Lecture on Inflation and Unemployment

hi class I&#39;d like to talk about inflation and unemployment so I know we talked about these things at the beginning of the class but I&#39;d like to really dig in and talk about some key issues because these are the two two of the biggest macroeconomic issues right here so first of all let&#39;s talk about inflation and who inflation is good for inflation is good for those who have cost-of-living adjustments so Cola stands for cost of living adjustment because if inflation goes up by let&#39;s say 3% then is what happens is a job with a cost-of-living adjustment the wage will go up by 3% right and you figure if your debt stays the same then inflation ends up being really good for you now of course not every job has cost-of-living adjustments in fact a lot of jobs don&#39;t I bet if you start paying attention to your work and you see that maybe you got a 2% increase in your wage is a cost-of-living adjustment if you compare that to say the 3% inflation then you would have lost 1% of your total wage I don&#39;t want to tell you where I worked but there was a company I worked for before I started graduate school that you know they had the big department meeting and there were one hundred and hundred 50 people there and I was a an economic student at the time an undergraduate and I knew from class that day that inflation was I don&#39;t remember 3.5% or something like that and they came out and said we&#39;re announcing today that everyone it&#39;s a 2.5 percent wage increase you know and if you make $50,000 that&#39;s this much money and everyone&#39;s like oh this is great this is great so everyone&#39;s celebrating and I raised my hand they said hi everyone you guys do realize that we&#39;ve actually lost 1% in terms of our wage because inflation was 3% and then everyone got quiet and I&#39;ll never forget my manager at the very front of the room just looking at me shaking her head so you know you can be that guy if you want but if you do kiss get a cost-of-living adjustment then you know then it&#39;s good also so good for one good for two people have a lot of debt because generally speaking even if you don&#39;t get a cost of living adjustment wages will rise whereas debt stays the same and so it erodes the real value of debt right maybe when you get your home it costs $1,000 a month and you&#39;re making $4,000 a month but overtime is inflation goes up the idea is is that also your wage would go up and maybe it goes up to you know $6,000 and so now that payment is a smaller percentage of your budget and of course this is why banks hate inflation is because it erodes the value of debt and that&#39;s how they make money is by you paying on debt and so they want low inflation because it hurts their bottom line if the value of the debt that you owe them is lower inflation is bad for well it&#39;s bad for banks like I just said I guess I should have made this list before I made started talking about that but it&#39;s bad for banks I can&#39;t even spell that and it&#39;s though it&#39;s bad for those whose wages do not keep up and when I say banks it&#39;s anyone who owns the debt sooo inflation is bad for and so this leads to kind of an interesting class conflict through a lot of the 18th well 18th 19th and 20th centuries quite frankly between the central bank and farmers and so you have farmers who are big portion of the economy for a lot of years and they are always in a lot of debt because they have to buy land left by machines they have to buy a bunch of stuff and then you&#39;ve got so these guys they like increase in inflation because that means an increase in prices which means the price of corn and other agricultural goods go up while their debt payments stay the same so farmers like inflation banks for the exact opposite reasons don&#39;t like inflation and so there&#39;s this class conflict because the role of the Federal Reserve is really to keep inflation low but at different times in history an assortment of people in the economy have wanted higher inflation and so you saw this in each 1896 you saw this in the Jacksonian era when the Federal Reserve was shut down in the 1980 the 1830s so it&#39;s you know you get that bit of trade-off there so let&#39;s talk a little bit about what causes inflation inflation is let me give you an equation here so this is expected inflation this is going to be the output gap in terms of employment this is a coefficient if any of you&#39;ve had business statistics this is going to be like your beta one this measures the sensitivity of inflation to the output gap and then this is a supply shock can be things like an oil shock so the output gap should make sense because well see if we have ad prime here look we have a recessionary gap in recessions you&#39;d expect prices to fall right where is if I drew an inflationary gap out here we&#39;d expect an inflation to go up and so you know if we&#39;re in a positive inflationary gap then this is going to be positive if we&#39;re in a recessionary gap it&#39;s going to be negative this is going to be just the effect of oil prices and other supply factors inflation and then the real issue what I&#39;m leading to here is expected inflation so what is the expectation of inflation and why does it matter that&#39;s I guess the first question we need to ask well think of it this way let&#39;s say that inflation was 5% last year and you were a business owner and you need to set your prices for this year how much you&#39;re gonna raise them well you&#39;re gonna look into the past and see how much inflation goes up and that&#39;s how much you&#39;re going to raise your prices and so previous inflation can have an effect on current inflation and that&#39;s the idea so the question is how does previous inflation have an effect on current inflation well there&#39;s a couple of competing theories the two I want to talk about in this class are adaptive expectations so this is adaptive ad apt iv&#39;e expectations and this comes from Milton Friedman who is a big economist you saw from our documentary and the idea is that this well let me scribble this out pi e is really just past inflation and so you can measure this a couple ways you can measure it as PI to the negative 1 meaning last year&#39;s inflation or I can do PI average of the last 5 years something like that some sort of looking in the past is going to be adaptive expectations and I think this is pretty well accepted there&#39;s some form of adaptive expectations in terms of inflation that if inflation starts to keep up or I&#39;m sorry creep up then is what happens is people are going to start to expect inflation and so they&#39;ll start raising their prices which then affects inflation and it just kind of spirals on and it becomes a problem so that&#39;s adaptive expectations to is more complicated this is what we call rational expectations rational expectations is where people take the full information set and forecast into the future and so what is the full information set so let&#39;s talk about that what is the full information set well let me give you an example let me try and make this argument so let&#39;s say that you&#39;re a baker and you wake up and the price is higher so you have to figure out now is it from an increase in the money supply or is it because of an increase in demand okay because if it&#39;s from an increase in demand you want to increase your output if it&#39;s just a general increase in money supply you just want to raise your price here you raise the output and raise the price so well I mean I guess that&#39;s kind of a circular argument we&#39;re assuming the price is already raised so let me take that back so here you do nothing because it&#39;s just an increase in the money supply which has no meeting in real terms whereas here it&#39;s an increase in demand we want to increase output so how do you know well let&#39;s go to a country that has a poor reputation for central banking let&#39;s go to Zimbabwe so say you wake up in Zimbabwe and the price is higher well the Baker is going to assume that it was an increase in the money supply and so they are going to do nothing okay they&#39;ll just match the prices of everybody else but now you wake up in the US or Germany and the price is higher you&#39;re going to know it&#39;s an increase in demand because you know in the US that the fed is committed to reducing inflation at almost all costs and you know that the Federal Reserve is not going to allow price level to get out of control due to changes in money supply and so this is what we call the signal extraction