Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Capitolo 13 Domanda Aggregata e Offerta Aggregata

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.1 Aggregate demand and aggregate supply Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.1 Aggregate demand and aggregate supply Output Inflation Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.2 IS-LM-BP and AD under fixed exchange rates Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.2 Fixed nominal exchange rates Rate of inflation Output Interest rate Output LM Financial integration line IS 0 A0A0 A0A0 LAD line 00 Y0Y0 Y0Y0 Interest rates determined by rate of return on assets in the rest of the world....the real money supply determines position of the LM curve,  =  0. Given the fixed exchange rate and now the inflation rate... We start from a position with the goods market clearing as well. Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.2 Suppose the inflation rate rises above  0... Rate of inflation Output Interest rate Output LM Financial integration line LAD line IS 0 A0A0 A1A1 A0A0 A1A1 Y0Y0 Y0Y0 00 IS 1 Y1Y1 Y1Y1 11 Because prices at home have risen faster than abroad, the demand for our exports will decrease, shifting the IS curve to the left. Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.2 Now suppose the inflation rate falls below  0... Rate of inflation Output Interest rate Output LM Financial integration line LAD line IS 0 A0A0 A1A1 A2A2 A0A0 A1A1 A2A2 Y0Y0 Y1Y1 Y0Y0 Y1Y1 00 11 IS 2 IS 1 Y2Y2 Y2Y2 22 Because prices at home have risen slower than abroad, the demand for our exports will increase, shifting the IS curve to the left. Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.2 AD under fixed exchange rates Rate of inflation Output Interest rate Output LM Financial integration line LAD line IS 0 A0A0 A1A1 A2A2 A0A0 A1A1 A2A2 Y0Y0 Y1Y1 Y2Y2 Y0Y0 Y1Y1 Y2Y2 00 11 22 IS 2 IS 1 Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.3 Shifts in the aggregate demand curve Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.2/3 Exogenous shift in IS shifts AD in same direction Rate of inflation Output Interest rate Output LM Financial integration line LAD line IS 0 A0A0 A´ 2 A0A0 Y0Y0 Y0Y0 00 IS 2 A´ 2 Y2Y2 Y2Y2 Suppose G increases, IS shifts to the right. Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.4 Aggregate demand and supply under fixed exchange rates Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.4 Aggregate demand and supply under fixed exchange rates: long-run Inflation A 0 Output gap LAD Note that we will be working with the output gap. Real exchange rate is unchanging Any inflation rate is sustainable along the output trend. Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.4 Aggregate demand and supply under fixed exchange rates: short-run Inflation A 0 LAD ‘Longer’ the short-run, the steeper the AS. ‘Longer’ the short-run, the flatter the AD. Fig Output gap

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.5 Fiscal policy under fixed exchange rates Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.5 Fiscal expansion under fixed exchange rates Inflation 0 A B Fig Output gap LAD

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.5 Fiscal expansion under fixed exchange rates Inflation 0 A B´ B Horizontal distance between B and B' is a measure of the deterioration of the primary current account Fig Output gap LAD

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.5 Transition: fiscal expansion must be followed by a contraction later on to pay for debt Inflation 0 A B Fig Output gap LAD

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.5 Transition: core inflation rate “catches up” to the higher inflation at B. Inflation 0 A B C Transition path of output gap passes through negative territory. Fig Output gap LAD

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.5 Long-run response of temporary fiscal expansion Inflation 0 A Fig Output gap B LAD

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.5 Fiscal expansion is cancelled Inflation 0 LAD A Fig Output gap B C Broad spiral from A to B to C, back to A.

