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Lecture 16

This document provides a summary and review of key macroeconomic concepts including: - Mundell-Fleming model and how fiscal and monetary policy affect exchange rates and output. - Exchange rate regimes like fixed rates and how this constrains monetary policy. - Building aggregate supply curves from wage and price determination models. - Deriving the natural rate of unemployment and relating unemployment to aggregate supply. - Combining aggregate supply and demand to examine canonical shocks. - Developing the Phillips curve relationship between inflation and unemployment.

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manojverma231988
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58 views21 pages

Lecture 16

This document provides a summary and review of key macroeconomic concepts including: - Mundell-Fleming model and how fiscal and monetary policy affect exchange rates and output. - Exchange rate regimes like fixed rates and how this constrains monetary policy. - Building aggregate supply curves from wage and price determination models. - Deriving the natural rate of unemployment and relating unemployment to aggregate supply. - Combining aggregate supply and demand to examine canonical shocks. - Developing the Phillips curve relationship between inflation and unemployment.

Uploaded by

manojverma231988
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© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Lecture 16: Review

Mundell-Fleming
AD-AS

Mundell-Fleming

IS : Y = C(Y-T) + I(Y,i) + G + NX(Y,Y*, E e / (1+i-i*)) Interest parity i LM

IS E

Y E =

e E -----1+i-i*

* Fiscal and Monetary policy

Fixed Exchange Rates (Credible)

- A little bit of it even in flexible exchange rates systems; commitment to E rather than M => => i = i*
M P
= YL(i*)

- Central Bank gives up monetary policy

Interest parity i LM

i* IS E

Y - Fiscal and Monetary policy


- Capital controls; imperfect capital flows

Exchange Rate Crises

LM

i* IS E

Note: There is a shift in the IS as well but this is small, especially in the short run

Building the Aggregate Supply

The labor market Simple markup pricing


Long run (Natural rate: Aggregate demand factors dont matter for Y) Short run

Impact: Same as before but P also change (partial) Dynamics (go toward Natural rate)

Wage Determination

Bargaining and efficiency wages

e W = P F(u,z)

Real wages Nominal wage setting

Bargaining power Fear of unemployment

Unemployment insurance Hiring rate (reallocation) Bargaining

Price Determination

Production function (simple)

Y = N =>

P = (1+) W

The Natural Rate of


Unemployment

Long Run P = Pe The wage and price setting relationships:

W = F(u,z) P P = 1+ W => The natural rate of unemployment F(u,z) = 1 1+

W/P

1 1+

Price setting Wage setting

Unemployment

z, markup

From un to Y
n
u = U = L-N =1-N =1 -Y L L L L

F(1 - Y /L, z) = n

1 1+

W/P

Wage setting

1 1+

Price setting

Y n

z, markup

Aggregate Supply

e W = P F(1-Y/L,z) P = (1+ ) W =>

P = Pe (1+ ) F(1-Y/L,z)

P = Pe (1+ ) F(1-Y/L,z)

P e AS

Y n

Aggregate Demand

IS: Y = C(Y-T) + I(Y,i) + G LM: M = Y L(i) P


LM [ P > P] i LM

AD:

Y = Y(M/P, G, T) + + -

AD

AD-AS: Canonical Shocks

P AS

AD

Yn Monetary expansion; fiscal expansion; oil shock

From AS to the Phillips Curve

* The price level vs The inflation rate

e
P(t) = P (t) (1+ ) F(u(t), z) Note that: P(t)/P(t-1) = 1 + (P(t)-P(t-1))/P(t-1)
e e
P(t)/P(t-1) = 1 + (P(t)-P(t-1))/P(t-1) Let

(t) = (P(t)-P(t-1))/P(t-1)

Then

e (1+(t)) = (1+(t)) (1+ ) F(u(t), z)

but
ln(1+x) x

if x is small

Let also assume that


ln(F(u(t), z)) = z u(t)

The Phillips Curve

* The price level vs The inflation rate

e P(t) = P (t) (1+ ) F(u(t), z)


>
e (t) = (t) + (+z) - u(t)

The Phillips Curve and The


Natural Rate of Unemployment

(t) = (t)
=>
un = (+z)
(t) = e(t) - (u(t) - un)

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