The big picture marcoeconomics 12e parkin chapter 12

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T H E B U S I N E S S C Y C L E , I N F L AT I O N , A N D D E F L A T I O N C h a p t e r THE BUSINESS CYCLE, INFLATION AND DEFLATION** The Big Picture Where we have been: Chapter 12 uses the AS-AD model developed in Chapter 10 to explore business cycles, inflation, and deflation The distinction between the short-run and longrun aggregate supply curves is useful for appreciating the difference between the short-run and long-run Phillips curves Chapter 12 also draws on the definition of inflation in Chapter Where we are going: Chapter 12 is the last of three chapters dealing with macroeconomic fluctuations The explanation of the business cycle through the lens of the aggregate supply-aggregate demand model lays the foundation for the next two chapters, on fiscal policy and monetary policy respectively N e w i n t h e Tw e l f t h E d i t i o n Along with the new title for the chapter, there is now a new section on deflation None of the other content was removed, but some sections were written more concisely and the chapter was reorganized to move the business cycle section to the beginning The Economics In Action about the United States Phillips Curve was shortened by including only data for the 2000’s The end of chapter Economics In The News feature has a 2014 article about the ECB’s attempts to fight stagnation in the Eurozone The Worked Problem covers demand-pull and cost-push inflation issues The Worked Problem gives aggregate demand and short-run aggregate supply schedules and then asks the effect of changes in aggregate demand and aggregate supply It also asks what type of output gap is created The answers use both the data in the aggregate demand and short-run aggregate supply functions as well as an aggregate supply/aggregate supply figure To include the new Worked Problem without lengthening the chapter, some problems have been removed from the Study Plan Problem and Applications These problems are still in the MyEconLab and are called Extra Problems 19 Lecture Notes The Business Cycle, Inflation and Deflation     Explain how aggregate demand shocks and aggregate supply shocks create the business cycle Explain how demand-pull and cost-push forces bring cycles in inflation and output Explain the causes and consequences of deflation Explain the short-run and long-run tradeoff between inflation and unemployment I The Business Cycle Business Cycles Most principles of economics textbooks have a chapter that is similar to this one However, many of them contain an extended discussion to the effect that, “This school of thought thinks this, but this other school of thought disagrees, and, by the way, here’s a third school of thought that thinks the first school is partially correct but partially wrong ” This material is (appropriately enough!) found to be exceptionally tedious by the students Fortunately, Parkin’s chapter is not at all like these other weak attempts Parkin shows the students how the schools relate to each other and presents an incredibly exciting chapter You can take advantage of this fact in your lecture by discussing with your students which school of thought best describes your views and what evidence convinced you Just as students are always fascinated by why their instructor chose his or her field, so, too, are students fascinated about where their instructor fits into the scheme of controversies that they are learning about By discussing your place in the line-up of different schools, be it “hard-line” monetarist, or new Keynesian, or an eclectic mixture, you can be guaranteed of your students’ strong interest when you discuss this topic You might also point out to the students that theories are not necessarily mutually exclusive For instance, even though you may be, perhaps, a monetarist, this does not necessarily mean that you totally deny that the factors emphasized by real business cycle proponents are occasionally important By identifying your point of view and also giving the students some instruction about your view as to the usefulness of the other approaches, you can not only interest them but also help give them an enhanced general understanding of macroeconomics Mainstream Business Cycle Theory The mainstream business cycle theory regardless fluctuations in aggregate demand around a growing potential GDP (and hence constantly rightward shifting LAS and SAS curves) as the cause of the business cycle Real GDP differs from potential GDP when money wage rates not offset changes in the price level    Keynesian Cycle Theory: The Keynesian cycle theory asserts that fluctuations in investment driven by fluctuations in business confidence—summarized by the phrase “animal spirits”—are the main source of fluctuations in aggregate demand Money wage rates are assumed rigid Monetarist Cycle Theory: The monetarist cycle theory asserts that fluctuations in both investment and consumption expenditure, driven by fluctuations in the growth rate of the quantity of money, are the main sources of fluctuations in aggregate demand Money wage rates are assumed rigid New Classical Cycle Theory: The new classical cycle theory asserts that the money wage rate and hence the position of the SAS curve are determined by the rational expectation of the price level, which depends on potential GDP and expected aggregate demand Because the money wage rate changes with expected changes in aggregate demand, only unexpected fluctuations in aggregate demand lead to business cycle fluctuations  New Keynesian Cycle Theory: The new Keynesian cycle theory asserts that today’s money wage rates were negotiated at many past dates, which mean that past rational expectations of the current price level influence the money wage rate and the position of the SAS