can be computed based on this identity: Natural Unemployment Rate - (A x [Actual Inflation - Expected Inflation]) "A" is how much unemployment responds to unexpected inflation.

Price Level

Adjustment of output to a new _____ requires the adjustment of nominal wages.

Samuelson and Solow

Affirmed veracity of Phillips Curve in the United States and gave it its name. Postulated that low unemployment leads to higher aggregate demand and, thus, higher wages and prices. There is therefore a tradeoff between unemployment and inflation. Intimated a "pick-a-point" menu of policy options.

Employment

After an inflationary boost in output, _____ returns to natural level because producers come to expect inflation and nominal wages accordingly adjust.

Robert Lucas

Argues that people adapt almost instantaneously to inflation, and thus that there's no tradeoff between inflation and unemployment.

Debt

Argument for a balanced budget is that this will lead to a decline in future standard of living. There will ultimately be a day of reckoning when debt and interest come due -- leading to taxes or lower spending.

Economic Stabilization

Attempts at this are not favored by some because of the lag effect (firms set plans in advance, so policy changes don't affect aggregate demand for some time). Also, because of bad economic forecasts, there is always the potential of violating "do no harm" principle.

Keynesians

Believe that spending is better than tax cuts because people will save money and not boost aggregate demand.

Flow

Borrowing and spending are a _____.

Real Business Cycle Theory

Business cycles are not a function of money or government, but real variables: e.g., productivity.

Expected Inflation

Concept of Friedman and Phelps. Dictates that people have expectations regarding how much the price level will change. Affects nominal wages and thus short-run aggregate supply.

John Maynard Keynes

Contended that business cycle results from variability of animal spirits and confidence in economy. Did not acknowledge the inflation/unemployment tradeoff. Was not big on equilibrium because of animal-spirits emphasis.

Karl Marx

Contended that capitalism causes business cycles by pushing down worker pay and working conditions.

Natural Rate of Unemployment

Contingent on minimum wage, unions, efficiency wages, and job search. Where economy settles provided there are no inflation expectations.

3%

Deficit threshold in the European Union. Was determined by an analysis which found that it would be manageable.

Milton Friedman

Defined the macroeconomic consensus on Phillips Curve: There's a temporary tradeoff between inflation and unemployment because of unexpected inflation. This tradeoff leads for 2 to 5 years.

Phillips Curve

Developed by A. W. Phillips. Shows that short-term unemployment was correlated with short-term inflation (measured in terms of nominal wages) in Great Britain.

Modern Monetary Theory

Dictates that countries that borrow in their own currency do not have to worry about debts. Economists at Booth disagree vigorously, partially because of potential for inflation.

Time Inconsistency of Policy

Discrepancy between what policymakers say they will do and what they actually do. For example, Fed will say inflation will remain at 0% so that public has no inflation expectations, and then indulges in short-run tradeoff and boosts employment. Responsible for the upward shift of Phillips Curve.

Saving

Disincentivized by taxes on interest income, the double-taxing of investors in corporations, and the penalty on estates. Also diminished by means-tested old-age benefits and college financial aid.

Great Recession

Housing prices declined by 1/3, banks were in red because of bets on housing prices, and aggregate demand declined. Culprit was essentially everyone.

Higher

If actual inflation is _____ than expected inflation, the unemployment rate will go down.

Surplus

Indicated by G - T being a positive value. Would usually be the case amid low unemployment and inflation. Has only occurred in four of the past 50 years.

4%

Inflation was _____ in 1984, despite fiscal policy intended to boost aggregate demand.

Quantity Theory of Money

Money should grow at same rate as one would like price level to grow.

Fiscal Year

October 1st through September 30th.

Balanced Budget

Opponents of proposals for this believe deficit per person is a small share of his lifetime income, that cutting the deficit can come at cost of future income (especially if education is affected), that parents can offset decline in national saving by saving for their children, and that debt will not cripple nation as long as it grows slower than ability to pay.

Milton Friedman

Subscribed to classical view of economics. He believed that the Fed can target nominal factors, but that its control over these quantities does not allow them to affect real factors. Contended in 1968 that the Phillips Curve is not applicable for the long term. Affirmed by Edmund Phelps.

Sacrifice Ratio

Percentage points of output lost for each reduction of inflation by one percentage point. Typically 5 because of reduced aggregate demand.

1/3

Portion of debt held abroad. China and Japan are the biggest creditors; 10 countries hold 75% of foreign component.

1/3

Portion of debt held by Fed or trust funds. "Within the family."

1/3

Portion of debt held by private entities, such as banks and families. They want a good rate of return.

National Saving

Private plus public saving. Can be boosted by increasing public saving by lowering deficit or increasing taxes. Can be diminished if taxes are reduced and private saving doesn't go up.

Natural Rate Hypothesis

Proposed by Friedman and Phelps. Basically, unemployment always returns to its natural rate regardless of inflation. Presented 1968 even though 1961-68 data confirmed Phillips Curve.

Incentivizing Saving

Shifts burden from wealthy to poor. Plus, substitution effect (wherein people save more when returns are higher) can be canceled out by the wealth effect (wherein people save less when returns are higher and they are wealthier).

Leftward

The Phillips Curve can be shifted _____ by addressing factors that lead to a higher rate of natural unemployment and thus boosting output.

Short Run

The Phillips Curve in the _____ intersects with the long-run Phillips Curve at the expected rate of inflation. Also, the _____ Phillips Curve shifts based on changes in inflation expectations.

High Inflation

When there is _____, unemployment goes down until expectations of inflation adjust. Afterwards, wages are set accordingly and unemployment goes up. The Phillips Curve shifts right in the process -- same amount of employment, higher price level.

No Bells

Winner of "eggheads" division of Market Madness, beating out invisible hands, HurriKeynes, and watchdogs. Composed of bad forecasters -- who predicted 22 of past five recessions.

Big MACs

Winner of the Main St. division of Market Madness, beating out foreclosures (allowance for subprime mortgages, low interest rates), Malthusians (higher costs for healthcare and Social Security), and stuff happens. Composed of "Middle American Consumers" who took on debt.

Moral Hazards

Winner of the Wall St. division of Market Madness, beating out excesses, bailouts, and feeding frenzies. Composed of AIG, Bear Stearns, etc. -- firms that took on risky bets and froze credit for everyone else.

Indifferences

Winner of the Washington, D.C. division of Market Madness, beating out yoyos (Fed -- with low interest rates, bailouts, and accommodation), PROGS, and distavores. Composed of Bush administration officials who limited regulations and permitted budget profligacy.

Balanced Budget Amendment

Would be pro-cyclical instead of counter-cyclical, which is the opposite of the goal of fiscal policy. Reduced taxes and increased unemployment benefits would mean spending goes down elsewhere.

Rules-Based Policy

Would eliminate political business cycle, time inconsistency, and incompetence. Opposed because there is no consensus on proper rule, and Fed should be able to make decisions in meantime.

Incentives

_____ for saving include the expansion of 401k's and IRAs, which would prevent interest and income from being taxed until withdrawal, and a consumption tax.