problem and it take that a step further to get back to what is the full information set rational expectations is this idea that economic agents are rational and they can think about a country&#39;s policy they can look at what&#39;s going on at the money supply look at data and make an educated decision that&#39;s beyond adaptive expectations okay so let&#39;s say the inflation crept up to six percent in the US and the Fed said you know what we guarantee that we are going to lower inflation to below three percent in the next year if you&#39;re in the u.s. that according to rational expectations you would lower your inflation expectations immediately okay now an adaptive expectations if you&#39;re looking at Y minus one you&#39;re going to need to see a few years of this before you reduce your expectations because you&#39;re just looking into what the last year&#39;s inflation rate was but in rational expectations you have this information from adaptive expectations and all this other information and plus the credibility which is important okay and then let&#39;s contrast that with the Zimbabwe where they print money and there&#39;s a variety of reasons that they print money bad policies one of them but necessity is probably another how do I want to put this so with rational expectations there&#39;s no credibility and so you&#39;re going to assume higher inflation because you&#39;ve you know you&#39;ve looked at the data if you look at their past you&#39;ve looked at their government and you&#39;ve made an educated rational decision that leads you to something beyond adaptive expectations so to be more simple adaptive expectations is this idea that only the past inflation matters an inflation has to be empirically low in other words people need to see a low year of inflation before they lower their inflation expectations rational expectations people look at a variety of data points to determine what inflation is going to be not just the past including the credibility of the Federal Reserve and if the Federal Reserve says they&#39;re going to keep inflation low then people will change their expectations if the Federal Reserve is credible and they will lower their inflation expectations so those are the two main theories I want to cover regarding rational expectations or I&#39;m sorry regarding inflation expectations so what else do I want to say I think I got it let me talk about this equation actually let&#39;s go back oh it&#39;s so far back I&#39;ll just write it nu pi is equal to PI minus 1 minus beta u minus u and plus V so this is usually measured as adaptive expectations because there&#39;s not good data for rational expectations so this is usually adaptive expectations this is something you can determine with the regression when you&#39;ve taken business statistics then you&#39;ll see what I&#39;m talking about but this is going to be your actual employment and this is what&#39;s called the natural rate and so if we&#39;re looking at this potential output point this would be the natural rate of unemployment okay and if Adu was below that point in a recessionary gap let&#39;s say it&#39;s five point five percent then over here it&#39;s four percent so you have negative one point five percent and so that&#39;s what we&#39;re looking at here and then this like I said earlier would just be measured by say WTI oil prices or something like that that&#39;s West Texas Intermediate the primary measure of price for crude oil in the United States okay so that&#39;s that&#39;s inflation let&#39;s talk about theories of inflation the first theory of money not home finish the first theory of inflation is the quantity theory of money and this is where inflation is always in everywhere a monetary phenomenon and so it&#39;s very simple if money supply increases then the price level will increase this is a Milton Friedman theory it&#39;s that Milton Friedman&#39;s theory Jiri popularized it in the 1950s I should say there have been a lot of famous economists that have talked about this quantity theory of money and the equation goes like this MV is equal to PQ I mean I think Aristotle talked about this there were some writers in the 17 and 1800&#39;s I think John Stuart Mill I want to say oh my goodness what&#39;s his name David Hume was the big philosopher and then Irving Fisher in the nineteen 1900s and then in the 1950s Friedman repopulated it so M in this case stands for money supply V in this case stands for velocity P stands for price and Q stands for quantity okay and so as well so this is true every economist agrees with this to some degree but this causality from money to prices is what&#39;s debatable Friedman held velocity and quantity constant and the reason that he did that is if you look at data on money velocity in the 1950s the graph you know in 30s 40s then the 50s it just kind of does this but then it starts to get crazy again and so this is when Friedman is writing and money velocity was holding steady you know you figure everybody gets back from the war and I should define that actually this is the number of times that money changes hands okay so money velocity is the number of times that money changes hands money supply is the total number of dollars and price and quantity are straightforward and so you figure in the 50s people a set in comes back from the war they&#39;re you know money&#39;s not changing hands that differently it&#39;s a it&#39;s set people&#39;s expenditures are pretty set so say steady now if you hold money velocity constant then the other question is well why doesn&#39;t increase quantity why does it increase price and the idea is is that quantity is also something that&#39;s kind of set you look back in the 50s people are on set budgets everybody&#39;s kind of living in the same size house they&#39;re buying the same stuff they have the same cars you know working dads stay-at-home mom three to four children everything&#39;s the same and so quantity was also relatively set and so M V equal PQ at that point in history I think is pretty accurate now the causality isn&#39;t quite accurate and I&#39;ll talk about that well it&#39;s debatable whether it&#39;s accurate but I&#39;ll talk about that when we talk about endogenous money so that is the quantity theory of money so the implications from the quantity theory of money are very straightforward is that the Fed needs to control the money supply okay in order to control inflation and so Friedman proposal was called the K percent rule and the K percent rule is you only increase the money supply at the rate of GDP growth and so this idea of the causality going from money to prices is something that&#39;s very debatable Friedman argued fiercely for it and won over many economists from this the 50s through the 80s 90s this type of thinking is called monetarism and monetarism I think was a very important thing in the history of economic thought I think it has fallen out of favor by a lot of economists in the modern times because the role of money has changed in a sophisticated international financial economy and and so the Fed no longer targets money supply growth with this k percent rule they stopped doing that in the mid-1980s and instead now they target the interest rate is the policy tool before they used to target the money supply following you know this type of thinking but empirically there&#39;s not a strong relationship between money supply and prices and if there were you could argue that it&#39;s prices going up that causes money supply to change and I will talk about that in a few minutes okay so that is the quantity theory of money [Music] let me continue on that a little bit actually let&#39;s talk about this with developing countries this is an issue in developing countries and specifically because of this issue called senior edge revenue that&#39;s how you spell it SE IG and I are a GE Wow my handwriting is so bad the letters oh I feel bad for you guys I&#39;m sorry I really do my best so anyways so think about Latin America okay think about Bolivia really cool country pretty poor country though especially when you get up in the mountains and some of the poor areas so you know if the United States if we need more money for health care for whatever we just raise taxes people make a lot of money here if we can raise taxes and pay for it but in Bolivia there&#39;s a whole section of the population that&#39;s off the grid the government of Bolivia can&#39;t track everybody there are people who are not making wages that&#39;s reported to the government there are a lot of poor farmers that are living subsistence living &#39;z which