Lecture 16: Review • Mundell-Fleming• AD-ASiYEISLMInterest parityMundell-Fleming* Fiscal and Monetary policyE = E 1+i-i*e------IS : Y = C(Y-T) + I(Y,i) + G + NX(Y,Y*, E / (1+i-i*))eFixed Exchange Rates (Credible)- A little bit of it even in “flexible” exchange rates systems; “commitment” to E rather than M=> i = i* => M = YL(i*)P- Central Bank gives up monetary policyiYEISLMInterest parity- Fiscal and Monetary policy- Capital controls; imperfect capital flowsi*iYEISLMi*Note: There is a shift in the IS as well… but this is small, especially in the short runExchange Rate CrisesBuilding the Aggregate Supply• The labor market • Simple markup pricing• Long run (Natural rate: Aggregate demand factors don’t matter for Y)• Short run – Impact: Same as before but P also change (partial)– Dynamics (go toward Natural rate)Wage Determination• Bargaining and efficiency wagesW = P F(u,z)eReal wagesNominal wage settingBargaining powerFear of unemploymentUnemployment insuranceHiring rate (reallocation)BargainingPrice Determination• Production function (simple)Y = N=>P = (1+µ) WThe Natural Rate of Unemployment• “Long Run” P = P• The wage and price setting relationships:eW = F(u,z)P P = 1+ µW=>The natural rate of unemploymentF(u,z) = 11+ µUnemploymentPrice settingWage setting11+ µW/Pz, markup unFrom u to Yu = U = L - N = 1 - N = 1 - YL L L LnnF(1 - Y /L, z) = 11+ µnYPrice settingWage setting11+ µW/Pz, markupYnAggregate SupplyW = P F(1-Y/L,z)P = (1+ µ) W=>P = P (1+ µ) F(1-Y/L,z)eeP = P (1+ µ) F(1-Y/L,z)YPASPYeneAggregate DemandIS: Y = C(Y-T) + I(Y,i) + GLM: M = Y L(i)PYiLMLM’ [ P’ > P]AD: Y = Y(M/P, G, T)+ + -YPADAD-AS: Canonical ShocksYPADASMonetary expansion; fiscal expansion; oil shock YnFrom AS to the Phillips Curve* The price level vs The inflation rateP(t) = P (t) (1+ µ) F(u(t), z)eNote 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 π(t) = (P(t)-P(t-1))/P(t-1)ee•Then(1+π(t)) = (1+π(t)) (1+ µ) F(u(t), z)butln(1+x) ≈ x if x is “small”Let also assume that ln(F(u(t), z)) = z – αu(t)eThe Phillips Curve* The price level vs The inflation rateP(t) = P (t) (1+ µ) F(u(t), z)e≈>π(t) = π (t) + (µ+z) - α u(t)eThe Phillips Curve and The Natural Rate of Unemploymentπ (t) = π (t) => u = (µ+z)απ(t) = π (t) - α (u(t) - u
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