EC4004 LECTURE 15. YESTERDAY Business Cycles & Unemployment. Important stuff to know 1.Inflation 2.Keynesian Model. Inflation.

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1 EC4004 LECTURE 15 Inflation. YESTERDAY Business Cycles & Unemployment Important stuff to know 1.Inflation 2.Keynesian Model

2 TODAY Inflation, Unemployment, Keynes NEWS Shares in AIB/BOI collapsing as NAMA stalls in committee stage ESB/IN/TSB Merger Mooted NAMA s SPV Rate of Decline in Sales leveling off, average transactions lower Unions out on strike (maybe) Irish Public Finance (% of GDP) % % Budget Balance (LHS) General Gov. Debt (RHS) (f) 2010(f) 2011(f) 2012(f) 2013(f) Source: Dept of Finance CURRENT BUDGET SITUATION

3 "#$%& "#$& "#"%& "&!"#"%& $'($& $'()& $'(%& $'((& $'('& $'*$& $'*)& $'*%& $'*(& $'*'& $''$& $'')& $''%& $''(& $'''& +""$& +"")& +""%& +""(& +""'&!"#$&!"#$%&,&-./012&341562/7&89:;& 7.5 Irish G D P (Y ear-o n -Y ear % C h an g e) (f) 2010 (f) 2011 (f) Source: Thomson Datastream, Forecasts AIB ERU

4 RECALL UE = (Total Seeking Work/Total Labour Force) * 100 Business Cycle = changes in Real GDP over time. GDP = C+I+G. % 6 Labour Force and Employment Growth Y/Y % Change Q1-01 Q1-02 Q1-03 Q1-04 Q1-05 Q1-06 Q1-07 Q1-08 Q1-09 Labour Force Employment Source; CSO Types of Unemployment 1. Cyclical 2. Structural 3. Frictional

5 The cost of cyclical unemployment is the GDP gap What is the GDP gap? The difference between fullemployment real GDP and actual real GDP NOW.

6 INFLATION. General Increase in the Price Level Price Level proxied by Consumer/Wholesale/Retail Price Index. Focus on CPI. CPI Measures changes in the average prices of goods and services. Index is a weighted sum of consumption bundles Calculate an index relative to a base year. CYP = cost of the market basket of products at current-year prices BYP = cost of the market basket of products at base-year prices CPI = CYP/BYP * 100 So CPI is always 100 in base year, Numerator=Denominator Inflation measured by comparing CPI in one period to the next. Deflation is when CPI goes negative. EXAMPLE EU Eurozone Ireland (GNP) Germany France Italy Spain Greece UK

7 SO WHAT? Inflation reduces peoples incomes by eroding their purchasing power. EG, make 100 Euros, price level of 10, can afford 10 things Make 100 Euros, price level of 20, can afford 5 things Important to distinguish Nominal from Real. RI = Real income NI = Nominal income CPI = CPI as a decimal or CPI 100 RI = NI/CPI INFLATION HELPS WEALTHY Inflation can benefit holders of wealth because the value of their assets tends to increase as prices rise. For salaried people, you get poorer if the rate of inflation is greater than your rate of income. US Auto Workers

8 INFLATION & INTEREST RATES Interest rate =Interest per year as a percentage of the amount loaned or lent Nominal Interest rate = The actual rate of interest earned over a period of time Real interest rate = The nominal rate of interest minus the inflation rate INFLATION & HOME BUYERS They can win or lose depending on the rate of inflation and interest WHY? Text answers to

9 6 Irish CPI Inflation Year-on-Year % Change Core Inflation (i.e. ex-mortgages) Sharp decline >2008 HICP -6.9% Lowest inflation in EU Competition from NI -2 Headline Inflation -4-6 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Source: Thomson Datastream Irish and Eurozone Inflation (HICP Rates) V low consumer spending Eurozone HICP Irish HICP -3.0 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Source: Thomson Datastream MATHEMATICA

10 NEXT TIME We ll put it all together: Business cycles, money, inflation, unemployment, macroeconomic disasters & try to solve the problem. See Cht 17 of the book.