Module 2

Economic Business cycles Unemployment – inflation Macro & international economics

ECON 6644

Managing in a Global Economy

Summer II 2022 – Module 2

Dr. Claude J. Chereau

 

 

 

Economic growth & business cycles

 

 

 

 

Economic Growth

Two types of growth

 

Economic growth is the fundamental determinant of the long-run success of any nation, the basis source of rising living standards, and the key to meeting the needs of the American people.

Economic Report of the President, 1992

 

 

 

 

Measures of Growth

Growth rate

Percentage change in real GDP from one year to the next

Economic growth is an exponential process

Small changes compound from year to year

 

A shortcut method of indicating growth rate is to use the Rule of 72:

To find how many years it takes to double GDP, divide 72 by the growth rate

At 3.5% growth rate, GDP will double in about 20 years

GDP per capita

 

GDP per worker

Real GDP divided by the labor force => a measure of productivity

If the labor force grows faster than the population, GDP per capita grows and living standards rise

 

Productivity is better measured by output per labor-hour

Increases in GDP per capita over recent decades are due to the rising productivity of the average American worker.

 

 

 

 

Productivity growth

When long-run growth of the labor force has stabilized

Continued growth in real GDP must rely on productivity growth

 

 

 

 

 

 

Technology

 

 

Growth rate of Growth rate of Growth rate of

total output = labor force + productivity

 

 

 

Causes, Sources, & Effects of Economic Growth

Causes of economic growth

Little understanding about causes of growth

Role of social and political influences

 

Sources of economic growth

Productivity gains

 

Other sources include

Better labor quality

Increased capital investment

Development of new products and production techniques

Improved management

Supportive government policies

 

Effects of economic growth

Growth is usually biased

 

It occurs in one sector more than others, causing relative supply to change

E.g., rapid growth has occurred in U.S. computer industries but relatively little growth has occurred in U.S. textile industries

 

 

 

 

Sources of Productivity gains

Increase in labor skills

 

More capital

An increase in the ratio of capital to labor

Primary determinant of labor productivity

 

Technological advancements

Scientific research

Product development

Innovations in production techniques

 

Improved management

Better use of available resources in the production process

Fostering new

 

 

 

entrepreneurship

Lower potential growth: potential causes

Demographics

Ageing in certain markets (e.g., developed economies)

 

High debt ratios that slow spending

 

Fall in corporate capital spending (global investment slump)

 

Hysteresis: the cycle affects the trend

 

Rise in income/wealth inequality

 

Slow structural reforms

 

Persistent global savings glut

 

What causes economic slumps?

 

Basically anything, e.g.,

Mid-sized bubbles, from private equity debt to emerging markets

The 79-82 double dip: Fed tightening to bring inflation down

2001: the tech bubble

2007-2009: financial crisis due to housing bust

Drop in consumer confidence brought on by oil price hikes and Gulf War jitters

Post-Cold War drawdown in defense spending

Pandemics

Covid-19

Ukraine/Russia war

 

 

 

 

 

Effects of Economic Slowdown

Impacts on household income

 

Reduced production means layoffs

decreased household income

 

Reduced income means less spending, and AD shifts further to the left away from full-employment

 

 

A relatively small problem could snowball into a much larger problem.

 

 

 

Economic business cycles

 

 

 

Business cycles

Alternating periods of economic growth and contraction

Long-term growth rate of the U.S. economy is approximately 3 percent a year

Some years GDP grows much faster; in other years growth is slower

 

Macroeconomics tries to explain

Alternating periods of growth and contraction that characterize the business cycle

How & why economies grow

What causes the recurrent ups and downs known as the business cycle

 

Three central questions

How stable is a market-driven economy?

What forces cause instability?

What, if anything, can the government do to promote steady economic growth?

 

 

International trade & financial flows tie nations together

 

 

 

 

 

The Business Cycle in U.S. History

Growth rate averages 3%, but the economy fluctuates around that average, occasionally achieving negative GDP growth or decline.

