Unemployment, Inflation And Output Flashcards
Define menu costs
Inflation forces firms to change prices more frequently
What are shoe leather costs?
The time and effort devoted to beating inflation
What are some costs of inflation?
Less liquid assets Shoe leather costs Menu costs Inefficient allocation of resources Difficult investment/saving decisions Hyperinflation can wipe out generation of savings
Describe the wage-price spiral:
Low unemployment leads to higher nominal wage, so firms increase prices, so workers ask for higher wage, so firms increase prices
The race between prices and wages results in steady wage and price ______
Inflation
The natural rate of unemployment is….
The unemployment rate such that the actual inflation rate is equal to the expected inflation rate
What does NAIRU stand for?
The non-accelerating-inflation-rate of unemployment
The rate of unemployment required to keep the inflation rate constant
Why has the natural unemployment rate increased in Europe?
Labour market rigidities: Unemployment insurance Employment protection Minimum wages Bargaining rules
What is wage indexation?
Automatically increases wages in line with inflation - has great effects when inflation is high or more variable
What is inflation?
The rate at which the price level increases
What is disinflation?
Decrease in inflation
How can disinflation be obtained?
Only at the cost of higher unemployment
What is the sacrifice ratio?
The number of point-years of excess unemployment needed to achieve disinflation of 1%
What is the Lucas critique?
It states that it is unrealistic to assume that wage setters would not consider changes in policy when forming their expectations
What are emphasised nominal to digitise?
Many prices and wages are not readjusted when there is a change in policy
What rigidities can make disinflation policy change challenging?
Fixed nominal contracts and staggering of wage decisions
What 3 conclusions did Laurence Ball reach when estimating sacrifice ratios for 65 disinflation episodes across 19 countries?
1) disinflations lead to a period of higher unemployment
2) faster disinflations are associated with smaller sacrifice ratios
3) sacrifice ratios are smaller in countries that have shorter wage contracts
Can the nominal interest rate ever be negative?
No because no one would hold bonds since money would be more appealing: it pays at least a zero nominal interest rate and can be used for transactions
Can the real interest rate be negative?
Yes if expected inflation exceeds the nominal interest rate. The value of money is decreasing because of inflation. You would still want bonds over cash because the real interest rates (which pay nominal interest) will exceed the real interest rate on money (which does not pay nominal interest) by the nominal interest rate.
What are the effects of a negative real interest rate on borrowing and lending?
Borrowing becomes very attractive and leads to a large demand for investment
