Macroeconomics Chapter 12

Consumer Price Index

Monthly index of consumer prices based on basket of goods in expenditure base period

Producer Price Index/Wholesale Price Index

Monthly index of commodity prices (agricultural and mineral), similar construction to CPI

Real GDP

Nominal GDP/GDP Deflator * 100

GDP deflator

100 * nominal GDP/real GDP

Inflation rate

𝜋_(𝑡+1) = (𝑃_(𝑡+1)−𝑃_𝑡) / (𝑃_𝑡) = (∆𝑃_(𝑡+1)) / (𝑃_𝑡)

Transaction costs

Costs incurred in order to facilitate the transactions of goods and services

Menu costs

Costs of price labelling, such as the cost of printing a new menu

Shoe leather costs

The resources used to economise currency holding

Information costs

The resources used to collect information on prices of goods and services

Wealth redistribution

Unanticipated inflation transfers, wealth from creditors to debtors

Inefficient allocation of resources

Efficient exchange and use of resources can only be maintained by the price mechanism in free markets. Inflation distorts the signals provided by changing prices and weakens the role of price mechanism as a means of conveying information in free markets

Fisher hypothesis

The real interest rate (𝑟_𝑡^𝑒) is independent of monetary measures. Therefore, the nominal interest rate will adjust to accommodate any changes in expected inflation

Fisher effect

There will be a one for one adjustment of the nominal interest rate to the expected inflation rate

Deflation

A continuing decrease in the general price level of goods and services

Consquences of Deflation

1. Unexpected deflation increases the real value of debt

2. Real value of debt increasing raises rates of loan defaults; banks are more cautious to extend loans

3. Deflation can aggravate recessions, leading to a deflationary spiral

4. Consumption and investment suffer, exerting more deflationary pressure on the economy

Debt deflation theory (Fisher)

A decline in prices except for debt and interest on debt, increasing borrowers’ real debt burden

Unemployment (three categories)

1. Employed: person has worked full- or part-time during the past week (incl. sick leave)

2. Unemployed: person didn’t work during the past week, but has looked for work in the past four

3. Not in the labour force: person didn’t look for work in the past week, nor during the past four (e.g. students, homemakers, retirees)

Labour Force

Employed + Unemployed

Unemployment Rate

Unemployed/Labour Force

Participation Rate

Labour Force/Adult Population

Employment Ratio

Employed/Adult Population

Frictional Unemployment

Search activity of firms and workers due to heterogeneity, matching process takes time

Structural Unemployment

The long-term and chronic unemployment that exists even when the economy is not in a state of recession; may be caused by some workers lacking skills enabling long-term employment or by reallocation of workers out of shrinking industries and/or depressed regions

Chronic Unemployment

Workers who are unemployed a large part of the time

Natural Rate of Unemployment

When there is only frictional and structural unemployment; when output and employment are at full employment levels

Cyclical unemployment

Difference between actual unemployment rates and natural rate of unemployment

Okun’s Law

Relationship between output (relative to full employment output: 𝑌̅) and cyclical unemployment (𝑢−𝑢̅)

(𝑌̅−𝑌) / 𝑌̅ = 2 (𝑢−𝑢̅)

Why is the Okun’s law coefficient 2 and not 1?

Other things occur when cyclical unemployment rises: such as falling labour force, declining hours of work per worker or declines in average productivity of labour.

• This results in a 2% reduction in output associated with a 1% increase in unemployment rate