 

 

 

Business Cycle

Variations around a growth trend that slopes upward

 

4 parts

The peak, where GDP maximizes

Contraction, where GDP declines

The trough, where GDP minimizes

Recovery, where GDP increases

 

 

Terms associated with business cycles:

 

Economic growth

Real GDP grows faster than 3%

Growth recession

Real GDP grows, but slower than 3%

The economy expands too slowly

Recession

Real GDP contracts (for two or more consecutive quarters)

Depression

An extremely deep recession

 

 

 

 

 

 

Defining the different phases of a business cycle

Business cycles Fluctuations in general level of economic activity (measured by changes in real GDP & rate of unemployment)
Expansion Economy is growing, +2-3% Unemployment reaches its natural rate Inflation near 2% target Stock market high
Peak (or boom) GDP > 3% Inflation > 2% Irrational exuberance => asset bubbles
Contraction GDP < 2%, if negative for 2 trimesters => recession Unemployment begins to rise Stocks enter a bear market
Recessionary trough When economy hits bottom Economy transitions from contraction phase to expansion

 

 

 

 

 

14

Recovery Shapes

 

 

https://www.businessinsider.com/recession-recovery-shapes

15

Business cycle: Where does the global economy currently stands?

The global economy is still growing

 

Yet, showdown

Ongoing Ukraine /Russia war

 

Tighter monetary policy by the Fed in the US to tackle rising inflation

 

 

 

16

Macroeconomic Outcomes

Aggregate Demand vs. Aggregate Supply

The Circular Flow of the Economy

 

 

Macro outcomes: Aggregate Demand vs. Aggregate Supply

Macro outcomes are transmitted through supply or demand

Environment characterized by limited resources & choice

=> scarcity vs. opportunity cost

 

Demand behavior & supply behavior interact in a market

A product/service has a market demand

People are willing/able to buy it at some price in the market

Determinants are taste, income, expectations, other goods, # buyers

 

A product/service has a market supply

Businesses are willing/able to produce, & sell it at some price in the market

Determinants are technology, factor costs, taxes, subsidies, expectations, other goods, # sellers

 

 

 

Aggregate Demand and Supply

Aggregate demand (AD)

Total quantity of output (real GDP) demanded at alternative price levels (price index) in a given time period

Collective behavior of all buyers in the marketplace

Comprises all goods and services

 

 

 

 

Aggregate supply (AS)

Total quantity of output (real GDP) producers are willing and able to supply at alternative price levels (price index) in a given time period

Collective behavior of all suppliers (sellers) in the marketplace.

Comprises all goods and services

 

 

 

The vertical axis represents a price level or price index, not a particular price of one good. This is not identical to a market model for one good.

The horizontal axis is total output, not output for one product. Total output is measured by real GDP.

AD and AS graphs are stylized representations that model, not replicate, the macroeconomy.

 

 

The Circular Flow of the Economy

 

 

https://www.ceicdata.com/en/united-states/consumer-confidence-index/consumer-confidence-index

Aggregate demand

 

 

 

Components of Aggregate demand

consumption (C)

 

investment (I)

 

government spending (G)

 

net exports (X – M)

 

$ tn GDP
Consumption 15.7 69%
Investment 3.9 17%
Government 4.0 18%
Net Exports (0.9) (4%)
2021 GDP 22.7 100%

 

 

Based on nominal annualized GDP

a/o June 30, 2021: $22.7tn

 

 

 

 

1- Consumption

Expenditure by consumers on final goods and services

 

Largest component of aggregate demand

https://fred.stlouisfed.org/series/PCE

 

https://www.theglobaleconomy.com/rankings/consumption_GDP/

 

 

Covid vs. Consumption (2020)

 

 

 

 

 

 

 

 

 

 

 

 

Jan 31 14,880 bn
Feb 29 14,877 bn
Mar 31 13,879 bn – 6.7%
Apr 30 12,112 bn – 12.7%
May 31 13,165 bn +8.7%
Jun 30 14,014 bn +6.4%
Jul 31 14,224 bn +1.5%
Aug 31 14,397 bn +1.2%
Sep 30 14,583 bn +1.3%
Oct 31 14,620 bn + 0.3%
Nov 30 14,533 bn – 0.6%
Dec 31 14,494 bn -.0.3%

 

 

 

 

Consumption Function

 

 

 

 

 

Autonomous consumption (a)

Determined by something other than income

Savings or borrowed funds

 

Income-dependent consumption (bYD)

Consumer spending that increases as income increases

YD: Disposable income

 

 

Total = Autonomous + Income-dependent

Consumption Consumption Consumption

C = a + bYD

 

 

 

Consumption vs. Income

 

 

 

 

 

 

Consumption = Disposal Income – Saving

C = YD – S

Disposal Income YD = Y – T

YD = Income – Taxes

 

