6. Short-run economic fluctuations Flashcards
What is potential output?
It is the normal level of output that an economy is able to produce.
Depends on resources: workforce, technology,
It is the output when resources are utilized at normal intensity.
What is the natural rate of unemployment?
It is the average/normal level of unemployment
What are economic booms?
Periods where actual output exceed potential output
What does Okun’s law say?
((Y - Y) / Y) = -2(U - U*)
The equation says that the output gap falls by 2 percentage points when unemployment rises 1 percentage point over the natural rate.
What is aggregate expenditure?
AE is the total spending on an economy’s goods and services by people, firms, and governments.
What is an expenditure shock?
Any event that changes aggregate expenditure for a given interest rate. Causes AE curve to shift
What are some examples of an expenditure shock?
Taxes, government spending, consumer confidence, new technologies, changes in bank lending, foreign business cycle
What is countercyclical monetary policy?
A change in interest rates to offset an expenditure shock in order to keep output unchanged
What are rational expectations? (Inflation)
Says that people’s expectations of future variables are the best possible forecasts based on all available information
What are adaptive expectations? (Inflation)
Also known as backward-looking expectations
Says that expectations are not based on all available information. Instead, it is determined by past inflation
Why are adaptive expectations reasonable? (Inflation)
- Convienient way to forecast inflation
2. Do not lose much because they are fairly good forecasts as inflation rates move very slowly. 1-2% at most
What is the key idea of the Phillips curve?
An economic boom raises inflation and a recession reduces inflation.
What is a supply shock, and give examples.
A supply shock, v, is an event that causes a major change in firm’s production costs
Examples: Oil price change, new labor contracts, change in exchange rate
What trade-offs do central banks face?
Policymakers can reduce inflation by raising the real interest rate, but at the cost of reducing output in the short run
What is accomodative monetary policy?
Central bank responds passively to supply shocks and lets inflation go wherever the shock pushes it
What is nonaccomodative monetary policy?
Central bank responds to supply shocks by raising/lowering output with interest rate changes in order to keep inflation stable.
What is disinflation?
Monetary policy where central bank raises interest rates temporarily to reduce inflation. The cost of disinflation is lower output.
What is long-run neutrality of money?
In long-run, monetary policy does not affect real variables, those that are adjusted for inflation, such as real GDP and real interest rates.
In long-run, policy only affects nominal GDP, nominal interest rates, and inflation (all not adjusted for inflation)
On what does potential output depend?
Labor force, capital stock, technology
NOT MONETARY POLICY
What does Okun’s law imply?
Unemployment is at its natural rate if output is equals potential output.
