Lecture 13-14: The Trade-off between Inflation and Unemployment

Transcription

1 EC201 Inrmdia Macroconomics EC201 Inrmdia Macroconomics Lcr 13-14: Th Trad-off bwn Inflaion and Unmploymn Lcr Olin: - Th hillips Crv: - Th rlaionship bwn inflaion and nmploymn; - Th hillips crv as an aggrga spply; Essnial rading: Mankiw: Ch Inrodcion: Th Original hillips Crv In an mpirical papr in 1958 A. W. hillips sdid h rlaionship bwn h chang in nominal wags and h nmploymn ra in UK for h priod H fond ha mpirically hr was a ngaiv rlaionship bwn h wo variabls. According o hillips findings, an incras (dcras) in nominal wags is associad wih a dcras (incras) in nmploymn ra. Th main findings hillips obaind wr: 1) Th rlaionship bwn nominal mony changs and nmploymn was non-linar; 2) Th rlaionship was STABLE in h sampl considrd; In pariclar, finding 2) is h mos rlvan. hillips fond ha associad wih h sam nmploymn ra hr was h sam chang in h nominal wags ovr yars. For xampl, if in 1875 and in 1952 h nmploymn ra was h sam, hn also h chang in nominal wag was h sam in hos wo diffrn yars. This mans ha h hillips crv is h sam in h shor and in h long-rn. Th rlaionship simad by hillips implid: whr W & = f () W& = W is h ra of chang of nominal wags and is h nmploymn W ' '' ra. Frhrmor, w hav ha f < 0 and f > 0, maning ha h rlaionship bwn W & and is ngaiv and convx. In pracic h hillips looks lik h following: 1

2 W/W b 0 Th lvl of nmploymn associad wih W & = 0 is calld (according o Milon Frdman) h Naral Ra of Unmploymn, ha is h lvl of nmploymn a which h ral op is a h naral lvl (aka h Fll-mploymn Eqilibrim). This mans ha a h Naral Ra of Unmploymn w hav ha h nmbr of nmployd workrs is qal o h nmbr of job vacancis availabl in h conomy. A ha nmploymn ra, nmploymn ms b only volnary. In h graph his is givn by 0. Th rsl of hillips was prly mpirical and hrfor h did no provid a flly conomic hory o xplain his findings. Th firs amp o provid a horical fondaion for h hillips crv was don by Lipsy in According o Lipsy h poin 0 is h poin whr h labor mark is a h qilibrim (labor dmand = labor spply). Thrfor, any ohr poin on h hillips crv ms b a poin whr h labor dmand is largr han h labor spply (lik a poin b) or vic vrsa. Considr poin b, whr nmploymn is lowr han h naral lvl and h ra chang of nominal wags is posiiv. A poin b, according o Lipsy, hr shold b an xcss of labor dmand. This xcss of labor dmand rsls in mor compiion among h firms o hir workrs and so hy offr highr wags. As h wags incras mor workrs ar willing o work and nmploymn dcrass. This implis ha any poin on h hillips crv ha is no 0 shold b a disqilibrim poin. Thrfor, w shold xpc an conomy o b mos of h im a 0 sinc disqilibrim siaions shold no las for long priods and mark forcs shold r-qilibra h sysm. This inrpraion of h hillips crv sms no vry saisfacory in xplaining h 2

3 STABILITY of h rlaionship ovr im, sinc i implis ha a sabl rlaionship is arising from disqilibrim siaions. Th hillips Crv as a Rlaionship bwn Inflaion and Unmploymn Afr h work of hillips, many ohrs hav rid o sima h sam rlaionship for ohr conris. In pariclar, Samlson and Solow in 1960 fond a similar rlaionship for h US. Howvr, hir main conribion was o sablish a hillips crv as a rlaionship bwn inflaion and nmploymn. Thy assm ha changs in nominal wags shold lad o proporional changs in h prics. Th ida is: if h prodcion coss for a firm incras, also h pric of h prodc prodcd shold incrass. For xampl, w know ha for a monopolisic firm h opimal pric is a fixd mark-p ovr h marginal cos: p 1 1 = MC, ε whr ε is h lasiciy of dmand and MC is h marginal cos. Sppos ha h prodcion rqirs only labor, hn h nominal wag rprsns h marginal cos for h firm (h cos of on ni of labor). I is clar ha an incras in MC (in his cas h nominal wag) will b rflcd in an incras in h pric. If his hold for all h firms in h conomy, hn an incras (dcras) in h nominal wag in h conomy will b rflcd in an incras (dcras) in h aggrga pric lvl. Th rlaionship givn by h hillips crv can b wrin as: whr now & = & = is h ra of inflaion. f () Afr h conribion of Samlson and Solow, h hillips crv is now rfrrd as a rlaionship bwn inflaion and nmploymn. Using daa for h US conomy bwn 1948 and 1969, h rlaionship bwn Inflaion and Unmploymn in a scar plo wold look lik: 3

