Post on 31-Dec-2015
Interest rate (r)
Infla
tion
rate
(π
)Fed Reaction Rule
If the Fed sees the inflation rate rising…
…it moves to raise interest rates
r0 r1
π1
π0
B
A
Figure 12.1 The Fed Reaction Rule
45
Income
Agg
rega
te D
em
and
and
Out
put
AD1 (with new, higher interest rate, r1)
E1
E0
AD0 (with old interest rate, r0)
Y1 Y0
A
B
Figure 12.2 Changing AD Equilibrium due to the Fed Reaction
Output (Y)
Infla
tion
rate
(π
)
Aggregate Demand Equilibrium (ADE)
If inflation rises…
…the Fed takes action to “cool off” the economy
Y1
π1
π0
Y0
A
B
Figure 12.3 The Aggregate Demand Equilibrium Curve
Output (Y)
Infla
tion
rate
(π
)
ADE0
ADE1
Figure 12.4 The Effect of Expansionary Fiscal Policy or Increased Confidence
Output (Y)
Infla
tion
rate
(π
)
ADE1
ADE05% target
10% target
Figure 12.5 The Effect of a Lower Target Inflation Rate
Output (Y)
Infla
tion
rate
(π
)
Aggregate Supply Response (ASR)
Maximum Capacity
Y*
Recession
Wage-Price Spiral
Figure 12.6 The Aggregate Supply Response (ASR) Curve
Output (Y)
Infla
tion
rate
(π
)ASR0
ASR1
Figure 12.7 An Increase in Inflationary Expectations
Output (Y)
Infla
tion
rate
(π
)
ASR1
ASR0
Expansion of Maximum Capacity
Figure 12.8 A Beneficial Supply Shock
Output (Y)
Infla
tion
rate
(π
)
ASR
Y*
Recession
ADEE0
Figure 12.9 An Economy in Recession
0
1
2
3
4
5
6
0 1 2 3 4 5 6 7 8
1963
19651964
Unemployment Rate (percent)
Infla
tion
(pe
rce
nt p
er
yea
r)
Figure 12.10 Unemployment and Inflation in the United States, 1963-1965
Output (Y)
Infla
tion
rate
(π
)
ASR
Y*
Recession
ADE0
ADE1E0
E1
Figure 12.11 Expansionary Fiscal Policy When the Economy Starts in a Recession
0
1
2
3
4
5
6
0 1 2 3 4 5 6 7 8
1963
19691968
1967
1966
19651964
Unemployment Rate (percent)
Infla
tion
(per
cent
pe
r ye
ar)
Figure 12.12 Unemployment and Inflation in the United States, 1963-1969
Output (Y)
Infla
tion
rate
(π
)ASR
Y*
ADE1
ADE0
E1
E0
Wage-Price Spiral
Figure 12.13 Expansionary Fiscal Policy When the Economy is at Full Employment
0
1
2
3
4
5
6
0 1 2 3 4 5 6 7 8
1963
19691968
1967
1966
19651964
Unemployment Rate (percent)
Infla
tion
(pe
rce
nt p
er
yea
r)
1970 1971
1972
1973
Figure 12.14 Unemployment and Inflation in the United States, 1963-1973
Output (Y)
Infla
tion
rate
(π
)
ASR0
Y*
ADE0
ADE1
E0
E1ASR1
Figure 12.15 Contractionary Fiscal Policy and Rising Inflationary Expectations
0123456789
10
0 1 2 3 4 5 6 7 8 9 10
Infla
tion
(per
cent
per
yea
r)
Unemployment Rate (percent)
19701969
1975
1963
1973
1974
1976
Figure 12.16 Unemployment and Inflation in the United States, 1963-1976
Output (Y)
Infla
tion
rate
(π
)
ASR0
ASR1
ADE
E1
E0
Lower Capacity
Figure 12.17 The Immediate Effect of the Oil Price Shock
Output (Y)
Infla
tion
rate
(π
)
ASR0
ASR1
ADE
E1
E0
12.18 Medium-Run Adjustment to the Oil Price Shock
0123456789
10
0 1 2 3 4 5 6 7 8 9 10
Infla
tion
(pe
rce
nt p
er
yea
r)
Unemployment Rate (percent)
19701969
1975
1983
1963
1981
Figure 12.19 Unemployment and Inflation in the United States 1963-1983
Output (Y)
Infla
tion
rate
(π
)
ASR
Y*
Recession
ADE0
ADE1
E0E1
Figure 12.20 The Immediate Effect of a Lowered Inflation Target
Output (Y)
Infla
tion
rate
(π
)
ASR0
Y*
Recession
ADE0
E0
E1ASR1
ADE1
Figure 12.21 The Medium-Run Effect of a Lowered Inflation Target
0123456789
10
0 1 2 3 4 5 6 7 8 9 10
Infla
tion
(pe
rce
nt p
er
yea
r)
Unemployment Rate (percent)
2000
1998
1984
1992
1989
Figure 12.22 Unemployment and Inflation in the United States, 1983-2004
0
0.5
1
1.5
2
2.5
3
3.5
4
0 1 2 3 4 5 6 7 8 9 10
Infla
tion
(pe
rce
nt p
er
yea
r)
Unemployment Rate (percent)
1992
1998
1999
1994
1997
Figure 12.23 Unemployment and Inflation in the United States, 1992-1999
Output (Y)
Infla
tion
rate
(π
)
ASR1
ASR0
ASR2
ADE
E0
E2
E1
Higher Capacity
Figure 12.24 The Effects of Technological Innovation
Output (Y)
Infla
tion
rate
(π
) Classical ASR
Y*
ADE
Figure 12.25 The Classical Aggregate Supply Curve
Year
Peak Peak
Trough
GDP
Y*
A A
B
Output (Y)
Infla
tion
rate
(π
)
ASR
Y*
ADE
ADE
A
B
(a) (b)
Figure 12.26 Business Cycles
Output (Y)
Infla
tion
rate
(π
)
Y*
ADE1
ADE0
E1
E0
Classical ASR
ASR1
ASR0
Figure 12.27 Expansionary Monetary Policy with Rational Expectations