means barely enough to survive and so if you want to build new roads in Bolivia how do you do it well you can&#39;t just raise taxes because a people can&#39;t afford to pay the taxes B people just won&#39;t pay the taxes because they&#39;re too poor see half the people you can&#39;t even collect taxes for them it&#39;s probably not half but you know I&#39;m just making my point because you know they&#39;re off the grid so what do you do well your only option then is a government if you want to spend money you can&#39;t tax and so you print money and spend well this definitely does lead to inflation there&#39;s no doubt about that when you start doing this that quantity theory of money kicks in right the way Friedman described it MV equal PQ you see that increase in money directly increase price and you almost always see inflation and then it&#39;s what happens is as when inflation increases say it goes up 10% now everything&#39;s ten percent more expensive but your wage has stayed the same that&#39;s the equivalent of a ten percent tax on everybody and so it&#39;s called an inflation tax it&#39;s not a good policy everybody wants to know why does Latin America keep doing that at such a bad policy well they have a hard time collecting taxes so this is what they do when they get desperate to spend money so that&#39;s this applied in developing countries and I have no doubt that it you got to think of it a couple different ways so let&#39;s say that the Federal Reserve had a helicopter and they put billions of dollars in the helicopter and they just flew over different cities and drop the money and let it float in the air and we all grabbed it what would happen well in that scenario I I can see the quantity theory money working almost perfectly I&#39;m sure it would lead directly to inflation it&#39;s printing money we all get it and you know and then you&#39;re gonna see inflation but is what happens in the real world is the Federal Reserve injects money into banks by purchasing bonds and then that money goes into excess reserves to be lent out but that money reaching the actual financial markets is constrained by the demand for loans and the price of money and the demand for loans is not purely a function of the price of money which is the interest rate so it&#39;s not necessarily true that when the Federal Reserve buys bonds and injects money into the banking system that this quantity theory of money theory is going to work out because it&#39;s not necessarily true that that money is going to hit the real economy and that&#39;s the big debate among economists right now in the monetarist sphere who are minority now is you know how how does that money actually hit the economy in the golden helicopter example the monetarists are 100% correct in latin america a senior revenue they&#39;ve been a hundred percent correct but in our economy ultimately the Fed could dump a ton of money into the banks but it doesn&#39;t mean that we&#39;re all gonna go out and get a loan interest rates are already historically low and everyone&#39;s not rushing out to buy a loan because we base stuff on our budget and so you can inject money into the banking system to help banks without necessarily causing hyperinflation and so you know the quantity theory of money is an interesting theory it&#39;s got a long history but it doesn&#39;t always describe every policy move okay second theory of inflation is what&#39;s called the institutional theory of inflation it&#39;s also known as the wage bargaining model and this is a big deal in Europe where labor unions are still a big deal so see so let&#39;s say workers request an increase in wage okay so they get it because their labor unions and so the firm increases the price so then the labor union figures out that prices are higher so they turn around and request a higher wage because they pay attention to their real wage wage over prices if prices goes up this whole thing goes down and they want this to go up so to least stays even so they have to give another wage increase but then the firm to pay for it has to raise prices so you can see how this is gonna go this is an infinite circle it&#39;s called a wage price inflation spiral and it&#39;s the reason why in the US and the UK Thatcher and Reagan fought against labor unions so fiercely and it&#39;s the reason why in parts of Europe that this is still an issue because things are highly unionized so the solution to these types of things is government intervention government intervenes you know I&#39;ve been to France five times Paris five times and a-three the times I&#39;ve been there they&#39;ve been a subway strike so maybe France doesn&#39;t want to see inflation increase so they go to the subway strikers and say listen we can&#39;t increase your wage but we can give you an extra holiday or you know free wine or I don&#39;t know I&#39;m sorry I&#39;m thinking of living in France drinking wine so government comes in helps negotiate to prevent the wage price inflation spiral from getting out of control third theory of inflation is what we&#39;re going to call endogenous money and this is the opposite of Friedman this is the idea that an increase in aggregate demand leads to an increase in output which leads to more loans you know more economic activity which increases the price level and then through fractional reserve banking necessitates an increase in the money supply and so Friedman argues that increase in money supply leads and causes an increase in the price level but these people called the post-keynesian z-- argue that this increase in the price level is what causes the increase in money supply okay or really this increase in output the leads that is related with the increase in the price level leads to the increase in money supply so here&#39;s the story for endogenous money the economy picks up people start spending more and they make more money they take out loans to buy cars when you take out a loan that gets the fractional reserve banking story going so you take out twenty thousand dollars for a car the car dealership gets then puts back in the bank and then the bank can lend out more of that and so money supply is created as a result of economic activity and was not the cause of economic activity and I have to say that in seventy years of economic history the endogenous money people really have won the majority of economists at this point most mainstream economists may not explicitly believe in endogenous money but in their models implicitly they are using endogenous money the European Central Bank the Federal Reserve money supply is no longer the causal factor in economic models it is the resulting factor of changes in economic activity and so endogenous money is in you know what we call new consensus macroeconomics which is the standard macroeconomic model I talk about it in intermediate macroeconomics and it&#39;s what you know people learning that go to the Fed and make policy so endogenous money this reverse causality from Friedman has really won over in the the last 50 70 years since Friedman was at his peak okay so let me go back a little bit so the policy implications are that money supply doesn&#39;t matter basically that is what roulette what matters is economic activity and you can manage economic activity this portion through aggregate demand management which is a Keynesian policy and if money supply increases that is not the problem and prices going up is not necessarily a problem because it means that there&#39;s strong strong economic activity a lot of Keynesian will prefer higher inflation and low unemployment whereas a lot of the classical economists are different iterations of that type of thinking would prefer lower inflation and higher unemployment assuming that there is a trade-off you know some people question whether that trade-off is dead that trade-off is called the Phillips curve and that&#39;s coming up in just a few minutes so you know these are overlap with the other three but you have what&#39;s called G&#39;s cost-push inflation which would be things like oil prices wages you know inputs shifting this aggregate supply curve to the left and causing inflation and then you have this other thing called demand pull it&#39;s where the demand is pulled out you know because the economy is doing well so positive economic activities pushing up prices that what&#39;s what we&#39;ve heard to as demand pull cost push demand pull so anyways so those are the five different types of inflation I&#39;d say these are the three theories you know quantity theory of money institutional theory endogenous money and then