Lecture Thur Sep 30 Flashcards
Why does the reserve bank worry about expansionary gaps? Why do they not worry about expansionary gaps?
The reserve banks worry about expansionary gaps not because Y > Y*, but more because these gaps are likely to be inflationary
GO BACK OVER TAYLOR’S RULE AND GO OVER SLIDE 5 WITH NOTES IN THE BOOK
ok :(
What would the reserve bank do if they feel the inflation is too high but we are at Y*?
The RB would tighten the MPR (higher r for every π, MPR shifts up).
Because of this, the AD shifts down (ie. shifts to the left) because an increase in r means that C and I have both decreased. There is now a recessionary gap which means that Y has decreased and unemployment has increased. Overtime, SRAS shifts down; Y is back at the Y* at lower inflation rates.
Does tightening the MPR cause higher or lower r for a given rate of inflation?
higher
What is the MPR?
This is the monetary policy rule. This describes how a reserve bank takes action in response to changes in the state of the economy. It has an inflation target of 1-3%. The target interest rate is the r the RB will obtain the goal (target inflation) see Taylor’s rule.
The higher the expected inflation the higher/lower the RB’s r choice is
higher
What 4 things happens when there is a tightening MPR?
- AD shifts down
- recessionary gap
- SRAS moves out over time
- we get back to long-run equilibrium
What are the SR costs of tightening the MPR?
- lower output
- higher unemployment
What are the LR benefits of this policy?
lower inflation
What does the short-run Phillips curve show?
It shows the trade off between unemployment and inflation, holding constant both the expected inflation rate and the natural rate of unemployment
If policy makers contract aggregate demand, they can lower ________, but at the cots of temporarily higher __________
inflation
unemployment
If policymakers expand demand, they can lower __________ but only at the cost of higher _________
unemployment
inflation
What is on each axis of the Phillips curve diagram and what shape is the short-run Phillip’s curve?
Unemployment is on the x axis and inflation rate is on the y axis
It is downwards sloping
What is on each axis of the Phillips curve diagram and what shape is the short-run Phillip’s curve?
Unemployment is on the x axis and inflation rate is on the y axis
What happens to the AD curve and the SRAS curve when the Ad is expected to increase?
If there is a positive outlook, AD will be expected to increase. The economy anticipates this increase and it responds with a shift in SRAS. This is because the increase in AD means that we are producing at a higher level of inflation. We are producing more output which means the Y > Y. This means firms are incurring extra costs and they are over-utilising. The firms respond by the SRAS curve decreasing so Y = Y and u = u*
What happens to the AD curve and the SRAS curve when the Ad is expected to increase?
If there is a positive outlook, AD will be expected to increase. The economy anticipates this increase and it responds with a shift in SRAS. This is because the increase in AD means that we are producing at a higher level of inflation. We are producing more output which means the Y > Y. This means firms are incurring extra costs and they are over-utilising. The firms respond by the SRAS curve decreasing so Y = Y and u = u*.
What happens if AD increased more than expected?
Actual inflation would be greater than expected inflation and so actual unemployment would be less than the natural rate of unemployment
What happens if AD did not increase as expected?
With the SRAS, actual inflation is less than expected inflation and actual unemployment is more than the natural rate of unemployment
What does the LRPC show?
This shows the relationship between unemployment and inflation when the actual inflation equals the expected inflation rate. As a result, the long-run Phillips curve is vertical at the natural rate of unemployment
What does the LRPC show?
This shows the relationship between unemployment and inflation when the actual inflation equals the expected inflation rate. As a result, the long-run Phillips curve is vertical at the natural rate of unemployment
Does changing the inflation affect the LRPC? What does this mean for the effectiveness of monetary policy?
Changing inflation doesn’t affect the LRPC, it remains at the natural rate of unemployment so monetary policy is ineffective in the long run because even when π changes, it has no effect on unemployment rate or Y* or u*
The SRPC is a mirror of what?
the AS curve
What does expected inflation measure? What does it adjust to in the long run?
This measures how much people expect the overall price level to change. In the long run, expected inflation adjusts to changes in actual inflation
When the economy’s expected inflation, there is a shift in what curve? This cause what else to change?
There is a shift in the SRAS curve so the SRPC shifts too
What happens to the SRPC if the inflation in the economy has increased?
eg. from a 7% inflation rate to a 10% inflation rate, we move up along the SRPC (not shift of the SRPC) to a higher inflation, lower unemployment. As inflation increases from 7-10%, if expectations haven’t adjusted, it will lead to an increase in output in the AD-AS model and this causes an output gap. This means that u < u*.
Overtime, inflationary expectations adjust as π = 10% so we expect the SRAS curve to shift upwards (the πe is now equal to 10%)
In the long run, expected inflation adjusts to changes in actual inflation, true of false?
true
The RBNZ’s ability to create unexpected inflation exists only in the short run. Why is this?
Once people anticipate inflation, the only way to get unemployment below the natural rate is for actual inflation to be above the anticipated rate.
The expectations-augmented Phillips curve suggests what?
That the unemployment rate = natural rate of unemployment - α(actual inflation - expected inflation)
What are two things that would cause a shift in the long-run Phillips curve?
- this could be due to changes in the natural rate of unemployment
- any change in the economy’s productive capacity (ie. if Y* shifted)
Describe what is meant by changes in the natural rate of unemployment affecting the LRPC
Policies which improve the functioning of the labour market may help reduce the natural rate unemployment. As more workers are producing more goods (ie because u* is lower), the long-run AS (LRAS) curve would shift to the right
The LRPC is a mirror image to what? Give an example of this
the LRAS
If there is an increase in Y*, you have to hire more workers so u decreases. As the LRAS curve shifts to the right, the LRPC shifts to the left
What is the natural experiment for the natural-rate hypothesis?
This is the view that unemployment eventually returns to its natural rate regardless of the rate of inflation
What causes shifts in the SR Phillips curve? Describe this?
- a supply shock
This is an events that directly alters the firms’ costs, and, as a result, the prices they charge. This shifts the economy’s SRAs curve, and as a result, the SR Phillips curve.
Major adverse changes in aggregate supply can worsen the short-run trade-off between unemployment and inflation. As adverse supply shock gives policymakers a less favourable tradeoff between inflation and unemployment
