ECON-002 Lecture Notes - Lecture 25: Potential Output, Factors Of Production, Aggregate Demand

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5 Jun 2017
April 27th, 2017
In the news:
Pull out of NAFTA (North American Free Trade Agreement)
Can the President do this? No.
Would it be a good idea? No.
Renegotiation? This is ok, sure. Negotiation is always good.
-negation involving looking at labor standards, agreements on the environment; there
are things we should probably bring back to the table
Tax proposal
“Economists debate how successful [the Reagan and Bush tax cuts] were in stimulating
the economy, but nearly all agree that the cuts ultimately added to the debt as they failed
to pay for themselves”
-corporations will only owe taxes on incomes generated on the US mainland, not on
other countries; there is concern that this will not stimulate profits on the US
Using the EFM to Understand US Recessions
1973-75 recession: “You never run out of things that can go wrong.”
This era set a catalog for things that can go wrong
Things that went wrong:
1) estimates of the GDP GAP were completely wrong; in reality, potential GDP was a lot
smaller than we thought. There was an overly-pessimistic assessment of the GAP that led to
excessive expansion of AD (aggregate demand)
2) In Fall 1973, oil prices quadrupled
-this is a price shock (as we learned in the last class), and a price shock will also lead to a
rise in inflation in the short run
-other industries had to raise prices to cover the cost; the inflation adjustment line had to
shift up
-they had to adopt new, more energy-efficient technologies, but the problem with adopting
new technology is that it takes time to introduce it into the system—> this leads to
decline in total factor productivity
-one side effect, which often occurs with price shocks, is that potential GDP declined (the
Y* curve shifted to the left)
-the oil price effect should have led to one-time inflation, but after that prices should have
just remained higher
3) Inflationary expectations began to grow; expectations became unanchored
-the CPI inflation was out of control
-people were expecting inflation to just keep on rising. This, of course, led to an actual rise
in inflation because upward shifts in the IA line are somewhat driven by inflationary
-we wanted to do everything we could to convince ourselves that prices weren’t going to
rise as rapidly
3 Sources of Inflationary Pressures: (Look at the slides)
1) Fed creates a large GDP GAP
2) Price shocks (Shift up in IA line)
3) Increase in inflationary expectations (shift up in the IA line)
1982 recession: “Desperate times call for desperate measures.”
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