inflation and expectations econ 102 2015 spring. phillips curve short-run phillips curve: in uk...
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Inflation and Expectations
Econ 102 2015 Spring
Phillips Curve
• Short-run Phillips Curve:
• In UK Phillips in 1958
Tradeoff between percentage change in wages and unemployment rate.
SR Phillips Curve
• Wages changes usually lead to price changes hence we see a similar relationship between between percentage change in price level and Unemployment
SR Phillips Curve
• What type of policy recommendations does this indicate?
SR Phillips Curve
Choose either
• Low inflation (high Unemp.
rate)or
• High inflation (low(low Unemp. rate)
SR Phillips Curve
Choose either
• Low inflation (high Unemp.
rate)or
• High inflation (low(low Unemp. rate)
What is behind this trade off?
• AD policies or changes...P
Y
ADAS
Y Potential
E2
E3
E1
Supply shock • 1973-1979 two oil price increase by OPEC
countries. Cost of production increased which can be seen as the following changes,
P
Y
ADAS
Y Potential
AS2
E1
E2
Supply shock
• Result is both inflation and unemployment increase.
Stagnation STAGNATION
Inflation
Stagflation (inflation and unemployment)
• AD policies or changes...P
Y
ADAS
Y Potential
E2
E1
AS2
Expectations
• Consumer and Producers do not have static views, they look into the future and form ‘expectations’.
• They form expectations about future prices, or the rate of change of prices.
• In all their consumption, production and labor supply decisions they take the expected inflation rate into consideration.
• What is your expected rate of inflation today for the next year in Turkey?
What happened to Phillips Curve
• How do we form expectations?
1. Look back, from the past: Adaptive expectations.
2. Look at all the information and think rationally:
Rational expectations
If you expect inflation?
• How will the firms decide on the price of their product?
• How will the workers decide for the wage Increases?
What happens to the AS curve?
• How will borrowers and lenders be affected?
Borrowers and lenders
2013Fusun borrowed from Ahmet
100 TL (if r= 8 %)
If inflation rate is 60%Then P2013=100
Will Ahmet be happy? NO
How should Ahmet be compensated?
2014Fusun will pay to Ahmet
108 TL
P2014=160
He wants to be compensated for inflation as well!
Interest rates under inflation
Wages continue to increase due to higher expected inflation...
• P
Y
AD
AS
Y Potential
AS2
E1
E2
AS3
E3
Aggregate Demand responds withMS increases
• P
Y
AD
AS
Y Potential
AS2
E1
E2
AS3E3
AD2
AD3
Short-run and Long-run Phillips Curve
• Inflation rate
Unemployment Rate Natural Rate of U
LONG TUN PHILIPS CURVE
SHORT_RUN PHILLIIPS CURVE
Monetarist view of best policy
• Quantity Theory of Money:
M is Money SupplyV is velocity –turn over rate of moneyP is price level Y is real output-real GDP.
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