1. Module 34: Phillips Curve
Module 35: History and Theories of Macroeconomics

2. Module 34: Phillips Curve
Shows the tradeoff between inflation and unemployment
Phillips concluded that when unemployment was high, wages fall and vise versa
SR Phillips Curve - negative SR relationship b/w unemployment & inflation

3. SRPC
Supply shocks affect he SRPC
Ex. oil prices

4. Module 34 Inflation expectations and the SRPC
Expected rate of inflation = the rate employers and workers expect in the near future
Increase in expected inflation shifts SRPC upward

5. Module 34 The Long Run Phillips Curve
There is not a trade-off b/w inflation and unemployment in the long run
If unemployment is at the non accelerating rate (NAIRU), inflation will match expectations and remain constant.
If it’s below the NAIRU, will require ever-accelerating inflation. (shown on the graph)
Please read page for further details.

6. Module 34
NAIRU - unemployment rate at which inflation does not change over time.
Long-Run Phillips Curve - vertical b/c any unemployment below NAIRU leads to accelerating inflation.
Limits to expansionary policy b.c unemployment rates below NAIRU cannot be maintained.

7. MOdule 34 Please read pages 337-340 for deeper explanations:
Natural Rate of Unemployment
Portion of UR that’s unaffected by swings in business cycle
NAIRU is another term for this
Cost of disinflation
Run contractionary policies, but could cause higher unemployment
Deflation
Falling aggregate price level
Debt Deflation
Effect of deflation reducing aggregate demand
Lenders gain (b.c real value of $ increases), borrowers lose (bc debt rises)

8. Module 34 Effects of expected deflation Zero bound
Nominal interest rate can’t go below zero
Can limit effectiveness of monetary policy: if you’re in a recession and interest rates are already 0, you can’t make it go down further.
Liquidity trap *test Q*
When monetary policy can’t be used to fight an economic slump bc nominal interest rates are up against the zero bound
Can occur when there’s a reduction in demand for loanable funds.

9. MOdule 34: The Fisher Effect
Please read and follow figure 34.6 in textbook - images not currently working
An increase in expected future inflation pushes both demand and supply curve upward by 1% for every percentage increase in expected future inflation

10. Questions The long run phillips curve
The same the short-run Phillips curve
Vertical
The SR Phillips curve plus inflation

11. Questions
The SR Phillips curve shows a ______ (positive/negative) relationship between ___________________________?
Negative - Agg. Price Level & Output
Positive - Agg. Price Level & Output
Negative - Unemployment and Inflation
Positive - Unemployment and Agg. Output
Positive - Unemployment and Agg. Price Level

12. Question 3. An increase in expected inflation will shift…..
The SRPC downward
The SRPC upward
The LRPC upward
The LRPC downward
Neither the short-run nor the long-run phillips curves

13. Module 35 History and Alternative Views of Macroeconomics
Previous Module: The Classical Model of the Price Level
Prices are flexible, AS curve vertical even in the short run
Increase MS = proportional rise in Aggregate price level w/ no effect on aggregate output
Increase in money supply creates inflation and that’s all.
Perhaps economists truly didn’t believe this, but rather that the long run is what’s truly important

14. Module 35 The business cycle Wesley Mitchell
Founded National Bureau of Economic Research
Declares beginnings of recessions and expansions
Some believed that expansionary policies would make recessions worse

15. Module 35 The Great Depression and the Keynesian Revolution
John Maynard Keynes
English economist
During the depression, economists argued over the correct policy theory
Keynes argued that the economy would need a complete overhaul

16. Module 35 Keynes’s Theory
Emphasized the short-run effects of the shifts in aggregate demand on aggregate output rather than the long-run determination of the aggregate price level
SR Aggregate supply curve slopes upward
Shifts in the aggregate demand curve affect output and employment as well as aggregate prices.
Figure illustrates difference b/w Keynesian and classical macroeconomics.

17. Module 35 Classical View Keynesian View
SRAS curve is vertical, shifts if AD affect Aggregate Price Level but not output
Keynesian View
SRAS curve slopes upward, so shifts in aggregate demand affect aggregate output AND aggregate prices.

18. Module 35 Classical Keynesian Vertical Supply Curve
Decline in AD = fall in prices
Emphasize role of changes in MS in shifting AD
Keynesian
Upward Slope
Decline in AD = fall in price AND output
Argues “Animal Spirits”, or business confidence, are mainly responsible for business cycles

19. Policy to Fight Recessions
Macroeconomic Policy Activism
Use of monetary policy and fiscal policy to smooth out business cycles
During depression, FDR had non-Keynesian economist advisors who urged him to balance budget and raise interest rates - which resulted in renewed slump
Today most agree in policies to fight recession

20. Module 35 Revival of Monetary Policy Monetary Policy Fiscal Policy
Keynes’s General Theory says monetary policy wouldn’t be effective in depression conditions
Ex. in a liquidity trap, monetary policy wouldn’t be effective if interest rate is down against the zero bound
1930’s IR were close to 0%
Monetary Policy
Changes in MS
Fiscal Policy
Changes in taxes or spending

21. Module 35
Monetarism
Asserts that GDP will grow steadily if the money supply grows steadily
Started by Milton Friedman
SR changes in AD = affect output and prices, like Keynesian
Argue for expansionary policies during depression
HOWEVER - argue most efforts of policymakers to smooth business cycles can make things worse.

22. Module 35 - Monetarists Continued
Discretionary Fiscal Policy
Use of changes in taxes or government spending
Can lead to further problems during a recession
Discretionary Monetary Policy
Use of changes in the interest rate or the money supply to stabilize the economy
Monetarists believe this faces same lags are DFP, but are less harmful

23. MOdule 35 - Figure 35.2
expansionary fiscal policy shifts the AD curve right
Drives up Agg. Price Level and Agg. Output
Leads to increase in Demand for money
B. Increase in money demanded drives up interest rates, reduced investment spending, offsets part of fiscal expansion
Fiscal policy becomes less effective when MS is fixed.

24. Module 35 Monetary Policy Rule Velocity of Money
Formula that determines central bank’s actions
Quantity Theory of Money
Emphasizes the positive relationship b/w the price level and MS.
M*V = P*Y
Velocity of Money
Ratio of nominal GDP to the Money Supply. It is a measure of the number of times the average dollar bill is spent per year.
Monetarists believe the velocity of money was stable in the SR, and changed only slowly in the LR.
Therefore, steady growth in the MS didn’t ensure steady growth in the economy

25. Module 35 Inflation and the Natural Rate of Unemployment
Expansionary Policies can cause problems w/ inflation
Natural Rate Hypothesis
To avoid accelerating inflation over time, the unemployment rate must be high enough that the actual inflation rate equals the expected inflation rate.
Limits role of activists
Bc government can’t keep unemployment below natural rate, goal to keep it stable

26. Module 35 Political Business Cycle New Classical Macroeconomics
Results when politicians use macroeconomic policy to serve political ends.
Such as?
New Classical Macroeconomics
An approach to the business cycle that returns to the classical view that shifts in the aggregate demand curve affect only the aggregate price level, not aggregate output
New approach evolved b/c they argued for
Rational expectations
The real business cycle theory

27. Module 35 Rational Expectations Real Business Cycle Theory
Theory by John Muth
Individuals and firms make decisions using all available information.
Real Business Cycle Theory
Claims that fluctuations in the rate of growth of total factor productivity cause the business cycle
AS is vertical
Recession occurs when a slowdown in productivity growth shifts of the AS curve leftward
Recovery occurs when a pickup in productivity growth shifts the SA curve rightward