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

2. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.1 Aggregate demand and aggregate supply Fig. 13.01

3. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.1 Aggregate demand and aggregate supply Output Inflation Fig. 13.01

4. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.2 IS-LM-BP and AD under fixed exchange rates Fig. 13.02

5. 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. 13.02

6. 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. 13.02

7. 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. 13.02

8. 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. 13.02

9. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.3 Shifts in the aggregate demand curve Fig. 13.03

10. 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. 13.03

11. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.4 Aggregate demand and supply under fixed exchange rates Fig. 13.04

12. 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. 13.04

13. 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. 13.04 Output gap

14. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.5 Fiscal policy under fixed exchange rates Fig. 13.05

15. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.5 Fiscal expansion under fixed exchange rates Inflation 0 A B Fig. 13.05 Output gap LAD

16. 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. 13.05 Output gap LAD

17. 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. 13.05 Output gap LAD

18. 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. 13.05 Output gap LAD

19. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.5 Long-run response of temporary fiscal expansion Inflation 0 A Fig. 13.05 Output gap B LAD

20. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.5 Fiscal expansion is cancelled Inflation 0 LAD A Fig. 13.05 Output gap B C Broad spiral from A to B to C, back to A.

21. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.8 A devaluation Fig. 13.06

22. 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. 13.06

23. 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. 13.06 BP IS´

24. 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. 13.06 BP IS´

25. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.7 Expansionary monetary policy under a fixed exchange rate regime Fig. 13.07

26. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.7 Periodic realignments of the exchange rate Time Real exchange rate Fig. 13.07

27. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.8 Fig. 13.08 85 90 95 100 105 110 115 1975M11978M11981M11984M11987M11990M11993M11996M1 Real exchange rate: Franc/DM 1975-98

28. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.9 IS-LM-BP and AD under flexible exchange rates Fig. 13.09

29. 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. 13.09

30. 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. 13.09 IS IS´

31. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.10 Aggregate demand and supply under flexible exchange rates Fig. 13.10

32. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.10 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. 13.10 Output gap

33. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.11 Monetary policy under flexible exchange rates Fig. 13.11

34. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.11 We start at the equilibrium point A... Inflation 0 A Fig. 13.11 Output gap

35. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.11... 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. 13.11 Output gap

36. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.11 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. 13.11 Output gap

37. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.12 Fig. 13.12 GDP in Hungary and Poland, 1989-2004 70 80 90 100 110 120 130 19891991199319951997199920012003 HungaryPoland

38. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.13(a) Fig. 13.13(a) 1965197519851995 300 200 100 Oil, metal, and food prices: 1965-1994 (1990=100)

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

40. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.14 An adverse supply shock Fig. 13.14

41. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.14 We start at point A... Inflation 0 A Fig. 13.14 Output gap

42. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.14...and we suffer an adverse supply shock Inflation 0 A B Stagflation is the result with both unemployment and inflation increasing. Fig. 13.14 Output gap

43. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.14 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. 13.14 Output gap

44. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.14...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. 13.14 Output gap

45. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.15 An adverse demand shock Fig. 13.15

46. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.15 Inflation 0 A Fig. 13.15 Output gap

47. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.15 An adverse demand shock Inflation 0 A B Fig. 13.15 Output gap

48. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.15 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. 13.15 Output gap

49. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.16 Fig. 13.16 Short-term interest rates in Euroland and USA

50. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.17 Disinflation Fig. 13.17

51. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.17 Policymakers want to reduce inflation from point A to point C Inflation 0 A C Fig. 13.17 Output gap

52. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.17 Contractionary demand-side policies results in unemployment pain at first Inflation 0 A B Fig. 13.17 Output gap

53. Burda, WyploszMACROECONOMIA: UNA PROSPETTIVA EUROPEA ©EGEA 2006 Figure 13.17 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. 13.17 Output gap