Macroeconomic Analysis 2003

1. Macroeconomic Analysis 2003 Phillips’ Curve and the Natural Rate of Unemployment Hypothesis Lecture 8

2. Contents • Motivation • Review of Inflation and unemployment rates over time • Phillips Curve • Output GAP: Potential and Actual Output • Wage Price Spiral • Expectation Augmented Phillips curve • Some exercises Lecture 8

3. Measurement and Analysis of Fluctuations in the Economy Lecture 8

4. Unemployment and Inflation Current unemployment rate: Current Inflation Rates from the Treasury Web page Lecture 8

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6. 92 recession Thatcher’ contraction Beginning of Stagflation Brown and New Labour independent MPC Lecture 8

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10. Oil price shock Breakdown of Bretton Woods Inflation targeting Independent central Bank Lecture 8

11. Average dwelling prices: by type of buyer in the UK (in thousands £) Lecture 8 Source: Office of the Deputy Prime Minister

12. Refer www.halifax.co.uk for the current prices Lecture 8

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15. www.londonstockexchange.com Lecture 8

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21. Phillips’ Curve Lecture 8

22. Phillips’ Curve: Unemployment Inflation Trade-Off 9 Inflation rate 5 Policy Menu 2.5 7 6 5 Unemployment Rate, u 1 2 -2 Deflation Lecture 8

23. LD Total Labour Force and Unemployment Rate in the UK in February 2003 LS LD0 0 LF=29.3 LS=LD 27.8 u = 5.1% 26.37 In Millions Pay rise by modernisation or bargaining? u=10% Lecture 8

24. Labour Demand, Labour Supply and Unemployment Labour Supply u LS w u w LS LD1 Labour Demand LD2 LF Lecture 8

25. Aggregate Demand, Productive Capacity and the Price Level Higher Wage Rate Translates into Higher Prices New Classical AS Price Level P5 P4 c AD3 b Keynesian P3 AD2 P1 a New Keynesian part AD1 AD4 AD0 Y3 Yc Y0 Y1 Output Gap Lecture 8

26. Phillips Curve and Expectation Augmented PC (NAIRU) Lecture 8

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29. Expectation Augmented Phillips Curve b =1 Lecture 8

30. Inflation Rational Expectation Time Deflation Expectation die very slowly. Lecture 8

31. Inflation and Unemployment with Static Expectation b =1 Lecture 8

32. Link Between Unemployment and Inflation Grate gn =7 gn =4 gn =5 Lecture 8

33. Evidence of the Phillips Curve in the UK Lecture 8

34. Wage Price Spiral: Modernisation or Negotiation? Lecture 8

35. Price Level to Inflation Rate Lecture 8

36. Inflation to Aggregate Supply or Expectation Augmented Phillips Curve Lecture 8

37. Inflation, Output and Unemployment in the Short Run LAS o Lecture 8

38. Inflation, Output and Unemployment in the Short Run LAS AS=f(w,pe) AD =f(M,G, T) o Lecture 8

39. Wage Setting and Price Setting Real Wage Firms set price Z includes Tax Benefit Reservation wage Bargaining power Minimum wage Structure of labour market Unions set wage rate Un Unemployment rate Lecture 8

40. Derivation of aggregate supply curve for the economy using price setting and wage setting relations Lecture 8

41. A natural rate of unemployment is obtained by intersection of price setting and wage setting relations Lecture 8

42. Friedman (1966, 1968) and Phelps (1967) natural rate of unemployment hypothesis Lecture 8

43. Natural Rate of Unemployment Hypothesis Lecture 8

44. Adaptive and Rational Expectation Views on a Positive Demand Shock LAS SAS c P2 b P1 P a P0 AD1 AD0 0 Yn Reply to demand shock Adaptive Expectation: a to b to c Rational expectation: a to c Y Lecture 8

45. Inflation is a Monetary Phenomenon Lecture 8

46. Exercise • Should wage rises of workers (fire fighters) come from modernisation of services as suggested by the government or by the negotiation between the unions and the government? • Natural rate of unemployment and price and wage bargaining • Aggregate supply Lecture 8