 

 

Disposable Income vs. Consumption

Average propensity to consume (APC)

 

 

 

 

 

 

Average propensity to save

 

 

 

 

When household income increases, consumer spending increases as well => marginal propensity to consumer

 

 

 

APC = Total consumption = C

Total disposable income YD

APS = 1 – APC

 

 

 

Marginal Propensity to Consume/Save

Marginal Propensity to Consume

(MPC)

Marginal fraction of each additional (marginal) dollar of disposable income spent on consumption

 

MPC = ∆ C / ∆ YD

 

Marginal Propensity to Save

(MPS)

Marginal fraction of each additional (marginal) dollar of disposable income saved

 

MPS = ∆ S / ∆ YD

 

 

MPC + MPS = 1

MPC & MPS predict consumer behavior

 

 

 

A change in consumption (C) causes AD to shift

. AD will shift in response to changes in:

Income

Expectations (consumer confidence)

Wealth

Credit conditions

Tax policy

 

 

Shifts in AD can be a cause of macro instability

 

 

 

2- Investment

Expenditures on new plants, equipment, structures, plus changes in inventories

 

Investment spending

Inversely related to interest rate

 

Most volatile category of spending

 

If expectations of future sales improve,

investment function shifts right, as will AD

=> vice versa applies

 

Currently, businesses putting off investment as wait for clarity on full cost of COVID

 

Investment in the global economy (as %GDP)

https://www.theglobaleconomy.com/rankings/investment_percent_of_gdp/

 

 

 

 

 

 

 

 

 

 

Foreign Direct Investment (FDI)

Many countries rely on FDI inflows as key source of aggregate demand and driver of real growth

 

 

 

Global FDI inflows – 2007-2021 (Billions of dollars and per cent)

 

 

3- Government Spending

Federal spending can be increased to counter spending decreases in the other components

Basis of Keynesian demand-side policy

Budget deficit (detailed later in this Module)

 

Yet, state and local spending to decrease when consumption & investment spending decrease

Balanced budget requirements

=> instability

 

Government spending multiplier

aka as fiscal multiplier (or simply the multiplier) represents the multiple by which GDP increases or decreases in response to an increase and decrease in government expenditures

 

Reciprocal of the marginal propensity to save (MPS)

 

 

 

 

 

4- Trade balance (X – M)

Economic downturns in other countries lead to a decrease in U.S. exports (X), and vice versa

 

Economic downturns in the U.S. lead to a decrease in U.S. imports (M), and vice versa

 

If X – M decreases, AD shifts left

If X – M increases, AD shifts right

 

 

 

 

Determinants of trade balance

Saving vs. Investment

 

Real exchange rate

 

Disposable income

Further explored in Modules 4 – 6

 

 

 

Anticipating AD shifts

The Index of Leading Indicators

List of 10 gauges that are supposed to indicate in what direction the economy is moving

 

How is the index used?

If index rises => good news for the economy (and vice versa)

Changes in the index are used to forecast changes in GDP and turns in the business cycle

 

The purpose of this index is to help predict movements in GDP and the business cycle in the economy tomorrow.

 

 

Average weekly hours worked by manufacturing workers

 

Average number of initial applications for unemployment insurance

 

Amount of manufacturers’ new orders for consumer goods and materials

 

Speed of delivery of new merchandise to vendors from suppliers

 

Number of new orders for capital goods unrelated to defense

 

Number of new building permits

for residential buildings

 

S&P 500 stock index

 

Inflation-adjusted monetary supply (M2)

 

Spread between long and short interest rates

 

Consumer sentiment

 

 

 

 

Consumer Confidence Index

Barometer of the US economy based on consumers’ perceptions of business/employment

 

The CCI has deteriorated since March

March 2020: 118.8 (from 132.6 In Feb) – basis 1985 = 100

August 2020: 84.80 (after a bump in June at 98.3)

July 2021: 129.1 (unchanged from June after rise over past 5 months)

 

The Present Situation Index – based on consumers’ assessment of current business and labor market conditions – moved up in July to 160.3 from 159.6

 

The Expectations Index – based on consumers’ short-term outlook for income, business and labor market conditions – unchanged in July (108.4) from June (108.5)

 

 

 

 

Consumer confidence index

 

 

https://www.ceicdata.com/en/united-states/consumer-confidence-index/consumer-confidence-index

