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No deflation since 1955 – why?

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real gdp and the price level in the long run

No deflation since 1955 – why?

Monetary policy has specific goals to keep a balance of relatively low inflation and low unemployment. Both high inflation and high unemployment make future consumption and production uncertain. Economic instability breeds economic instability. Periods of deflation lead to even more severe unemployment as experienced in the Great Depression and briefly in the Great Recession.

The Fed adjusts monetary policy to keep inflation low, but positive. So, no deflation since 1955 due to intervention by the Fed. We will

Real GDp and the price level in the long run
reductions in greenhouse gas emissions

According to the textbook, EPA economists state that reaching greenhouse gas emissions goals will reduce real GDP substantially. What economists and what study?

Reducing greenhouse gas emissions can set off technological developments in batteries and alternative, renewable sources of energy. By moving from carbon based energy to renewables we can become energy independent. This would prevent another oil crises like the two in the 1970s that brought about persistent stagflation.

Even if you are not interested in saving the world, there are economic and national security issues to be considered in this discussion.

Reductions in greenhouse gas emissions
planned expenditures

McDonalds budget:

Washington Post: http://www.washingtonpost.com/blogs/wonkblog/wp/2013/07/16/that-mcdonalds-budget-people-are-making-fun-of-isnt-cruel-its-realistic/

Forbes: http://www.forbes.com/sites/laurashin/2013/07/18/why-mcdonalds-employee-budget-has-everyone-up-in-arms/

Planned expenditures
determinants of aggregate demand

Changes that cause an increase or a decrease in aggregate demand.

Tax decreases and tax increases are treated the same without specificity as to whose taxes are increased or decreased.

The classical paradigm would argue that tax breaks for upper incomes and “job creators” would decrease unemployment and increase investments. This in turn would theoretically increase demand.

The Keynesian paradigm would argue that reductions at the bottom end of the income scale would provide the most rapid and sustained expansionary effect. Individuals who are living hand to mouth would spend (consume) 100% of a tax reduction. Higher income individuals, lacking productive investment opportunities, would likely put it in a speculative market.

Determinants of aggregate demand
explaining the drop in aggregate demand in the late 2000s

The WC explanation is a lack of credit available to businesses meant businesses had to lay off workers. While this certainly contributed to the severity of the downturn, it is hard to justify it as the cause as the downturn was already under way. In fact, business loans initially increased briefly after the recession started until it became clear that this was a severe recession. A little like saying the firetruck started the fire.

Explaining the drop in aggregate demand in the late 2000s
2006 2008

From the Keynesian perspective the real estate bubble had been caused by low tax rates at the top, reduced demand at the bottom, deregulation of the financial industry, and various questionable financial products. The causes of the bubble are too complex to get into here, but primarily, declines in demand by consumers were masked by increases in demand for real estate investments, causing overproduction in the housing market.

2006-2008
timeline of events
Timeline of events

Manufacturing jobs had been declining for years, but its effect on the economy was masked by new construction and jobs in the financial sector.

  • Early 2006 construction spending begins decline
  • Home prices at first reduce rate of growth before falling into negative growth. 2nd and 3rd quarter 2006.
sudden unemployment
Sudden unemployment

Midyear 2007 a precipitous drop begins in employment in the construction and financial sectors. Unemployed workers reduce aggregate demand.

  • Construction

Financial sector employment

recession starts

The NBER declared that the recession started in December of 2007, although it did not announce this until December of 2008 due to chain-weighting. Initially banks increased business loans, perhaps to make up for losses on mortgages. It wasn’t until close to the end of 2008 that credit dried up for businesses. By that point, millions had already lost their jobs. Making loans when aggregate demand has taken a severe hit is not particularly prudent.

Recession starts
populism and silver

Data prior to 1913 is hard to come by. 1872 to 1894 were years of significant capital accumulation at the top of the income scale. If a wealthy few were hoarding dollars or trading them in asset markets, then few dollars remain for Main street commerce.

Populism and silver

David Hume, early monetarist: “It seems a maxim almost self-evident, that the prices of everything depend on the proportion between commodities and money.”

reasons for inflation

As suggested by the David Hume quote, inflation is the result of too many dollars pursuing limited resources.

When employment drops below the non-accelerating inflation rate of unemployment (NAIRU), employment levels are higher than would be expected, shifting the LRAS to the right. Workers, as a limited resource, are able to demand higher wages. With the higher wages, they are willing and able to pay higher prices for goods and services.

Compare wage rates in Canada and the US. Canadian prices are higher as that is what the market will bear in that wage environment.

The other cause of inflation would be the Fed. In order for the economy to grow without deflation, the Fed needs to increase the money supply so that the ratio of currency to goods and services remains consistent. If the Fed increases the money supply by too much, inflation occurs.

Reasons for inflation