Debates on Macroeconomic Policy
By: Jeff, Billy, Chris T, Yuki, Chris H
* Day 1 Focus ** Day 1 Focus *
Demand-pull inflation, and the tradeoffs between inflation and unemployment as expressed by the Phillips Curve
Cost-push inflation and stagflation
Wage and price controls, and wage and price guidelines
Demand-pull inflation, and the tradeoffs between inflation and unemployment as expressed by the Phillips Curve
Cost-push inflation and stagflation
Wage and price controls, and wage and price guidelines
Demand-Pull Inflation
Demand-Pull Inflation
Caused by increase in aggregate demand inflation increases and unemployment decreases Increase in aggregate demand increases inflation
and output Increase in output lower unemployment and
higher wages Increase in wages further increases inflation Can be shown using a Phillips curve
Caused by increase in aggregate demand inflation increases and unemployment decreases Increase in aggregate demand increases inflation
and output Increase in output lower unemployment and
higher wages Increase in wages further increases inflation Can be shown using a Phillips curve
Demand-Pull InflationDemand-Pull Inflation
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The Phillips CurveThe Phillips Curve Keynesian economist A.W.H.
Phillips believed inverse relationship between inflation and unemployment was predictable
Created the curve called the Phillips curve
Government could use curve to predict how policy would affect the economy
Keynesian economist A.W.H. Phillips believed inverse relationship between inflation and unemployment was predictable
Created the curve called the Phillips curve
Government could use curve to predict how policy would affect the economy
The Phillips Curve
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Shifts in the Phillips Curve
Shifts in the Phillips Curve
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Cost-Push InflationCost-Push Inflation Caused by decreases in aggregate
supply, due to increase in input prices Cost of production increases higher
inflation and less output Less output higher unemployment Inflation and unemployment have direct
relationship, as both increase at same time, called stagflation (worst-case scenario)
Caused by decreases in aggregate supply, due to increase in input prices
Cost of production increases higher inflation and less output
Less output higher unemployment Inflation and unemployment have direct
relationship, as both increase at same time, called stagflation (worst-case scenario)
Cost-Push Inflation Cost-Push Inflation
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Wage and Price Policies
Wage and Price Policies
Attempted by government in 1970s and 1980s to solve stagflation
Consisted of wage and price controls, and wage and price guidelines
Attempted by government in 1970s and 1980s to solve stagflation
Consisted of wage and price controls, and wage and price guidelines
Wage and Price GuidelinesWage and Price Guidelines
Implemented from 1969-1975 Government encouraged voluntary caps on
wages and prices by labour unions and businesses
Businesses and labour unions were un-cooperative
Inflation was 5% when the commission was formed in 1969, and rose to 10% by 1975
Ineffective at battling inflation
Implemented from 1969-1975 Government encouraged voluntary caps on
wages and prices by labour unions and businesses
Businesses and labour unions were un-cooperative
Inflation was 5% when the commission was formed in 1969, and rose to 10% by 1975
Ineffective at battling inflation
Wage and Price ControlsWage and Price Controls
Implemented in 1975 Wages and salaries were only allowed to
increase by a maximum percentage each year (wages could increase by max of 8% in 1976, 6% in 1977, and 4% in 1978)
Businesses allowed price increases only to cover increase in costs, and restrictions put on profits
Inflation dropped during the next three years from 10% in 1975, to between 7.5-9% from 1976-1978, but rose above 10% by 1980, two years after wage and price controls were lifted
Implemented in 1975 Wages and salaries were only allowed to
increase by a maximum percentage each year (wages could increase by max of 8% in 1976, 6% in 1977, and 4% in 1978)
Businesses allowed price increases only to cover increase in costs, and restrictions put on profits
Inflation dropped during the next three years from 10% in 1975, to between 7.5-9% from 1976-1978, but rose above 10% by 1980, two years after wage and price controls were lifted
Debate Over Wage and Price PoliciesDebate Over Wage and Price Policies
Opposition to policies because they are ineffective, unfair, and inefficient
Ineffective because wage and price guidelines are voluntary are unsuccessful at decreasing inflation, and wage and price controls only work in short run but inflation rises again once the controls have been removed
Unfair because some sectors are easier to regulate than others and wage and price controls cannot be universally applied, so people in some sectors will have limited wage increases, and others will not.
