unemployment.ppt

Unemployment, Inflation and

Growth

Unemployment, Inflation and

Growth

Money and PricesMoney and Prices

• The quantity theory of money

• The equation of exchange: MV = PY– M money supply

– V velocity of circulation

– P price level (number of times greater than in base year)

– Y real value of output at base-year prices

– MV = PQ

• The link between money and prices– quantity theory holds if V and Y are determined

independently of M

• The quantity theory of money

• The equation of exchange: MV = PY– M money supply

– V velocity of circulation

– P price level (number of times greater than in base year)

– Y real value of output at base-year prices

– MV = PQ

• The link between money and prices– quantity theory holds if V and Y are determined

independently of M


• Assumptions about the velocity of circulation

– the short run

• uncertain relationship between money and prices

• the monetary transmission mechanism

– the money–interest rate link

– the interest rate–spending link

– the long run

• the theory of portfolio balance

• Assumptions about the velocity of circulation

– the short run

• uncertain relationship between money and prices

• the monetary transmission mechanism

– the money–interest rate link

– the interest rate–spending link

– the long run

• the theory of portfolio balance


• Assumptions about output and prices

– the short-run aggregate supply curve

• relatively elastic in short run

– stickiness of wages and prices

– confidence





– confidence

O

Pric

e le

vel

National output

AS

Different aggregate supply curvesDifferent aggregate supply curves

O

AS

Pric

e le

vel

National output

Y1

P1

AD1


P2

O

AS

Y1

Pric

e le

vel

National output

Y2

P1

AD2

AD1


Q1

Short-run response of a profit-maximisingfirm to a rise in demand


MC

AR1

MR1

£

Q

P1

AR1

MR1

P1

Q1

AR2

MR2

£

Q

MC



AR1

MR1

P1

Q1

AR2

MR2Q2

P2

£

Q

MC








– confidence

– the long run aggregate supply curve





– confidence







– confidence


• relatively inelastic





– confidence



O

AS

Pric

e le

vel

National output

Y


P1

O

Pric

e le

vel

National output

AD1

Y

AS


O

P1

Pric

e le

vel

National output

AD2

P2

Y

AS

AD1







– confidence



– the interdependence of markets





– confidence









– confidence




– the flexibility of prices





– confidence





O

Pri

ce le

vel

National output

AD1

SRAS1

(expected price level = P1)

P1

Q1

a

The long-run aggregate supply curvewhen firms are interdependent


O

Pri

ce le

vel

National output

AD1

SRAS1


P1

AD2

a

bP2

Q2

SRAS2

(expected price level = P3 )

P3

c

Q1



O

Pri

ce le

vel

National output

AD1

SRAS1


P1

Qn

AD2

a

bP2

Q2

SRAS2

(expected price level = P3 )

cP3

LRAS








– confidence





• the effects of investment on aggregate supply





– confidence





• the effects of investment on aggregate supply

Effect of investment on the long-run AS curveEffect of investment on the long-run AS curve

AD1

Pri

ce le

vel

National output

a

AS1 (short run)

AS (long run)

AS2 (short run)

AD1

Pri

ce le

vel

National output

a

AD2

b

d

AS1 (short run)

Effect of investment on the long-run AS curveEffect of investment on the long-run AS curve

Inflation and Unemployment: Introducing ExpectationsInflation and Unemployment: Introducing Expectations

• Expectations augmented Phillips curve– adaptive expectations


O

P (%).

U (%)

aP1

.

U1

P2

.

U2

A Phillips curveA Phillips curve

b


• The accelerationist theory


• The accelerationist theory



• The accelerationist theory– accelerating inflation






• when unemployment is kept below the ‘natural’ level





0

4

8

12

16

20

0

P (%).

U (%)6 8I (Pe = 0)

.

b

The accelerationist theory of inflationThe accelerationist theory of inflation

a

IV (Pe = 12%).

III (Pe = 8%).

II (Pe = 4%)

P (%).

U (%)6

a

b c

d

8I (Pe = 0)

.

.

e

The accelerationist theory of inflationThe accelerationist theory of inflation

f

0

4

8

12

16

20

0




– the long-run Phillips curve






Un

0

4

8

12

16

20

0

P (%).

U (%)6 8

The long-run Phillips curveThe long-run Phillips curve





– effects of deflationary policies







0

2

4

6

8

10

12

14

16

18

20

22

24

0

P (%).

