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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(P1P0)/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(22) +1/2(33) = 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(32) +1/2(33) = 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(12) +1/2(03) = 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.
 Fall '10
 Sungu

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