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Unformatted text preview: 1 241 Inflation and the DAD SAS Model: A General Framework for Macroeconomic Analysis, Part 4 242 Agenda Inflation and the Triangle Model. The DAD SAS Model. Inflation Adjustment and the Attainment of General Equilibrium. Inflation, Disinflation, and Deflation. 243 Inflation and the triangle model Definition of inflation: S t = { ( P t P t1 ) / P t1 } * 100 Where P is the general price level. 244 Inflation and the triangle model Three explicit factors for explaining inflation. Called the triangle model. Inflation, S , depends on 3 components: Inflationary expectations, S e . Excess demand, S ED . Inflation shocks, S Z . 2 245 Inflation and the triangle model Inflationary expectations, S e : If people expect a particular level of inflation, that level will likely occur even without any pressure from the output or labor market. 246 Inflation and the triangle model Inflationary expectations, S e : Modeling S e is extremely difficult. Rational expectations Based on forwardlooking behavior. Adaptive expectations Based on backwardlooking behavior Dependent on effect of staggered wage and price behavior. 247 Inflation and the triangle model Inflationary expectations, S e : Key Assumption : Inflation expectations are formed by simple adaptive expectations. S t e = S t1 248 Inflation and the triangle model Excess demand inflation, S ED : Excess demand is measured by the output gap. S ED = f ( Y Y* ) Where f > 0. The bigger is the output gap, the faster is the change in S t for any given f. The bigger is f, the faster is the change in S t for any given output gap. 3 249 Inflation and the triangle model Excess demand inflation, S ED : Key Assumption : Because of wage and price stickiness, current excess demand inflation depends on lagged excess demand. S ED t = f ( Y t1 Y* t1 ) 2410 Inflation and the triangle model Inflation shocks, S Z : Inflation shocks are assumed to be exogenous. Changes in input costs that are independent of demand. Changes in imported goods prices, especially oil. Foreign price versus exchange rate. Changes in competitive pressures. 2411 Inflation and the triangle model Inflation shocks, S Z : Key Assumption : Inflation shocks affect inflation contemporaneously. S Z t = Z t 2412 Inflation and the triangle model Inflation: S t = S t1 + f ( Y t1 Y* t1 ) + Z t Expected inflation, plus Excess demand inflation, plus Inflation shocks. This is also the new SRAS curve. 4 2413 The SRAS curve The original SRAS curve was based on Plevel adjustment The new SRAS curve is now based on S adjustment 2414 The SRAS Curve Y 2415 The Phillips curve and the SRAS curve The expectationsaugmented Phillips curve: S = S e f ( u u ) Okuns Law: ( Y*  Y ) / Y* = 2( u u ) or u u = 0.5 ( Y*  Y ) / Y* 2416 The Phillips curve and the SRAS curve Shortrun Aggregate Supply (SRAS) curve:...
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 Summer '10
 Wood

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