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1、,CHAPTER 12,The Phillips Curve and Expectations,1,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Questions,What is the Phillips curve? How has the natural rate of unemployment changed in the U.S. over the past two generations? What determines the expected rate of inflation? H
2、ow can we tell how expectations of inflation are formed-whether they are static, adaptive, or rational?,2,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Questions,How useful is the aggregate demand-aggregate supply framework-the IS-LM model and the Phillips curve-for understa
3、nding macroeconomic events in the U.S. over the past two generations? How do we connect up the sticky-price model with the flexible-price model?,3,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Okuns Law,Okuns law shows the relationship between the unemployment rate and real
4、GDP,or,4,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,The Three Faces of Aggregate Supply,Aggregate supply relates the price level to the level of real GDP Aggregate supply can also relate the inflation rate to the level of real GDP Using Okuns law, aggregate supply can als
5、o relate the inflation rate to the unemployment rate this relationship is known as a Phillips curve,5,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,The Phillips Curve,Aggregate supply can relate the inflation rate to the level of real GDP,The right-hand side of this equation
6、 can be substituted into Okuns Law,6,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,The Phillips Curve,Letting =2.5/, we get the Phillips curve,To allow for supply shocks, we will add an extra term to the Phillips curve (s),7,Copyright 2002 by The McGraw-Hill Companies, Inc.
7、All rights reserved.,Figure 12.1 - The Phillips Curve,8,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 12.2 - Three Faces of Aggregate Supply,9,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,The Phillips Curve,The slope of the Phillips curve dep
8、ends on how sticky prices and wages are the stickier are wages and prices, the smaller is parameter , and the flatter is the Phillips curve When the Phillips curve is flat, even large changes in the unemployment rate have little effect on the price level,10,Copyright 2002 by The McGraw-Hill Companie
9、s, Inc. All rights reserved.,The Phillips Curve,Whenever unemployment is equal to its natural rate, inflation is equal to expected inflation the position of the Phillips curve can be determined if we know the natural rate of unemployment and the expected inflation rate,11,Copyright 2002 by The McGra
10、w-Hill Companies, Inc. All rights reserved.,The Phillips Curve,The Phillips curve shifts if either expected inflation or the natural rate of unemployment changes or if a supply shock occurs a higher natural rate moves the Phillips curve to the right higher expected inflation moves the Phillips curve
11、 up adverse supply shocks move the Phillips curve up,12,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 12.3 - Shifts in the Phillips Curve,13,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Aggregate Demand,The aggregate demand function developed
12、 in Chapter 11 shows how real GDP relates to the inflation rate,We can use Okuns Law to develop an aggregate demand equation with unemployment on the left-hand side,14,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Aggregate Demand,The parameter is the product of three things
13、 how much the central bank raises the real interest rate in response to inflation how much real GDP changes in response to a change in the real interest rate how large a change in unemployment is produced by a change in real GDP,15,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserve
14、d.,Equilibrium Levels of Inflation and Unemployment,Together, the unemployment form of the aggregate demand relationship and the Phillips curve equation allow us to determine what the inflation and unemployment rates will be in the economy the economys equilibrium is where the two curves cross,16,Co
15、pyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 12.4 - Equilibrium Levels of Unemployment and Inflation,17,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Equilibrium,The economys equilibrium inflation and unemployment rates depend on the natural ra
16、te of unemployment (u*) the expected rate of inflation (e) supply shocks (s) the level of unemployment when the real interest rate is at what the central bank thinks is its long-run average (u0) the central banks target level of inflation (),18,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Solving for Equilibrium,To solve for the equilibrium unemployment rate, substitute the Phillips curve equation into the monetary policy reaction function,19,Copyright 2002 by
