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7. Expectations and the Phillips Curve

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- Exogenousbusinesscycleexplanation
- rational expectations
- resultedfromcritiqueof Phillips curve
- extreme results in theory
- substantial impact on economicthought

Konjunktur und Beschäftigung

U. van Suntum KuB 6 1

U van Suntum, Lecture KuB 1

Lucas supply function:*)

- Robert E. Lucas jr.
- born 1937
- Nobelprize 1995

Konjunktur und Beschäftigung

U. van Suntum KuB 6 2

U van Suntum, Lecture KuB 2

- With p = pe and u = 0 => Yreal = Yreal*
- p endogenous, dependent on pe

Konjunktur und Beschäftigung

U. van Suntum KuB 6 3

U van Suntum, Lecture KuB 3

Three versions of expectations:

a) static (Keynesian version ):

b) adaptive (monetaristic version):

With it follows:

c) rational (new classical version):

Konjunktur und Beschäftigung

U. van Suntum KuB 6 4

U van Suntum, Lecture KuB 4

Konjunktur und Beschäftigung

U. van Suntum KuB 6 5

U van Suntum, Lecture KuB 5

Konjunktur und Beschäftigung

U. van Suntum KuB 6 6

U van Suntum, Lecture KuB 6

Numerical example model Ab: one-off increase of M with adaptive expectations*)

Neuklassisches Konjunkturmodell.xls

Konjunktur und Beschäftigung

U. van Suntum KuB 6 7

U van Suntum, Lecture KuB 7

Phillipscurve in model Ab:

Konjunktur und Beschäftigung

U. van Suntum KuB 6 8

U van Suntum, Lecture KuB 8

Numerical example model Ab: constant growth rate of M with adaptive expectations*

Neuklassisches Konjunkturmodell.xls

Konjunktur und Beschäftigung

U. van Suntum KuB 6 9

U van Suntum, Lecture KuB 9

Phillipscurve in modelBb:

Konjunktur und Beschäftigung

U. van Suntum KuB 6 10

U van Suntum, Lecture KuB 10

Phillipscurve in Germany 1973 – 2001(I)

Inflation rate

Unemployment rate

year

Konjunktur und Beschäftigung

U. van Suntum KuB 6 11

U van Suntum, Lecture KuB 11

Phillipscurve in Germany 1973 – 2001 (II)

inflation rate

Unemployment rate

Konjunktur und Beschäftigung

U. van Suntum KuB 6 12

U van Suntum, Lecture KuB 12

Phillipscurve in Germany 1973 – 2001 (III)

inflation rate

Unemployment rate

Konjunktur und Beschäftigung

U. van Suntum KuB 6 13

U van Suntum, Lecture KuB 13

Phillipscurve in Germany 1973 – 2001 (IV)

1970s

1980s

1990s

inflation rate

Unemployment rate

Konjunktur und Beschäftigung

U. van Suntum KuB 6 14

U van Suntum, Lecture KuB 14

Strengths:

Role of expectations is highlighted

Different versions of Phillips curve can be explained

Simultanous explanation of inflation and business cycle

Weaknesses:

Rational expectations not a realistic assumption

Money supply exongenous?

One-sided

Konjunktur und Beschäftigung

U. van Suntum KuB 6 15

U van Suntum, Lecture KuB 15

What is a Lucas supply function?

What kinds of expectations can be distiguished?

What is the impact of different combinations of monetary policy and expectations on the Phillips curve?

What are the key drivers for fluctuations in new classical theory?

Konjunktur und Beschäftigung

U. van Suntum KuB 6 16

U van Suntum, Lecture KuB 16