These notes were prepared based on the lectures and supplemented by information from textbooks and tutorials where parts of the lecture were unclear. Graphs, equations, and bullet-point explanations included. Prepared by a first class Economics and Management student for the FHS Macroeconomics pape...
HT1 Macroecons (Monetary Policy)
Overview of lectures in weeks 1-3
Lectures 1-3: IS-PC-MR model
o Extends the ISMP and ASAD with imperfect competition on supply-side and hypotheses
on monetary policy objectives
o Address optimal policy response to macro shocks, problems of time inconsistency/
inflation bias and related issues
Lectures 5-6: sticky prices
o Micro foundation for sticky prices
o Aggregate implications (New Keynesian Philipps Curve)
o Implications of NKPC for inflation dynamics and optimal policy
Lectures 7-8
o macroeconomics at the zero lower bound for interest rates
o problems of instability at the lower bound
o what can monetary policy achieve in this case? what is the role of quantitative easing
and forward guidance for interest rates?
o do we need a new monetary policy framework to address challenges posed during deep
recessions?
Lecture 1: Macroeconomic Theory and Policy in a Closed Economy
Outline
Recap of labour markets and aggregate supply under perfect competition
Labour markets under imperfect competition
o voluntary and involuntary unemployment
o determinants of labour market equilibrium
Relationship to aggregate supply: short-run and long-run Phillips curves (1/3 of IS-PC-MR model)
Equilibrium output under perfect competition
Y = f(A; K; E)
o Y output, A technology, K capital, E labour
o A, K is considered fixed over short time horizons of 1-2yrs
o E varies even in short time periods and thus drives short-term Y fluctuations
o Assume Y has CRS to K and E (doubling both K and E would double Y)
Under perfect competition
o Labour demand (ED) = Marginal product of labour (MPL)
Offering real wage > MPL is loss making, offering real wage < MPL gets positive
profits which gets competed away by other firms offering higher wages
o Labour supply (ES) positively sloped (increases with real wage)
Real wage is the opportunity cost of leisure. As real wage rises agents switch
leisure to labour, increasing employment
Assumed increasing marginal disutility of work (sacrificing leisure), means higher
real wages have to be offered to obtain higher employment
Real wage is nominal wage (W) relative to consumer prices (P) and adjusts to clear labour
market (panel A)
, Employment is then determined and feeds into production function to set output, given that A,
K are fixed in the short term (panel B)
So, equilibrium output is unique and therefore invariant to consumer price level giving vertical
aggregate supply curve (panel D)
o Relates to the classical dichotomy of real and nominal variables. Change in prices does
not affect equilibrium output levels.
Labour supply under imperfect competition
Trade unions have degree of monopoly power and use this to target real wages above the E S
schedule
o So there is a wage-setting (WS) curve above labour supply curve
WS curve becomes the labour supply curve given imperfect competition
WS gives workers excess return beyond a real wage that just covers their
opportunity cost of leisure (ES)
o Size of real wage premium reflects bargaining power of unions
Closed shop industries of 1960s and 1970s (membership of given union required
for employment in particular industry) conferred significant monopoly power on
unions and widened the WS-ES gap
Reforms in 1980s limited union power (WS coincides with E S in limiting case of
perfect competition)
WS diverges from ES as E increases
, o Could argue union power rises with employment (fewer unemployed to replace existing
workers) so WS diverges from ES.
What shifts the WS curve?
o Bargaining power (and hence ability to extract wage premium) depend on
Legal framework: liberal industrial relations laws with restrictions on firing
workers make strike action credible/ effective as workers can strike without fear
of job loss
Regional/ occupational dispersion of employment: premium a union can extract
constrained by the risk that firms will replace union labour with non-union
labour, but risk diminished if unemployed labour is concentrated in one region/
industry so there are limits to labour mobility
Such effects often cited as factor behind persistent rise in UK unemployment in
early 1980s
o Aspirations of trade unions depend on
Labour productivity (unions may seek to share in the gains from rising output
per worker)
Wage accords (unions may agree to limit wage premium in return for public
investment in their industry, improved working conditions etc.)
o Since WS is determined as markup on ES, factors shifting ES may shift WS
Demographic factors affecting labour supply (net migration, retirement ages) as
well as variations in labour force participation can shift WS
But ES shifts need not shift WS proportionately– rises in labour supply from
immigration or parents returning to work only shift WS proportionately if new
workers are effective substitutes for union labour (they need not be given their
skills, experience etc.)
If new workers are ineffective substitutes, WS shifts down/ right less than E S
does (can be seen as increase in union bargaining power and real wage
premium at each employment level as potential unemployed replacements are
less suitable to do the work)
Labour demand under imperfect competition
Firms have some monopoly power in goods market and set prices above marginal cost to
generate excess profits
o If this is so, then factor inputs do not receive the full value of their marginal product
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