4 As w can s hr is indd a ngaiv rlaionship arising from h daa, as hillips fond for h UK. Th r imporanc of h hillips crv is ha i is consisn wih h Kynsian conomic hory. According o Kyns w canno hav high nmploymn and high inflaion a h sam im. If wha mars in h conomy is h aggrga dmand, hn whn aggrga dmand is low nmploymn shold b high b inflaion shold b low (low dmand ps downward prssr on prics ha shold dcras). Th opposi will b r whn aggrga dmand is high. Th hillips Crv and Economic olicy If h hillips crv is sabl as hillips blivd and many conomiss in h 60 s, hn i provids a rad-off bwn inflaion and nmploymn ra. Figr 1. 4

5 / b 1 This rad-off provids a clar rsl for conomic policy: if a govrnmn wans o rdc nmploymn, i can do i a h pric of incrasing inflaion (for xampl a poin b). Frhrmor, if h objciv of h govrnmn is o rdc inflaion, hn i ms accp a highr nmploymn ra. Govrnmns can do ha by affcing aggrga dmand sing policis. Thrfor, according o h hillips crv, h problm of conomic policy is o choos h opimal rad-off bwn inflaion and nmploymn. How do w choos h opimal rad-off? I dpnds on h prfrncs of h sociy. Sppos w liv in a sociy ha prfrs low nmploymn (sinc a govrnmn is vod by h sociy, is policy shold rflc h prfrnc of h sociy). Thn a govrnmn wold hav an incniv o choos a poin on h hillips crv whr inflaion is highr and nmploymn is lowr. Th hillips Crv Agmnd wih Expcaions: h Inrpraion of Fridman-hlps Afr h 1970, h rlaionship bwn inflaion and nmploymn dscribd prviosly smd o vanish. Using daa for h US conomy bwn 1970 and 2000, h rlaionship bwn Inflaion and Unmploymn in a scar plo wold look lik: 5

6 Wha happnd? Th bhavior of inflaion changd in h 60s and i bcam mor prsisn. This fac implis ha wag srs changd h way hy formd hir inflaion xpcaions. Th inflaion ra in US looks lik: Whn inflaion is always posiiv, wag srs sar o xpc highr pric lvl in h fr. This ida of inrodcing h rol of xpcaions ino h hillips crv analysis is d o Milon Fridman and Edmnd hlps. Th ida of Fridman and hlps is: sppos w sar a poin 1 in h figr blow and sppos w mov o poin b whr inflaion is now highr and nmploymn 6

7 lowr. This siaion canno prsis, sinc afr a whil h workrs and h firms will rvis hir xpcaions abo prics. In pariclar, sinc prics ar incrasing, also xpcaions will incras. Thrfor workrs will ask for highr nominal wags han bfor. This incras in nominal wags will incras prics frhr. This mans ha for h sam ra of nmploymn h ra of inflaion will b highr han bfor (for xampl a poin c). / Long rn hillips Crv c b Shor rn hillips Crvs 1 This implis ha h hillips crv shifs p whn xpcaions incras. According o Fridman and hlps, hr ar diffrn SHORT-RUN hillips Crvs for diffrn xpcd prics, whil in h LONG-RUN h hillips Crv is Vrical a h naral nmploymn ra. This mans ha h Trad-off bwn inflaion and nmploymn holds only in h shor-rn whil in h long-rn hr is no rad-off. Wha is h adjsmn procss from h shor-rn o h long rn? Th answr dpnds on how h xpcaions ar formd. Fridman and hlps assm ha xpcaions ar ADATIVE. W know ha his mans ha xpcaions adjs js for a fracion vry priod and sysmaic rrors can occr. 7