U (%)8 13

J

X (Pe = 20%).

k

The effects of deflationThe effects of deflation

0

2

4

6

8

10

12

14

16

18

20

22

24

0

P (%).

U (%)8 13

k

X (Pe = 20%).

XI (Pe = 18%).

XII (Pe = 16%).

l

J

m


0

2

4

6

8

10

12

14

16

18

20

22

24

0

P (%).

U (%)8 13

k

l

m

a

J







• Phillips loops






• Phillips loops


Year 20

20

0

P (%).

U (%)Un

ab

c

Year 0, 1

Clockwise Phillips loopsClockwise Phillips loops

Year 5

Year 4

0

20

0

P (%).

U (%)Un

ab

c

d

ef

Year 0, 1

Year 2

Year 3


0

20

0

P (%).

U (%)Un

ab

c

d

ef

h

i

J

Year 0, 1, 10

Year 2, 9

Year 3, 8

Year 4, 7

Year 5, 8


g






• Phillips loops

• Policy implications






• Phillips loops

• Policy implications


Inflation and Unemployment: New Classical ViewsInflation and Unemployment: New Classical Views

• Assumption of flexible wages and prices

• Rational expectations– meaning of rational expectations

– imperfect information

– implications for AS and the Phillips curve

– policy implications

• Real business cycles– fluctuations in aggregate supply

– causes of changes in aggregate supply


• Assumption of flexible wages and prices

• Rational expectations– meaning of rational expectations

– imperfect information

– implications for AS and the Phillips curve


• Real business cycles– fluctuations in aggregate supply

– causes of changes in aggregate supply


Inflation and Unemployment: Keynesian ViewsInflation and Unemployment: Keynesian Views

• Changes in equilibrium unemployment– structural unemployment– hysteresis

• The persistence of demand-deficient unemployment– payment of efficiency wages– insider power

• Incorporation of expectations– expansion of aggregate demand– contraction of aggregate demand

• Keynesian criticism of non-intervention

• Changes in equilibrium unemployment– structural unemployment– hysteresis

• The persistence of demand-deficient unemployment– payment of efficiency wages– insider power

• Incorporation of expectations– expansion of aggregate demand– contraction of aggregate demand

• Keynesian criticism of non-intervention

Common ground between economists?Common ground between economists?

• Short-run effect of changes in AD– major effect on output and employment

– relatively small effect on prices

• Long-run effect of changes in AD– relatively small effect on output and jobs

– relatively large effect on prices

– some Keynesians disagree• stress long-run effects of changes in AD on

investment

• Importance of expectations

• Short-run effect of changes in AD– major effect on output and employment

– relatively small effect on prices

• Long-run effect of changes in AD– relatively small effect on output and jobs

– relatively large effect on prices

– some Keynesians disagree• stress long-run effects of changes in AD on

investment

• Importance of expectations

Demand-side PolicyDemand-side Policy

• Attitudes towards demand management

• Case against discretion– time lags

– problem of over-correction

– government may ignore long-term consequences

• Case for rules– help to reduce inflationary expectations

– create a stable environment for investment and growth

• Attitudes towards demand management

• Case against discretion– time lags

– problem of over-correction

– government may ignore long-term consequences

• Case for rules– help to reduce inflationary expectations

– create a stable environment for investment and growth

Source: The Use of Explicit Targets for Monetary Policy: Practical Experiencesof 91 economies in the 1990s, (Bank of England, August 1999)

Who sets explicit targets and monitoring ranges forthe exchange rate, money and inflation












• Case against rules– can cause severe fluctuations in interest

rates and can cause greater instability

– which rule to choose?

– rules may conflict

– rules may become unsuitable

• Case for discretion– fine tuning can be improved by better

forecasting and quick-acting policies

– allows governments to respond to changing circumstances

• Case against rules– can cause severe fluctuations in interest

rates and can cause greater instability

– which rule to choose?

