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