CH 30 - Inflation & Disinflation

CH 30 - Inflation & Disinflation - CHAPTER 30 INFLATION...

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CHAPTER 30 30.1 ADDING INFLATION TO THE MODEL WHY WAGES CHANGE: Wages + the Output Gap: How changes in money wages are influenced by the output gap: o The excess demand for labor that is associated with an inflationary gap (Y > Y*) puts upward pressure on money wages o The excess supply of labor associated with a recessionary gap (Y < Y*) puts downward pressure on money wages o The absence of either an inflationary or recessionary gap (Y = Y*) means that demand forces do not exert any pressure on money wages Wages + Expected Inflation: o The expectation of some specific inflation rate creates pressure for money wages to rise by that rate Overall Effect on Wages: Changes in = Output Gap + Expectational Money Wages Effect Effect o Rational Expectation = the theory that people understand how the economy works and learn quickly from their mistakes so that even though random erros may be made, systematic + persistent errors are not Sustained price inflation will be accompanied by closely related growth in wages and other factor prices and that the AS curve is shifting upward o Factors that influence shifts in the AS curve can be divided into 2 main components: Output gaps Expectations o Random supply-side shocks will also exert an influence Inflationary output gaps = tend to cause wages to rise Recessionary output gaps = tend to cause wages to wall How do People Form their Expectations? o Expectations of inflation tend to cause wage increase equal to the expected price-level increases o Expectations can be backward-looking, forward looking, or some combo of the two Backward-Looking Expectations = tend to change slowly because some time must pass before a change in the actual rate of inflation provides enough past experience to cause expectations to adjust Forward-Looking Expectations = can adjust quickly to changes in events. Instead of being based on past inflation rates, expected inflation is based on expected economic conditions + government policies FROM WAGES TO PRICES: The net effect of the 2 factors acting on wages (output gaps + inflation expectations) determines what happens to the AS curve Actual = Output Gap + Expected + Supply Shock
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Inflation Inflation Inflation Inflation CONSTANT INFLATION: Inflation + monetary policy have been constant for several years, the expected rate of inflation will tend to equal the actual rate of inflation The absence of supply shocks, if expected inflation equals actual inflation, real GDP must
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This note was uploaded on 04/18/2008 for the course ECON 295 taught by Professor Ragan during the Spring '08 term at McGill.

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CH 30 - Inflation & Disinflation - CHAPTER 30 INFLATION...

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