Macroeconomics week 5 + 6
Module code: EC108
Lecturer: Stefania Paredes Fuentes
Topics
● Expectations of the Phillips Curve
● Shifts of the Phillips Curve
● Monetary rules
● Graphical derivation of the monetary rule
● Demand shocks
● Supply shocks
Expectations of the Phillips curve
How expectations influence economics
1. Demand side (consumer decisions, firms’ investment decisions)
2. Supply side (wage setters’ decisions, price setters’ decisions)
Expectations
- Expectations refer to the forecasts or views that decision makers hold about the future
- They are formed by households, firms and policymakers
- They influence consumption, investment, wage-setting and policy decisions
- Firms: future profits (Tobin’s Q)
- Households: future income (PIH)
- Wage setters: inflation
- Policy makers: inflation next period (monetary policy)
Risk and uncertainty:
- Risk → known probabilities can be attached to future outcomes
- Uncertainty → impossible to assign probabilities to known outcomes and
unknown outcomes
, Demand-side
- The IS curve shows combos of the real IR (r) + output (Y) under the goods market eq.
- YD = C + I + G (in a closed economy)
Consumption:
- Spending decisions today are influenced by future expectations
- Desire to smooth C (PIH) = taking into account the future + ability to save/borrow
Investment:
- Firms make investment decisions based on expected future profits
- Tobin’s q theory of investment
- Stock market value is forward looking, indicates how well the firm is able to
implement the investment
Stagflation = stagnation (economy that isn’t growing) + inflation
- P inc while wages don’t, production is less profitable as AD can’t keep up with inc P
Modelling expectations
- People are forward looking (changes in current P used to predict changes in future P)
- Expected inflation shifts PC
1. Original phillips curve → -ive relationship
between unemployment + inflation
2. Rewrite function using output gap → when
output inc so does unemployment
Module code: EC108
Lecturer: Stefania Paredes Fuentes
Topics
● Expectations of the Phillips Curve
● Shifts of the Phillips Curve
● Monetary rules
● Graphical derivation of the monetary rule
● Demand shocks
● Supply shocks
Expectations of the Phillips curve
How expectations influence economics
1. Demand side (consumer decisions, firms’ investment decisions)
2. Supply side (wage setters’ decisions, price setters’ decisions)
Expectations
- Expectations refer to the forecasts or views that decision makers hold about the future
- They are formed by households, firms and policymakers
- They influence consumption, investment, wage-setting and policy decisions
- Firms: future profits (Tobin’s Q)
- Households: future income (PIH)
- Wage setters: inflation
- Policy makers: inflation next period (monetary policy)
Risk and uncertainty:
- Risk → known probabilities can be attached to future outcomes
- Uncertainty → impossible to assign probabilities to known outcomes and
unknown outcomes
, Demand-side
- The IS curve shows combos of the real IR (r) + output (Y) under the goods market eq.
- YD = C + I + G (in a closed economy)
Consumption:
- Spending decisions today are influenced by future expectations
- Desire to smooth C (PIH) = taking into account the future + ability to save/borrow
Investment:
- Firms make investment decisions based on expected future profits
- Tobin’s q theory of investment
- Stock market value is forward looking, indicates how well the firm is able to
implement the investment
Stagflation = stagnation (economy that isn’t growing) + inflation
- P inc while wages don’t, production is less profitable as AD can’t keep up with inc P
Modelling expectations
- People are forward looking (changes in current P used to predict changes in future P)
- Expected inflation shifts PC
1. Original phillips curve → -ive relationship
between unemployment + inflation
2. Rewrite function using output gap → when
output inc so does unemployment
