Lecture Thur Sep 30

Question 1

Why does the reserve bank worry about expansionary gaps? Why do they not worry about expansionary gaps?

Answer 1

The reserve banks worry about expansionary gaps not because Y > Y*, but more because these gaps are likely to be inflationary

Question 2

GO BACK OVER TAYLOR’S RULE AND GO OVER SLIDE 5 WITH NOTES IN THE BOOK

Answer 2

ok :(

Question 3

What would the reserve bank do if they feel the inflation is too high but we are at Y*?

Answer 3

The RB would tighten the MPR (higher r for every π, MPR shifts up).
Because of this, the AD shifts down (ie. shifts to the left) because an increase in r means that C and I have both decreased. There is now a recessionary gap which means that Y has decreased and unemployment has increased. Overtime, SRAS shifts down; Y is back at the Y* at lower inflation rates.

Question 4

Does tightening the MPR cause higher or lower r for a given rate of inflation?

Answer 4

higher

Question 5

What is the MPR?

Answer 5

This is the monetary policy rule. This describes how a reserve bank takes action in response to changes in the state of the economy. It has an inflation target of 1-3%. The target interest rate is the r the RB will obtain the goal (target inflation) see Taylor’s rule.

Question 6

The higher the expected inflation the higher/lower the RB’s r choice is

Answer 6

higher

Question 7

What 4 things happens when there is a tightening MPR?

Answer 7

• AD shifts down
• recessionary gap
• SRAS moves out over time
• we get back to long-run equilibrium

Question 8

What are the SR costs of tightening the MPR?

Answer 8

• lower output

- higher unemployment

Question 9

What are the LR benefits of this policy?

Answer 9

lower inflation

Question 10

What does the short-run Phillips curve show?

Answer 10

It shows the trade off between unemployment and inflation, holding constant both the expected inflation rate and the natural rate of unemployment

Question 11

If policy makers contract aggregate demand, they can lower ________, but at the cots of temporarily higher __________

Answer 11

inflation

unemployment

Question 12

If policymakers expand demand, they can lower __________ but only at the cost of higher _________

Answer 12

unemployment

inflation

Question 13

What is on each axis of the Phillips curve diagram and what shape is the short-run Phillip’s curve?

Answer 13

Unemployment is on the x axis and inflation rate is on the y axis
It is downwards sloping

Question 13

What is on each axis of the Phillips curve diagram and what shape is the short-run Phillip’s curve?

Answer 13

Unemployment is on the x axis and inflation rate is on the y axis

Question 14

What happens to the AD curve and the SRAS curve when the Ad is expected to increase?

Answer 14

If there is a positive outlook, AD will be expected to increase. The economy anticipates this increase and it responds with a shift in SRAS. This is because the increase in AD means that we are producing at a higher level of inflation. We are producing more output which means the Y > Y. This means firms are incurring extra costs and they are over-utilising. The firms respond by the SRAS curve decreasing so Y = Y and u = u*

Question 14

What happens to the AD curve and the SRAS curve when the Ad is expected to increase?

Answer 14

If there is a positive outlook, AD will be expected to increase. The economy anticipates this increase and it responds with a shift in SRAS. This is because the increase in AD means that we are producing at a higher level of inflation. We are producing more output which means the Y > Y. This means firms are incurring extra costs and they are over-utilising. The firms respond by the SRAS curve decreasing so Y = Y and u = u*.

Question 15

What happens if AD increased more than expected?

Answer 15

Actual inflation would be greater than expected inflation and so actual unemployment would be less than the natural rate of unemployment

Question 16

What happens if AD did not increase as expected?

Answer 16

With the SRAS, actual inflation is less than expected inflation and actual unemployment is more than the natural rate of unemployment

Question 17

What does the LRPC show?

Answer 17

This shows the relationship between unemployment and inflation when the actual inflation equals the expected inflation rate. As a result, the long-run Phillips curve is vertical at the natural rate of unemployment

Question 17

What does the LRPC show?

Answer 17

This shows the relationship between unemployment and inflation when the actual inflation equals the expected inflation rate. As a result, the long-run Phillips curve is vertical at the natural rate of unemployment

Question 18

Does changing the inflation affect the LRPC? What does this mean for the effectiveness of monetary policy?

Answer 18

Changing inflation doesn’t affect the LRPC, it remains at the natural rate of unemployment so monetary policy is ineffective in the long run because even when π changes, it has no effect on unemployment rate or Y* or u*

Question 19

The SRPC is a mirror of what?

Answer 19

the AS curve

Question 20

What does expected inflation measure? What does it adjust to in the long run?

Answer 20

This measures how much people expect the overall price level to change. In the long run, expected inflation adjusts to changes in actual inflation

Question 21

When the economy’s expected inflation, there is a shift in what curve? This cause what else to change?

Answer 21

There is a shift in the SRAS curve so the SRPC shifts too

Question 22

What happens to the SRPC if the inflation in the economy has increased?

Answer 22

eg. from a 7% inflation rate to a 10% inflation rate, we move up along the SRPC (not shift of the SRPC) to a higher inflation, lower unemployment. As inflation increases from 7-10%, if expectations haven't adjusted, it will lead to an increase in output in the AD-AS model and this causes an output gap. This means that u < u*. Overtime, inflationary expectations adjust as π = 10% so we expect the SRAS curve to shift upwards (the πe is now equal to 10%)

Question 23

In the long run, expected inflation adjusts to changes in actual inflation, true of false?

Answer 23

true

Question 24

The RBNZ's ability to create unexpected inflation exists only in the short run. Why is this?

Answer 24

Once people anticipate inflation, the only way to get unemployment below the natural rate is for actual inflation to be above the anticipated rate.

Question 25

The expectations-augmented Phillips curve suggests what?

Answer 25

That the unemployment rate = natural rate of unemployment - α(actual inflation - expected inflation)

Question 26

What are two things that would cause a shift in the long-run Phillips curve?

Answer 26

- this could be due to changes in the natural rate of unemployment - any change in the economy's productive capacity (ie. if Y* shifted)

Question 27

Describe what is meant by changes in the natural rate of unemployment affecting the LRPC

Answer 27

Policies which improve the functioning of the labour market may help reduce the natural rate unemployment. As more workers are producing more goods (ie because u* is lower), the long-run AS (LRAS) curve would shift to the right

Question 28

The LRPC is a mirror image to what? Give an example of this

Answer 28

the LRAS If there is an increase in Y*, you have to hire more workers so u decreases. As the LRAS curve shifts to the right, the LRPC shifts to the left

Question 29

What is the natural experiment for the natural-rate hypothesis?

Answer 29

This is the view that unemployment eventually returns to its natural rate regardless of the rate of inflation

Question 30

What causes shifts in the SR Phillips curve? Describe this?

Answer 30

- a supply shock This is an events that directly alters the firms' costs, and, as a result, the prices they charge. This shifts the economy's SRAs curve, and as a result, the SR Phillips curve. Major adverse changes in aggregate supply can worsen the short-run trade-off between unemployment and inflation. As adverse supply shock gives policymakers a less favourable tradeoff between inflation and unemployment