Inefficient because wage and price controls are similar to price ceilings, so price cannot be used to gauge changes in supply and demand, and resources may be allocated to inefficient businesses rather than those who run more efficently
Opposition to policies because they are ineffective, unfair, and inefficient
Ineffective because wage and price guidelines are voluntary are unsuccessful at decreasing inflation, and wage and price controls only work in short run but inflation rises again once the controls have been removed
Unfair because some sectors are easier to regulate than others and wage and price controls cannot be universally applied, so people in some sectors will have limited wage increases, and others will not.
Inefficient because wage and price controls are similar to price ceilings, so price cannot be used to gauge changes in supply and demand, and resources may be allocated to inefficient businesses rather than those who run more efficently
Day One SummaryDay One Summary
Demand-Pull InflationThe Phillips CurveCost-Push InflationWage and Price Policies
Demand-Pull InflationThe Phillips CurveCost-Push InflationWage and Price Policies
Day 2 FocusDay 2 Focus
Monetarism: -central equations (velocity of money, equation
of exchange, quantity of money) -inflationary rates and monetary growth -monetarist policies -the monetary rule
Supply-Side Economics: -reduction in incentives -focus on aggregate supply -the Laffer curve -the influence of supply side economics
Monetarism: -central equations (velocity of money, equation
of exchange, quantity of money) -inflationary rates and monetary growth -monetarist policies -the monetary rule
Supply-Side Economics: -reduction in incentives -focus on aggregate supply -the Laffer curve -the influence of supply side economics
MonetarismMonetarism
An economic perspective that emphasizes the influence of money on the economy and the ability of private markets to accommodate fluctuations in economy
An economic perspective that emphasizes the influence of money on the economy and the ability of private markets to accommodate fluctuations in economy
Monetarists versus Keynesians
Monetarists versus Keynesians
Oppose fiscal policies preferred Keynesians, instead favour monetary policies
Monetarists agree that economy is susceptible to shocks, but misguided government intervention only worsens situation
Believe unwise use of monetary policy is mostly to blame for shocks in economy
Oppose fiscal policies preferred Keynesians, instead favour monetary policies
Monetarists agree that economy is susceptible to shocks, but misguided government intervention only worsens situation
Believe unwise use of monetary policy is mostly to blame for shocks in economy
The Velocity of Money (V)
The Velocity of Money (V)
Concept that is central to monetarism Velocity of money (V) = nominal GDP
money supply (M) Velocity of money (V): the average # of
times money is spent on final goods and services during a year
Nominal GDP: total dollar value of final goods and services produced in economy
Money supply (M) = M1 (publicly held currency and publicly held deposits, excluding cash reserves)EX1: If Canada’s nominal GDP is $800 billion, and M1 is $ 50 billion, what is the velocity?
Concept that is central to monetarism Velocity of money (V) = nominal GDP
money supply (M) Velocity of money (V): the average # of
times money is spent on final goods and services during a year
Nominal GDP: total dollar value of final goods and services produced in economy
Money supply (M) = M1 (publicly held currency and publicly held deposits, excluding cash reserves)EX1: If Canada’s nominal GDP is $800 billion, and M1 is $ 50 billion, what is the velocity?
The Equation of Exchange
The Equation of Exchange
Nominal GDP = V x M GDP expresses both price level (P)
and output (Q) Nominal GDP = P x Q
EX2: $800 billion = 2.0 x $400 billion
V x M = P x Q
Using EX1 and EX2:
$50 billion x 16 = 2.0 x $400 billion
Nominal GDP = V x M GDP expresses both price level (P)
and output (Q) Nominal GDP = P x Q
EX2: $800 billion = 2.0 x $400 billion
V x M = P x Q
Using EX1 and EX2:
$50 billion x 16 = 2.0 x $400 billion
The Quantity of MoneyThe Quantity of Money
The velocity of money changes over time due to long-run factors, almost constant in short run
Real output varies slightly from potential level in short run, wages are flexible so economy adjusts to changes in prices or unemployment (after a brief period of inflexible wages)
Velocity of money and real output are reasonably stable, so V* and Q* are set as constant values
M x V* = P x Q* Result is direct relationship between money
and prices
The velocity of money changes over time due to long-run factors, almost constant in short run
Real output varies slightly from potential level in short run, wages are flexible so economy adjusts to changes in prices or unemployment (after a brief period of inflexible wages)
Velocity of money and real output are reasonably stable, so V* and Q* are set as constant values
M x V* = P x Q* Result is direct relationship between money
and prices
Inflation Rates and Monetary Growth
Inflation Rates and Monetary Growth
Extension of quantity theory of money that shows relationship between inflation rates and growth in money supply
When both velocity and real output are constant, the percentage changes in money supply and in price level are equal
