(Transcript of audio with descriptions. Transcript includes narrator headings and description headings of the visual content)
(Speaker)
In the next part, we're going to use the slope of the Phillips curve to explain the effectiveness of monetary and fiscal policies.
(Description)
What does the shape of the Phillips curve imply about the effectiveness of monetary and fiscal policy to reduce the unemployment rate?
(Speaker)
We are going to start by analyzing the effectiveness of policy for Japan using a basic AD-AS graph and a graph of a relatively flat Philips curve.
(Description)
On the Figure there are graphs of aggregate supply and demand. Horizontal axis corresponds to real GDP. Vertical axis corresponds to aggregate price level. Two straight lines are plotted in the first quadrant with a negative slope aggregate demand line AD1 and positive slope aggregate supply line. Lines intersect at some point and additional line parallel to y-axis LRAS is plotted through the intersection point. On the second Figure there is a Phillips curve. The horizontal axis corresponds to unemployment rate. The vertical axis corresponds to the inflation rate. The straight line SRPC with a negative flat slope crossing the unemployment rate axis at point E1 4 percent is plotted in the first and the fourth quadrants. Additional line LRPC parallel to y-axis is plotted through E1.
(Speaker)
You will also note that we drew a relatively flat AS curve. This depicts the idea that inflationary expectations are slow to adjust in Japan. The economy begins at point E1. When Japan implements expansionary policy, the AD line will shift to the right causing prices to increase and real GDP to be above potential GDP.
(Description)
On the Figure there are graphs of aggregate supply and demand. Two straight lines are plotted in the first quadrant with a negative slope aggregate demand line AD1 and positive slope aggregate supply line. Lines intersect at point E1 and additional line parallel to y-axis LRAS is plotted through the intersection point. Additional line AD2 parallel to AD1 and shifted to the right is plotted. New intersection point withAS1 is E2. Arrows indicate the shift to the right. On the second Figure there is a Phillips curve. The straight line SRPC with a negative flat slope crossing the unemployment rate axis at point E1 4 percent is plotted in the first and the fourth quadrants. Additional line LRPC parallel to y-axis is plotted through E1. There is a shift along the SRPC curve from E1 to E2 with coordinates (2 percent, 1 percent), shift to the left side is indicated by the arrow.
(Speaker)
The increase in AD will correspond with a movement along the Phillips curve. Japan will move along the Phillips curve to the left. This movement shows a decrease in unemployment and an increase in the inflation rate. In the figure, we show that the government is able to use expansionary policy and lower unemployment rates from 4 percent to 2 percent, and inflation only increases by 1 percent. Because Japan gas a slow adjustment to the rise in inflation, they will be able to keep output above potential for a considerable period without risking further increases in inflation. Over time, inflationary expectations will begin to slowly adjust in Japan. This will cause the short run AS curve to shift to the right and the SRPC to shift up.
(Description)
On the Figure there are graphs of aggregate supply and demand. Straight lines: AS1 for aggregate supply, AD1 and AD2 for aggregate demand, parallel to each other, and crossing AS1 in E1 and E2 correspondingly, LRAS line parallel to y-axis through E1 are plotted. Additional line AS2 parallel to AS1 and shifted to the left is plotted so, that AS2, AD2 and LRAS intersect in the same point E3. Arrows indicate the shift to the left. On the second Figure there is a Phillips curve. The straight line SRPC1 with a negative flat slope crossing the unemployment rate axis at point E1 4 percent is plotted in the first and the fourth quadrants. Additional line LRPC parallel to y-axis is plotted through E1. New line SRPC2 parallel to SRPC1 and shifted up is plotted so that it crosses LRPC line in E3 on the same level of 1 percent with E2. Shift up is indicated by arrows.
(Speaker)
The economy will return to potential GDP at a slightly higher inflation rate. Conversely, when Zimbabwe conducts expansionary policy, the effects will be drastically different. To start you will notice we have drawn the AD-AS graph and Phillips curve line for Zimbabwe, but this time the AS and SRPC lines are much steeper.
(Description)
On the Figure there are graphs of aggregate supply and demand. Horizontal axis corresponds to real GDP. Vertical axis corresponds to aggregate price level. Two straight lines are plotted in the first quadrant with a negative slope aggregate demand line AD1 and positive slope aggregate supply line. Lines intersect at some point and additional line parallel to y-axis LRAS is plotted through the intersection point. On the second Figure there is a Phillips curve. The horizontal axis corresponds to unemployment rate. The vertical axis corresponds to the inflation rate. The straight line SRPC with a negative almost vertical slope crossing the unemployment rate axis at point E1 4 percent is plotted in the first and the fourth quadrants. Additional line LRPC parallel to y-axis is plotted through E1.
(Speaker)
This reflects that inflationary expectations adjust much faster in Zimbabwe. Any attempt to conduct expansionary policy will cause inflation to rise rapidly with little effect on unemployment. If the government of Zimbabwe attempts to conduct expansionary policy, it will have almost no impact on unemployment. Expansionary policy will still shift AD to the right, but this time the result will be drastically higher prices and almost no change in unemployment. The shift in AD will correspond to a movement up the Phillips curve, but with a steep Phillips curve, the effects will largely be faster inflation. Here we show inflation increases to 10 percent, and unemployment has a slight decrease to 3.75 percent.
(Description)
On the Figure there are graphs of aggregate supply and demand. Two straight lines are plotted in the first quadrant with a negative slope aggregate demand line AD1 and positive slope aggregate supply line AS1. Lines intersect at point E1 and additional line parallel to y-axis LRAS is plotted through the intersection point. Additional line AD2 parallel to AD1 and shifted to the right is plotted. New intersection point with AS1 is E2. Arrows indicate the shift to the right. On the second Figure there is a Phillips curve. The straight line SRPC with a negative almost vertical slope crossing the unemployment rate axis at point E1 4 percent is plotted in the first and the fourth quadrants. Additional line LRPC parallel to y-axis is plotted through E1. There is a shift along the SRPC curve from E1 to E2 with coordinates (3.75 percent, 10 percent), shift to the left side is indicated by the arrow.
(Speaker)
Zimbabwean monetary and fiscal policy makers face a nearly vertical short run Philips curve, which will cause them to be largely ineffective in reducing unemployment below the NAIRU. Quickly, inflationary expectations will begin to adjust in Zimbabwe. This will cause the short run AS curve to shift to the left and the SRPC to shift up. The economy will return to potential at a significantly higher inflation rate.
(Description)
On the Figure there are graphs of aggregate supply and demand. Straight lines: AS1 for aggregate supply, AD1 and AD2 for aggregate demand, parallel to each other, and crossing AS1 in E1 and E2 correspondingly, LRAS line parallel to y-axis through E1 are plotted. Additional line AS2 parallel to AS1 and shifted to the left is plotted so that AS2, AD2 and LRAS intersect in the same point E3. Arrows indicate the shift to the left. On the second Figure there is a Phillips curve. The straight line SRPC1 with a negative flat slope crossing the unemployment rate axis at point E1 4 percent is plotted in the first and the fourth quadrants. Additional line LRPC parallel to y-axis is plotted through E1. New line SRPC2 parallel to SRPC1 and shifted up is plotted so that it crosses LRPC line in E3 on the same level of 10 percent with E2. Shift up is indicated by arrows.