Chapter 14 Flashcards
why do wages changes? inflationary gap
excess labour demand when Y > Y*
this puts upward pressure on nominal wages
workers have more bargaining power
when do wages change? recessionary gap
excess supply of labour when Y < Y*
puts downward pressure on nominal wages
but adjustment may be quite slow
pressure on wages during absence of inflationary or recessionary gap
no pressure on wages
what’s the unemployment rate when GDP is equal to Y*?
NAIRU
the non-accelerating inflation rate of unemployment
when Y > Y*, what’s U looking like?
U < U*
unemployment is LOWER than NAIRU
when Y < Y*, what’s U looking like?
U > U*
what does an expectation of some specific inflation rate create?
creates pressure for NOMINAL WAGES TO RISE by that rate
overall effect on wages = output gap + expectational effect
what determines what happens to the AS curve?
“what happens to the AS curve” aka ACTUAL INFLATION
actual inflation = output gap inflation + expected inflation + supply shock inflation
best example of a non-wage supply shock
a change in the PRICES OF MATERIALS used as INPUTS in production
if there’s constant inflation, what two things will be equal?
expected inflation = actual inflation
what’s going on with Y when expected inflation equals actual inflation?
Y must equal Y*
(no output gap)
what 3 things must be true in order for there to be a constant inflation with Y = Y*?
the 3 below things must all be consistent with the actual inflation rate:
- rate of monetary expansion
- rate of wage increase
- expected rate of inflation
in the AD/AS model with no supply shocks, constant inflation occurs when what equals what?
Y = Y*
- expectations of constant inflation rate cause AS curve to shift upward at a uniform rate
- monetary expansion by central bank causes AD curve to shift up at the same time
- so GDP remains at Y
- constant inflation takes the price level up
demand inflation
inflation arising from an inflationary output gap
caused in turn by a positive AD shock
the kind of inflation produced by a demand shock that isn’t validated
temporary
monetary validation of a positive demand shock does what?
causes AD curve to shift further to the right
this offsets the upward shift in the AS curve
continued validation of a demand shock turns what would have been transitory inflation…
into SUSTAINED inflation, fuelled by monetary expansion
what would happen if Bank acted to maintain output above Y*?
acceleration hypothesis
states that when real GDP is held above potential, the persistent inflationary gap will cause inflation to accelerate
supply inflation
inflation arising from a negative AS shock (that isn’t the result of excess demand in the domestic markets for factors of production)
with no monetary validation, reduction in wages and other factor prices make the AS curve shift slowly back down to AS0
supply shocks with monetary validation
AD curve shifts from AD0 to AD1
result: higher price level but much faster return to potential output than would occur if recessionary gap were relied on to reduce wages and other factor prices
monetary validation of a negative AS shock causes the intial rise in P…
to be followed by a further rise
risk: wage-price spiral
wage price spiral
risk that can occur after monetary validation of a negative AS shock
even if the monetary validation closes the output gap, if expectations have changed then inflation will continue to increase
means must keep increasing money supply to avoid a recession
but this only causes higher inflation
sustained inflation is only caused by what?
monetary validation/expansion
why is reducing inflation costly?
lost output and unemployment