 

 

 

Global Leading Economic Index Data

Composite Leading Indicator (CLI)

Provides early signals of turning points in business cycles

Shows short-term economic movements in qualitative rather than quantitative terms

 

 

https://data.oecd.org/leadind/composite-leading-indicator-cli.htm

(May 2022)

 

https://www.oecd-ilibrary.org/economics/main-economic-indicators_22195009 (May 2022)

 

 

 

 

 

 

Policies that affect AD

To be explored in Module 3

 

 

To be explored in Module 3

Aggregate supply

 

 

 

Aggregate supply (AS)

Total quantity of output (real GDP) producers are willing & able to supply at alternative price levels in a given time period

Collective behavior of all suppliers (sellers) in the marketplace

Comprises all goods and services

 

AS slopes upward => suppliers bring more goods and services to market at higher price levels, and vice versa

Price effect

Cost effect

 

There is a maximum capacity to produce at any time in an economy

As output nears that capacity, output increases slowdown but price increases accelerate.

 

 

When considering the Aggregate Supply curve, we need to distinguish short-run and long-run

 

Short-run:

In the short-run, households & businesses are unable to adjust these prices when unexpected changes occur, including unexpected changes in the price level

 

Period of time during which some prices, particularly those in resource markets, are set by prior contracts & agreements

 

Long-run:

Period of sufficient time so that people have opportunity to modify their behavior in response to price changes

 

 

 

 

Shape of the AS Curve

Short-Term

AS curve with an upward slope that increases near full employment

 

Inflation accelerates in that region of the curve as AD shifts right.

 

Long-Term

LRAS is related to the economy’s production possibilities constraint

 

 

 

 

LRAS

YF

(full employment rate of output)

 

 

Change in price level does not affect quantity supplied in the long run.

Goods & Services (real GDP)

Potential GDP

 

Price Level

 

 

An economy’s full employment rate of output (YF), the largest output rate that is sustainable, is determined by supply of resources, level of technology, & structure of the institutions

These factors are insensitive to changes in the price level

Hence, the verticality of LRAS curve.

 

What Shifts the AS Curve?

Shifting AS right

Policies that provide incentives for suppliers to increase production

Tax incentives for saving, investment, and work

Human capital investment

Deregulation

Trade liberalization

Infrastructure development

 

Generates desirable macro outcomes

Shifting AS left

Policies that provide disincentives for suppliers to increase production

Tax increases for saving, investment, and work

Deteriorating human capital investment

Excessive, costly regulation

Trade restrictions

Decaying infrastructure

 

Negative external shocks, such as natural disasters and war

 

Generates undesirable macro outcomes

Output decreases, unemployment rises, and inflation increases

 

 

 

 

Supply-Side Policy

Policies that alter the willingness/ability to supply goods at various price levels will shift the aggregate supply curve

=> less inflation and less unemployment

 

Reduce marginal tax rates

High tax rates discourage extra work, investment, and saving shifting the AS curve to the left

 

Investments in human capital

 

Reduction of regulatory costs

 

Infrastructure development

 

Reduction of trade barriers

 

 

 

 

Macroeconomic Outcomes

Unemployment

Inflation

 

 

 

Unemployment

Civilian Population: 16 years and older

 

 

 

 

 

 

 

 

 

 

 

A snapshot of unemployment around the world – 2022

https://countryeconomy.com/unemployment

 

Inability of labor force participants to find jobs

 

When economy is growing, both unemployment rate & duration decrease

 

When the economy stagnates or goes into decline, both unemployment rate & duration increase

 

Idled resource, so the economy operates inside its PPC, in the inefficient zone.

Okun’s Law: a 1%increase in unemployment results in a 2 % decrease in GDP

 

 

 

 

 

Unemployment in the US

 

 

https://tradingeconomics.com/united-states/unemployment-rate

 

https://fred.stlouisfed.org/series/UNRATE

46

Measuring Unemployment

Unemployment rate: the proportion of the labor force that is unemployed

 

A person is counted as unemployed if he or she is not working but actively seeking work.

 

Measurement glitches

Underemployment

People who want full-time work in their field but can find only part-time work or work at jobs below their capability.

They are counted as employed

 

People who must claim to be looking for work in order to receive public assistance or unemployment compensation but don’t really want to take a job.

