eco202_note08 - Macroeconomics Theory and Policy Modified...

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Macroeconomics Theory and Policy Masoud Anjomshoa 1 Masoud Anjomshoa 1 Modified Phillips Curve: If unemployment rate goes below the natural rate of unemployment rate, the increase in price level is accelerating, i.e. inflation rate is increasing, and vice versa. = = π = π + μ + α π = π n e t t t e t t u u Y Y : Run Medium ) z ( u : Curve Phillips 0 ) z ( u n = + μ + α α + μ = ) z ( u n ) u u ( : Curve Phillips Augmented n Expectatio n t e t t α = π π If unemployment rate is equal to natural rate of unemployment rate, the inflation rate is fixed. u n = NAIRU N on A ccelerating I nflation R ate of U nemployment = π π = π π = π π %) 4 . 9 u ( 53 . 0 : Europe %) 2 . 6 u ( 72 . 0 : . S . U %) 6 . 8 u ( 50 . 0 : Canada t 1 t t t 1 t t t 1 t t 1 t e t : Suppose π = π Masoud Anjomshoa 2 If output/income, Y, is fixed (for example in medium run): = + + T , G , P M Y Y : AD t mt yt g g : AD π = mt t g = π = + t t P M Y Y : fixed kept are T and G If Aggregate Demand:
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Macroeconomics Theory and Policy Masoud Anjomshoa 2 Masoud Anjomshoa 3 Okun’s Law: Okun’s Law: The negative relationship between growth rate of real output and change in unemployment rate: g yt u t- u t-1 %) 7 . 3 g ( 33 . 0 u u : Canada For yt 1 t t = g y : As we assume that Y is fixed, so in our AS/AD model: g y = 0 0 < β < 1: Meaning that a 1% increase in growth rate of output leads to less than 1% decrease in unemployment rate. Because of: -- - y g Masoud Anjomshoa 4 Inflation in Medium Run : β = = π α = π π ) g g ( u u : OL g g : AD ) u u ( : PC y yt 1 t t yt m t n t e t t u π % 14 y m g g = MRPC u n =8.6% y yt n t e t t e t t g g , Y Y , u u , , P P : Run Medium In = = = π = π = My Assumption : PC e t t π = π u u : OL 1 t t = g g : AD y m t = = π O: Medium Run Equilibrium % 14 e t = π AD
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Macroeconomics Theory and Policy Masoud Anjomshoa 3 Masoud Anjomshoa 5 % 4 e t = π SRPC 2 Inflation in Medium Run : u π % 14 y m g g = MRPC u n =8.6% SRPC O O’: New Medium Run Eq’m with low inflation. -What should be done if we want to reduce the inflation rate to 4% per year? - How costly is the inflation reduction policy? % 4 y m g ' g = O’ -If ± ± π e =14% Î Point A Î u = u A Î Short Run Equilibrium and Policy Credibility .
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This note was uploaded on 08/12/2010 for the course ECO 202 taught by Professor Anjomshoa during the Spring '08 term at University of Toronto- Toronto.

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eco202_note08 - Macroeconomics Theory and Policy Modified...

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