these are just different types of inflation but I put them on the same list okay moving on let&#39;s talk about the Phillips curve Phillips curve is this relationship between inflation and unemployment okay so since downward-sloping it&#39;s called p.c and it came about from some empirical data and they put it on a graph they graphed inflation against unemployment and they had this straight line so mr. Phillips got a curve named after him so you can have according to the Phillips curve high inflation and low unemployment or low inflation and high unemployment and if you notice in this a das model this a das model reflects this okay so let me do this we&#39;ll call this point number one which on your phillips curve so that would be point number one and then higher inflation lower unemployment would be point number two on the phillips curve and if we went down here a t double prime point number three this would be point number three okay so this aggregate demand trade-off implicitly assumes phillips curve trade-off and so one of the arguments well let me let me explain something so you know nineteen fifties you had this is what it looked like okay nice clean phillips curve 1970s phillips curve gets crazy now you have stagflation you&#39;re way out here 1890s now things get awesome just low and inflation and low this is low inflation and low unemployment and you know it&#39;s really been this way in the 2000s you had kind of a standard phillips curve probably graph like this if you do the 2010s so it&#39;ll mix cuz early 2010s you&#39;re looking at high unemployment below inflation so you would have will see high i guess i should label stuff huh high unemployment below inflation then the other part of the 2010 is the last five years then you were over here so really 2010&#39;s look like this so the question is is the phillips curve still around you know that&#39;s that&#39;s an interesting question I think the Phillips curve is what it is it reflects this aggregate demand trade-off it&#39;s maybe not a rule of physics you know like I talked about in my first lecture just as one of those institutional things that when aggregate supply stays steady when aggregate demand rises and falls you have a bit of this inflation trade-off but [Music] you knows what we&#39;re learning it&#39;s going back to the inflation theories going back to this cost-push stuff is that inflation doesn&#39;t necessarily go up when aggregate demand goes up so I have published research on this particular question and is what I found is using some advanced statistical methods called a time series econometrics is that wages are the biggest thing so wages are most related to prices so if you keep wages low which they have been since the 80s then prices stay low so that&#39;s a cost push issue I find oil has a small effect and the other thing is import prices which is exchange rate related but basically stands for global trade import prices have fallen drastically is globalization has picked up and these are the two things that are responsible now for low inflation that the economy has seen since the mid 80s you know monetarist tried to take credit for saying there&#39;s good Federal Reserve policy and lowering the money supply but I tested that too interest rate and I didn&#39;t find much evidence for that and so you know different research will disagree but that&#39;s been my investigation to this so I&#39;m very much in the cost-push camp because my research proves cost-push with wages and import prices here&#39;s how does that relate with the Phillips curve well it means that there are times when aggregate demand can shift up and there won&#39;t be inflation and so is what you&#39;re seeing now is these low inflation low unemployment economies or low inflation high unemployment economies like in Europe or in the early 2010&#39;s in the United States so it&#39;s not an empirically there&#39;s not really great evidence for the Phillips curve anymore honestly because when these cost-push factors are low even when aggregate demand shifts out you don&#39;t see the inflation part pick up so anyways that&#39;s the Phillips curve your book will have a little bit more information but I think that&#39;s what I want to get across in my lecture ok let&#39;s touch on some important pourraient points of unemployment and then we will be done so let&#39;s talk about what&#39;s called job search job search is when workers spend time looking for jobs and we have what&#39;s called frictional unemployment and then structural unemployment which we&#39;ve already discussed okay so frictional unemployment is unemployment due to the time workers spend in job search and structural unemployment is where more people are seeking jobs that are available so we&#39;ll do it this way job seekers are greater than jobs for a variety of reasons so you can consider structural unemployment if we look at wages quantity the supply of labor the demand for labor this would be structural unemployment so the natural rate of unemployment is this idea that some structural and frictional unemployment or natural and so we figure the natural rate of unemployment is frictional plus structural and actual unemployment is natural plus cyclical right so cyclical is going to be business cycle unemployment&#39;s higher at the top of the business cycle I&#39;m sorry lower at the top of the business cycle higher at the bottom of the business cycle so the natural rate of unemployment is frictional plus structural unemployment but the actual unemployment rate is the natural rate of unemployment plus whatever is going on cyclically so you figure the natural rate of unemployment is estimated to be between 4.5 and 5 percent somewhere in there so we&#39;re gonna say 5 percent okay so if an economy is at 3 point 6 percent unemployment then the difference here is going to be cyclical if they&#39;re at 8 percent unemployment then the difference is cyclical but this 5 percent in a normal economy the average is going to be the frictional plus the structural unemployment now these things change over time in the 19 whoops 50s it was estimated to be 5.3 percent the 1970s it was estimated to be 6.3 percent the 1990s it was 5 point she&#39;s 5 point 2 percent and then the late 2010 we&#39;re looking at between 4 point 5 and 5 percent and so what in the heck would cause the natural rate of unemployment to change the first is changes in labor force characteristics so in the 1970s all the baby boomers hit the job market at the same time so you&#39;re gonna have a higher rate of structural unemployment for 18 to 25 year olds because they&#39;re all they all have the same skill set and they&#39;re trying to get the same job so that&#39;s gonna bump up the natural rate of unemployment because it&#39;s going to increase structural unemployment the second is changes in labor market institutions so labor unions were destroyed in the 1980s that destroyed but drastically reduced that helped reduce the natural rate of unemployment so that&#39;s an institutional change that would generally brought that rate down from the 1970s three is changes in government policy so the minimum wage is a good example or unemployment insurance if unemployment insurance goes up that&#39;s going to increase job search time because if you get double the time of unemployment insurance you&#39;re gonna take your time to find the job you want that&#39;s going to increase frictional unemployment and then for these changes in productivity 19 so there&#39;s a 1970s productivity slowdown and this change in productivity increased the natural rate of unemployment because if you have higher I&#39;m sorry lower productivity then it&#39;s going to hurt the labor force okay so those are some key points I wanted to get across in this lecture on inflation and unemployment so I don&#39;t think there&#39;s anything else I have left here let me see now I think there&#39;ll be some other smaller details in your book but I think I&#39;ve covered a lot of the main points which is really my goal in these lectures so let me know if you guys have any questions