curve Because the money wage rate does not change with newly expected changes in aggregate demand, both expected and unexpected fluctuations in aggregate demand lead to business cycle fluctuations Real Business Cycle Theory The real business cycle theory (or RBC theory) regards random fluctuations in productivity as the main source of economic fluctuations    RBC Impulse: changes in the growth rate of productivity that results from technological change A decrease in productivity growth brings a recession and an increase brings an expansion Productivity shocks are measured using growth accounting The RBC Mechanism: A change in productivity changes investment demand and the demand for labor  If productivity falls, investment demand and hence the demand for loanabe fund decreases In addition, the demand for labor decreases The decrease in the demand for loanable funds means the real interest rate falls According to RBC theory, the fall in the real interest rate decreases the supply of labor because of intertemporal substitution Because both the supply of labor and the demand for labor decrease, employment decreases and the change in the real wage rate is small Real GDP decreases Money plays no role in generating business cycles in the RBC theory; it affects only the price level I like to motivate RBC theory by suggesting that economists, such as Lucas and Prescott, challenged our previous portrayal of the LAS curve as being a stable curve that the short run fluctuations revolve around You can use your arm to suggest that the LAS curve itself might shift leftward and rightward because of technology continuously impacting productivity in unstable ways Criticisms and Defenses of Real Business Cycle Theory   Critics assert that money wages are sticky and that intertemporal substitution is too weak to account for large fluctuations in the supply of labor, which are necessary for RBC theory to explain the empirical fact that there are large fluctuations in employment with only small fluctuations in the real wage rate A second criticism of RBC theory has to with the direction of causality between productivity and business cycle fluctuations RBC theory assumes changes in productivity cause business cycle fluctuations Traditional aggregate demand theories suggest that measures of productivity change as a result of business cycle fluctuations For instance, they assert that in expansions, capital and labor are used more intensely so that measured productivity increases, even with no change in technology What does it mean to use capital and labor more intensely? It is easy to see with labor hours A firm could record the same number of labor hours in an expansion as in a recession But, if the firm is trying to increase production to meet high demand in the expansion, workers will work harder and, therefore, be more productive in the expansion This change in productivity is not related to technology but growth accounting likely will (erroneously) attribute the increase in productivity to a technological advance 122  CHAPTER 11 RBC theory defenders point out that the theory is consistent with microeconomic evidence about labor supply decisions and labor demand and investment demand decisions II Inflation Cycles Inflation is a process in which the price level is rising and money is losing value Inflation is not a rise in one price—it is a broad increase in the price level Inflation also is not a onetime jump in the price level It is an ongoing process There are many examples of one-time jumps in the price level that are not the same as inflation In Canada, when the federal sales tax was changed in the early 1990s, there was a one-time increase in the CPI Likewise, when the euro was introduced in 2001, there were one-time increases in many prices in some countries Neither of these events led to a persistent rise in the rate at which the price level increased and measured inflation using the CPI fell to previous levels soon after the one-time events Demand-Pull Inflation An inflation that results from an initial increase in aggregate demand is called demandpull inflation Any factor that increases aggregate demand, such as an increase in the quantity of money, an increase in government expenditure, or an increase in exports, can start a demand-pull inflation    In the short run, an increase in aggregate demand raises the price level and increases real GDP In the figure the aggregate demand curve shifts from AD0 to AD1 so that the economy moves from point a to point b and the price level rises from 100 to 110 Real GDP exceeds potential GDP and so in the tight labor market the money wage rate rises The rise in the money wage rate decreases short-run aggregate supply In the figure, the SAS curve shifts from SAS to SAS1 As a result, the economy moves from point b to point c and the price level rises even more, in the figure to 120 Real GDP returns to potential GDP Inflation occurs only if aggregate demand continues to increase And aggregate demand continues to increase only if the quantity of money persistently increases Demand-Pull Inflation The potential difficulty with both demand-pull and cost-push inflation stories is how the one-time increase translates into an inflationary process It is relatively easy to come up with stories as to why aggregate demand might shift to the right, for example because of persistent government budget deficits (However immediately tell the students that if the budget deficit does not constantly increase in size relative to GDP, it will not lead to a constant increase in aggregate demand.) What is a little harder is to provide a plausible story as to why the monetary authorities would continue to accommodate the budget deficit with continuous increases in the quantity of money Point out that this has been rare in the United States, and has tended