% in M = % in P Velocity of money and real output are
not perfectly constant, so inflation is not always identical to the rate of monetary growth, but they will be close
Extension of quantity theory of money that shows relationship between inflation rates and growth in money supply
When both velocity and real output are constant, the percentage changes in money supply and in price level are equal
% in M = % in P Velocity of money and real output are
not perfectly constant, so inflation is not always identical to the rate of monetary growth, but they will be close
Inflation Rates and Monetary Growth –
EXAMPLE
Inflation Rates and Monetary Growth –
EXAMPLEM x V* = P x Q*
$50 billion x 16 = 2.0 x $400 billion $55 billion x 16 = 2.2 x $400 billion
% in M = ($55 billion - $50 billion) x 100
% $50 billion
= 10 % % in P = (2.2 – 2.0) x 100%
2.0 = 10%
M x V* = P x Q* $50 billion x 16 = 2.0 x $400 billion $55 billion x 16 = 2.2 x $400 billion
% in M = ($55 billion - $50 billion) x 100
% $50 billion
= 10 % % in P = (2.2 – 2.0) x 100%
2.0 = 10%
Monetarist PoliciesMonetarist Policies
Money is the key factor in the economy, unlike Keynesians who believe it is only one of many factors
Fiscal policy has little influence due to “crowding out effect”
Even monetary policy cannot change output from its potential level
Only way to stabilize economy is minimizing harmful effects of inflation, when bank of Canada minimizes rate of growth of money supply
Money is the key factor in the economy, unlike Keynesians who believe it is only one of many factors
Fiscal policy has little influence due to “crowding out effect”
Even monetary policy cannot change output from its potential level
Only way to stabilize economy is minimizing harmful effects of inflation, when bank of Canada minimizes rate of growth of money supply
The Monetary RuleThe Monetary Rule
The monetary rule forces central banks to increase the money supply by a constant rate each year
Recommended at 3% based on real long-term growth in economy
The monetary rule forces central banks to increase the money supply by a constant rate each year
Recommended at 3% based on real long-term growth in economy
Supply-Side EconomicsSupply-Side Economics
Focuses on influence of production costs on prices and incomes
Influence on aggregate supply is most important result of government policy
Focuses on influence of production costs on prices and incomes
Influence on aggregate supply is most important result of government policy
Reduction in IncentivesReduction in Incentives
Recent government has impaired economic activity by reducing incentives to be productive
Personal Income and Business Taxes: When taxes increase, disposable income falls
Sales Taxes: Reduces amount of products that can be bough with a given disposable income
Transfers and Subsidies: welfare, Unemployment Insurance, and farm subsidies diminish incentives to generate private income
Regulation: Environmental, safety…regulations have all increased business costs and reduced incentives to invest
Recent government has impaired economic activity by reducing incentives to be productive
Personal Income and Business Taxes: When taxes increase, disposable income falls
Sales Taxes: Reduces amount of products that can be bough with a given disposable income
Transfers and Subsidies: welfare, Unemployment Insurance, and farm subsidies diminish incentives to generate private income
Regulation: Environmental, safety…regulations have all increased business costs and reduced incentives to invest
Focus on Aggregate SupplyFocus on Aggregate Supply
More taxes and government regulation decrease aggregate supply, and the AS curve shifts to the left
Same as cost-push inflation; increased costs push up prices a the same time that unemployment rises stagflation
Supply-siders call for tax cuts and deregulation to lower prices and unemployment
More taxes and government regulation decrease aggregate supply, and the AS curve shifts to the left
Same as cost-push inflation; increased costs push up prices a the same time that unemployment rises stagflation
Supply-siders call for tax cuts and deregulation to lower prices and unemployment
Effect of Government InterventionEffect of Government Intervention
The Laffer CurveThe Laffer Curve
Demonstrates an assumed relationship between tax rates and tax revenues
Tax rates and tax revenues have direct relationship at low tax rates, therefore tax increase at lower tax rates also increases tax revenues, and positive slope on graph
Tax rates and tax revenues have indirect relationship at high tax rates, therefore a tax increase at higher tax rates decreases tax revenues, and negative slope on graph
Tax increases at higher tax rates have dampening effect on economic activity
Demonstrates an assumed relationship between tax rates and tax revenues
Tax rates and tax revenues have direct relationship at low tax rates, therefore tax increase at lower tax rates also increases tax revenues, and positive slope on graph
Tax rates and tax revenues have indirect relationship at high tax rates, therefore a tax increase at higher tax rates decreases tax revenues, and negative slope on graph
Tax increases at higher tax rates have dampening effect on economic activity
The Laffer CurveThe Laffer Curve
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