hi class I&amp;#39;d like to talk about inflation and unemployment so I know we talked about these things at the beginning of the class but I&amp;#39;d like to really dig in and talk about some key issues because these are the two two of the biggest macroeconomic issues right here so first of all let&amp;#39;s talk about inflation and who inflation is good for inflation is good for those who have cost-of-living adjustments so Cola stands for cost of living adjustment because if inflation goes up by let&amp;#39;s say 3% then is what happens is a job with a cost-of-living adjustment the wage will go up by 3% right and you figure if your debt stays the same then inflation ends up being really good for you now of course not every job has cost-of-living adjustments in fact a lot of jobs don&amp;#39;t I bet if you start paying attention to your work and you see that maybe you got a 2% increase in your wage is a cost-of-living adjustment if you compare that to say the 3% inflation then you would have lost 1% of your total wage I don&amp;#39;t want to tell you where I worked but there was a company I worked for before I started graduate school that you know they had the big department meeting and there were one hundred and hundred 50 people there and I was a an economic student at the time an undergraduate and I knew from class that day that inflation was I don&amp;#39;t remember 3.5% or something like that and they came out and said we&amp;#39;re announcing today that everyone it&amp;#39;s a 2.5 percent wage increase you know and if you make $50,000 that&amp;#39;s this much money and everyone&amp;#39;s like oh this is great this is great so everyone&amp;#39;s celebrating and I raised my hand they said hi everyone you guys do realize that we&amp;#39;ve actually lost 1% in terms of our wage because inflation was 3% and then everyone got quiet and I&amp;#39;ll never forget my manager at the very front of the room just looking at me shaking her head so you know you can be that guy if you want but if you do kiss get a cost-of-living adjustment then you know then it&amp;#39;s good also so good for one good for two people have a lot of debt because generally speaking even if you don&amp;#39;t get a cost of living adjustment wages will rise whereas debt stays the same and so it erodes the real value of debt right maybe when you get your home it costs $1,000 a month and you&amp;#39;re making $4,000 a month but overtime is inflation goes up the idea is is that also your wage would go up and maybe it goes up to you know $6,000 and so now that payment is a smaller percentage of your budget and of course this is why banks hate inflation is because it erodes the value of debt and that&amp;#39;s how they make money is by you paying on debt and so they want low inflation because it hurts their bottom line if the value of the debt that you owe them is lower inflation is bad for well it&amp;#39;s bad for banks like I just said I guess I should have made this list before I made started talking about that but it&amp;#39;s bad for banks I can&amp;#39;t even spell that and it&amp;#39;s though it&amp;#39;s bad for those whose wages do not keep up and when I say banks it&amp;#39;s anyone who owns the debt sooo inflation is bad for and so this leads to kind of an interesting class conflict through a lot of the 18th well 18th 19th and 20th centuries quite frankly between the central bank and farmers and so you have farmers who are big portion of the economy for a lot of years and they are always in a lot of debt because they have to buy land left by machines they have to buy a bunch of stuff and then you&amp;#39;ve got so these guys they like increase in inflation because that means an increase in prices which means the price of corn and other agricultural goods go up while their debt payments stay the same so farmers like inflation banks for the exact opposite reasons don&amp;#39;t like inflation and so there&amp;#39;s this class conflict because the role of the Federal Reserve is really to keep inflation low but at different times in history an assortment of people in the economy have wanted higher inflation and so you saw this in each 1896 you saw this in the Jacksonian era when the Federal Reserve was shut down in the 1980 the 1830s so it&amp;#39;s you know you get that bit of trade-off there so let&amp;#39;s talk a little bit about what causes inflation inflation is let me give you an equation here so this is expected inflation this is going to be the output gap in terms of employment this is a coefficient if any of you&amp;#39;ve had business statistics this is going to be like your beta one this measures the sensitivity of inflation to the output gap and then this is a supply shock can be things like an oil shock so the output gap should make sense because well see if we have ad prime here look we have a recessionary gap in recessions you&amp;#39;d expect prices to fall right where is if I drew an inflationary gap out here we&amp;#39;d expect an inflation to go up and so you know if we&amp;#39;re in a positive inflationary gap then this is going to be positive if we&amp;#39;re in a recessionary gap it&amp;#39;s going to be negative this is going to be just the effect of oil prices and other supply factors inflation and then the real issue what I&amp;#39;m leading to here is expected inflation so what is the expectation of inflation and why does it matter that&amp;#39;s I guess the first question we need to ask well think of it this way let&amp;#39;s say that inflation was 5% last year and you were a business owner and you need to set your prices for this year how much you&amp;#39;re gonna raise them well you&amp;#39;re gonna look into the past and see how much inflation goes up and that&amp;#39;s how much you&amp;#39;re going to raise your prices and so previous inflation can have an effect on current inflation and that&amp;#39;s the idea so the question is how does previous inflation have an effect on current inflation well there&amp;#39;s a couple of competing theories the two I want to talk about in this class are adaptive expectations so this is adaptive ad apt iv&amp;#39;e expectations and this comes from Milton Friedman who is a big economist you saw from our documentary and the idea is that this well let me scribble this out pi e is really just past inflation and so you can measure this a couple ways you can measure it as PI to the negative 1 meaning last year&amp;#39;s inflation or I can do PI average of the last 5 years something like that some sort of looking in the past is going to be adaptive expectations and I think this is pretty well accepted there&amp;#39;s some form of adaptive expectations in terms of inflation that if inflation starts to keep up or I&amp;#39;m sorry creep up then is what happens is people are going to start to expect inflation and so they&amp;#39;ll start raising their prices which then affects inflation and it just kind of spirals on and it becomes a problem so that&amp;#39;s adaptive expectations to is more complicated this is what we call rational expectations rational expectations is where people take the full information set and forecast into the future and so what is the full information set so let&amp;#39;s talk about that what is the full information set well let me give you an example let me try and make this argument so let&amp;#39;s say that you&amp;#39;re a baker and you wake up and the price is higher so you have to figure out now is it from an increase in the money supply or is it because of an increase in demand okay because if it&amp;#39;s from an increase in demand you want to increase your output if it&amp;#39;s just a general increase in money supply you just want to raise your price here you raise the output and raise the price so well I mean I guess that&amp;#39;s kind of a circular argument we&amp;#39;re assuming the price is already raised so let me take that back so here you do nothing because it&amp;#39;s just an increase in the money supply which has no meeting in real terms whereas here it&amp;#39;s an increase in demand we want to increase output so how do you know well let&amp;#39;s go to a country that has a poor reputation for central banking let&amp;#39;s go to Zimbabwe so say you wake up in Zimbabwe and the price is higher well the Baker is going to assume that it was an increase in the money supply and so they are going to do nothing okay they&amp;#39;ll just match the prices of everybody else but now you wake up in the US or Germany and the price is higher you&amp;#39;re going to know it&amp;#39;s an increase in demand because you know in the US that the fed is committed to reducing inflation at almost all costs and you know that the Federal Reserve is not going to allow price level to get out of control due to changes in money supply and so this is what we call the signal extraction problem and it take that a step further to get back to what is the full information set rational expectations is this idea that economic agents are rational and they can think about a country&amp;#39;s policy they can look at what&amp;#39;s going on at the money supply look at data and make an educated