- [Instructor] Assume that the United States economy
is currently in a short run equilibrium
with the actual unemployment rate above
the natural rate of unemployment.
Part A says draw a single correctly labeled graph
with both the long run Phillips curve
and the short run Phillips curve.
Label the current short run equilibrium point P.
So like always, pause this video,
get a pencil and paper out
and see if you can sketch this yourself
before we work through this together.
You'll get more out of this video.
Alright, now let's do this together.
So if we're thinking about Phillips curves,
we're going to, we're gonna have two axes.
Our horizontal axis is going to be the unemployment rate.
Unemployment rate,
which is going to expressed as a percentage.
And our vertical axis is going to be our inflation rate,
which is going to be expressed inflation rate,
which is also going to be expressed as a percentage.
So let's start with the long run Phillips curve.
So the long run Phillips curve,
that's just going to be fixed
at the natural rate of unemployment,
so that's just going to be a vertical line.
So let's just put that right over there
and let me label it.
That is our long run Phillips curve
and now let's do the short run Phillips curve.
Well, the short run Phillips curve
sews this association between our inflation rate
and our unemployment rate.
High rates of inflation are associated
with low unemployment,
and low rates of inflation are associated
with high rates of unemployment.
And so our short run Phillips curve
is going to look something, something like that,
and so let me just label that short run Phillips curve
and now they want us to label
the current short run equilibrium point P.
So a lot of times when people talk about equilibrium points,
it's tempting to just look at the intersection
of these two curves,
but that wouldn't be the case here.
The equilibrium point is going to be some point
along our short run Phillips curve.
In fact, every point on our short run Phillips curve
represents a potential equilibrium point.
If we were looking at aggregate demand
versus aggregate supply,
well then our equilibrium point would be
at the intersection of the aggregate demand
and short run aggregate supply,
but here, our equilibrium point could be any point
along our short run Phillips curve,
and they say that we're currently in a place
where the actual unemployment rate
is above the natural rate of unemployment,
so the natural rate of unemployment is here,
the actual rate of unemployment is higher,
but we're going to be on our short run Phillips curve,
so we could be at a point just like that.
So let's just label that point P.
So part B says assuming no policy actions are taken,
will the short run Phillips curve shift to the right,
or upward, shift to the left and downward,
or remain the same in the long run.
Explain.
So pause this video again
and see if you could work through that
before I do that with you.
So the way to think about this is
when aggregate output, aggregate output is less than,
less than full employment output,
you have higher unemployment rate and lower inflation.
You have a higher unemployment rate above the natural rate,
higher unemployment rate, and lower inflation.
This decreases inflation expectations.
So one way to think about it,
at a given unemployment rate,
you will over time have a lower inflation rate
because of the lowered inflation expectations.
And so instead of our inflation rate being right over there,
it might be right over here.
And so for this point on our short run Phillips curve
instead of the inflation rate being there,
it might be over there.
And so it would actually shift the short run Phillips curve
to the left and downwards.
Now, they're not asking us to draw that
so I don't wanna do that here.
I just did that to hopefully help explain the intuition,
but I will just answer their question right over here.
So this, so this shifts, shifts the short run Phillips curve
left slash downward, downward.
Alright, part C.
If the Federal Reserve Bank wants to lower unemployment,
what expansionary open market operation should it use?
So pause the video again and see if you can answer that.
Well, there's several tools that the Federal Reserve Bank
can use to lower unemployment.
It could change the reserve requirements for banks,
but here they're explicitly talking about
open market operations,
and so the typical open market operation
that the Federal Reserve Bank would do
if it wants to lower unemployment,
it wants to inject more money into the economy.
It wants to increase the amount of reserves in banks
which will of course increase the money supply.
And so to do that,
they will go out into the open market and buy bonds.
So the Federal Reserve Bank will buy bonds.
Remember, when they're buying bonds,
the people who sell those bonds will take
those Federal Reserve Notes, deposit them in banks,
that will increase the reserves of the banks,
the banks will be able to lend more,
and the money supply will increase.
Part D, how will the open market operation
you identified in part C affect each of the following,
federal funds rate, explain.
So I just touched on it.
We can say buying bonds will increase bank reserves,
bank reserves, which will lead
the federal funds rate to go down.
So the fed funds rate will decrease.
Remember, the federal funds rate is the rate
which banks borrow reserves from each other.
If there is a total of more reserves now,
well then there's less demand to borrow
and there's more supply of reserves,
so the cost of borrowing, which is the interest rate,
the federal funds rate, will decrease.
Real interest rate in the short run.
Well, this will also decrease.
Also decrease.
An increase in the money supply,
so I could say an increase,
increase in reserves slash money supply, money supply,
will decrease nominal and real interest rates,
interest rates in the short run, in the short run.
There is a situation where maybe you have
run away inflation, the nominal rates go down,
but somehow that doesn't affect the real rate as much,
but in the short run, we can pretty confidently say
that if nominal interest rates are going down
that real interest rates will go down as well.
And then there's a last part here that is off the screen
and it says given your answer in part D two,
this last part, what is the effect on
real gross domestic product, GDP, in the short run?
Explain.
Well, lower real interest rates, interest rates,
lead to more interest, interest sensitive,
interest sensitive consumption, consumption
and investment, investment,
and we're talking about investment,
we could talk about plant and equipment, equipment,
which should increase GDP, real GDP.
Which should increase real GDP in the short run,
in the short run, and we are done.