24 The AD - AS Model, Part 4

24 The AD - AS Model, Part 4 - 1 24-1 Inflation and the DAD...

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Unformatted text preview: 1 24-1 Inflation and the DAD SAS Model: A General Framework for Macroeconomic Analysis, Part 4 24-2 Agenda Inflation and the Triangle Model. The DAD SAS Model. Inflation Adjustment and the Attainment of General Equilibrium. Inflation, Disinflation, and Deflation. 24-3 Inflation and the triangle model Definition of inflation: S t = { ( P t P t-1 ) / P t-1 } * 100 Where P is the general price level. 24-4 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 24-5 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. 24-6 Inflation and the triangle model Inflationary expectations, S e : Modeling S e is extremely difficult. Rational expectations Based on forward-looking behavior. Adaptive expectations Based on backward-looking behavior Dependent on effect of staggered wage and price behavior. 24-7 Inflation and the triangle model Inflationary expectations, S e : Key Assumption : Inflation expectations are formed by simple adaptive expectations. S t e = S t-1 24-8 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 24-9 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 t-1 Y* t-1 ) 24-10 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. 24-11 Inflation and the triangle model Inflation shocks, S Z : Key Assumption : Inflation shocks affect inflation contemporaneously. S Z t = Z t 24-12 Inflation and the triangle model Inflation: S t = S t-1 + f ( Y t-1 Y* t-1 ) + Z t Expected inflation, plus Excess demand inflation, plus Inflation shocks. This is also the new SRAS curve. 4 24-13 The SRAS curve The original SRAS curve was based on P-level adjustment The new SRAS curve is now based on S adjustment 24-14 The SRAS Curve Y 24-15 The Phillips curve and the SRAS curve The expectations-augmented Phillips curve: S = S e f ( u u ) Okuns Law: ( Y* - Y ) / Y* = 2( u u ) or u u = 0.5 ( Y* - Y ) / Y* 24-16 The Phillips curve and the SRAS curve Short-run Aggregate Supply (SRAS) curve:...
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24 The AD - AS Model, Part 4 - 1 24-1 Inflation and the DAD...

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