Chapter 11: Inflation, ln activity, and Money Growtl 9111: Output, Unemployment, and Inflation ●11-2: The medium run o11-3: Disinflation a First Pass .11-4: Expectations, Credibility, and Nominal Contracts e11-5: The U.s. Disinflation 1979 to 1985 2003-7-28
2003-7-28 1 Chapter 11: Inflation, activity, and Money Growth 11-1: Output, Unemployment, and Inflation 11-2: The Medium Run 11-3: Disinflation: A First Pass 11-4: Expectations, Credibility, and Nominal Contracts 11-5: The U.S. Disinflation, 1979 to 1985
11-1: Output, Unemployment, and Inflation e In thinking about the interactions between output unemployment, and inflation, you must keep in mind three relations o 1.okun's law, which relates the change in unemployment to the deviation of output growth from normal o 2. The phillips curve, which relates the change in inflation to the deviation of unemployment from natural rate 3. The aggregate demand relation, which relates output growth to the rate of growth of nominal money minus the rate of inflation 2003-7-28
2003-7-28 2 11-1: Output, Unemployment, and Inflation In thinking about the interactions between output, unemployment, and inflation, you must keep in mind three relations: ⚫ 1.Okun’s law, which relates the change in unemployment to the deviation of output growth from normal. ⚫ 2.The Phillips curve, which relates the change in inflation to the deviation of unemployment from natural rate. ⚫ 3.The aggregate demand relation, which relates output growth to the rate of growth of nominal money minus the rate of inflation
okuns lawHoutput growth and changes in unemployment We assumed that output and employment moved together, so change in output led to equal changes in employment. And we assumed the labor force was constant, so changes in employment were reflected one for one in opposite changes in unemployment. Let gw denote the growth rate of output. Then, under these two assumptions the following relation should hold ue-u -gyt continue 2003-7-28 3
2003-7-28 3 Okun’s law:output growth and changes in unemployment We assumed that output and employment moved together, so change in output led to equal changes in employment. And we assumed the labor force was constant, so changes in employment were reflected one for one in opposite changes in unemployment. Let gyt denote the growth rate of output. Then, under these two assumptions ,the following relation should hold: ut –ut-1=-gyt (11.1) continue
okuns law:output growth and changes in unemployment e According to the experience, the relation actually should be 0.4(gyt-3%) (11.2) e Equation(11.2) differs in two ways from equation(11.1) o Annual output growth has to be at least 3% to prevent the unemployment rate from rising The coefficient on the deviation of output growth from the normal growth rate is-0. 4 in equation(11.2), not.0 in equation (11.1) To continue 2003-7-28
2003-7-28 4 Okun’s law:output growth and changes in unemployment According to the experience, the relation actually should be: ut –ut-1= -0.4(gyt – 3%) (11.2) Equation (11.2) differs in two ways from equation (11.1) ⚫ Annual output growth has to be at least 3% to prevent the unemployment rate from rising ⚫ The coefficient on the deviation of output growth from the normal growth rate is –0.4 in equation (11.2), not –1.0 in equation (11.1). To continue
okuns law:output growth and changes in unemployment e There are two reasons why e 1. Firm adjust employment less than one for one in response to deviations of output growth from the normal growth rate More specifically, output growth that is 1% above normal for one year leads to only a 0.6% increase in the employment rate 2. An increase in the employment rate does not lead to a one for one decrease in the unemployment rate. More specifically, a 0.6%increase in the employment rate leads to only a0.4% decrease in the unemployment rate To continue 2003-7-28 5
2003-7-28 5 Okun’s law:output growth and changes in unemployment There are two reasons why: ⚫ 1.Firm adjust employment less than one for one in response to deviations of output growth from the normal growth rate. More specifically, output growth that is 1% above normal for one year leads to only a 0.6% increase in the employment rate. ⚫ 2.An increase in the employment rate does not lead to a one for one decrease in the unemployment rate. More specifically, a 0.6% increase in the employment rate leads to only a 0.4% decrease in the unemployment rate. To continue