decision that&amp;#39;s beyond adaptive expectations okay so let&amp;#39;s say the inflation crept up to six percent in the US and the Fed said you know what we guarantee that we are going to lower inflation to below three percent in the next year if you&amp;#39;re in the u.s. that according to rational expectations you would lower your inflation expectations immediately okay now an adaptive expectations if you&amp;#39;re looking at Y minus one you&amp;#39;re going to need to see a few years of this before you reduce your expectations because you&amp;#39;re just looking into what the last year&amp;#39;s inflation rate was but in rational expectations you have this information from adaptive expectations and all this other information and plus the credibility which is important okay and then let&amp;#39;s contrast that with the Zimbabwe where they print money and there&amp;#39;s a variety of reasons that they print money bad policies one of them but necessity is probably another how do I want to put this so with rational expectations there&amp;#39;s no credibility and so you&amp;#39;re going to assume higher inflation because you&amp;#39;ve you know you&amp;#39;ve looked at the data if you look at their past you&amp;#39;ve looked at their government and you&amp;#39;ve made an educated rational decision that leads you to something beyond adaptive expectations so to be more simple adaptive expectations is this idea that only the past inflation matters an inflation has to be empirically low in other words people need to see a low year of inflation before they lower their inflation expectations rational expectations people look at a variety of data points to determine what inflation is going to be not just the past including the credibility of the Federal Reserve and if the Federal Reserve says they&amp;#39;re going to keep inflation low then people will change their expectations if the Federal Reserve is credible and they will lower their inflation expectations so those are the two main theories I want to cover regarding rational expectations or I&amp;#39;m sorry regarding inflation expectations so what else do I want to say I think I got it let me talk about this equation actually let&amp;#39;s go back oh it&amp;#39;s so far back I&amp;#39;ll just write it nu pi is equal to PI minus 1 minus beta u minus u and plus V so this is usually measured as adaptive expectations because there&amp;#39;s not good data for rational expectations so this is usually adaptive expectations this is something you can determine with the regression when you&amp;#39;ve taken business statistics then you&amp;#39;ll see what I&amp;#39;m talking about but this is going to be your actual employment and this is what&amp;#39;s called the natural rate and so if we&amp;#39;re looking at this potential output point this would be the natural rate of unemployment okay and if Adu was below that point in a recessionary gap let&amp;#39;s say it&amp;#39;s five point five percent then over here it&amp;#39;s four percent so you have negative one point five percent and so that&amp;#39;s what we&amp;#39;re looking at here and then this like I said earlier would just be measured by say WTI oil prices or something like that that&amp;#39;s West Texas Intermediate the primary measure of price for crude oil in the United States okay so that&amp;#39;s that&amp;#39;s inflation let&amp;#39;s talk about theories of inflation the first theory of money not home finish the first theory of inflation is the quantity theory of money and this is where inflation is always in everywhere a monetary phenomenon and so it&amp;#39;s very simple if money supply increases then the price level will increase this is a Milton Friedman theory it&amp;#39;s that Milton Friedman&amp;#39;s theory Jiri popularized it in the 1950s I should say there have been a lot of famous economists that have talked about this quantity theory of money and the equation goes like this MV is equal to PQ I mean I think Aristotle talked about this there were some writers in the 17 and 1800&amp;#39;s I think John Stuart Mill I want to say oh my goodness what&amp;#39;s his name David Hume was the big philosopher and then Irving Fisher in the nineteen 1900s and then in the 1950s Friedman repopulated it so M in this case stands for money supply V in this case stands for velocity P stands for price and Q stands for quantity okay and so as well so this is true every economist agrees with this to some degree but this causality from money to prices is what&amp;#39;s debatable Friedman held velocity and quantity constant and the reason that he did that is if you look at data on money velocity in the 1950s the graph you know in 30s 40s then the 50s it just kind of does this but then it starts to get crazy again and so this is when Friedman is writing and money velocity was holding steady you know you figure everybody gets back from the war and I should define that actually this is the number of times that money changes hands okay so money velocity is the number of times that money changes hands money supply is the total number of dollars and price and quantity are straightforward and so you figure in the 50s people a set in comes back from the war they&amp;#39;re you know money&amp;#39;s not changing hands that differently it&amp;#39;s a it&amp;#39;s set people&amp;#39;s expenditures are pretty set so say steady now if you hold money velocity constant then the other question is well why doesn&amp;#39;t increase quantity why does it increase price and the idea is is that quantity is also something that&amp;#39;s kind of set you look back in the 50s people are on set budgets everybody&amp;#39;s kind of living in the same size house they&amp;#39;re buying the same stuff they have the same cars you know working dads stay-at-home mom three to four children everything&amp;#39;s the same and so quantity was also relatively set and so M V equal PQ at that point in history I think is pretty accurate now the causality isn&amp;#39;t quite accurate and I&amp;#39;ll talk about that well it&amp;#39;s debatable whether it&amp;#39;s accurate but I&amp;#39;ll talk about that when we talk about endogenous money so that is the quantity theory of money so the implications from the quantity theory of money are very straightforward is that the Fed needs to control the money supply okay in order to control inflation and so Friedman proposal was called the K percent rule and the K percent rule is you only increase the money supply at the rate of GDP growth and so this idea of the causality going from money to prices is something that&amp;#39;s very debatable Friedman argued fiercely for it and won over many economists from this the 50s through the 80s 90s this type of thinking is called monetarism and monetarism I think was a very important thing in the history of economic thought I think it has fallen out of favor by a lot of economists in the modern times because the role of money has changed in a sophisticated international financial economy and and so the Fed no longer targets money supply growth with this k percent rule they stopped doing that in the mid-1980s and instead now they target the interest rate is the policy tool before they used to target the money supply following you know this type of thinking but empirically there&amp;#39;s not a strong relationship between money supply and prices and if there were you could argue that it&amp;#39;s prices going up that causes money supply to change and I will talk about that in a few minutes okay so that is the quantity theory of money [Music] let me continue on that a little bit actually let&amp;#39;s talk about this with developing countries this is an issue in developing countries and specifically because of this issue called senior edge revenue that&amp;#39;s how you spell it SE IG and I are a GE Wow my handwriting is so bad the letters oh I feel bad for you guys I&amp;#39;m sorry I really do my best so anyways so think about Latin America okay think about Bolivia really cool country pretty poor country though especially when you get up in the mountains and some of the poor areas so you know if the United States if we need more money for health care for whatever we just raise taxes people make a lot of money here if we can raise taxes and pay for it but in Bolivia there&amp;#39;s a whole section of the population that&amp;#39;s off the grid the government of Bolivia can&amp;#39;t track everybody there are people who are not making wages that&amp;#39;s reported to the government there are a lot of poor farmers that are living subsistence living &amp;#39;z which means barely enough to survive