Short-Run Economic Fluctuations Flashcards
Definition of Business cycle:
- short-run (year-to-year) fluctuations in an economy’s output and unemployment
Definition of Unemployment rate (U):
- percentage of the labor force without jobs
Potential output (Y*)
- the normal or average level of output, as determined by resources and technology
Definition of Natural rate of unemployment (U*)
- normal or average level of unemployment
Definition of Economic boom:
- period when actual output exceeds potential output
Definition of Recession:
- period when actual output falls below potential output
Output gap (Y~)
- percentage difference between actual and potential output;
(Y - Y*)/Y* = Ý
Definition of Okun’s law: (Unemployment Fluctuations)
- Relation between output and unemployment over the business cycle:
the output gap falls by 2 percentage points when unemployment rises 1 point above the natural rate;
(Y - Y*)/Y* = 2(U - U*)
Effects of aggregate expendeture :
Definition of Aggregate expenditure (AE):
- total spending on an economy’s goods and services by people, firms, and governments.
- These ideas were developed by the British economist John Maynard Keynes in his 1936 book The General Theory of Employment, Interest, and Money.
Equilibrium output: (graph)
A shift in monetary policy : (graph)
what is “Expenditure shock”?
- event that changes aggregate expenditure for a given interest rate, shifting the AE curve
Types of Expenditure Shocks:
- Government spending
- Taxes
- Consumer confidence
- New technologies
- Changes in bank lending
- Foreign business cycles
what is the meaning of Credit crunch
- a sharp reduction in bank lending
how government spending affect the economy ? ( Expenditure Shocks)
- The goverment can create an Expenditure Shocks when it start consuming more and increasing its share of aggregate consume
what is “Countercyclical monetary policy”?
- adjustments of the real interest rate by the central bank to offset expenditure shocks and thereby stabilize output
Expected inflation formula:
pi = pie
where “pi” is actual inflation and “pie” is expected inflation.
Is adaptive expectations a reasonable assumption?
Supporters make two points:
- For the firm managers who set prices, forecasting that inflation will equal past inflation is an easy shortcut.
- Although adaptive expectations are not the best possible forecasts, they are fairly good ones, adaptive forecasts of inflation have not been far off.
Phillips curve (PC)
- the positive short-run relationship between output and inflation; also, the negative short-run relationship between unemployment and inflation
- inflation equals expected inflation when output is at potential
- The key idea behind the Phillips curve is that an economic boom raises inflation and a recession reduces
Phillips curve (PC) graph
Why can we draw the Phillips curve in two different ways?
- Okun’s law
- which tells us that output and unemploy- ment move in opposite directions over the business cycle
Output Phillips Curve (formula)
pi = pie + X . (Y - Y*)/ Y* ; (X > 0)
- pi mean inflation
- pie mean expected inflation
- X is a positive constant that measures how strongly output affects inflation.
- Y mean output
- Y* is potential output
Unemployment Phillips Curve: (formula)
pi = pie - 2X (U - U*)
- pi mean inflation
- piemean expected inflation
- X is a positive constant that measures how strongly output affects inflation.
- U is the deviation of unemployment from the natural rate.
Output Phillips Curve with Adaptive Expectations (formula)
p - pi(-1) = X . (Y - Y*)/Y*
- “pi” mean inflation
- “pie “ mean expected inflation
- “X” is a positive constant that measures how strongly output affects inflation.
- Y* is potential output
Unemployment Phillips Curve with Adaptive Expectations (formula)
pi - pi(-1) = 2X . (U - U*)
- “pi” mean inflation
- “pie“ mean expected inflation
- “X” is a positive constant that measures how strongly output affects inflation.
- “U” is the deviation of unemployment from the natural rate.
what is NAIRU ?
- Acronym for nonaccelerating inflation rate of unemployment, the unemployment rate that produces a constant inflation rate; another name for the natural rate of unemployment, U*
The definition of Supply shock (v): (with inflation)
- event that causes a major change in firms’ production costs, which in turn causes a short-run change in the inflation rate
- An adverse supply shockraises costs
- a beneficial supply shock reduces costs
Output Phillips Curve with Supply Shocks (formula)
pi = pie + X . (Y - Y*)/ Y* + v
- pi mean inflation
- pie mean expected inflation
- X is a positive constant that measures how strongly output affects inflation.
- Y mean output
- Y* mean potential output
- V mean supply shock
Output Phillips Curve with Adaptive Expectations and supply shock (formula)
p - pi(-1) = X . (Y - Y*)/Y* + v
- “pi” mean inflation
- “pie “ mean expected inflation
- “X” is a positive constant that measures how strongly output affects inflation.
- “v” mean supply shock
Aggregate expenditure/ Phillips curve (AE/PC) model
- theory of short-run economic fluctuations that assumes a negative relationship between the interest rate and output (the AE curve) and a positive relationship between output and inflation (the Phillips curve)
The Complete Economy:graph
what is “Accommodative monetary policy”?
- decision by the central bank to keep the real interest rate constant when a supply shock occurs, allowing inflation to change.
- An accommodative monetary policy allows a supply shock to raise inflation permanently.
what is “Nonaccommodative monetary policy”?
- decision by the central bank to adjust the interest rate to offset a supply shock and keep inflation constant.
what is “Disinflation” to the central bank ?
- monetary policy of reducing inflation by temporarily raising the real interest rate.
- a temporary fall in output reduces inflation permanently
Definition of “Long-run monetary neutrality” ?
- principle that monetary policy cannot permanently affect real variables (variables adjusted for inflation)
what is the Neutral real interest rate (rn)?
- the real interest rate that makes output equal potential output, given the aggregate expenditure curve
what is the meaning of Hysteresis?
- theory that the short-run path of a variable, such as unemployment, affects its long-run level, such as the natural rate of unemployment
