Alban William Phillips Alban William Housego Phillips Unemployment Rate [%]

Alban William Housego Phillips Unemployment Rate [%] Inflation

NAIRU Inflation Rate 10 % 8% 4% 2% 0 1% 2% 4% 5% 6% 7% 9% 10% Phillips Curve Unemployment Rate Traditional Phillips Curve Menu of Choices [“ Menu of Choices ”] “ Natural Rate of [If the “ Natural Rate of Unemployment ” 5% Unemployment ” is 5% ] 3%

6.8% 3% 1% Inflation [Chg in PL over time] 10 % PC 5% 5 % is U * (F) with 2 % anticipated PL. 5 % is U * (F) with 2 % anticipated PL. 2% Unemployment Inflat.Gap SRAS LRAS Y*5% AD 1 AD 2 PL [Particular price index] [ so, partic. point in time] 103 LRPC Alban William Housego Phillips SRPC Unempl. NAIRU Y I 3%

9

Government policies are a major culprit. 8% Japan Greece U.S. Canada Britain Germany Switzerland Italy Finland France Denmark Netherlands 13% 14% 15% 16% 29% 33% 34% 36% 39% 50% 53% The U.S. is not a good country to be unemployed.

Price Level [whole balloon]

President Bush’s $400,000 salary in 2001 would be = to $526,256 today. [177.1 CPI in 2001 to CPI in 2013] – 177.1=55.9/177.1x100=32% inflation [ ] $400,000 x 233.0/177.1 = $526, PL 1 PL 2 Change/Original x /177.1 x 100 = 32%

Mr. Norman’s $2.60 yearly allowance in 1961[5¢ week ] would be = to $20.26 today. [29.9 CPI in 1961 to CPI in 2013] $2.60x233.0/29.9=$20.26 a year PL 1 PL 2 But my 5¢ will buy a snicker.

PL 1 [103] PL 1 [103] SRAS E1E1E1E1 Y* Real GDP AD LRAS When PL is anticipated, equilibrium is the same for both the SRAS curve & the LRAS curve at potential output.

Capital Goods Consumer Goods Price Level Potential RGDP LRAS 1 Y1Y1Y1Y1 Y2Y2Y2Y2 1. Increase in resources - 2. Better resource quality - 2. Better resource quality - 3. Technological advances - advances - a b c d

. o

Inflation Unemployment LRPC 1 NRU 1 (4%) 0% 10% 10

10% 10% Stagflation Phillips Curve AS 2 AS 1 AD 3% 6% GDP PL but not the LR.

0 PL 1 PC

o PL 2 PL 3 PL 4 Y1Y1Y1Y1 Y2Y2Y2Y2 Y3Y3Y3Y3 Y4Y4Y4Y4 PC

Annual rate of * Inflation * Unemployment rate (percent) 7%6%5%5%4%3%1%7%6%5%5%4%3%1% PC

B C A Phillips curve C B A AS SRPC Price Level Y/Employment 2% 5% 9% 9 % 5 % 2% %9%3%3%1%1%9%9%3%3%1%1% Price Level Inflation Real Y/Unemployment Unemployment Rate * a movement up the PC another movement up the PC

PL AD Inflation AS 1 AS 2 AS 3 AS 4 AS 5 PC 1 PC 2 PC 3 PC 4 PC 5 And if there is a beneficial supply shock [AS shifts right], then the SRPC shifts left.

0% GDP Speed L imit [5 % ] Y F Inflation Rate 10 % 8% 5% 4% 2% 1% 0 1% 2% 4% 5% 6% 7% 9% 10% InflationGap Phillips Curve Unemployment Rate Traditional Phillips Curve Menu of Choices [“Menu of Choices”] “Natural Rate of [If the “Natural Rate of Unemployment”5% Unemployment” is 5%] PC 3% 8% 3%

% 6% 9% 12% 15% Annual Rate of Inflation (Percent) Unemployment Rate (Percent) SRPC 3 SRPC 2 SRPC 1 a1a1 b1b1 a2a2 a3a3 b2b2 b3b3 c3c3 c2c2