to happen when the political situation was such that the Fed was not willing to be blamed for an increase in unemployment In other countries, particularly where the central bank is less independent than in the United States, it has been more common for the central bank to consistently monetize budget deficits Cost-Push Inflation An inflation that results from an initial increase in costs is called cost-push inflation The two main sources of increases in costs are an increase in money wage rates or an increase in the money prices of raw materials    The cost hike decreases short-run aggregate supply, which raises the price level and decreases real GDP In the figure the short-run aggregate supply curve shifts from SAS0 to SAS so that the economy moves from point a to point b and the price level rises from 100 to 110 The combination of a rise in the price level and a fall in real GDP is called stagflation One possible response to the decrease in real GDP is for the Fed to use monetary policy to increase aggregate demand If the Fed increases aggregate demand, real GDP increases and the price level rises still higher In the figure, this Fed policy shifts the aggregate demand curve from AD0 to AD1 and the price level rises to 120 Inflation occurs only if, in response to the higher price level, the force that initially decreased aggregate supply recurs so that aggregate supply continues to decrease and, at the same time, the Fed continues to increase aggregate demand Cost-Push Inflation The text gives a good description of the first oil price increase in the 1970s as a cost-push inflation, and contrasts it well with the Fed’s refusal to accommodate the second oil price increase in 1979 An explanation of how cost-push can be a more widespread cause of inflation in other countries can be given in terms of countries where labor is highly unionized, and in effect there are attempts by different interest groups to obtain shares of GDP that add up to more than 100 percent, with accommodation by a weak monetary authority Such a process of repeated wage increases, inflation, and monetary accommodation can give rise to continuing inflation Analysts often “explain” the cause of inflation by focusing attention on the good or service whose price increased the most during the most recent time period This is incorrect; inflation is the result of monetary growth To explain inflation, economists are looking for an explanation that fits all cases not an explanation that focuses on specific prices of specific goods that differ from one inflation to another Expected Inflation   When inflation is anticipated, the money wage rate changes to keep up with the anticipated inflation So when the AD curve shifts rightward, increasing the price level, the money wage rate increases and the SAS curve shifts leftward If the increase in the price level is fully anticipated, then the money wage rate rises by the same percentage so that the real wage rate remains constant There are no deviations from full employment The magnitude of the shift in A D equals that in SAS so that GDP remains equal to potential GDP and the economy moves up along the LAS curve, from point a to point c in the figures above If inflation is not perfectly anticipated, the money wage rate changes but by a different percentage than the price level Some of the inflation is unanticipated, so as a result the real wage rate changes and there are deviations from full employment If aggregate demand grows faster than anticipated, real GDP exceeds potential GDP and the economy behaves as if it were in a demand-pull inflation If 124  CHAPTER 11 aggregate demand grows slower than anticipated, real GDP is less than potential GDP and the economy behaves as if it were in a cost-push inflation Because of the costs of unanticipated inflation, there are benefits to forming accurate forecasts of inflation The best available forecast is the one that is based on all relevant information and is called a rational expectation III Deflation An economy experiences deflation when it has a persistently falling price level What Causes Deflation?  The starting point for understanding the cause of deflation is to distinguish between a one-time fall in the price level and a persistently falling price level A onetime fall in the price level is not deflation Deflation is a persistent and ongoing falling price level The Quantity Theory and Deflation  The quantity theory of money explains the trends in inflation by focusing on the trend influences on aggregate supply and aggregate demand The foundation of the quantity theory is the equation of exchange, which in its growth rate version and solved for the inflation rate states: Inflation rate = Money growth rate + Rate of velocity change - Real GDP growth rate   The quantity theory adds to the equation of exchange two propositions  First, the trend rate of change in the velocity of circulation does not depend on the money growth rate and is determined by decisions about the quantity of money to hold and to spend  Second, the trend growth rate of real GDP equals the growth rate of potential GDP and, again, is independent of the money growth rate With these two assumptions, the equation of exchange becomes the quantity theory of money and predicts that a change in the money growth rate brings an equal change in the inflation rate What are the Consequences of Deflation? The effects of deflation (like those of inflation) depend on whether it is anticipated or unanticipated But because inflation is normal and deflation is rare, when deflation occurs, it is usually unanticipated  Unanticipated deflation redistributes income and wealth, lowers real GDP and employment, and diverts resources from production  Workers with long-term wage contracts find their real wages rising But employers respond to a higher and rising real wage by hiring fewer workers, so employment and output decrease  With lower output and profits, firms re-evaluate their investment plans and cut back on projects that they now see as unprofitable This fall in investment slows the pace of capital accumulation and slows the growth rate of potential GDP An Economics in Action explores the “Fifteen Years of Deflation in Japan.” The Economics in Action feature describes how the deflation was unexpected, which decreased Japan’s economic growth rate, and was the result of monetary growth that was kept too low How Can Deflation be Ended?  