They are counted as unemployed (Phantom unemployment)

 

 

Discouraged workers

Former job seekers who have given up and no longer actively seek employment.

They drop out of the labor force.

Numbers increase during times of high unemployment.

They are no longer counted in unemployment statistics

 

 

 

Defining Full Employment

Full employment is not the same as zero unemployment

 

Full employment: the lowest unemployment rate compatible with price stability; zero cyclical unemployment.

-Some frictional and structural unemployment will exist at full employment.

 

The four categories of unemployment.

1. Seasonal unemployment

2. Fictional unemployment

3. Structural unemployment

4. Cyclical unemployment

 

At full employment, all of these exist except cyclical unemployment

 

Near full employment when rising prices signal near production capacity – that is, on the PPC, and near the inflationary flashpoint

Inflationary flashpoint: the rate of output at which inflationary pressures intensify

At or below 4% unemployment.

 

 

 

Categories of unemployment

Seasonal unemployment: due to seasonal changes in employment The Labor Department reports seasonally adjusted unemployment rates for every month Unemployment data exclude effects of seasonal unemployment Frictional unemployment: brief periods of unemployment (between jobs or into labor market) Adequate demand for frictionally unemployed Have skills required for existing jobs
Structural unemployment: caused by mismatch skills/location of job seekers vs. requirements/location of available jobs Caused by a change in: market for the product made Technology Process by which the goods are made Workers require retraining or relocation Cyclical unemployment: caused by a decline in economic activity Demand for products decreases and workers get laid off excess supply of workers for remaining available jobs The economy must grow at least as fast as the labor force to avoid cyclical unemployment.

 

 

 

The “Natural” Rate of Unemployment

Long-term rate of unemployment determined by structural forces in labor and product markets

 

Changes in Structural Unemployment

Changes in structural unemployment come from changes in society itself

Growing numbers of youth and women

Changes in transfer payments for the jobless

Changes in products demanded by consumers

Changes in how (and where) products are made

 

During periods of change, structural unemployment increases

 

When changes are fully absorbed, structural unemployment decreases

 

 

 

 

Human Costs of Unemployment

Loss of income

 

Loss of confidence

 

Social stress

 

Lost lives

 

 

 

Controversial topics related to unemployment

Unemployment vs. Trade

 

Unemployment vs. Technology

 

Unemployment vs. International labor Migration

 

 

 

Inflation

Prices of a specific market basket of goods are collected and computed into an average price level for that basket in a year

A rise in that average price level is inflation

A decrease in that average price level is deflation

 

Core problems of inflation

What kind of price increases are referred to as “inflation”?

Who is hurt and who is helped by inflation?

What is an appropriate goal for “price stability”?

 

 

Increase in average level of prices

Not a change in any specific price of a good, not a market function

 

 

 

Inflation

Prices of a specific market basket of goods are collected and computed into an average price level for that basket in a year

A rise in that average price level is inflation

A decrease in that average price level is deflation

 

Core problems of inflation

What kind of price increases are referred to as “inflation”?

Who is hurt and who is helped by inflation?

What is an appropriate goal for “price stability”?

 

 

Increase in average level of prices

Not a change in any specific price of a good, not a market function

 

 

 

https://fred.stlouisfed.org/graph/?g=rocU#

54

Measuring Inflation

Inflation rate

Annual percentage rate of increase in the average price level

 

Measuring inflation serves two purposes:

gauging the average rate of inflation

identifying its principal victims

 

Consumer price index (CPI):

Measure (index) of the average price of consumer goods and services

Used to calculate the inflation rate

 

Core inflation: changes in CPI, excluding food and energy prices, which are volatile

 

 

 

 

 

 

Other measures of inflation

 

Producer price index (PPI):

Changes in the average prices at intermediate steps of production

 

GDP deflator:

changes in prices of all goods and services included in GDP

Used to adjust nominal GDP to real GDP.

 

 

 

 

 

 

 

Creating a Price Index

Select a “market basket” of goods

standardized list of goods and services a typical consumer buys

 

Select a base year

reference year whose dollar value will be used

 

Set the price index in the base year equal to 100

 

Measure the prices for the basket of goods in both the current year and in the base year.