Inflation 15 % SRPC3SRPC3SRPC3SRPC3 SRPC1SRPC1SRPC1SRPC1 SRPC2SRPC2SRPC2SRPC2 0 3 % 5 % 7 % My salary just isn’t keeping up. 12 % 9 % 6 % 3 % a1a1a1a1 a2a2a2a2 a3a3a3a3 b1b1b1b1 b2b2b2b2 b3b3b3b3 C1C1C1C1 c2c2c2c2 c3c3c3c3 Wow, my raise exceeds inflation. But my salary went up by only 3%. It can’t get any better. My raise exceeds inflation. But when it comes time to sign a new contract, his boss says … But my raise was only 6%.

15 % SRPC3SRPC3SRPC3SRPC3 SRPC1SRPC1SRPC1SRPC1 SRPC2SRPC2SRPC2SRPC2 0 3 % 5 % 7 % 12 % 9 % 6 % 3 % a1a1a1a1 a2a2a2a2 a3a3a3a3 b1b1b1b1 b2b2b2b2 b3b3b3b3 C1C1C1C1 c2c2c2c2 c3c3c3c3 LRPC Inflat.GapRecess.Gap Inflation 13 14

What is the conclusion of the Phillips curve ? Annual Rate of Inflation

97 98 The new economy was helped by a favorable supply shock [oil dropping from $26 to $11] and a speedup in productivity. 3.9 % 2%2%2%2% Alban William Housego Phillips

Annual Rate of Inflation

Unemployment Rate (percent) Inflation Rate (percent per year) We had a Phillips “Curl” Instead of a Phillips Curve.

Unemployment Rate (percent) Inflation Rate (percent per year)

Inflation Unemployment Rate 1

Inflation 8%8%8%8% 4%4%4%4% 5%

inflation is not generated too little unemployment [3%] generates wage inflationtoo much unemployment [12%] causes wages to fall NOT a constantThere exists a level of unemployment where inflation is not generated. Having too little unemployment [3%] generates wage inflation, & too much unemployment [12%] causes wages to fall. This special level of unemployment IS NOT a constant. It varies based on the conditions and restrictions society places upon it. Shifters of the NAIRU [and therefore the LRPC]Shifters of the NAIRU [and therefore the LRPC] Changes in the labor force characteristicsChanges in the labor force characteristics. Age, sex, # of married both employed couples, # of new workers entering, structural changes in demand for labor skills, & educational level. Changes of government policiesChanges of government policies. Minimum wages, *unemployment compensation, job training programs, employment subsidies to workers or the employers. Changes in ProductivityChanges in Productivity. Increases in productivity w/o wage increases makes workers more desirable, and slowing of productivity without a corresponding slowing of wage increases makes workers less desirable. Changes in Labor Market InstitutionsChanges in Labor Market Institutions. Power of labor unions to negotiate wages above equilibrium level, temporary employment agencies, and the internet for job searches.

LRPC 1 Unemployment Y1Y1 Y2Y2Y2Y2 LRPC 2 Annual Rate of Inflation

Inflation Y* No LR trade-off [ just change in inflation] SRPC

Unemployment 2%2%2%2% 7% 4%4%4%4% 5% A A. W. Phillips

SRPC Inflation 6%6% Unemployment 5% LRPC A

SRPC 1 Inflation 6%6% Unemployment 5% LRPC A SRPC 2 3%3% C B

LRPC SRPC Inflation Unemployment Rate 3% 1% 5%

LRPC SRPC I Inflation Unemployment Rate 3% 8% 5%

LRPC SRPC Inflation Unemployment Rate 2% 4% 0 2% 4% 5% 6% 8% 10% 1 (b) Using your graph in part (a), show the effect of an increase in the expected rate of inflation. (c) What is the effect of the increase in the expected rate of inflation on the long-run Phillips curve ?