Deflation can be ended by removing its cause: The quantity of money is growing too slowly If the central bank ensures that the quantity of money grows at the target inflation rate plus the growth rate of potential GDP minus the growth rate of the velocity of circulation, then, on average, Money Growth, Not the Quantity of Money  It takes an increase in the growth rate of the money stock, not a one-time increase in the quantity of money, to end deflation  Central banks sometimes increase the quantity of money and fail to increase its growth rate IV Inflation and Unemployment: The Phillips Curve A Phillips curve shows the relationship between inflation and unemployment There are two time frames for a Phillips curve: the short run and the long run HISTORY NOTE: The Phillips Curve As a description of how economics advances, I like to give the students a stylized history of the Phillips curve The story I tell starts in 1958 when A W Phillips published his empirical work At that time the mainstream economic model was quite different from the AS-AD model derived in the text Essentially, it was similar to the simple aggregate expenditure model presented in Chapter 11 He had British data that covered a long period of time and so his results appeared to be a long run phenomenon The model was based on the assumption that the price level was constant, making the inflation rate zero This assumption was not too unrealistic immediately after World War II By 1955, however, the inflation rate began to creep higher and averaged 2.7 percent per year between 1956 and 1959 Inflation was beginning to be perceived as a problem, one that a model with a “fixed price level assumption” was poorly suited to solve In this environment, economists gladly welcomed the simple, short-run Phillips curve, for it gave them a handle on inflation They believed that they could predict the unemployment rate from their standard model and then combine this unemployment rate with the Phillips curve to determine the resulting inflation rate The vital assumption in this procedure is that the Phillips curve captures a fixed tradeoff between the actual inflation rate and the unemployment rate that is part of the economy’s structure This type of analysis reached its peak of popularity during the early and middle 1960s By 1967, however, it was under attack On a theoretical level, economist Milton Friedman— among others—pointed out the flimsy justification behind the simple, fixed Phillips curve assumption On an empirical level, the simple, fixed Phillips curve failed as the inflation rate rose toward the end of the 1960s and into the 1970s: the unemployment rate did not fall as predicted by the fixed Phillips curve At this point the idea of a long-run Phillips curve (as distinct from the short-run one) was developed The concept that aggregate supply is an important component of macroeconomics was taking hold, as was the idea that short-run Phillips curves shift because of changes in people’s expectations Thus the profession advanced significantly between the initial discussion of the Phillips curve and what students learn today This advance was the result of the interaction between theory, suggesting that the idea of a fixed short-run Phillips curve was inadequate, and empirical work that reinforced the point that the simple, early approach was deficient 126 CHAPTER 11 The Short-Run Phillips Curve   The short-run Phillips curve (SRPC) shows the relationship between the inflation rate and the unemployment rate holding constant the expected inflation rate and the natural unemployment rate The figure shows a short-run Phillips curve Inflation and unemployment have a negative relationship in the short run, so moving along a short-run Phillips curve, a higher inflation rate (holding constant the expected inflation rate) leads to lower a unemployment rate The downward sloping short-run Phillips curve is equivalent to the upward sloping short-run aggregate supply curve When aggregate demand unexpectedly increases so that real GDP and the price level both unexpectedly rise, the increase in real GDP lowers the unemployment rate and the unexpectedly higher price level means there is unexpectedly high inflation The short-run Phillips curve captures the relationship between the lower unemployment rate and higher inflation rate Use the board to create a scatter plot of observations that allow you to later “statistically fit” a line through the points as the Phillips curve As you make the points on the graph, you can call them out as different years from 1950-1969 Now discuss how policy-makers embraced this model as getting to choose where they want to be on the Phillips curve You can motivate this by picking two points and asking the students which one they thought would be preferred, high inflation and low unemployment or vice versa As government started to think it could “fine-tune the economy,” we began to observe data points that had high inflation and high unemployment Was Phillips wrong? Ask the students what might have happened and you may get someone to say it shifted! This answer is, of course, correct Economists started to explore the effect of expected inflation as a factor that shifts the Phillips curve You can