Macro and labour market

Question 1

Phillips Curve – What does it show?

Answer 1

Inverse relationship between unemployment and inflation. Original: lower unemployment leads to higher inflation. Modern: expectations-augmented Phillips Curve includes inflation expectations.

Question 2

Expectations-augmented Phillips Curve

Answer 2

Inflation equals expected inflation plus (mark-up plus wage pressure) minus alpha times unemployment. Shows how inflation depends on expectations and labor market tightness.

Question 3

What causes the Phillips Curve to shift?

Answer 3

Changes in expected inflation. Supply shocks like oil price increases. Changes in bargaining power or mark-up.

Question 4

Natural Rate of Unemployment

Answer 4

Rate at which inflation is stable, also known as NAIRU. Determined by structural factors like union power, minimum wage, and job matching efficiency.

Question 5

WS-PS Model – What is it?

Answer 5

Wage-setting and price-setting determine natural unemployment. Wage-setting: wages depend on expected prices and unemployment. Price-setting: prices depend on wages and mark-up.

Question 6

What shifts the WS and PS curves?

Answer 6

Wage-setting shifts: changes in bargaining power, unemployment benefits, labor market policies. Price-setting shifts: changes in mark-up or productivity.

Question 7

Short-run vs Medium-run in IS-PC-LM

Answer 7

Short-run: shocks affect output and inflation. Medium-run: inflation expectations adjust which shifts the Phillips Curve and brings output back to potential.

Question 8

How does inflation adjust in the medium run?

Answer 8

If inflation is higher than expected, expected inflation goes up and the Phillips Curve shifts up. If inflation is lower than expected, expected inflation goes down and the Phillips Curve shifts down.

Question 9

How do supply shocks affect inflation and unemployment?

Answer 9

Negative supply shocks increase inflation and unemployment which is called stagflation. The Phillips Curve shifts up and policymakers face a trade-off.

Question 10

Rational Expectations vs Adaptive Expectations

Answer 10

Adaptive: expected inflation based on past inflation. Rational: expected inflation uses all available information including future policy. Policies are less effective under rational expectations.

Question 11

Role of Wage Indexation

Answer 11

When wages adjust automatically to inflation. Makes inflation more persistent and the Phillips Curve steeper. Harder to reduce inflation without increasing unemployment.

Question 12

Monetary Policy in IS-PC-LM

Answer 12

Tight monetary policy shifts LM left, output goes down, unemployment goes up, and inflation goes down over time. Effective to reduce inflation but costly in the short run.

Question 13

Disinflation – what is it?

Answer 13

Policy to reduce inflation. Requires temporarily higher unemployment. Example: Volcker disinflation in the United States in the 1980s.

Question 14

Zero Lower Bound and Phillips Curve implications

Answer 14

At zero interest rates, monetary policy is limited. Phillips Curve effects alone are not enough. Fiscal stimulus may be needed.

Question 15

Draw IS-PC-LM diagram for demand shock

Answer 15

IS shifts right leads to output and inflation going up. In short run, move along the Phillips Curve. In medium run, expectations adjust and the Phillips Curve shifts up to bring output back to potential.