Lecture 16: Review

1
Lecture 16 Review

• Mundell-Fleming
• AD-AS

2
Mundell-Fleming
e
IS Y C(Y-T) I(Y,i) G
NX(Y,Y, E / (1i-i))
Interest parity
i
LM
IS
E
Y
e
E E 1i-i
------
Fiscal and Monetary policy
3
Fixed Exchange Rates (Credible)
- A little bit of it even in flexible exchange
rates systems commitment to E rather
than M gt i i gt
M YL(i) P - Central
Bank gives up monetary policy
4
Interest parity
i
LM
i
IS
E
Y
- Fiscal and Monetary policy - Capital controls
imperfect capital flows
5
Exchange Rate Crises
i
LM
i
IS
E
Y
Note There is a shift in the IS as well but
this is small, especially in the short run
6
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)

7
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
8
Price Determination

• Production function (simple)

Y N
gt P (1?) W
9
The Natural Rate of Unemployment

• Long Run P P
• The wage and price setting relationships

e
W F(u,z) P P 1 ? W
gt The natural rate of unemployment
F(u,z) 1 1
?
10
W/P
1 1 ?
Price setting
Wage setting
u
Unemployment
n
z, markup
11
From u to Y
n
n
u U L - N 1 - N 1 - Y
L L L L
F(1 - Y /L, z) 1
1 ?
n
12
W/P
Wage setting
1 1 ?
Price setting
Y
Y
n
z, markup
13
Aggregate Supply
e
W P F(1-Y/L,z)
P (1 ?) W
gt P P (1 ?) F(1-Y/L,z)
e
14
e
P P (1 ?) F(1-Y/L,z)
AS
P
e
P
Y
Y
n
15
Aggregate Demand
IS Y C(Y-T) I(Y,i) G LM M Y
L(i) P
LM P gt P
i
LM
Y
16
AD Y Y(M/P, G, T)
-
P
AD
Y
17
AD-AS Canonical Shocks
AS
P
AD
Yn
Y
Monetary expansion fiscal expansion oil shock
18
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)
P(t)/P(t-1) 1 (P(t)-P(t-1))/P(t-1) Let
?(t) (P(t)-P(t-1))/P(t-1)
e
e
19

• Then

e
(1?(t)) (1?(t)) (1 ?) F(u(t),
z) but ln(1x) ? x if x is small Let
also assume that ln(F(u(t), z)) z ?u(t)
20
The Phillips Curve
The price level vs The
inflation rate
e
P(t) P (t) (1 ?) F(u(t), z)
?gt ?(t) ? (t) (?z) - ? u(t)
e
21
The Phillips Curve and The Natural Rate of
Unemployment
e
? (t) ? (t) gt u
(?z) ? ?(t) ? (t) - ?
(u(t) - u )
n
e
n