Lecture 16: ReviewSlide 2Fixed Exchange Rates (Credible)Slide 4Slide 5Building the Aggregate SupplyWage DeterminationPrice DeterminationThe Natural Rate of UnemploymentSlide 10From u to YSlide 12Aggregate SupplySlide 14Aggregate DemandSlide 16AD-AS: Canonical ShocksFrom AS to the Phillips CurveSlide 19The Phillips CurveThe Phillips Curve and The Natural Rate of UnemploymentLecture 16: Review •Mundell-Fleming•AD-ASiYEISLMInterest parity Mundell-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+) WThe Natural Rate of Unemployment•“Long Run” P = P•The wage and price setting relationships:e W = F(u,z) P P = 1+ W =>The natural rate of unemployment F(u,z) = 1 1+ UnemploymentPrice settingWage setting 1 1+ W/Pz, markup unFrom u to Yu = U = L - N = 1 - N = 1 - Y L L L Lnn F(1 - Y /L, z) = 1 1+ nYPrice settingWage setting 1 1+ W/Pz, markupYnAggregate Supply W = P F(1-Y/L,z) P = (1+ ) W => P = P (1+ ) F(1-Y/L,z)eeP = P (1+ ) 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+ ) 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 (t) = (P(t)-P(t-1))/P(t-1)ee•Then(1+(t)) = (1+(t)) (1+ ) F(u(t), z)butln(1+x) x if x is “small”Let also assume that ln(F(u(t), z)) = z – u(t)eThe Phillips Curve* The price level vs The inflation rateP(t) = P (t) (1+ ) F(u(t), z)e>(t) = (t) + (+z) - u(t)eThe Phillips Curve and The Natural Rate of Unemployment (t) = (t) => u = (+z) (t) = (t) - (u(t) - u
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