now discuss the distinction between the long-run and the sort-run Phillips curve The Long-Run Phillips Curve  The long-run Phillips curve (LRPC) shows the relationship between the inflation rate and the unemployment rate when the actual inflation rate equals the expected inflation rate As illustrated in the figure, the long-run Phillips curve is vertical at the natural unemployment rate  The short-run Phillips curve intersects the long-run Phillips at the expected inflation rate In the figure the expected inflation rate is equal to percent  In the long run, higher or lower inflation has no effect on the unemployment rate This result is analogous to the conclusion from the AS-AD model that in long run, a higher or lower price level has no effect on real GDP, which equals potential GDP so that the economy is at full employment The Phillips curve and the AS-AD model: Students can become confused about the tie between the Phillips curve and the aggregate supply/aggregate demand (AS-AD) model Although this relationship is nicely developed in the text, some students will remain baffled I not think that a principles course is the appropriate place to derive the link between the two in much detail But I think that my lectures are an appropriate place to convey the idea of the relationship Thus I point out that the vertical long-run aggregate supply curve is analogous to the vertical long-run Phillips curve If you graph the two side by side, identify potential real GDP and the natural rate of unemployment on the two graphs at the intersection of the long run curves and the horizontal axis The point that the long-run aggregate supply curve is vertical means that a higher price level has no effect on real GDP and hence no effect on the unemployment rate Similarly, the fact that the long-run Phillips curve is vertical implies that a higher inflation rate has no effect on the unemployment rate and hence no effect on real GDP The analogy also carries over to the short-run curves: the positively sloped short-run aggregate supply curve shows that in the short-run an unexpected higher price level raises real GDP and thus lowers unemployment In the same way, the negatively sloped short-run Phillips curve demonstrates that in the short-run an unexpected higher inflation rate lowers unemployment, thereby raising real GDP Students find that the two diagrams actually complement each other I think that this approach is preferable to having the two diagrams compete with each other! Shifts of the Phillips Curves   A change in the expected inflation rate shifts the SRPC vertically upward or downward by the amount of the change but has no effect on the LRPC A change in the natural unemployment rate shifts both the SRPC and the LRPC An increase in the natural rate shifts the SRPC and LRPC rightward by the amount of the increase; a decrease shifts the curves leftward by the amount of the decrease The U.S Phillips Curves Because of changes in the expected inflation and the natural rate of unemployment, the short-run Phillips curve has shifted around a lot over time so that there is no single obvious negative relationship between inflation and unemployment The Economics in the News section analyzes the EBC’s response to potential deflation in 2014 128 CHAPTER 11 Additional Problems Has the U.S economy experienced inflation or deflation during recent recessions? Explain The spreadsheet provides information about the economy in Argentina Column A is the year, Column B is real GDP in billions of 2000 pesos, and Column C is the price level a In which years did Argentina experience inflation? In which years did it experience deflation (a falling price level)? b In which years did recessions occur? In which years did expansions occur? c In which years you expect the unemployment rate was highest? Why? d Do these data show a relationship between unemployment and inflation in Argentina? 10 11 12 A 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 B 277 288 278 276 264 235 256 279 305 331 359 384 C 105.6 103.8 101.9 102.9 101.8 132.9 146.8 160.4 174.5 198.0 226.1 267.7 Solutions to Additional Problems 1, The United States has experienced inflation during recent recessions, though there have been instances when the inflation rate fell during recessions For instance in late 2008 the inflation rate fell as the economy moved into a recession Inflation, however, generally continued because aggregate demand continued to increase during the recessions, though at a slower rate a Argentina experienced inflation in 2000 and from 2002 through 2008 Argentina experienced deflation in 1998, 1999, and 2001 b Argentina had recessions in 1999, 2000, 2001, and 2002 Argentina had expansions in 1998 and 2003 through 2008 c The unemployment rate was probably high in all of the recessionary years It was probably the highest in 2000 and 2002 when the recessions were at their worst d There is not a strong relationship between unemployment and inflation in the data The unemployment rate would likely have been higher in the recession years of 1999, 2000, 2001, and 2002 In 2000 Argentina experienced low inflation and 2002 Argentina experienced high inflation In 1999 and 2001 Argentina experienced deflation But Argentina also experienced deflation 1998 So there is no consistent relationship between either inflation and high unemployment or deflation and high unemployment There also is a similar lack of relationship between inflation and low unemployment or deflation and low unemployment Additional Discussion Questions 11 Some economists claim that inflation is always a “monetary phenomenon.” What they mean by this claim and are they correct? This claim points to the result that an on-going inflation requires the central bank to constantly increase the quantity of money In the absence of continual monetary growth, the price level might rise but it would eventually stabilize The price level will continue to rise, which means that on-going inflation will occur, only if the Federal Reserve constantly increases the quantity of money Because inflation requires constant growth in the quantity of money, inflation can be thought of as a “monetary phenomenon.” 