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1、CHAPTER 12The Phillips Curve and Expectations1Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Questions What is the Phillips curve? How has the natural rate of unemployment changed in the U.S. over the past two generations? What determines the expected rate of inflation? How ca
2、n we tell how expectations of inflation are formed-whether they are static, adaptive, or rational?2Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Questions How useful is the aggregate demand-aggregate supply framework-the IS-LM model and the Phillips curve-for understanding ma
3、croeconomic events in the U.S. over the past two generations? How do we connect up the sticky-price model with the flexible-price model?3Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Okuns Law Okuns law shows the relationship between the unemployment rate and real GDP*Y*Y-Y-0
4、.4u*-uu*)-(u-2.5*Y*Y-Y or4Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Three Faces of Aggregate Supply Aggregate supply relates the price level to the level of real GDP Aggregate supply can also relate the inflation rate to the level of real GDP Using Okuns law, aggregat
5、e supply can also relate the inflation rate to the unemployment ratethis relationship is known as a Phillips curve5Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Phillips Curve Aggregate supply can relate the inflation rate to the level of real GDP)-(*Y*Y-Ye The right-hand
6、 side of this equation can be substituted into Okuns Law)-(u*)-(u2.5-eu*)-(u2.5-e6Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Phillips Curve Letting =2.5/, we get the Phillips curve To allow for supply shocks, we will add an extra term to the Phillips curve (s)u*)-(u-es
7、eu*)-(u-7Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Figure 12.1 - The Phillips Curve8Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Figure 12.2 - Three Faces of Aggregate Supply9Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Th
8、e Phillips Curve The slope of the Phillips curve depends on how sticky prices and wages arethe stickier are wages and prices, the smaller is parameter , and the flatter is the Phillips curve When the Phillips curve is flat, even large changes in the unemployment rate have little effect on the price
9、level10Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Phillips Curve Whenever unemployment is equal to its natural rate, inflation is equal to expected inflationthe position of the Phillips curve can be determined if we know the natural rate of unemployment and the expecte
10、d inflation rate11Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Phillips Curve The Phillips curve shifts if either expected inflation or the natural rate of unemployment changes or if a supply shock occursa higher natural rate moves the Phillips curve to the righthigher e
11、xpected inflation moves the Phillips curve upadverse supply shocks move the Phillips curve up12Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Figure 12.3 - Shifts in the Phillips Curve13Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Aggregate Demand The
12、aggregate demand function developed in Chapter 11 shows how real GDP relates to the inflation rate)(-YY0 We can use Okuns Law to develop an aggregate demand equation with unemployment on the left-hand side)(-uu014Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Aggregate Demand
13、The parameter is the product of three thingshow much the central bank raises the real interest rate in response to inflationhow much real GDP changes in response to a change in the real interest ratehow large a change in unemployment is produced by a change in real GDP)(-uu015Copyright 2002 by The M
14、cGraw-Hill Companies, Inc. All rights reserved.Equilibrium Levels of Inflation and Unemployment Together, the unemployment form of the aggregate demand relationship and the Phillips curve equation allow us to determine what the inflation and unemployment rates will be in the economythe economys equi
15、librium is where the two curves cross16Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Figure 12.4 - Equilibrium Levels of Unemployment and Inflation17Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Equilibrium The economys equilibrium inflation and unempl
16、oyment rates depend onthe natural rate of unemployment (u*)the expected rate of inflation (e)supply shocks (s)the level of unemployment when the real interest rate is at what the central bank thinks is its long-run average (u0)the central banks target level of inflation ()18Copyright 2002 by The McG
17、raw-Hill Companies, Inc. All rights reserved.Solving for Equilibrium To solve for the equilibrium unemployment rate, substitute the Phillips curve equation into the monetary policy reaction functionse1)(1*u1u11u019Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Solving for Equi
18、librium To solve for the equilibrium inflation rate, substitute the monetary policy reaction function into the Phillips curvese11)u*u(1111020Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.A Decrease in Exports If export demand falls, and the central bank does nothing, u0 will
19、rise by u0 The effect on the equilibrium level of unemployment will be The effect on the equilibrium level of inflation will be0u11u0u1-21Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Figure 12.5 - Effects of a Fall in Exports22Copyright 2002 by The McGraw-Hill Companies, Inc
20、. All rights reserved.The Natural Rate of Unemployment Unemployment cannot be reduced below its natural rate without accelerating inflation If the natural rate of unemployment is high, expansionary fiscal and monetary policy are largely ineffective as tools to reduce unemployment Most estimates of t
21、he current natural rate in the U.S. lie between 4.5 and 5.0 percent23Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Figure 12.6 - Fluctuations in Unemployment and the Natural Rate24Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Natural Rate of Unempl
22、oyment Four sets of factors influence the natural rate of unemploymentdemography the relative age and educational distribution of the labor forceinstitutions labor unions, worker mobility, taxesproductivity growth wage growthpast levels of unemployment25Copyright 2002 by The McGraw-Hill Companies, I
23、nc. All rights reserved.Figure 12.7 - Real Wage Growth Aspirations and Productivity26Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Expected Inflation The natural rate of unemployment and expected inflation together determine the position of the Phillips curvehigher expected i
24、nflation moves the Phillips curve upward27Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Expected Inflation There are three basic scenarios for how inflation expectations are formedstatic expectations prevail when people ignore the fact that inflation can changeadaptive expect
25、ations prevail when people assume the future will be like the recent pastrational expectations prevail when people use all the information they have as best they can28Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Phillips Curve under Static Expectations If inflation expec
26、tations are static, expected inflation never changesthe trade-off between inflation and unemployment will not change from year to year If inflation has been low and stable, businesses will probably hold static inflation expectations29Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reser
27、ved.Figure 12.9 - Static Expectations of Inflation30Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Static Expectations of Inflation in the 1960s In the 1960s, the Phillips curve did not shift up or down in response to changes in expected inflationwhen unemployment was above 5.