8 / Long rn hillips Crv d c Shor rn hillips Crvs b 1 Adapiv xpcaions ar formd according o: = a( 1) whr is h xpcaion mad a -1 of h pric lvl a im, 1 xpcaion mad a -2 for h pric lvl a im -1, and 0 a 1. is h Sppos w sar a 1 and sppos ha h growh ra of mony spply incrass prmannly. This implis ha INFLATION incrass (rmmbr h rlaionship bwn inflaion and mony growh from h qaniy hory). Givn, w mov along h shor-rn hillips crv o poin b. Afr a whil, agns will sar o rvis hir xpcaions according o h formla abov. Sppos w sar from a siaion whr xpcd prics wr zro (for simpliciy) and w ar a im -1. According o h formla abov, h nw xpcaions whn w ar a poin b will b: = 0 + a( 1 0) a( 1) If a < 1, hn agns will incras hir xpcaions by lss hn h acal pric lvl. This mans ha w mov on a highr hillips crv b w also mov o h righ. So from poin b w mov o poin c. A poin c xpcaions ar highr b sill lss han h acal pric lvl. A poin c agns will rvis hir xpcaions, b again hy will no flly corrc hm and w will mov o anohr hillips crv and o a poin lik d. This procss will conin nil w rach h long-rn hillips crv. On ha crv, by h dfiniion of h long rn =, and so h xpcaions ar (in avrag) corrc. So w will nd p a poin whr h nmploymn ra is a h naral lvl b inflaion is now prmannly highr. Noic ha w hav dfind 8

9 adapiv xpcaions in rms of h xpcd pric LEVEL and no in rms of inflaion. Howvr, +1 π = is h xpcd inflaion ra bwn and +1 and i dpnds on h xpcd pric lvl a +1. Thrfor, by changing h xpcaion of h pric lvl w chang also h xpcaion of h inflaion ra. Howvr, w shold say ha hr ar diffrn hillips crvs in h shor-rn according o diffrn xpcaions on h INFLATION RATE. According o his viw, h hillips crv in h shor rn shold b wrin as: π = π f ( ) 1) ' whr w assm ha f ( ) < 0 and f ( 0) = 0. Exprssion 1) is calld h hillips crv agmnd wih xpcaions. Noic ha whn π = 0, maning ha wag srs xpc h pric lvl in priod o b qal h on in priod -1, hn w go back o h original hillips crv dscribd by Samlson and Solow. Inflaion Acclraion and h hillips Crv Sppos h simpls cas of Adapiv xpcaions whn a = 1. This implis ha xpcaions ar givn by: = 1 Thrfor, in rms of inflaion w can assm ha agns form hir xpcaions as: π = π 1 Agns xpc for omorrow h sam inflaion as oday. This implis ha hr is inflaion INERTIA. Undr his assmpion abo xpcaions, h hillips crv bcoms: π π f ( ) 1) = 1 In his pariclar cas h naral lvl of nmploymn is also calld NAIRU, Non Acclraing Inflaion Ra of Unmploymn ha is h ra of nmploymn a which inflaion rmains consan. Th implicaion of his assmpion abo xpcaions has h following impac on h hillips crv. Sppos a siaion whr h govrnmn wans o rdc nmploymn from 1 o 2 prmannly. 9

10 / d Long rn hillips Crv c Shor rn hillips Crvs b 2 1 Sppos w sar a 1 whr inflaion and xpcd inflaion ar zro. Now h govrnmn incrass aggrga dmand o dcras nmploymn. W mov a poin b whr acal inflaion is highr han xpcd inflaion (ha is zro a h momn). A poin b agns rvis hir xpcaions for h nx priod o b qal o h acal ra of inflaion. If h govrnmn wans o kp h conomy a 2, h incras in h xpcaions will shif h hillips crv and w mov o poin c. A poin c, inflaion has incrasd again. Agns rvis hir xpcaions and h hillips crv shif again and w mov o poin d. A poin d h inflaion is highr han a c and so agns rvis hir xpcaions. Th procss may conin forvr. This implis ha in ordr o kp a lowr nmploymn ra han h naral lvl inflaion ms acclra ovr im. Afr a whil, a rsriciv policy ms b sd o rdc inflaion and o bring back h conomy a h long-rn qilibrim. According o his viw, any xpansionary policy cras problms in rms of inflaion and shold b avoidd. Can qaion 1) xplain h rlaionship bwn inflaion and nmploymn afr h 1970? Noic ha qaion 1) implis ha: π π = f ( ) 1 Thrfor now h rlaionship is bwn h CHANGE in inflaion and h nmploymn ra. Using US daa from 1970 o 2000 w hav: 10