Price index in current year Basket price in current year

Price index base year = Basket price in base year

CPI year 2 – CPI year 1

Inflation rate = X 100

CPI year 1

 

 

 

Measurement concerns

From year to year, there are quality

improvements in the basket of goods

 

 

The market mechanism causes prices of

individual goods/services to rise/fall

 

 

Relative price: price of one good compared to the price of other goods

Buyers switch from one good to another when their relative prices diverge

 

New products change the content of the basket of goods we buy

 

 

 

 

Causes & Effects of Inflation

Causes

Money Supply > Money Demand

Too much money pumped into the economy by the Federal Reserve

 

Demand-pull inflation:

Results from excessive pressure to buy on the demand side of the economy

A booming economy creates shortages

 

Cost-push inflation:

Results from higher production costs putting pressure on suppliers to push up prices

Effects

Some prices rise & some fall

 

If prices rise, need to reallocate purchasing power to ensure most satisfaction per spent dollar

 

Difference between nominal income and real income

 

 

 

 

58

 

Exercise in Money Illusion

The inflation rate in 1980 was 13.5%

 

In 1979, income was $10,000

 

In 1980, income was $11,000

 

Did purchasing power increase? Decrease? Stay the same?

 

 

 

 

Decrease! income went up 10% while prices went up 13.5%

 

 

 

Redistributive Effects of Inflation

Price effects Those who buy products that are increasing in price the fastest end up worse off Those who sell products that are increasing in price the fastest end up better off Those who buy products that are increasing in price the slowest end up better off Those who sell products that are increasing in price the slowest end up worse off Income effects People with nominal incomes rising more slowly than inflation end up worse off People with nominal incomes rising faster than inflation end up better off.
Wealth effects Those who own assets that are declining in real value end up worse off Those who own assets that are increasing in real value end up better off Money illusion: Using nominal dollars rather than real dollars to gauge changes in one’s income or wealth

 

 

 

Inflation & Interest Rate

Real interest rate: the nominal interest rate minus the anticipated inflation rate

The borrower pays the nominal rate

 

 

 

 

The inflation-adjusted (real) rate of interest:

protects the lenders. Hurts the borrowers

borrowers will pay back loan using more lower-valued dollars, but lenders receive the same purchasing power

Real interest rate = Nominal interest rate – Anticipated rate of inflation

 

 

61

 

Macro Consequences of Inflation

Uncertainty

Not knowing the prices of goods in the future makes purchasing & production decision making more difficult

 

Speculation

Decisions to shift from standard economic activity to betting on the future prices of goods

 

Bracket creep

In a progressive tax system, when nominal incomes rise, the taxpayer gets pushed into a higher tax bracket

 

Yet, a little inflation might be a good thing

Challenge is to find the optimal rate of inflation

High enough to encourage more spending

Low enough not to raise the specter of an inflationary flashpoint

 

Protective Mechanisms

Cost of living adjustment (COLA): automatic adjustments of nominal income to the rate of inflation

COLA protects real income from inflation

help those on fixed incomes, such as Social Security recipients

 

Adjustable-rate mortgage (ARM):

a mortgage (home loan) that adjusts the

nominal interest rate to changing rates of

inflation

ARMs protect lenders (not mortgagees) so they do not lose money

 

 

 

 

Runaway Inflation

Inflation rate in excess of 200 percent, lasting at least 1 year

Spending accelerates & production declines

 

In 1790s, revolutionary inflation in France

1789: large deficit => debt

Printed money, yet collateralized by land stolen from Church & aristocracy

But, then continued printing as needed more money

Currency became worthless; prices spiked

France stopped printing money

 

In 1923, prices in Germany more than doubled every day

No one saved, invested, or made long-run plans

Production came to a halt

Unemployment increased by a factor of 10

The economy collapsed

Ultimately Hitler came to power

 

Zimbabwe and Venezuela experienced a similar economic disaster in 2007-2008 and 2015-2017 respectively

Hyperinflation exercise

 

The current price of a good is $1.

If its price doubles every day, what will its price be in 10 days? 20 days?

 

In 10 days, $512.

 

In 20 days, $524,288.

 

 

 

 

1985-2020: low inflation

Central banks commitment: to keep inflation low

80s: + 13%

With 2008 crisis, 0% interest rate + quantitative easing

Inflation was expected to rise up

Did not happen

 

 

 

 

 

Did supply shocks (temporary or permanent) keep inflation low?