28、5%, inflation was below 1.5%when unemployment was below 4%, inflation was above 4% The economy moved along a stable Phillips curve31Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Figure 12.10 - Static Expectations and the Phillips Curve, 1960-196832Copyright 2002 by The McGraw
29、-Hill Companies, Inc. All rights reserved.The Phillips Curve under Adaptive Expectations If the inflation rate varies too much for workers and businesses to ignore it and if last years inflation rate is a good guide to inflation this year, individuals are likely to hold adaptive expectationsinflatio
30、n will be forecasted by assuming that this year will be like last yearforecast will be good only if inflation changes slowly33Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Phillips Curve under Adaptive Expectations The Phillips curve can be writtenst*tt1-tt)u-(u- The Phil
31、lips curve will shift up and down depending on whether last years inflation was higher or lower than the previous yearsinflation accelerates when unemployment is less than the natural rate34Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Adaptive Expectations Examplethe governm
32、ent pushes the unemployment rate down 2 percentage points below the natural rate=1/2last years inflation rate = 4%2-1-ttThis years inflation rate = 4+1/22=5Next years inflation rate = 5+1/22=6And so on35Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Figure 12.11 - Accelerating
33、 Inflation36Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Adaptive Expectations and the Volcker Disinflation At the end of the 1970s, expected inflation gave the U.S. an unfavorable short-run Phillips curve trade-off Between 1979 and the mid-1980s, Fed chairman Paul Volcker r
34、educed inflation from 9 to 3 percent per year The fall in inflation triggered a fall in expected inflationthe Phillips curve shifted down37Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Figure 12.12 - The Phillips Curve before and after the Volcker Disinflation38Copyright 2002
35、 by The McGraw-Hill Companies, Inc. All rights reserved.The Phillips Curve under Rational Expectations If the economy is changing rapidly enough that adaptive expectations lead to large errors, individuals will switch to rational expectationsPeople form their forecasts of future inflation not by loo
36、king backward but by looking forward they look at what current and expected government policies tell us about what inflation will be39Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Phillips Curve under Rational Expectations The Phillips curve will shift as rapidly as chang
37、es in economic policy that affect aggregate demand Anticipated changes in economic policy turn out to have no effect on the level of production or employment40Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Government Policy to Stimulate the Economy Suppose that the unemploymen
38、t rate is equal to its natural rate and inflation is equal to expected inflation The government takes steps to stimulate the economy by cutting taxes and raising government spending to reduce the unemployment rate below the natural rate41Copyright 2002 by The McGraw-Hill Companies, Inc. All rights r
39、eserved.Figure 12.13 - Government Attempts to Stimulate the Economy42Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Government Policy to Stimulate the Economy If the policy comes as a surprise, the economy moves up and to the left along the Phillips curve in response to the ch
40、ange in government policy Unemployment will be lower, production will be higher, and the rate of inflation will be higher43Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Figure 12.14 - Results if the Shift in Policy Comes as a Surprise44Copyright 2002 by The McGraw-Hill Compan
41、ies, Inc. All rights reserved.Government Policy to Stimulate the Economy If the policy is anticipated, individuals will take the policy into account when they form their expectations of inflation The Phillips curve will shift up There will be no effect on unemployment or output The rate of inflation
42、 will rise45Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Figure 12.15 - Results if the Shift in Policy Is Anticipated46Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.What Kind of Expectations Do We Have? If inflation is low and stable, expectations are
43、 probably static If inflation is moderate and fluctuates slowly, expectations are probably adaptive When shifts in inflation are clearly related to changes in monetary policy, swift to occur, and large enough to seriously affect profitability, expectations are probably rational47Copyright 2002 by Th
44、e McGraw-Hill Companies, Inc. All rights reserved.From the Short Runto the Long Run In the case of an anticipated shift in economic policy under rational expectations, the long run is now In the absence of supply shocksu*)-(u-e If expectations are rational and changes in policy foreseen, expected in
45、flation will be equal to actual inflation and unemployment will be at its natural rate48Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Figure 12.16 - Rational Expectations: The Long Run Is Now49Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.From the Shor
46、t Runto the Long Run If expectations are adaptive, the economy will approach the long run graduallyan expansionary shock will lower unemployment, increase real GDP, and lead to an increase in the inflation rateindividuals will raise their expectations of inflation in the next periodsas time passes,
47、the gaps between actual unemployment and its natural rate and actual and expected inflation will shrink to zero50Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Figure 12.17 - Adaptive Expectations Convergence to the Longer Run51Copyright 2002 by The McGraw-Hill Companies, Inc.
48、 All rights reserved.From the Short Runto the Long Run Under static expectations, the long run never arrivesthe gap between expected and actual inflation can grow arbitrarily large as different shocks hit the economy if the gap between actual and expected inflation becomes large, individuals will no
49、t remain so foolish as to retain static expectations52Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Chapter Summary The location of the Phillips curve is determined by the expected rate of inflation and the natural rate of unemployment (and possibly by current, active supply
50、shocks)in the absence of current, active supply shocks, the Phillips curve passes through the point at which inflation is equal to its expected value and unemployment is equal to its natural rate53Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Chapter Summary The slope of the