lecture6 - Lecture VI Economics 202A Fall 2007 In the...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
1 Lecture VI Economics 202A Fall 2007 In the models that we have just explored, there is one key relationship. That key relationship is the Phillips Curve. The classical models give very limited scope for monetary policy. This theory says that monetary policy cannot do systematically any better than obtaining the natural rate of unemployment, and it is also dubious as well that a counter-cyclical monetary policy can even stabilize output. By injecting randomness into the economy, however, a random monetary policy is capable of increasing output instability. The remarkable thing about this way of thinking about the economy is that the model that produces it has multiple situations in which people make exact inflation adjustments. Here is the first class of such adjustments: insofar as people have given inflationary expectations, those expectations are added exactly one-for-one into all wage and all price setting. The second class of adjustment is that expectations are rational. This says that insofar as inflation will be higher in expected value by a given amount, all wage setters and all price setters exactly add that amount to their inflationary expectations. There are two questions in the setting of wages and prices. The first is whether or not inflationary expectations are exactly rational , and the second is whether or not, given expectations, price setting and wage setting exactly compensate for those price and wage expectations. We can see both of those in the standard Phillips curve of Lucas and Sargent. In terms of the Phillips Curve from Lucas and Sargent and also from standard natural rate theory: B t = $ (U* - U t ) + B e t , where U* is the natural rate of unemployment. B e t behaves exactly according to rational expectations, which is something that anyone but an economist would doubt. And , in addition, insofar as wage and price setters have inflationary expectations their wage and price setting exactly takes that into account and adds it in.
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
2 The coefficient of B e t is exactly one. This might be reasonable in a case where there is only one price setter, as in these models. These models are representative agent models where there is one agent who is making a single price setting decision. But, remarkably, they believe that this full offset occurs in the full economy. That economy has millions of people involved in wage setting and price setting and these representative agent models are said to represent the equilibrium of these millions of wage and price setters, with each wage and price setter taking account of every other wage and price setter and expecting all of these other people in the economy to make the exact same inflationary offset. So theory has shown us an interesting possibility. But that theory rests upon much shakier ground than the textbooks would have us believe.
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 21

lecture6 - Lecture VI Economics 202A Fall 2007 In the...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online