Using+AD+and+AS+-+F11

Using+AD+and+AS+-+F11 - Using Using Aggregate Aggregate...

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Unformatted text preview: Using Using Aggregate Aggregate Demand Demand and Aggregate Supply Supply Changes in equilibrium Changes • Changes in AD P A S P1 P0 AD AD Y0 Eco 301 - Fall 2011 Y1 Y – P↑ Y↑ Changes in equilibrium Changes • Changes in AS P A S – Resource growth AS(↑) P0 P1 AD Y0 Eco 301 - Fall 2011 Y1 Y • P↓ Y↑ Changes in equilibrium Changes P • Changes in AS AS(↓) A S – Resource Cost • P↑ P0 P1 AD Y1 Eco 301 - Fall 2011 Y0 Y Y↓ Aggregate Demand and Supply Aggregate Equilibrium AS(K and L↑, W↑, Penergy↑) P A S •AD increases •AS P1 AS(K and L↑) P0 AD 1 AD –increases •K ↑ •L ↑ –Decreases •(smaller than increase) •Wages ↑ •Energy costs ↑ •Overall Y0 Eco 301 - Fall 2011 Y1 Y –P ↑ Y↑ GDP Deflator Inflation Rate GDP Eco 301 - Fall 2011 GDP Deflator Inflation Rate GDP Eco 301 - Fall 2011 GDP Deflator Inflation Rate GDP Eco 301 - Fall 2011 Aggregate Demand and Supply Equilibrium Aggregate Stagflation P AS(K and L↑, W, Penergy) A S AS(K and L↑) P1 –increases •K ↑ •L ↑ P0 –Decreases AD1 AD Y1 0 Y Eco 301 - Fall 2011 •AD increases •AS Y •(larger than increase) •Wages ↑ •Energy costs ↑ •Overall - Stagflation –P ↑ Y↓ Aggregate Demand and Supply Equilibrium Aggregate Recession and small price change AS(K and L↑, W, Penergy) A P S AS(K and L↑) •AD Decreases •AS –increases •K ↑ •L ↑ P1 P0 –decreases AD1 Y1 Eco 301 - Fall 2011 Y0 AD Y •Wages ↑ •Energy costs ↑ •Overall –P ↑ Y↓ Aggregate Demand and Supply Equilibrium Aggregate Recession and no price change AS(K and L↑, W, Penergy) A P S AS(K and L↑) •AD Decreases •AS –increases •K ↑ •L ↑ P0 –decreases AD1 Y1 Eco 301 - Fall 2011 Y0 AD Y •Wages ↑ •Energy costs ↑ •Overall –P constant Y↓ AD and AS AD and Taylor Rule Taylor Y0 (1+yT) P B AS A P0 (1+ΠT) P0 C D AD Y0 Eco 301 - Fall 2011 Y AD and AS AD and Taylor Rule Taylor P Π>2 Y<3 Y0 (1+yT) B AS Π>2 Y>3 A P0 (1+ΠT) P0 C D Π<2 Y<3 AD Y0 Eco 301 - Fall 2011 Y Π<2 Y>3 AD and AS AD Neutral Monetary Policy and Taylor Rule Taylor P Π>2 Y<3 Uncertain Monetary Policy Y0 (1+yT) B AS Π>2 Y>3 A P0 (1+ΠT) P0 C Expansionary Monetary Policy AD Π<2 Y<3 Uncertain Monetary Policy AD Y0 Eco 301 - Fall 2011 D Π<2 Y>3 Y Restrictive Monetary Policy AD Inflation and Inflation Targets Inflation Eco 301 - Fall 2011 Inflation and Inflation Targets Inflation Core Inflation Eco 301 - Fall 2011 Growth and Growth Targets Growth Eco 301 - Fall 2011 Growth and Inflation and the Fed and Eco 301 - Fall 2011 Growth and Inflation and the Fed and Eco 301 - Fall 2011 Expansionary Monetary Policy Expansionary P – GDP GDP Deflator Deflator • Lower Target Fed Funds Rate – i ↓ Inv ↑ AD ↑ Note: AD may still fall other forces are causing AD to fall AD(iff ↓) AD Y – Real GDP Eco 301 - Fall 2011 Restrictive Monetary Policy Restrictive P – GDP GDP Deflator Deflator • Higher Target Fed Funds Rate – i ↑ Cons & Inv ↓ AD ↓ Note: AD may still rise if other forces are causing AD to rise AD(iff↑) AD Y – Real GDP Eco 301 - Fall 2011 Inflation and Growth Inflation Demand Growth • Changes in G, C, I, and NX Supply Growth • Changes in K and Labor Force • Changes in Wages and Energy P AS0 AS1 P1 P0 AD Prices rise from P0 to P1 1 – Inflation=100(P1-P0)/P0 AD0 Y0 Eco 301 - Fall 2011 Y1 Y Output Rises from Y0 to Y1 – Economic Growth= 100(Y1Y )/Y Choosing a Fed Funds Target Choosing Taylor Rule • Target Fed Fund Rate i Target = Π + ri equilibrium + 1/2 (Π − Π T ) + 1/2(y − y T ) FF FF • Π – Inflation Rate – ΠT Fed Inflation Target ≈ 2% • y – output growth rate – yT – output growth target ≈ 3% • riFFEquil = Real Equilibrium Fed Funds Rate – Real Fed Funds rate (i- Π) consistent