Chapter 15 Debates on Macroeconomic Policy Day One Main Focus Inflation and Unemployment The Phillips Curve Wages and Price Policies The Debate Over wage and Price Policies Inflation and Unemployment Relationship between inflation and unemployment is inverse
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Debates on Macroeconomic Policy
Relationship between inflation and unemployment is inverse
The Phillips Curve expresses the inverse relationship of unemployment and inflation. - aggregate demand - ª unemployment - « inflation - ª - aggregate demand - « unemployment - ª inflation - « - on Fig. 15.2, the inverse relationship is shown.
**The curve is rarely straight - also used by governments as a policy menu. Expansionary fiscal or monetary policies would move an economy up the curve, contractionary policies would cause a move down. - the effect to which the curve is applicable can be shown in 3 different time periods.
• There was generally higher inflation with lower unemployment (thus there was demand pull inflation). Since the points fell in a broad band a Phillips Curve could be drawn and used to predict how stabilization policies would affect the economy
• Generally inflation and unemployment were both higher %. Their relationship was sometimes direct: a rise in inflation would accompany a rise or non-movement in unemployment. This caused stagflation
• Unemployment rates remained generally high, but inflation rates generally lower. Because of an inconsistent relationship, the Phillips curve could not be drawn for this period.
• Inflation was lower because oil prices dropped, reducing cost-push inflation, and because of an economic recession.
Guidelines are only voluntary in the private sector, and have very little success because most businesses do not follow them
Wage & Price controls may reduce inflation in the short run, but after the controls are removed, inflation almost instantaneously rises.Is It Effective?
Monetarism: It is an economic perspective that emphasizes the influence of money on the economy & the ability of private markets to accommodate change
Monetarists VS Keynesians
-Referred to the economist Keynesians, fiscal and monetary policies perform a beneficial role by smoothing the ups and downs of the business cycle
* Because they stress the importance of money, monetarists blame unwise use of monetary policies in particular.
Concept Central to Monetarism known as
Velocity of Money : the number of times, on average, the money is spent on final goods and services during given year is the velocity of money
1) Nominal GDP
2) $800 billion
16 = $ 50 billion
Equation of Exchange - the money supply multiplied by the velocity of money equals price level multiplied by real output.
Given: Nominal GDP = P x Q
800 billion = 2.0 x 400 billion
Money Supplied (M) x Velocity of Money (V) = price level (P) x real output (Q)
The Quantity of Money – a theory stating that the velocity of money and real output are relatively stable over short periods.
Crowding - Out - Effect:The effect of more government borrowing raising interest rates, which reduces or “crowds out” private investment spending
The Monetary Rule
Sales Taxes have very little success because most businesses do not follow them
Transfers and Subsidies
Regulation have very little success because most businesses do not follow them
Applying the Laffer Curve