12 How can a higher price of oil create inflation? By itself a higher price of oil cannot create inflation Taken by itself a higher price of oil can lead to a higher price level but after the adjustment is made to the higher price of oil, the price level stops rising—that is, inflation stops A higher price of oil can lead to inflation only if the central bank “ratifies” it by increasing the quantity of money If the central bank, the Federal Reserve in the United States, responds to the decrease in real GDP created by the higher price of oil by increasing the quantity of money, then inflation can result The increase in the quantity of money will drive the price level still higher In this situation oil producers might respond by again boosting the price of oil If the Fed responds once again in turn, the process can continue indefinitely and a cost-push inflation results 13 What is the relationship between the short-run aggregate supply curve and the short-run Phillips curve? Between the long-run aggregate supply curve and the long-run Phillips curve? The short-run aggregate supply curve and the short-run Phillips curve are closely related If aggregate demand increases, the economy moves upward along its short-run aggregate supply curve so that the price level and real GDP both increase The rise in the price level means that inflation rises and the increase in real GDP means that unemployment falls The rise in the inflation rate combined with the fall in the unemployment rate correspond to a movement upward along the economy’s short-run Phillips curve Similarly the long-run Phillips curve and long-run aggregate supply curve also are closely related In the long run an increase in aggregate demand moves the economy upward along its longrun aggregate supply curve so that the price level rises and real GDP does not change—it remains equal to potential GDP The rise in the price level means that the inflation rate rises and the result that real GDP remains equal to potential GDP means that the unemployment rate remains equal to its natural rate The rise in the inflation rate combined with the unemployment rate remaining equal to its natural rate correspond to a movement upward along the economy’s long-run Phillips curve 14 Suppose the expected and actual inflation rates are percent and the natural rate of unemployment is percent If the inflation rate falls to percent while the expected inflation rate remains at percent, what happens to the unemployment rate? If the actual inflation rate falls and the expected inflation rate does not change, the economy moves downward along a short-run Phillips curve so that the unemployment rate increases 15 Suppose the expected and actual inflation rates are percent and the natural rate of unemployment is percent If the inflation rate falls to percent and the expected inflation rate also falls to percent, what happens to the unemployment rate? If the actual inflation rate and the expected inflation rate fall by the same amount, the economy moves downward along its long-run Phillips curve so that the unemployment rate does not change—it remains equal to the natural unemployment rate 16 Suppose that the actual inflation rate is percent and that the economy is at the natural unemployment rate If the Fed announces that it is going to lower the inflation rate and people believe this announcement (so that the decline in the inflation rate is not a 130 CHAPTER 11 surprise), what happens to the unemployment rate? Suppose that people believe the Fed’s announcement and that the expected inflation rate falls, but then the Fed keeps the inflation rate at percent Now what happens to the unemployment rate? If the Fed follows through on its announcement, both the actual and expected inflation rate fall by the same amount so that the unemployment rate remains equal to its natural rate However if the Fed actually does not lower the inflation rate, then the actual inflation rate exceeds the expected inflation rate In this case the short-run Phillips curve shifts downward The economy moves to a point on its new short-run Philips curve at the unchanged inflation rate and the unemployment rate falls 17 How you think recessions influence elections? Recessions have large impacts on elections If an election occurs during (or near) a recession, the incumbent party suffers This empirical result holds true for President Ford who lost his reelection bid in 1976; President Carter who lost his reelection bid in 1980; President Bush who lost his reelection bid in 1992; and Senator McCain who lost his election bid in 2008 All of these candidates were members of the incumbent party and all faced election either near or during a recession President Obama’s re-election in 2012 was an unusual case in that the economy was in recovery but unemployment was still high near percent ... by the students Fortunately, Parkin s chapter is not at all like these other weak attempts Parkin shows the students how the schools relate to each other and presents an incredibly exciting chapter. .. addition, the demand for labor decreases The decrease in the demand for loanable funds means the real interest rate falls According to RBC theory, the fall in the real interest rate decreases the supply... level, the money wage rate increases and the SAS curve shifts leftward If the increase in the price level is fully anticipated, then the money wage rate rises by the same percentage so that the
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