Lecture20_Econ100B - ECONOMICS 100B Professor Steven Wood...

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ECONOMICS 100B Professor Steven Wood 03/31/11 Lecture 20 ASUC Lecture Notes Online is the only authorized note-taking service at UC Berkeley. Do not share, copy, or illegally distribute (electronically or otherwise) these notes. Our student-run program depends on your individual subscription for its continued existence. These notes are copyrighted by the University of California and are for your personal use only. D O N O T C O P Y Sharing or copying these notes is illegal and could end note taking for this course. LECTURE: Today’s lecture continues on the Macroeconomic Policy and Aggregate Demand and Supply Analysis. ANNOUNCEMENTS: Midterm 2 will be next Tuesday, April 5. Know the IS-MP-PC model, the IS-MP-AD/AS model, and the AD/AS model. TEMPORARY NEGATIVE AGGREGATE SUPPLY SHOCK: Suppose the economy is initially in general equilibrium at the target inflation rate, and there is a temporary negative aggregate supply shock. The central bank responds with a policy to stabilize inflation at π T in the short-run. In the following graph, we see that a negative temporary aggregate supply shock will shift the SRAS curve left to SRAS 1 , increasing inflation to π 1a , increasing the real interest rate along the MP curve to r 1a , and reducing economic output to Y 1a . To stabilize inflation at its target rate, the central bank immediately responds with an autonomous tightening of monetary policy. This shifts the MP curve left to MP 1 and the AD curve left to AD 1 , increasing the real interest rate, reducing economic output, and reducing inflation to π T . A negative output gap will shift the SRAS curve the right to SRAS 2 , reducing inflation to π 2a , reducing the real interest rate to r 2a , and increasing economic output to Y 2a . The central bank must now respond with an autonomous easing of monetary policy, shifting the MP curve right to MP 2 and the AD curve right to AD 2 . This reduces the real interest rate to r 2 , increases economic output to Y 2 , and increases inflation to π T . In the very short-run (year 1a): 1. Y 1a < Y P0 2. π 1a > π T 3. r 1a > r*0. In the short-run (year 1): 1. Y1 < Y 1a < Y p0 2. π 1 = π T 3. r 1 > r*0 In the long-run (year x): 1. Y X = Y P 2. π X = π T 3. r X = r*0. After a temporary aggregate supply shock, a central bank monetary policy of stabilizing inflation leads to deviations of economic output from its potential level, with π, r, and Y fluctuating from year to year. Although the economy goes back to general equilibrium in the long-run, the economic fluctuations can continue for a long time.
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ECONOMICS 100B ASUC Lecture Notes Online: Approved by the UC Board of Regents 03/31/11 D O N O T C O P Y Sharing or copying these notes is illegal and could end note taking for this course. 2
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Lecture20_Econ100B - ECONOMICS 100B Professor Steven Wood...

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