1.The SRPC is (downsloping/vertical/upsloping). 2.The LRPC is (downsloping/vertical/upsloping). 3.The Traditional PC has (1/2/3) curve(s) but the New PC has (1/2/3) curve(s). 4.On the PC, a recessionary gap is on the (left/right) and an inflationary gap is on the (left/right). 5. An increase in AD causes (an increase in the SRPC/ movement up the SRPC). 6. A decrease in AD causes (a decrease in the SRPC/movement down the SRPC). 7. If the SRAS shifts left [adverse supply shock], the SRPC (shifts left/shifts right). 8. If the SRAS shifts right [beneficial supply shock], the SRPC (shifts left/shifts right). 9. (REP/C+Ig+G+Xn) shifts both the SRAS and SRPC and they shift in (the same/opposite) directions. 10. The Unemployment Rate is shown on the horizontal PC axis and (price level/inflation) is shown on the vertical PC axis. 11. There (is a/is no) SR tradeoff between Inflation and unemployment. 12. There (is a/is no) LR tradeoff between inflation and unemployment even if an easy monetary policy has increased AD in the SR. 13. The “Natural Rate Hypothesis” says there (is a/is no) tradeoff on the SRPC and that there (is a/is no) tradeoff on the LRPC. 14. (Rational Expectations/Adaptive Expectations) says there are 2 Phillips curves but (Rational Expectations/Adaptive Expectations) says there is just one Phillips curve. 15. Assume last year unemployment was 2% and Inflation was 8%. This year unemployment is 5% and inflation is 4% as a result of a shift in AD. a. Draw a correctly labeled graph of a SRPC for Country X, showing the actual unemployment and inflation rates for both years. Label the Phillips curve as SRPC. b. Now assume the SRAS has shifted left. Name one factor that could cause this. ________________ c. Now on the graph show how this shift will affect the SRPC. 16. Assume that the natural rate of unemployment in Country X is 5%. a. Draw a correctly labeled graph of the long-run Phillips curve and label it as LRPC. b. What is the relationship between the unemployment rate and the inflation rate in the long run? ________________________________________________________________ 17. Assume that the government reduces the level of unemployment compensation. a. Explain how this affects the natural rate of unemployment. __________________________ ____________________________________________________________________________ b. Using a correctly labeled graph, show how this affects the long-run P hillips curve.

20. Assume that the Fed takes action to lower inflation from 6% to 3%. What will happen to each of the following as the economy approaches a new long-run equilibrium. a. The short-run Phillips Curve. Explain _________________________________ _______________________________________________________________ b. The natural rate of unemployment? __________________________________ _______________________________________________________________ 21. Assume that the U.S. economy is currently in a recession in a short-run equilibrium. (a) Draw a correctly labeled graph of the short run and long-run Phillips curves. Use the letter R to label a point that could represent the current state of the economy in Recession. 19. Assume that the U.S economy is in long-run equilibrium with an expected inflation rate of 6% and an unemployment rate of 5%. The nominal interest rate is 8%. a. Using a correctly labeled graph with both the short-run and long-run Phillips curves and the relevant numbers from above, show the current long-run equilibrium as point “A”. b. Calculate the real interest rate in the long-run equilibrium. ____________________________________________________________________________ 18. Assume the U.S. economy is operating at full-employment output. A drop in consumer confidence reduces consumption spending, causing the economy to enter into a recession. a. Using a correctly labeled graph of the short-run Phillips curve, show the effect of the * decrease in consumption spending. Label the initial position “A” and the new position “B”. b. What is the impact of the recession on the federal budget? Explain. ______________________ ______________________________________________________________________________ 22. Draw a SRPC. (a) Show the effect of an increase in the expected rate of inflation. (b) What effect does this have on the LRPC? __________________________________________ (c) With the expected increase in inflation, does the NIR on new loans increase, decrease, remain unchanged?_________________________________ (d) Will the RIR on new loans increase, decrease, or remain unchanged? ________________________ (e) If NIR is 8 and expected inflation is 3%, calculate the real interest rate [RIR]. ______.