Category: LPsection

The term NAIRU (non-accelerating inflation rate of unemployment) is a term first used by James Tobin in 1980, in his article “Stabilization Policy Ten Years After”. It refers to the level of unemployment at which the economy settles if monetary policy is held stable. In these terms, it can be associated to Friedman’s natural rate of unemployment. The NAIRU is based on empirical evidence regarding inflation and unemployment. Indeed, in most countries, inflation rises when unemployment is low beca...

The Layard-Nickell NAIRU model emerged as a reply from New Keynesian Economics to the natural rate of unemployment, devised by Milton Friedman as a criticism of the Neoclassical Synthesis’ Phillips curve. This NAIRU model comes from an article entitled “Unemployment in Britain”, 1986, by Richard Layard and Stephen Nickell. Indeed, the Layard-Nickell NAIRU model was able to explain the paradigm shift by moving away from assumptions of a perfectly competitive labour market into a model based on wa...

Menu costs are costs that result from price changes. An easy way to understand menu costs is by means of a typical example: restaurants. When a restaurant manager wants to change prices, the cost of changing the menus (in order to show the new prices) must be taken into consideration. Therefore, the manager will need to assess whether the increase in prices will cover for the cost of printing new menus. As Gregory Makiw demonstrates in his article “Small Menu Costs and Large Business Cycles: A M...

New Keynesian Economics argue that menu costs are the reason for price stickiness. Price stickiness, the suboptimal adjustment of prices in response to demand shocks, can result in business cycles. Gregory Mankiw proved in 1985 in his article “Small Menu Costs and Large Business Cycles: A Macroeconomic Model of Monopoly” that sticky prices can be both privately efficient and socially inefficient. In fact, as Mankiw points out, even small menu costs can cause large welfare losses. Mankiw uses a s...

Business cycle, as Joseph Schumpeter saw it, is the economic activity fluctuation that occurs over time, and that comes from the succession of expansionary and contracting seasons. It is analysed comparing real GDP to potential GDP (Y*). There are a few common characteristics, which help differentiate cycles, such as its phases, the way it oscillates, the periodicity and a few stylized facts:   1. Phases: Four phases can be distinguished, following Richard Lipsey’s classification: -Trough o...

In 1958, A. W. Phillips wrote a paper on Economica (London School of Economics), entitled “The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957”. Analysing data concerning money wages and unemployment rates in the UK, Phillips managed to draw a curve representing the inverse relation between these variables. It must be said that Irving Fisher had already pointed out a relationship between price levels and unemployment in his paper “A Stati...

The term natural rate of unemployment was introduced by Milton Friedman in 1968, in his article “The Role of Monetary Policy”, following his presidential address delivered at the annual meeting of the American Economic Association, in 1967. It is based in Knut Wicksell’ concept of “natural” rate, which defines how there will be no permanent changes in the considered variable below or above its natural level. The natural rate of unemployment defines the level at which unemployment will remain, no...

The term NAIRU (non-accelerating inflation rate of unemployment) is a term first used by James Tobin in 1980, in his article “Stabilization Policy Ten Years After”. It refers to the level of unemployment at which the economy settles if monetary policy is held stable. In these terms, it can be associated to Friedman’s natural rate of unemployment. The NAIRU is based on empirical evidence regarding inflation and unemployment. Indeed, in most countries, inflation rises when unemployment is low beca...

Adaptive expectation models are ways of predicting an agent’s behaviour based on their past experiences and past expectations for that same event. They are first used by Irving Fisher in his book “The Purchasing Power of Money”, 1911, and further developed in the 1940s and 1950s, especially by Phillip Cagan in his article “The Monetary Dynamics of Hyper-Inflation”, 1956 and, most famously, by Milton Friedman in 1957, in his book “A Theory of the Consumption Function”. Models are usually based ar...