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7. Expectations and the Phillips Curve. Exogenous business cycle explanation rational expectations resulted from critique of Phillips curve extreme results in theory substantial impact on economic thought.

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7 expectations and the phillips curve
7. Expectations and the Phillips Curve

  • 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


Phillipscurve and expectations
Phillipscurve and Expectations

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


Business cycle modell with lucas supply function
Business cycle modell with Lucas supply function

  • 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


Nine possible combinations with monetary policy six are relevant
Nine possible combinations with monetary policy (six are relevant):

Konjunktur und Beschäftigung

U. van Suntum KuB 6 5

U van Suntum, Lecture KuB 5


Konjunktur und Beschäftigung relevant):

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 adaptive expectations* 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 adaptive expectations* in modelBb:

Konjunktur und Beschäftigung

U. van Suntum KuB 6 10

U van Suntum, Lecture KuB 10


Phillipscurve in Germany 1973 – 2001(I) adaptive expectations*

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) adaptive expectations*

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) adaptive expectations*

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) adaptive expectations*

1970s

1980s

1990s

inflation rate

Unemployment rate

Konjunktur und Beschäftigung

U. van Suntum KuB 6 14

U van Suntum, Lecture KuB 14


Criticism of new classical theory

Strengths: adaptive expectations*

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

Criticism of new classical theory

Konjunktur und Beschäftigung

U. van Suntum KuB 6 15

U van Suntum, Lecture KuB 15


Learning goals questions

What is a Lucas supply function? adaptive expectations*

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?

Learning goals/Questions

Konjunktur und Beschäftigung

U. van Suntum KuB 6 16

U van Suntum, Lecture KuB 16


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