New Monetarism/New Classical/Rational Expectations Flashcards
How does the new model, in general, explain quantity adjustments after a shock?
A surprise-shock will cause an interaction between expectations and search resulting in changes in Y and UN. This is because workers don’t know which companies are paying what or have perfect knowledge of the price level.
What role does the reservation wage have in Search Behavior?
Each employee has a certain wage they won’t say no to, and they search until they find that wage. Higher reservation wage leads to longer search times.
What influences Search Behavior?
Subsidies to Searching (Un ↑, Y ↓), Anticipated Inflation (No impact), Unanticipated Inflation (UN ↓, Y↑).
Adaptive v Rational Expectations
Adaptive expectations are based on what is going on now. Rational expectations use all info to correctly, on average, predict inflation based on the correct model of the econ. (rational expectations are a dumb assumption).
On Average, for an anticipated shock what happens?
Anticipated shocks in either direction have no effect because the model is the same as the old model in the case that things are anticipated. When people can expect more inflation, their reservation wage increases and everything stays the same.
On average, what happens for an inflationary, unanticipated shock?
Supply increases temporarily because workers get fooled. Eventually, they learn of their deception and return to normal. Initial increase occurs because workers think that the higher nominal wages they are seeing are higher real wages, but they are not. Workers take more jobs when searching because they don’t know any better.
On average, what happens for a deflationary, unanticipated shock?
Employers lower nominal wages (though real wage stays the same), so workers quit in order to go searching, however, they cannot find anything because all jobs are paying less.
How do the results of surprise shocks create the Phillips curve?
Because at higher inflation, there is lower UN. At lower inflation, there is higher UN. Yay.
What is a critique of the deflationary shock results?
In an economic downturn, it is unlikely that people will be quitting their jobs.
What about anticipated, but not average, cases?
If people have too low of expectations, then there will be a temporary expansion. Vice Versa. These shocks are not as big though.
How does this new Monetarism/Rational Expectations ideology lead to an even stronger critique of policy?
Because anticipated policies are useless when correctly anticipated, but in non-average cases the could produce either a contraction or an expansion.
Real Business Cycle Theory
S-Side theory of cycles that is based on random shocks to growth factors (which influence productivity). What is a random shock? It is a nebulous idea. This theory is bad empirically because it based on flawed assumptions about what people do with an increase in productivity (taxi example).
What does Real Business Cycle Theory do to the Phillips curve?
There are multiple vertical Phillips curves depending on the random shocks that occur. As a result of changes in production, people engage in “consumption smoothing.”
What competing effects undermine the “Incentive to Work” behind supply-side tax cuts?
Substitution and Income effects. Can’t decide in theory but in practice it seems that the income effect dominates, dealing a blow to S-side tax cuts.
Substitution effect:
When there is a change in relative price, we buy more of the cheaper good. Therefore if wages increase, leisure becomes more expensive compared to buying stuff. So we buy stuff and work more.
