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Lecture 16: Review

Lecture 16: Review. Mundell-Fleming AD-AS. Mundell-Fleming. e. IS : Y = C(Y-T) + I(Y,i) + G + NX(Y,Y*, E / (1+i-i*)). Interest parity. i. LM. IS. E. Y. e. E = E 1+i-i*. ------. * Fiscal and Monetary policy.

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Lecture 16: Review

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  1. Lecture 16: Review • Mundell-Fleming • AD-AS

  2. Mundell-Fleming e IS : Y = C(Y-T) + I(Y,i) + G + NX(Y,Y*, E / (1+i-i*)) Interest parity i LM IS E Y e E = E 1+i-i* ------ * Fiscal and Monetary policy

  3. Fixed Exchange Rates (Credible) - A little bit of it even in “flexible” exchange rates systems; “commitment” to E rather than M => i = i* => M = YL(i*) P - Central Bank gives up monetary policy

  4. Interest parity i LM i* IS E Y - Fiscal and Monetary policy - Capital controls; imperfect capital flows

  5. Exchange Rate Crises i LM i* IS E Y Note: There is a shift in the IS as well… but this is small, especially in the short run

  6. Building the Aggregate Supply • The labor market • Simple markup pricing • Long run (Natural rate: Aggregate demand factors don’t matter for Y) • Short run • Impact: Same as before but P also change (partial) • Dynamics (go toward Natural rate)

  7. Wage Determination • Bargaining and efficiency wages e W = P F(u,z) Real wages Nominal wage setting Bargaining power Fear of unemployment Unemployment insurance Hiring rate (reallocation) Bargaining

  8. Price Determination • Production function (simple) Y = N => P = (1+) W

  9. The Natural Rate of Unemployment • “Long Run” P = P • The wage and price setting relationships: e W = F(u,z) P P = 1+  W => The natural rate of unemployment F(u,z) = 1 1+ 

  10. W/P 1 1+  Price setting Wage setting u Unemployment n z, markup

  11. From u to Y n n u = U = L - N = 1 - N = 1 - Y L L L L F(1 - Y /L, z) = 1 1+  n

  12. W/P Wage setting 1 1+  Price setting Y Y n z, markup

  13. Aggregate Supply e W = P F(1-Y/L,z) P = (1+ ) W => P = P (1+ ) F(1-Y/L,z) e

  14. e P = P (1+ ) F(1-Y/L,z) AS P e P Y Y n

  15. Aggregate Demand IS: Y = C(Y-T) + I(Y,i) + G LM: M = Y L(i) P LM’ [ P’ > P] i LM Y

  16. AD:Y = Y(M/P, G, T) + + - P AD Y

  17. AD-AS: Canonical Shocks AS P AD Yn Y Monetary expansion; fiscal expansion; oil shock

  18. From AS to the Phillips Curve * The price level vs The inflation rate e P(t) = P (t) (1+ ) F(u(t), z) Note that: P(t)/P(t-1) = 1 + (P(t)-P(t-1))/P(t-1) P(t)/P(t-1) = 1 + (P(t)-P(t-1))/P(t-1) Let (t) = (P(t)-P(t-1))/P(t-1) e e

  19. e (1+(t)) = (1+(t)) (1+ ) F(u(t), z) but ln(1+x)  x if x is “small” Let also assume that ln(F(u(t), z)) = z – u(t) • Then

  20. The Phillips Curve * The price level vs The inflation rate e P(t) = P (t) (1+ ) F(u(t), z) > (t) =  (t) + (+z) -  u(t) e

  21. The Phillips Curve and The Natural Rate of Unemployment e  (t) =  (t) => u = (+z)  (t) =  (t) -  (u(t) - u ) n e n

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