with inflation at the target level and output at the target growth level ≈ 2% Eco 301 - Fall 2011 Taylor Rule mechanics Taylor • Assume (Π and y at target levels) – Π=2% – y=3% – Then from the Taylor Rule, • IFFTarget = 2+2 +1/2(2-2) +1/2(3-3) = 4% – Real rate = 2% • 4% iFF and a 2% real Fed Funds Rate – Neutral Fed Funds Rate – Neutral Monetary Policy Eco 301 - Fall 2011 Taylor Rule mechanics Taylor • Assume – Π=3% – y=3% – Then from the Taylor Rule, • IFFTarget = 3+2 +1/2(3-2) +1/2(3-3) = 5.5% – Real rate = 2.5 Eco 301 - Fall 2011 Taylor Rule mechanics Taylor • Assume – Π=1% – y=0% – Then from the Taylor Rule, • IFFTarget = 1+2 +1/2(1-2) +1/2(0-3) = 1% – Real rate = 0% Eco 301 - Fall 2011 Taylor Rule Taylor • Real interest rate will be above 2% will above tend slow the economy down and reduce both Π and y. – Restrictive Monetary Policy Policy • Real interest rate will be below 2% will below tend speed the economy up and increase both Π and y. Expansionary Monetary Policy Eco 301 - Fall 2011 AD and AS AD and Taylor Rule Taylor Y0 (1+yT) P B AS A P0 (1+ΠT) P0 C D AD Y0 Eco 301 - Fall 2011 Y AD and AS AD and Taylor Rule Taylor Y0 (1+yT) P AS AS1 P1 P* A P0 (1+ΠT) P0 AD1 AD Y0 Eco 301 - Fall 2011 Y* Y1 Y Π > ΠT y > yT iFF > 4 (neutral FF rate) AD and AS AD and Taylor Rule • Restrictive Fed Funds target/rate. – Restrictive monetary policy • Investment and Consumption fall • AD shifts in • Note: Policy has no impact on AS Eco 301 - Fall 2011 AD and AS AD and Taylor Rule Taylor Y0 (1+yT) P A AS AS1 P1 P* P0 (1+ΠT) P0 AD1 AD2 AD Y0 Eco 301 - Fall 2011 Y* Y1 Y Π > ΠT y > yT iFF > 4 (neutral FF rate) AD and AS AD and Taylor Rule Taylor Y0 (1+yT) P A AS AS1 P1 P* P0 (1+ΠT) P0 AD1 AD2 AD Y0 Eco 301 - Fall 2011 Y2 Y* Y1 Y Π > ΠT y > yT iFF > 4 (neutral FF rate) AD and AS AD and Taylor Rule Taylor Y0 (1+yT) P AS AS1 P0 (1+ΠT) P* P1 P0 What happens if the new equilibrium is in region C? C AD1 AD Y0 Eco 301 - Fall 2011 Y1 Y* Y AD and AS AD and Taylor Rule Taylor B Y0 (1+yT) AS1 P AS P1 P0 (1+ΠT) P* P0 AD1 AD Y1 Y0 Eco 301 - Fall 2011 Y* Y Π > ΠT y >< yT iFF > or < 4 (neutral FF rate) AD and AS AD and Taylor Rule Taylor B Option I Inflation effects biggest iFF target ↑ AD falls Y0 (1+yT) P AS P1 P0 (1+ΠT) P* P0 Lower AD causes lower output as it reduces inflation pressure. AD Y2 Eco 301 - Fall 2011 Y1 Y0 Y* Y AD and AS AD and P P2 B Taylor Rule Taylor AS1 Option II Outout effects biggest Outout iFF target ↓ AD increases Y0 (1+yT) AS P1 P0 (1+ΠT) P* P0 Higher Higher AD leads to added inflation pressure as MP tries to deal with low output. output. AD2 AD1 AD Y1 Y0 Y2 Eco 301 - Fall 2011 Y* Y AD and AS AD and Taylor Rule Taylor What happens if the new equilibrium is in region D? Y0 (1+yT) P AS AS1 P* P1 P0 (1+ΠT) P0 AD1 D AD Y0 Eco 301 - Fall 2011 Y* Y1 Y AD and AS AD and Taylor Rule Taylor Y0 (1+yT) ? MP P Restrictive MP AS B A P* P0 (1+ΠT) P0 C D Expansionary Expansionary MP MP AD Y0 Eco 301 - Fall 2011 Y* Y ? MP Taylor Rule Taylor • Real interest rate will be above 2% will tend slow the economy down and decrease both Π and y. Restrictive Monetary Policy • Real interest rate will be below 2% will tend speed the economy up and increase both Π and y. Expansionary Monetary Policy Eco 301 - Fall 2011 Fed Alternative Policy Rules Fed • Current Dual Policy looks at growth (employment) and price stability (inflation) • Alternatives – Inflation targeting – Price Level targeting – Nominal GDP targeting Eco 301 - Fall 2011 ...
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This note was uploaded on 12/15/2011 for the course ECO 301 taught by Professor Sungu during the Fall '10 term at Miami University.

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