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.8 A devaluation Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.6 Starting at point A, there is a nominal devaluation which depreciates the real exchange rate… Rate of inflation Output gap Interest rate Output gap LM BP LAD IS A A 0 0 LAS AS AD Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 B B Figure 13.6 …the improved current account shifts the IS curve to IS´ Rate of inflation Output gap Interest rate Output gap LM LAD IS A A 0 LM´ 0 LAS AS AD AD´ Fig BP IS´

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 B B Figure 13.6 …Inflation is now above the world level and competitiveness is reduced, shifting IS back Rate of inflation Output gap Interest rate Output gap LM LAD IS A A 0 LM´ 0 LAS AS AD AD´ Fig BP IS´

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.7 Expansionary monetary policy under a fixed exchange rate regime Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.7 Periodic realignments of the exchange rate Time Real exchange rate Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.8 Fig M11978M11981M11984M11987M11990M11993M11996M1 Real exchange rate: Franc/DM

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.9 IS-LM-BP and AD under flexible exchange rates Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 IS Figure 13.9 Flexible exchange rates, rate of growth of money supply (  ) equals rate of inflation (  ) Rate of inflation Output gap Interest rate Output gap A A LM BP M/P constant since numerator and denominator assumed to grow at same rate. Recall: position of IS curve is now endogenous, shifting with the real exchange rate so it passes through A in upper figure. Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 AD A´A´ Figure 13.9 Now suppose domestic inflation increases to  ´. Rate of inflation Output gap Interest rate Output gap LM ´ A A´A´ A LM BP M/P falling since numerator now grows slower than the denominator. Exchange rate appreciated in move to A´ which is why output fell. Fig IS IS´

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure Aggregate demand and supply under flexible exchange rates Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure Aggregate demand and supply under flexible exchange rates Inflation 0 Money growth line Monetary authority chooses the rate of growth of money supply (thereby determining long-run inflation). Nominal exchange rate changes so that PPP holds. Fig Output gap

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure Monetary policy under flexible exchange rates Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure We start at the equilibrium point A... Inflation 0 A Fig Output gap

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure Now an expansionary monetary policy under flexible exchange rates Inflation 0 A B Increase in the growth of the money supply has an expansionary impact at first (A to B). Fig Output gap

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure Core inflation increases as long as the output gap is positive. Inflation 0 A B C Because of the positive slope of AS, inflation rates along AS are greater than core inflation for a positive output gap. Fig Output gap

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure Fig GDP in Hungary and Poland, HungaryPoland

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.13(a) Fig (a) Oil, metal, and food prices: (1990=100)

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.13(b-d) Fig (b-d) Oil Shock: A turning point, pre- and post-1973

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure An adverse supply shock Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure We start at point A... Inflation 0 A Fig Output gap

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure and we suffer an adverse supply shock Inflation 0 A B Stagflation is the result with both unemployment and inflation increasing. Fig Output gap

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure Suppose we try to fight induced unemployment with expansionary demand policies... Inflation 0 A B C We successfully fight unemployment, but at a cost of increased inflation in the long- run equilibrium at C. Fig Output gap

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure or we try to fight the inflationary impact of the adverse supply shock. Inflation 0 A B D We successfully fight inflation, but at a cost of increased unemployment until we return to the long- run equilibrium at A. Fig Output gap

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure An adverse demand shock Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure Inflation 0 A Fig Output gap

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure An adverse demand shock Inflation 0 A B Fig Output gap

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure In principle we could “fight fire with fire”, i.e., AD policy change to offset demand shock Inflation 0 A B Once the policy orthodoxy (in the 1960s), this demand policy response has been remarkably subdued in European countries. Fig Output gap

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure Fig Short-term interest rates in Euroland and USA

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure Disinflation Fig

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure Policymakers want to reduce inflation from point A to point C Inflation 0 A C Fig Output gap

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure Contractionary demand-side policies results in unemployment pain at first Inflation 0 A B Fig Output gap

Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure Long-run equilibrium achieved when short-run aggregate supply shifts down sufficiently Inflation 0 A B C Speed of the AS shift depends on speed with which core inflation adjusts downward in the face of unemployment. Fig Output gap