and so if you want to build new roads in Bolivia how do you do it well you can&amp;#39;t just raise taxes because a people can&amp;#39;t afford to pay the taxes B people just won&amp;#39;t pay the taxes because they&amp;#39;re too poor see half the people you can&amp;#39;t even collect taxes for them it&amp;#39;s probably not half but you know I&amp;#39;m just making my point because you know they&amp;#39;re off the grid so what do you do well your only option then is a government if you want to spend money you can&amp;#39;t tax and so you print money and spend well this definitely does lead to inflation there&amp;#39;s no doubt about that when you start doing this that quantity theory of money kicks in right the way Friedman described it MV equal PQ you see that increase in money directly increase price and you almost always see inflation and then it&amp;#39;s what happens is as when inflation increases say it goes up 10% now everything&amp;#39;s ten percent more expensive but your wage has stayed the same that&amp;#39;s the equivalent of a ten percent tax on everybody and so it&amp;#39;s called an inflation tax it&amp;#39;s not a good policy everybody wants to know why does Latin America keep doing that at such a bad policy well they have a hard time collecting taxes so this is what they do when they get desperate to spend money so that&amp;#39;s this applied in developing countries and I have no doubt that it you got to think of it a couple different ways so let&amp;#39;s say that the Federal Reserve had a helicopter and they put billions of dollars in the helicopter and they just flew over different cities and drop the money and let it float in the air and we all grabbed it what would happen well in that scenario I I can see the quantity theory money working almost perfectly I&amp;#39;m sure it would lead directly to inflation it&amp;#39;s printing money we all get it and you know and then you&amp;#39;re gonna see inflation but is what happens in the real world is the Federal Reserve injects money into banks by purchasing bonds and then that money goes into excess reserves to be lent out but that money reaching the actual financial markets is constrained by the demand for loans and the price of money and the demand for loans is not purely a function of the price of money which is the interest rate so it&amp;#39;s not necessarily true that when the Federal Reserve buys bonds and injects money into the banking system that this quantity theory of money theory is going to work out because it&amp;#39;s not necessarily true that that money is going to hit the real economy and that&amp;#39;s the big debate among economists right now in the monetarist sphere who are minority now is you know how how does that money actually hit the economy in the golden helicopter example the monetarists are 100% correct in latin america a senior revenue they&amp;#39;ve been a hundred percent correct but in our economy ultimately the Fed could dump a ton of money into the banks but it doesn&amp;#39;t mean that we&amp;#39;re all gonna go out and get a loan interest rates are already historically low and everyone&amp;#39;s not rushing out to buy a loan because we base stuff on our budget and so you can inject money into the banking system to help banks without necessarily causing hyperinflation and so you know the quantity theory of money is an interesting theory it&amp;#39;s got a long history but it doesn&amp;#39;t always describe every policy move okay second theory of inflation is what&amp;#39;s called the institutional theory of inflation it&amp;#39;s also known as the wage bargaining model and this is a big deal in Europe where labor unions are still a big deal so see so let&amp;#39;s say workers request an increase in wage okay so they get it because their labor unions and so the firm increases the price so then the labor union figures out that prices are higher so they turn around and request a higher wage because they pay attention to their real wage wage over prices if prices goes up this whole thing goes down and they want this to go up so to least stays even so they have to give another wage increase but then the firm to pay for it has to raise prices so you can see how this is gonna go this is an infinite circle it&amp;#39;s called a wage price inflation spiral and it&amp;#39;s the reason why in the US and the UK Thatcher and Reagan fought against labor unions so fiercely and it&amp;#39;s the reason why in parts of Europe that this is still an issue because things are highly unionized so the solution to these types of things is government intervention government intervenes you know I&amp;#39;ve been to France five times Paris five times and a-three the times I&amp;#39;ve been there they&amp;#39;ve been a subway strike so maybe France doesn&amp;#39;t want to see inflation increase so they go to the subway strikers and say listen we can&amp;#39;t increase your wage but we can give you an extra holiday or you know free wine or I don&amp;#39;t know I&amp;#39;m sorry I&amp;#39;m thinking of living in France drinking wine so government comes in helps negotiate to prevent the wage price inflation spiral from getting out of control third theory of inflation is what we&amp;#39;re going to call endogenous money and this is the opposite of Friedman this is the idea that an increase in aggregate demand leads to an increase in output which leads to more loans you know more economic activity which increases the price level and then through fractional reserve banking necessitates an increase in the money supply and so Friedman argues that increase in money supply leads and causes an increase in the price level but these people called the post-keynesian z-- argue that this increase in the price level is what causes the increase in money supply okay or really this increase in output the leads that is related with the increase in the price level leads to the increase in money supply so here&amp;#39;s the story for endogenous money the economy picks up people start spending more and they make more money they take out loans to buy cars when you take out a loan that gets the fractional reserve banking story going so you take out twenty thousand dollars for a car the car dealership gets then puts back in the bank and then the bank can lend out more of that and so money supply is created as a result of economic activity and was not the cause of economic activity and I have to say that in seventy years of economic history the endogenous money people really have won the majority of economists at this point most mainstream economists may not explicitly believe in endogenous money but in their models implicitly they are using endogenous money the European Central Bank the Federal Reserve money supply is no longer the causal factor in economic models it is the resulting factor of changes in economic activity and so endogenous money is in you know what we call new consensus macroeconomics which is the standard macroeconomic model I talk about it in intermediate macroeconomics and it&amp;#39;s what you know people learning that go to the Fed and make policy so endogenous money this reverse causality from Friedman has really won over in the the last 50 70 years since Friedman was at his peak okay so let me go back a little bit so the policy implications are that money supply doesn&amp;#39;t matter basically that is what roulette what matters is economic activity and you can manage economic activity this portion through aggregate demand management which is a Keynesian policy and if money supply increases that is not the problem and prices going up is not necessarily a problem because it means that there&amp;#39;s strong strong economic activity a lot of Keynesian will prefer higher inflation and low unemployment whereas a lot of the classical economists are different iterations of that type of thinking would prefer lower inflation and higher unemployment assuming that there is a trade-off you know some people question whether that trade-off is dead that trade-off is called the Phillips curve and that&amp;#39;s coming up in just a few minutes so you know these are overlap with the other three but you have what&amp;#39;s called G&amp;#39;s cost-push inflation which would be things like oil prices wages you know inputs shifting this aggregate supply curve to the left and causing inflation and then you have this other thing called demand pull it&amp;#39;s where the demand is pulled out you know because the economy is doing well so positive economic activities pushing up prices that what&amp;#39;s what we&amp;#39;ve heard to as demand pull cost push demand