Keynesian Macroeconomics: Aggregate Supply Mankiw Chapter 13 Williamson Chapter 12

Keynesian Macroeconomics: Aggregate Supply Mankiw Chapter 13 Williamson Chapter 12 1 Aggregate Supply • • • • 2 Frictions in Three Models So far ...
4 downloads 3 Views 214KB Size
Keynesian Macroeconomics: Aggregate Supply Mankiw Chapter 13 Williamson Chapter 12

1

Aggregate Supply • • • •

2

Frictions in Three Models

So far focus on Aggregate demand Time to look at Aggregate Supply Curve A bit more careful treatment of SRAS curve (so far an extreme assumption is made: prices are fixed in the short run!)

• Sticky Wage Model • Sticky Price Model • Imperfect Information Model (is in fact a market clearing model) – All three models predict upward sloping SRAS

3

What determines SRAS?

4

What determines SRAS? • When the actual price level deviates from its expected level, output deviates from its natural (trend level)

Y = Y + α (P − Pe ) 1/ α : slope of SRAS − Curve 5

6

1

Sticky Wage Model

Sticky Wage Model

• In the micro-founded models we assumed that labour market clears in each instant • Here, it is not anymore the case • Longer term wage contracts • Sluggish adjustment of nominal wages • When nominal wage is inflexible in the SR, a rise in the price level lowers the real wage • More hiring • More output

• Nominal wage bargaining: labour unions and efficiency wages keep the target real wage higher than the market clearing wage • W: nominal wage ω: target real wage • After the nominal wage is set and BEFORE hiring materialized, firms observe the actual price level P 7

8

Labour demand & supply • Hiring is based on the actual real wage • L=Ld(W/P)

• Nominal Wage

– In the micro-founded models Ld was solely determined by marginal productivity of labour NOT Price level)

• Production takes place: Y=F(L)

W = ω Pe

• Model neglects the labour supply decision (once nominal contract is signed, labour supply is guaranteed even if actual real wages are lower than the target real wages! • It implies countercyclical real wages! (opposite of the stylized facts!) • Role of productivity shocks

• Real Wage

W/ P=ω*Pe / P 9

10

11

12

2

Imperfect Information Model (Lucas Island Model)

Table 10-1

• Goods and labour markets clear in each instant • However SRAS and LRAS differ because of temporary misperception about prices • Suppose an overall price level increases unexpectedly • As a producer (worker) you have to decide how much to produce (offer labour as in the micro-founded model) • You have to make a decision based on the prices you observe around you (e.g. market price of the good that you produce (or help to produce via labour supply))

13

Imperfect Information Model

14

Table 11-1

• Mechanism: Nominal wage rise is perceived as being real wage riseÎ Labor supply increasesÎ Labor market eq´m: higher employment and lower real wages ÎLabor realizes that prices have also risenÎ labor supply curve shifts backÎ initial eq´m reestablishes • Confusion between overall change in prices with relative prices

Y = Y + α (P − P e)

15

16

Pricing Decision

Sticky Price Model • Firms do not adjust their prices instantaneously w.r.t. AD shocks

• Depends here on two macro-variables • 1. Aggregate price level: the higher the aggregate price level the higher the costs of production, the higher the price of the individual good • 2. Aggregate Income: means also higher demand for the individual good, higher final prices

– Menu costs – Imperfect competition (firms are price setters)

17

18

3

Pricing Decision

Pricing Decision • Desired prices

• Aggregate Prices will thus be

P = sP e + (1 − s )[ P + a (Y − Y )]

p = P + a (Y − Y ) • Two types of firms (flexible and rigid firms) • Flexible firms (1-s):

• Subtract (1-s)P from both sides and rearrange for P

e

p = P e + a(Y e − Y )

P = P e + [(1 − s ) a / s ] (Y − Y ) 

α

• Rigid firms (s):

p = Pe 19

20

21

22

• When firms expect higher inflation (higher costs) set their prices high, others follow