Globalization

Weaker workers and unions

More competition

Technological innovations

Still low oil and commodity prices

Temporary factors

 

 

 

 

 

 

2021/2022: Inflation is rising…

May 2022: 8.6%

 

Core inflation: 6.0%

 

Energy index: 34.6%

Food index: 10.1%

 

 

 

 

 

Business outlook

Seeing cost increases in labor, raw materials, and freight

Impact getting worse, some CEOs calling the inflationary environment as “unprecedented”

Potential corporate tax increases to be considered.

 

 

 

 

Deflation: what is it?

General decrease in average prices

 

This has redistribution effects that are the opposite of those for inflation

 

This has macro consequences also

Sellers are reluctant to stock inventory

Buyers are reluctant to buy now

Businesses are reluctant to borrow funds or invest

Incomes fall, and asset values decrease

 

 

 

 

What about Stagflation?

Both inflation and unemployment are high, and economic growth is stagnant.

Fiscal restraint and tight money will reduce inflation but increase unemployment

 

Fiscal stimulus and easy money will reduce unemployment but increase inflation

 

If caused by adverse policy (high taxes, excessive regulation), supply-siders propose reversing those policies

 

If caused by external forces (oil price spike, natural disaster), no policy can help much

 

 

Here, for stagflation.

67

The Phillips Curve: Unemployment vs. inflation

 

 

 

Inflation-Unemployment Trade-Off: the Phillips curve

Upward-sloping AS curve suggests demand-side policies will always cause some unwanted inflation or unemployment

This is the inflation-unemployment trade-off, which is expressed in the Phillips curve

 

As the economy moves from point A to B to C (left picture), the inflation-unemployment trade-off shifts from point a to b to c (right picture) on the Phillips curve.

 

 

 

 

 

Shifts of the Phillips Curve

When AS shifts right, the Phillips curve shifts left

Reduces unemployment and inflation at the same time

Also increases output

Shifting AD cannot do this

 

When AS shifts left, the Phillips curve shifts right

Both unemployment and inflation increase

Output decreases

Inflation-unemployment trade-off much more severe

 

The US Phillips curve has been flattening since the 90s

 

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This demonstrates what happens when AS shifts. Right? Good! Left? Bad!

The Flattening of the Phillips Curve

The Phillips curve (late ‘50s)

 

Flattening of the curve over the past decade

3 potential explanations

Curve is a statistical artefact as exploited by policymakers

 

Inflation expectations reacted more slowly to economic data than in the past

 

Curve still exists, yet ‘non-linear’

To what extent are firms’ costs (wages) rising?

Are firms passing on those costs by raising prices?

 

 

 

 

 

Factors which may have contributed to the flattening of the curve in the 1990s/2000s

Technology

Allows economy to produce more with its finite resources

 

The ‘Amazon effect’: online prices have been falling steadily

In the 1990s/2000s: Walmart, target and their global supply chains

Before the great recession, prices held up because of services

Today, both goods/services prices are low

 

Statisticians fail to capture some technological advances

Consumers are buying new products

Statisticians miss precipitous price falls early in a product’s life

Also, how much better the new products are compared to what they were before

Irrelevance of basket of goods

Effect of price being zero from the start

Free services replace services which were paid for before

 

Globalization

Low inflation is a global phenomenon with global causes

 

3 main factors

Price of commodities

 

Trade in goods

Cross-border supply chains

 

Capital flows

Long-term real interest-rates have synchronized across borders

Falling ‘equilibrium’ short-term rates, close to zero

2019 trade tariffs sparked fears about global growth, triggering a rush into safe assets such as Treasury bonds; long-term yields fell, & the dollar surged. In response, the Fed cut rates and the ECB restarted QE

 

 

 

Implications for Managing in a Global economy

As we all know COVID-19 has affected the world in many different ways. One of the biggest effects the pandemic has had on the world is the unemployment rate. In December 2020, the unemployment rate in the United States was 6.7%. There was a total of eleven million people unemployed.

 

In the beginning of the pandemic, tens of millions of people lost their jobs. Throughout 2020, the unemployment rate remained high. Since then, progress has been made. Currently, in the United States, as of June 2022, the unemployment rate is 3.6%. There are five point nine million people unemployed.

 

https://www.cbpp.org/research/poverty-and-inequality/tracking-the-covid-19-economys-effects-on-food-housing-and (Links to an external site.)

 

Being that there is a current spike in COVID-19 cases, do you think the unemployment rate will increase again? If so, how would that affect our economy, being that we are still trying to recover from 2020?

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