pull so anyways so those are the five different types of inflation I&amp;#39;d say these are the three theories you know quantity theory of money institutional theory endogenous money and then these are just different types of inflation but I put them on the same list okay moving on let&amp;#39;s talk about the Phillips curve Phillips curve is this relationship between inflation and unemployment okay so since downward-sloping it&amp;#39;s called p.c and it came about from some empirical data and they put it on a graph they graphed inflation against unemployment and they had this straight line so mr. Phillips got a curve named after him so you can have according to the Phillips curve high inflation and low unemployment or low inflation and high unemployment and if you notice in this a das model this a das model reflects this okay so let me do this we&amp;#39;ll call this point number one which on your phillips curve so that would be point number one and then higher inflation lower unemployment would be point number two on the phillips curve and if we went down here a t double prime point number three this would be point number three okay so this aggregate demand trade-off implicitly assumes phillips curve trade-off and so one of the arguments well let me let me explain something so you know nineteen fifties you had this is what it looked like okay nice clean phillips curve 1970s phillips curve gets crazy now you have stagflation you&amp;#39;re way out here 1890s now things get awesome just low and inflation and low this is low inflation and low unemployment and you know it&amp;#39;s really been this way in the 2000s you had kind of a standard phillips curve probably graph like this if you do the 2010s so it&amp;#39;ll mix cuz early 2010s you&amp;#39;re looking at high unemployment below inflation so you would have will see high i guess i should label stuff huh high unemployment below inflation then the other part of the 2010 is the last five years then you were over here so really 2010&amp;#39;s look like this so the question is is the phillips curve still around you know that&amp;#39;s that&amp;#39;s an interesting question I think the Phillips curve is what it is it reflects this aggregate demand trade-off it&amp;#39;s maybe not a rule of physics you know like I talked about in my first lecture just as one of those institutional things that when aggregate supply stays steady when aggregate demand rises and falls you have a bit of this inflation trade-off but [Music] you knows what we&amp;#39;re learning it&amp;#39;s going back to the inflation theories going back to this cost-push stuff is that inflation doesn&amp;#39;t necessarily go up when aggregate demand goes up so I have published research on this particular question and is what I found is using some advanced statistical methods called a time series econometrics is that wages are the biggest thing so wages are most related to prices so if you keep wages low which they have been since the 80s then prices stay low so that&amp;#39;s a cost push issue I find oil has a small effect and the other thing is import prices which is exchange rate related but basically stands for global trade import prices have fallen drastically is globalization has picked up and these are the two things that are responsible now for low inflation that the economy has seen since the mid 80s you know monetarist tried to take credit for saying there&amp;#39;s good Federal Reserve policy and lowering the money supply but I tested that too interest rate and I didn&amp;#39;t find much evidence for that and so you know different research will disagree but that&amp;#39;s been my investigation to this so I&amp;#39;m very much in the cost-push camp because my research proves cost-push with wages and import prices here&amp;#39;s how does that relate with the Phillips curve well it means that there are times when aggregate demand can shift up and there won&amp;#39;t be inflation and so is what you&amp;#39;re seeing now is these low inflation low unemployment economies or low inflation high unemployment economies like in Europe or in the early 2010&amp;#39;s in the United States so it&amp;#39;s not an empirically there&amp;#39;s not really great evidence for the Phillips curve anymore honestly because when these cost-push factors are low even when aggregate demand shifts out you don&amp;#39;t see the inflation part pick up so anyways that&amp;#39;s the Phillips curve your book will have a little bit more information but I think that&amp;#39;s what I want to get across in my lecture ok let&amp;#39;s touch on some important pourraient points of unemployment and then we will be done so let&amp;#39;s talk about what&amp;#39;s called job search job search is when workers spend time looking for jobs and we have what&amp;#39;s called frictional unemployment and then structural unemployment which we&amp;#39;ve already discussed okay so frictional unemployment is unemployment due to the time workers spend in job search and structural unemployment is where more people are seeking jobs that are available so we&amp;#39;ll do it this way job seekers are greater than jobs for a variety of reasons so you can consider structural unemployment if we look at wages quantity the supply of labor the demand for labor this would be structural unemployment so the natural rate of unemployment is this idea that some structural and frictional unemployment or natural and so we figure the natural rate of unemployment is frictional plus structural and actual unemployment is natural plus cyclical right so cyclical is going to be business cycle unemployment&amp;#39;s higher at the top of the business cycle I&amp;#39;m sorry lower at the top of the business cycle higher at the bottom of the business cycle so the natural rate of unemployment is frictional plus structural unemployment but the actual unemployment rate is the natural rate of unemployment plus whatever is going on cyclically so you figure the natural rate of unemployment is estimated to be between 4.5 and 5 percent somewhere in there so we&amp;#39;re gonna say 5 percent okay so if an economy is at 3 point 6 percent unemployment then the difference here is going to be cyclical if they&amp;#39;re at 8 percent unemployment then the difference is cyclical but this 5 percent in a normal economy the average is going to be the frictional plus the structural unemployment now these things change over time in the 19 whoops 50s it was estimated to be 5.3 percent the 1970s it was estimated to be 6.3 percent the 1990s it was 5 point she&amp;#39;s 5 point 2 percent and then the late 2010 we&amp;#39;re looking at between 4 point 5 and 5 percent and so what in the heck would cause the natural rate of unemployment to change the first is changes in labor force characteristics so in the 1970s all the baby boomers hit the job market at the same time so you&amp;#39;re gonna have a higher rate of structural unemployment for 18 to 25 year olds because they&amp;#39;re all they all have the same skill set and they&amp;#39;re trying to get the same job so that&amp;#39;s gonna bump up the natural rate of unemployment because it&amp;#39;s going to increase structural unemployment the second is changes in labor market institutions so labor unions were destroyed in the 1980s that destroyed but drastically reduced that helped reduce the natural rate of unemployment so that&amp;#39;s an institutional change that would generally brought that rate down from the 1970s three is changes in government policy so the minimum wage is a good example or unemployment insurance if unemployment insurance goes up that&amp;#39;s going to increase job search time because if you get double the time of unemployment insurance you&amp;#39;re gonna take your time to find the job you want that&amp;#39;s going to increase frictional unemployment and then for these changes in productivity 19 so there&amp;#39;s a 1970s productivity slowdown and this change in productivity increased the natural rate of unemployment because if you have higher I&amp;#39;m sorry lower productivity then it&amp;#39;s going to hurt the labor force okay so those are some key points I wanted to get across in this lecture on inflation and unemployment so I don&amp;#39;t think there&amp;#39;s anything else I have left here let me see now I think there&amp;#39;ll be some other smaller details in your book but I think I&amp;#39;ve covered a lot of the main points which is really my goal in these lectures so let me know if you guys have any questions

Transcript for:Lecture on Inflation and Unemployment

Transcript for:
Lecture on Inflation and Unemployment