– rules may conflict

– rules may become unsuitable

• Case for discretion– fine tuning can be improved by better

forecasting and quick-acting policies

– allows governments to respond to changing circumstances


• Demand-side policy in the UK– increasingly rules-based

– fiscal policy• 'golden rule'

• but some flexibility

– monetary policy• target of 2% inflation set by government

• Monetary Policy Committee adjusts interest rates to meet this 2% target

• benefits of transparency

• benefits for expectations

• Demand-side policy in the UK– increasingly rules-based

– fiscal policy• 'golden rule'

• but some flexibility

– monetary policy• target of 2% inflation set by government

• Monetary Policy Committee adjusts interest rates to meet this 2% target

• benefits of transparency

• benefits for expectations

Long-term Economic GrowthLong-term Economic Growth

• Growth over the decades• Growth over the decades

30

40

50

60

70

80

90

100

110

120

1950 1960 1970 1980 1990 2000

Re

al

GD

P (

19

95

= 1

00

)UK GDP at market prices (1995=100)UK GDP at market prices (1995=100)

30

40

50

60

70

80

90

100

110

120

1950 1960 1970 1980 1990 2000

Re

al

GD

P (

19

95

= 1

00

)UK GDP at market prices (1995=100)UK GDP at market prices (1995=100)


• The causes of economic growth

– increase in quantity of factors

– increase in productivity of factors

• Capital accumulation

– a simple model of economic growth

• effect of an increase in capital

• diminishing returns

• steady-state national income









K0

Depreciation (D)

Investment (I)

Steady-state outputSteady-state output

Capital stock (K)

Ou

tpu

t (Y

), In

vest

me

nt (

I), D

epre

cia

tion

(D

)

K1

Y1

Output (Y)

g

Y0

bI0

D0

O

c

f

a










– effect of an increase in the saving rate









– effect of an increase in the saving rate

Capital stock (K)

K1 K2

Y2

Y1

Y

D

I2

I1g

m

nh

Ou

tpu

t (Y

), In

vest

me

nt (

I), D

epre

cia

tion

(D

)

f

Effect of an increase in the rate of saving and investmentEffect of an increase in the rate of saving and investment


• Technological progress– effect on steady-state output

• Technological progress– effect on steady-state output

Capital stock (K)

K1 K2

Y2

Y2

D

I2

I1g

p

nh

Ou

tpu

t (Y

), In

vest

me

nt (

I), D

epre

cia

tion

(D

)Effect of a technological advanceEffect of a technological advance

Y1

Y1

f


• Technological progress– effect on steady-state output– endogenous growth theory

• Technological progress– effect on steady-state output– endogenous growth theory


• Productivity and economic growth

– importance of productivity

– determinants of productivity

• private investment

• public investment in infrastructure and education

• innovation

• business environment

• management and entrepreneurial activity

• Productivity and economic growth

– importance of productivity

– determinants of productivity

• private investment

• public investment in infrastructure and education

• innovation

• business environment

• management and entrepreneurial activity

Supply-side PolicySupply-side Policy

• The use of supply-side policies

– to reduce unemployment

– to reduce inflation

– to increase economic growth

• Market-orientated supply-side policies

– reducing government expenditure

• The use of supply-side policies

– to reduce unemployment

– to reduce inflation

– to increase economic growth



Government expenditure (central plus local) as a percentage of GDP

















– tax cuts



– tax cuts




– tax cuts

• effects on labour supply and employment



– tax cuts





– tax cuts


• importance of incentives



– tax cuts






– tax cuts



• effects on imports



– tax cuts







– tax cuts




• tax cuts for business



– tax cuts




• tax cuts for business


• Market-orientated supply-side policies (cont.)

– reducing the power of labour

– reducing welfare

– policies to encourage competition

• privatisation

• deregulation

• introducing market relationships into the public sector

• the Private Finance Initiative

• free trade and capital movements

• Market-orientated supply-side policies (cont.)

– reducing the power of labour

– reducing welfare

– policies to encourage competition

• privatisation

• deregulation

• introducing market relationships into the public sector

• the Private Finance Initiative

• free trade and capital movements


• Background to interventionist policy

– the UK's poor productivity record



Productivity in selected countries, 2001 (UK = 100)Productivity in selected countries, 2001 (UK = 100)

Source: Budget 2003, Economic and Fiscal Strategy Report (HM Treasury, 2003)










– the UK's poor investment record



– the UK's poor investment record

Gross fixed capital formation as % of GDPGross fixed capital formation as % of GDP







• Interventionist supply-side policy– failure of the market to provide adequate

training, R&D and investment

– help to firms• direct provision

• finance for research and development

• assistance to small firms

• advice and persuasion

• information

– infrastructure development

– training and education

• Interventionist supply-side policy– failure of the market to provide adequate

training, R&D and investment

– help to firms• direct provision

• finance for research and development

• assistance to small firms

• advice and persuasion

• information

– infrastructure development

– training and education

Documents

unemployment.ppt