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Lecture 91 Macroeconomic Analysis 2003 An Example of a Stabilisation Programme.

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Presentation on theme: "Lecture 91 Macroeconomic Analysis 2003 An Example of a Stabilisation Programme."— Presentation transcript:

1 Lecture 91 Macroeconomic Analysis 2003 An Example of a Stabilisation Programme

2 Lecture 92 Contents Need for Stabilisation: Costs of Inflation and Unemployment Review of Wage and Price Spiral and Inflation Output gap and Mark ups Stabilisation experience Phillips and Okun Curves Set up of the Stabilisation Programme Inflation reduction and Unemployment Growth rate of output, inflation and money supply Sacrifice Ratio inflation policy game between public and the government: Rules or Discretion? Analysis of Stabilisation using AS-AD diagrams

3 Lecture 93 2003 Y Movement of Economy Around the Trend: A Reminder 1982 1992 35 million unemployed in the OECD Recession Boom

4 Lecture 94 Needs for Stabilisation: Costs of Inflation Inflation distorts relative prices and makes the market system less efficient as prices cannot signal relative scarcity Inflation transfers resources from creditors to debtors Redistributes income from fixed income group to property holders Taxes are not indexed for inflation, low income families are pushed up to the tax threshold Shoe leather and bookkeeping costs rise with inflation It creates uncertainty. Creates illusions, confusions and complicates economic calculation It is harmful for economic growth; reduces saving and investment activities It create social tension

5 Lecture 95 Needs for Stabilisation: Costs of Unemployment Loss of output and income and utility Personal psychological costs –Unhappiness –Stress and tension –Discouragement and disappointment –Morale and motivation –Uncompetitive feeling –Dignity of human life –Insecurity Loss of productive skills productivity Lack of learning by doing opportunity Rise in social unrest and crimes

6 Lecture 96 Main cause of Inflation: Wage Price Spiral Modernisation or Negotiation? wage Price TimeWagePrice 11.00 21.20 31.44 41.73 52.07 62.49 72.99 83.58 94.30 105.16 116.19 127.43 138.92 1410.70 1512.84 1615.41 1718.49 1822.19 1926.62 2031.95 2138.34 =0.2,

7 Lecture 97 Price Level to Inflation Rate Ignore these small numbers

8 Lecture 98 Inflation to Aggregate Supply or Expectation Augmented Phillips Curve

9 Lecture 99 AS=f(w,p e ) o LAS Inflation, Output and Unemployment in the Short Run AD =f(M,G, T)

10 Lecture 910 AS=f(w,p e ) o LAS Supply Shock and Stagflation AD =f(M,G, T) Stagflation AS1

11 Lecture 911 Time Rational Expectation Inflation Deflation Expectation die very slowly.

12 Lecture 912 Friedman (1966, 1968) and Phelps (1967) natural rate of unemployment hypothesis

13 Lecture 913 Natural Rate of Unemployment Hypothesis

14 Lecture 914 Four Main Theories of Natural Rate of Unemployment 1. Search cost and job mismatch theory: s = job separation rate f = job finding rate u = unemployment rate 2. Insider-Outsider theory: Inefficient Bargaining between firms and workers Members of the union demand higher wages and non-member remain unemployed 4. Rigidity in the labour Market: Minimum wage laws Entry deterrence and labour market standards 3. Efficiency wage theory Firms pay higher wages to workers to reduce hiring and firing costs and to reduce shirking and the monitoring costs or to appear as an ideal employer but that makes others unemployed

15 Lecture 915 Determination of the Natural Rate of Unemployment: An Example

16 Lecture 916 Recent Experience of Stabilisation in the UK

17 Lecture 917 Inflation is a Monetary Phenomenon

18 Lecture 918 Standard Measures of Stabilisation Control of Aggregate Demand –Increase or decrease in money supply –Control in the tax and spending programme –Monetisation or contraction of the budget deficit Aggregate supply –Wage renegotiations –Efficiency enhancing measures Trade and Exchange Rates Measures –Appreciation or depreciation of the currency –Trade and exchange rate agreements

19 Lecture 919 Unemployment and Output Gap: Okuns Curve Output Gap Unemployment Gap Inflation gap Higher growth rate means lower unemployment rate Higher unemployment causes wages and inflation to fall Sacrifice ratio

20 Lecture 920 Inflation Reduction Programme: Output, Inflation and Unemployment

21 Lecture 921 Stabilisation: Table 1

22 Lecture 922 Basic Parameters for the Stabilisation Programme Model

23 Lecture 923 Disinflation (Stabilisation Program

24 Lecture 924 Parametric Specification and solution steps for inflation reduction Programme

25 Lecture 925 Transitional path of output and money growth and unemployment rate in the inflation reduction programme Timepiugygm 0145317 1129-57 2109313 389311 46939 54937 62935 725 13 82535 92535 =14% - a = 0.5 b = 0.5

26 Lecture 926

27 Lecture 927 Stabilisation: Table 2

28 Lecture 928 Stabilisation: Table 3

29 Lecture 929 Disinflation Path and the Steady State

30 Lecture 930 Another Set of Parameters for the Stabilisation Programme Model

31 Lecture 931 Transitional path of output and money growth and unemployment rate in the inflation reduction programme

32 Lecture 932

33 Lecture 933 Inflation Policy Game

34 Lecture 934 Inflation Policy Game C is the most preferred and B is the least wanted scenario of the government uLuL uHuH Non cooperative Game may end at point D with high inflation and high unemployment rate

35 Lecture 935 P Y Yn AD0 AD1 LAS SAS a b c 0 Reply to demand shock Adaptive Expectation: a to b to c Rational expectation: a to c Adaptive and Rational Expectation Views on a Positive Demand Shock P0 P2 P1

36 Lecture 936 a b c d e AD0 AD1AD3 f Yn Price Level AS0 AS1 AS2 SA3 YLYH P0 P1 P2 P3 Movement of Aggregate Demand and Supply Around the Natural Rate 0

37 Lecture 937 Exercises Okuns Curve Phillips curve Inflation reduction program Sacrifice ratio Money supply, inflation and economic growth rate in the steady state Policy Game

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