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Unformatted text preview: 1 241 Inflation and the DAD â€“ SAS Model: A General Framework for Macroeconomic Analysis, Part 4 242 Agenda Â¡ Inflation and the Triangle Model. Â¡ The DAD Â¢ SAS Model. Â¡ Inflation Adjustment and the Attainment of General Equilibrium. Â¡ Inflation, Disinflation, and Deflation. 243 Inflation and the triangle model Â¡ Definition of inflation: S t = { ( P t â€“ P t1 ) / P t1 } * 100 Â¾ Where P is the general price level. 244 Inflation and the triangle model Â¡ Three explicit factors for explaining inflation. Â¾ Called the triangle model. Â¡ Inflation, S , depends on 3 components: Â¾ Inflationary expectations, S e . Â¾ Excess demand, S ED . Â¾ Inflation shocks, S Z . 2 245 Inflation and the triangle model Â¡ Inflationary expectations, S e : Â¾ 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 Â¡ Inflationary expectations, S e : Â¾ Modeling S e is extremely difficult. Â¡ Rational expectations Â¢ Based on forwardlooking behavior. Â¡ Adaptive expectations Â¢ Based on backwardlooking behavior Â¾ Dependent on effect of staggered wage and price behavior. 247 Inflation and the triangle model Â¡ Inflationary expectations, S e : Â¾ Key Assumption : Inflation expectations are formed by simple adaptive expectations. S t e = S t1 248 Inflation and the triangle model Â¡ Excess demand inflation, S ED : Â¾ Excess demand is measured by the output gap. S ED = f ( Y â€“ Y* ) Â¡ Where f > 0. Â¡ The bigger is the output gap, the faster is the change in S t for any given f. Â¡ The bigger is f, the faster is the change in S t for any given output gap. 3 249 Inflation and the triangle model Â¡ Excess demand inflation, S ED : Â¾ Key Assumption : Because of wage and price stickiness, current excess demand inflation depends on lagged excess demand. S ED t = f ( Y t1 â€“ Y* t1 ) 2410 Inflation and the triangle model Â¡ Inflation shocks, S Z : Â¾ Inflation shocks are assumed to be exogenous. Â¡ Changes in input costs that are independent of demand. Â¢ Changes in imported goods prices, especially oil. Â» Foreign price versus exchange rate. Â¢ Changes in competitive pressures. 2411 Inflation and the triangle model Â¡ Inflation shocks, S Z : Â¾ Key Assumption : Inflation shocks affect inflation contemporaneously. S Z t = Z t 2412 Inflation and the triangle model Â¡ Inflation: S t = S t1 + f ( Y t1 â€“ Y* t1 ) + Z t Â¾ Expected inflation, plus Â¾ Excess demand inflation, plus Â¾ Inflation shocks. Â¡ This is also the new SRAS curve. 4 2413 The SRAS curve Â¡ The original SRAS curve was based on Plevel adjustment Â¡ The new SRAS curve is now based on S adjustment 2414 The SRAS Curve Y ÊŒ 2415 The Phillips curve and the SRAS curve Â¡ The expectationsaugmented Phillips curve: S = S e â€“ f ( u â€“ u ) Â¡ OkunÂ¢s Law: ( Y*  Y ) / Y* = 2( u â€“ u ) Â¾ or u â€“ u = 0.5 ( Y*  Y ) / Y* 2416 The Phillips curve and the SRAS curve Â¡ Shortrun Aggregate Supply (SRAS) curve:...
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 Summer '10
 Wood
 Inflation, triangle model

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