• When output (Y) is high, demand is high. Flexible firms set prices high (s matters)

Evidence

Evidence II

• If there is learning about AD fluctuations or if AD is quite volatile (any change in Y-Ybar reflects rather aggregate price level change instead of relative price changes) α is expected to be smallÎ flat SRAS Curve • If AD is rather stable, a change in Y-Ybar is expected to reflect relative price change , α is expected to be large Î steep SRAS Curve • Lucas (1973): finds evidence in support of imperfect information model, i.e. AD changes have largest impact on Y only in those countries where Prices and AD are in general stable! 23

• Sticky price model: high rate of inflation calls for more frequent price adjustments (high inflation countries face a large α (steep SRAS) (low inflation countries face a low α (flat SRAS) – Confirmed by data

24

4

Main Conclusion • Imperfections cause SR monetary nonneutrality • Compatible with LR monetary neutrality

25

Inflation, Unemployment and Phillips Curve

26

Deriving the Phillips Curve

• Policymakers objectives may conflict • Three factors drive PC

– Low inflation and high employment – Phillips Curve

– Expected future inflation – Cyclical unemployment – Supply shocks – i,.e.

π = π e − β (u − un ) +υ

27

• Subtract Pt-1 from both sides

Deriving PC

P − P−1 = P e − P−1 +

• Rewrite AS equation as a function of P

P = Pe +

1

α

(Y − Y )

1

α

1

α

(Y − Y ) + υ

• i.e.

• Add υ to capture an exogenous AS shock (e.g. oil prices, deregulation etc)

P = Pe +

28

π =πe+

1

α

(Y − Y ) + υ

(Y − Y ) + υ 29

30

5

• Use Okun’s Law that is

1

α

Essential Issue (Y − Y ) = − β ( u − u n )

• PC and /or SRAS brake the classical dichotomy in the Short run

• rewrite AS equation to obtain Phillips Curve such that

π = π e − β (u − u n ) + υ

• policy (more precisely monetary policy) effectiveness

• Classical dichotomy breaks down in the short run!

31

32

How to make PC Workable: Adaptive Expectations • backward looking behaviour

• Inflation inertia

• Agents form expectations by looking at the previous period inflation data

• Past inflation affects current expectations that affects wages and prices!

π = π t −1 • • Rewrite Phillips Curve accordingly (NAIRU) e

π = π−1 − β (u − un ) +υ

33

34

Causes of Rising and Falling Inflation • Demand pull inflation • Cost push inflation

35

− β (u − u n )

υ

36

6

SR Trade-off between Inflation and Unemployment β determines the trade off between inflation and unemployment

• Early evidence indicated a SR trade off • Now very little support if any! 37

38

Disinflation • Under adaptive expectations disinflation is costly! • In the absence of favourable supply shock (decline in u via say a decline in energy prices) lowering inflation requires an increase in unemployment and decline in real output . • If agents are rational, (as in the micro-founded models) expectation formation should use all available information. Less pain in terms of output loss! 39

40

Disinflation and Sacrifice Ratio • Sacrifice ratio: percentage of a year’s GDP (or unemployment: by Okun’s Law) that must be foregone to reduce inflation by 1% point. (estimates: for 1% inflation decline sacrifice about 5% of a year’s GDP)

π = π e − β (u − un ) +υ 1

α

(Y − Y ) = − β ( u − u n ) 41

42

7

Hysteresis

Conclusions

• Characterizes long lasting influence of AD on natural rate.. • E.g. A long lasting recession

• • • •

– May cause loss of skills – Reduction in desire to find a job – Insiders/outsiders

Three theories of SRAS Phillips Curve Inertia: adaptive expectations Natural rate hypothesis

– Permanent implications on the labour market – Hysteresis raises the sacrifice ratio (output is permanently lost even if disinflation is over) 43

44

8

Suggest Documents