Expectations, Inflation and Full Employment
As so far developed, aggregate demand and aggregate supply curves are of limited interest. They come into their own when ‘augmented’ with price expectations. The vehicle for moving to expectations augmented aggregate supply and demand is the Phillips curve, which summarises the relationship between unemployment and the rate of inflation via the intermediary of money wage changes. First we consider the alleged trade-off between the level of unemployment and the rate of inflation (the ‘Phillips curve’), which allows one to derive the ‘expectations augmented’ versions of aggregate demand and supply. Section 14.2 puts together the aggregate supply and demand curves in their expectations-augmented versions to tell inflation stories, with emphasis on the new classical parables. Section 14.3 retells the stories with a fixed money wage.
KeywordsLabour Market Real Wage Money Supply Demand Curve Excess Demand
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Notes and References
- 5.‘… the long-run Phillips Curve is vertical, or, in substance, that in the long run money is neutral …’ (F. Modigliani, ‘The Monetarist Controversy, or Should We Forsake Stabilization Policies?’, reprinted in Konlinas and Thorn (eds), Modern Macroeconomics (New York: Harper & Row, 1979), p. 119). Emphasis added.Google Scholar
- 12.Parkin summarises the argument in his New Classical textbook, Firms are not being supposed, in some sense, to be smarter than households. Rather, the asymmetry arises from the fact that firms sell a small number of goods, so they and their workers are specialized in information concerning the prices of those goods. In contrast, households buy a large number of goods and services and are not specialized in information concerning the prices in all of those markets. It is this asymmetry … that provides the basis for a modified theory of aggregate supply that is capable of explaining the observed relationship between output (employment and unemployment) and inflation. (Parkin, 1984, p. 353.) Emphasis added. The argument was first made in Milton Friedman, ‘The Role of Monetary Policy’, American Economic Review, vol. 58 (March 1968). The importance of the asymmetry stressed by Parkin is often not noted in textbook presentations. See, for example, Edgmand, who says only ‘… if people’s expectations are incorrect, the aggregate supply curve will be positively sloped.’ (Michael R. Edgmand, Macroeconomics: Theory and Policy (Englewood Cliffs: Prentice-Hall, 1987) third edn, p. 252.)Google Scholar