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Unformatted text preview: 1 161 Unemployment and Inflation, Part 3 162 Agenda • Inflation and the Triangle Model. • The DAD – SAS Model. • Inflation Adjustment and the Attainment of General Equilibrium. • Inflation, Disinflation, and Deflation. 163 Inflation and the triangle model • Definition of inflation: π t = { ( P t – P t1 ) / P t1 } * 100 ¾ Where P is the general price level. 164 Inflation and the triangle model • Three explicit factors for explaining inflation. ¾ Called the triangle model. • Inflation, π , depends on 3 components: ¾ Inflationary expectations, π e . ¾ Excess demand, π ED . ¾ Inflation shocks, π Z . 2 165 Inflation and the triangle model • Inflationary expectations, π e : ¾ If people expect a particular level of inflation, that level will likely occur even without any pressure from the output or labor market. 166 Inflation and the triangle model • Inflationary expectations, π e : ¾ Modeling π e is extremely difficult. • Rational expectations – Based on forwardlooking behavior. • Adaptive expectations – Based on backwardlooking behavior ¾ Dependent on effect of staggered wage and price behavior. 167 Inflation and the triangle model • Inflationary expectations, π e : ¾ Key Assumption : Inflation expectations are formed by simple adaptive expectations. π e = π t1 168 Inflation and the triangle model • Excess demand inflation, π ED : ¾ Excess demand is measured by the output gap. π ED = f ( Y – Y* ) • Where f > 0. • The bigger is f, the faster is the change in π t for any given output gap. • The bigger is the output gap, the faster is the change in π t for any given f. 3 169 Inflation and the triangle model • Excess demand inflation, π ED : ¾ Key Assumption : Because of wage and price stickiness, current excess demand inflation depends on lagged excess demand. π ED t = f ( Y t1 – Y* t1 ) 1610 Inflation and the triangle model • Inflation shocks, π Z : ¾ Inflation shocks are assumed to be exogenous. • Changes in input costs that are independent of demand. – Changes in imported goods prices, especially oil. » Price versus exchange rate. – Changes in competitive pressures. 1611 Inflation and the triangle model • Inflation shocks, π Z : ¾ Key Assumption : Inflation shocks affect inflation contemporaneously. π Z t = Z t 1612 Inflation and the triangle model • Inflation: π t = π t1 + f ( Y t1 – Y* t1 ) + Z t ¾ Expected inflation, plus ¾ Excess demand inflation, plus ¾ Inflation shocks. • This is also the new SRAS curve. 4 1613 The SRAS curve • The original SRAS curve was based on Plevel adjustment • The new SRAS curve is now based on π adjustment 1614 The SRAS Curve Y π 1615 The Phillips curve and the SRAS curve • The expectationsaugmented Phillips curve: π = π e – f ( u – u ) • Okun’s Law: ( Y*  Y ) / Y* = 2( u – u ) ¾ or u – u = 0.5 ( Y*  Y ) / Y* 1616 The Phillips curve and the SRAS curve • Shortrun Aggregate Supply (SRAS) curve:...
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This note was uploaded on 04/01/2008 for the course ECON 100B taught by Professor Wood during the Spring '08 term at Berkeley.
 Spring '08
 Wood
 Deflation, Inflation, Unemployment

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