Phillips Curve

Phillips Curve

Short run
Time too short for wages to adjust to the price level

Workers may not be aware of changes in their real wages due to inflation and have adjusted their labor supply decisions and wage demands accordingly

Nominal wages: amount of money received per day per hour or per year

Sticky wages: nominal wage level is set according to an initial price level and it does not vary

Long run aggregate supply
Time long enough for wages to adjust to the price level
-flexible wage and price level
-both offset each other

Phillips curve: Represents relationship between unemployment and inflation
-the trade off between inflation and unemployment only occurs in the short run
-long run Phillips curve: occurs at the natural rate of unemployment , if the natural rate of unemployment change, the lspc change
▪️represented by a vertical line
▪️no trade off between unemployment and inflation in the long run this means the economy produces at. A full employment level
▪️lrpc will only shift if the LRAS curve shifts otherwise it is assumed to be stable
▪️major lrpc assumption is that more worker benefits create higher natural rates and fewer worker benefits creates lower natural rates

Short run Phillips curve
-there is an inverse relationship between inflation and unemployment
-has a relevance to Okun's law
-since wages are sticky inflation changes on the srpc
-if inflation persists an expected rate of inflation rise then the entire srpc moves upward which causes stagflation
-if inflation expectations drop, due to new technology or economic growth then the srpc will move downward
-aggregate supply shocks can create both higher rates of inflation and higher rates of unemployment
-supply shocks: rapid and significant increase in resource cost

Misery index: a combination of unemployment and inflation in any given year
- single digit misery is good


The long run Phillips curve (lrpc)
-because the long run Phillips curve exists at the natural rate of unemployment (Un), structural changes in the economy that affect Un will also cause the lrpc to shift
-increases in Un will shift lrpc ➡️
-decreases in Un will shift lrpc ⬅️

Stagflation: period where we have high inflation and high unemployment occurring at the same time
-after Vietnam war
-baby boom
-civil rights movement
-women's movement


Disinflation: reduction in inflation rate from year to year

Deflation: it is a situation in which there is an actual drop in the price level

It is the belief that the as curve will determine levels of inflation, unemployment and economic growth

-to increase the economy the as curve should shift to the right which will always benefit the company first

Amount paid on the last dollar earned or on each additional dollar earned so by reducing the marginal tax rate, supply siders believe that you will encourage more people to work longer and forego leisure time for extra income

Support policies that promote GDP growth that arguing that the high marginal tax rate along with the current system of transfer payments, they provide disincentives to work, invest, innovate, and undertake entrepreneurial ventures

Reaganomics : lower marginal tax rate to get the us out of a recession ➡️Results in deficit

Laffer curve: It is a trade off between tax rates and government revenue
-it is used to support the supply side argument
3 criticisms of the laffer curve
1. Research suggest that the impact of tax rates on incentives to work, save, and invest are small
2. Tax cuts increase demand which can fuel inflation and causes demand to exceed supply
3. Where the economy is actually located on the curve is difficult to determine

Balance of Payments

 Balance of payments: measure of money inflows and outflows between the united stated and the rest of the world (ROW)
-inflows are referred to as credits
-outflows are referred to as debits
-balance of payments is divided into 3 accounts
1. Current account
2. Capital/financial account
3. Official reserves
Double entry bookkeeping: every transaction in the balance of payments is recorded twice in accordance with standard accounting practice
Ex: us manufacturer, john Deere, exports $50 million worth if farm equipment to Ireland
-$50 million worth of farm equipment or physical assets
-a debit of $50 million to the capital/financial account (+$50 million worth of euros or financial assets)

Balance of trade or net exports
-exports of goods/services-import of goods/services
-exports create a credit to the balance of payment
-imports create a debut to the balance of payments
Net foreign income
-income earned by us owned foreign assets - income paid to foreign held us assets
-ex. Interest payments on is owned Brazilian bonds - interest payments on German owner us treasury bonds
Net transfers (unilateral)
-foreign aid ->a debut to the current account
-ex: Mexican migrant workers send money to family in Mexico
Capital/financial account
-the balance of capital ownership
-includes the purchase of both real and financial assets
-direct investment in the United States is a credit to the capital account
-purchases of stocks and bonds by foreigners
-purchase of foreign financial assets represents a debit to the capital account
-ex. Warren buffet buys stock in petrochina
-purchase of domestic financial assets by foreigners represents a credit to the capital account
-United Arab emirates sovereign wealth find purchases a large stake in the NASDAQ
Relationship between current and capital account
-The current account and the capital account should zero each other out
-If the current account has a negative balance (deficit) then the capital account should then have a positive balance (surplus)
 
 Official reserves:

• The foreign currency holdings of the us federal reserve system
• when there is a balance of payments surplus the fed accumulated foreign currency and debits the balance of payments
• When there is a balance of payments deficit the fed depletes it's reserves of foreign currency and credits the balance of payments
• The official reserves zero out the balance of payments

Active v. Passive official reserves

• The United States is passive in it's use of official reserves. It does not seek to manipulate the dollar exchange rate
• The peoples republic of china is active in it's use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate with the United States.

Formulas

Balance of trade:

• goods and services exports - goods and services imports
• (if imports > exports) trade deficit or trade surplus (if exports > imports)
• goods exports + good imports

Current account:

Balance of trade + net investment + net transfer

Capital account:

Foreign purchases of U.S. assets + U.S. purchases of assets abroad

Official reserves:

Current account + capital account

How to calculate goods and services:

Good imports + service imports