Chapter_16_Notes[1]

Chapter_16_Notes[1] - Chapter 16 Notes Expansionary policy...

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PC con PC E Expansionary policy workers and firms have adaptive expectations. Move along SR PC expand contract Chapter 16 Notes Chapter 16 Inflation, Unemployment, and Federal Reserve Policy Chapters 14 and 15 covered monetary and fiscal policy. Both chapters showed that expansionary policy to increase AD and decrease unemployment had the consequence of raising the price level higher than if no action were taken. When discussing the goals of monetary policy, price stability and maximum employment were mentioned as the two main goals of monetary policy. Of course, illustrating expansionary policy shows that these two can be at odds in certain circumstances. A structural relationship is one that depends on the basic behavior of consumers and firms and remains unchanged over long periods. Many economists argued that the tradeoff between inflation and unemployment represented by the downward sloping Phillips curve was, in fact, a structural relationship. They believed this was a permanent tradeoff. Permanently low inflation rate permanently higher unemployment, vice versa. However, over time, it was realized that this was not a structural relationship. 1
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Chapter 16 Notes During the 1960’s, it appeared the Phillips curve held a stable relationship. In the early 60’s, the inflation rate was low and unemployment rate was high. In the late 60’s, the inflation rate was high and the unemployment rate was low. However, since most economists agreed that the LRAS was vertical, Milton Friedman and Edmund Phelps argued that the Phillips curve could not be downward sloping in the long run. They argued that no tradeoff exists between unemployment and inflation in the long run. They argued that no tradeoff exists between unemployment and inflation in the long run. The Long-Run Phillips Curve Remember in the long-run, the level of GDP is potential GDP where all firms are operating at normal capacity and there is only structural and frictional unemployment. The natural rate of unemployment is the unemployment rate that exists when the economy is at potential GDP. While the rate of unemployment will change in the short run, but will always come back to the natural rate (just as the economy will always return to potential real GDP). It does matter how high or low the inflation rate is because the unemployment rate will always go back to the natural rate. The long-run Phillips curve is a vertical line at the natural rate of unemployment. The Role of Expectations of Future Inflation 2
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Chapter 16 Notes In the long-run, no trade-off exists between unemployment and inflation. Friedman also argues that the short-run trade off existed in the 50’s and 60’s because of differences between expectations of inflation and the actual inflation rate. 31.50/105 x 100 = $30
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This note was uploaded on 04/27/2010 for the course ECON 2010 taught by Professor Roussel during the Spring '08 term at LSU.

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Chapter_16_Notes[1] - Chapter 16 Notes Expansionary policy...

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