"So even if you believe that you have to stick with a fixed exchange rate,
a short sharp recession is much less efficient than a more modest but prolonged recession. "
demo:
assume we need a 20% relative price level reduction
to restore global competitive ness
the june bug:
"Suppose that, for given inflation expectations, a 1% output gap will reduce inflation by 1%. "
now with can opener in hand ...lets jump down the rabbit hole
"A short sharp shock of output 20% below potential for a year
will give you -20% inflation in that year,
so you will have restored competitiveness quickly, but at great cost."
" Now think about spreading the correction over two years. "
ready for another bout of supposin' and assumin' ?
"Suppose
a Phillips curve where this year’s inflation rate
depends on next year’s expected
inflation,"
" and
assume people are pretty rational in forming their
expectations. "
"What if we have an output gap next year of -10%. This will mean
that inflation next year will also be -10%. But this year we do not need any
output gap at all. Inflation will still be -10%, because expected inflation is
-10%."
"So we get our competitiveness adjustment over two years, but at half the
cost in terms of lost output."
get it ?
in this model we can let agents know
we're gonna use macro policy to cut next years output by 10%
and we'll get disinflation today and equal disinflation tomorrow
add in the one for one convenience assumption and bingo we have half the real loss on the pathy to a competitive price level
don't like ratex?
"Imagine instead that the Phillips curve is of the old fashioned kind,
where expectations are naive and backward looking, so current inflation effectively depends on past inflation. In this case we need an output gap of -10% this year, but then nothing next year, and we still get our correction over two years at half the cost"
notic the macronauts know what price level they need
but without a mark up market they have to use voodoo to get anything better then brute strangulation of production produces
don't like ratex?
"Imagine instead that the Phillips curve is of the old fashioned kind,
where expectations are naive and backward looking, so current inflation effectively depends on past inflation. In this case we need an output gap of -10% this year, but then nothing next year, and we still get our correction over two years at half the cost"
notic the macronauts know what price level they need
but without a mark up market they have to use voodoo to get anything better then brute strangulation of production produces