11 Thr is indd a ngaiv rlaionship bwn h chang in h inflaion ra and h nmploymn ra. Th qaion in h graph: π π = 6% 1.0 is a rgrssion lin simad from h daa in h graph. 1 If w wri h hillips crv as: π θπ f ( ), or analysis says ha bfor = 1 h 1970 w had θ = 0 maning ha wag srs xpcd h pric lvl o b h sam as in h prvios priod. Afr 1970 w hav θ = 1. Thrfor, h chang in hillips crv can b xplaind by h chang in h way wag srs formd xpcaions. Th Modrn Vrsion of h hillips Crv Afr h conribion of Fridman and hlps, h modrn form of h hillips crv is h following: π = π β ( ) + ν 2) whr β > 0 is a consan and ν is a spply shock (a random variabl). Noic ha qaion 2) is linar whil w know ha h hillips crv is non-linar. So w can inrpr qaion 2) as h log-linar vrsion of a non-linar hillips crv. Eqaion 2) says ha inflaion in h shor-rn is mainly casd by wo lmns: 11

12 a) cos-psh inflaion: inflaion rsling from spply shocks. Advrs spply shocks ypically rais prodcion coss and indc firms o rais prics, pshing inflaion p. b) dmand-pll inflaion: inflaion rsling from dmand shocks. osiiv shocks o aggrga dmand cas nmploymn o fall blow is naral ra, which plls h inflaion ra p. hillips Crv, Aggrga Spply and h Okn s Law W can driv h hillips crv in 2) from h aggrga spply w dfind in prvios lcrs. Wri h aggrga spply in h logs of h variabls and wih a spply shock in i: p 1 = p + ( y y) + ν α whr h small lrs now dno h naral log of a variabl. Wih simpl algbra w hav ha: 1 p p 1 = p p 1 + ( y y) + ν α 1 π = π + ( y y) + ν α Now w inrodc an mpirical rglariy in conomics ha is calld Okn s Law. This law rlas h chang in ral op wih changs in nmploymn. W can wri h Okn s Law in his form 1 : whr γ > 0 ( y y) = γ ( ). This says ha dviaions of ral op from is naral lvl ar invrsly rlad wih dviaions of nmploymn from is naral lvl. Whn nmploymn incrass abov is naral lvl ( > ) ral op ns o dcras blow is naral lvl and vic vrsa. From h Okn s Law dfinγ = βα. Us his fac ino qaion 3): This is xacly or hillips crv. Sacrific Raio π = π β ( ) + ν Givn h rad-off in h shor-rn implid by h hillips crv, o rdc inflaion, 3) 1 Th original Okn s Law is givn by: (rcnag chang in ral GD) = 3.5% - 2 (Chang in nmploymn). 12

13 policymakrs can conrac aggrga dmand, casing nmploymn o ris abov h naral ra. Th sacrific raio masrs h prcnag of a yar s ral GD ha ms b forgon o rdc inflaion by 1 prcnag poin. A ypical sima of h raio is 5. This is an sima ha coms from a hillips crv wih inflaion inria (if xpcaions ar calclad diffrnly from h simpls adapiv xpcaions cas hn his nmbr can b diffrn). Exampl: To rdc inflaion from 6 o 2 prcn, w ms sacrific 20 prcn of on yar s GD: GD loss = (inflaion rdcion) x (sacrific raio) = 4 x 5 This loss cold b incrrd in on yar or sprad ovr svral,.g., 5% loss for ach of for yars. Th cos of disinflaion is los GD. On cold s Okn s law o ransla his cos ino nmploymn. 13