Long-Run Consequences of Stabilization Policies

Both policies work by shifting AD in the short run. Fiscal policy 财政政策 changes government spending or taxes; monetary policy 货币政策 changes the money supply 货币供给 and thus the interest rate. They can work together (both expansionary to fight a deep recession) or be mixed (e.g. loose fiscal + tight monetary). In the short run, expansionary policy raises output and the price level and lowers unemployment; contractionary policy does the reverse.

The policy mix in one table. Use it to check the direction of each effect before you write an answer.

When two policies push AD in opposite directions, the effect on output is indeterminate. Say so in an FRQ, and explain that it depends on which shift is larger.

The Phillips curve 菲利普斯曲线 shows the short-run trade-off between inflation and unemployment:

• The short-run Phillips curve (SRPC) 短期菲利普斯曲线 slopes downward – lower unemployment comes with higher inflation. It is the mirror image of AD-AS: a rightward AD shift moves the economy up-left along the SRPC (less unemployment, more inflation).
• The long-run Phillips curve (LRPC) 长期菲利普斯曲线 is vertical at the natural rate of unemployment 自然失业率 – the counterpart of vertical LRAS. In the long run there is no trade-off: policy changes inflation, not unemployment. One demand shock on two graphs: AD shifts right on the AD-AS graph (A to B), and the economy moves up-left along the short-run Phillips curve

Translate between the two graphs. A shift of AD is a movement along the SRPC (right on AD means up-left on the SRPC). A shift of SRAS is a shift of the SRPC, in the opposite direction: SRAS left means SRPC right. Point A on LRAS matches point A on LRPC, because full-employment output goes with the natural rate of unemployment.

• A supply shock 供给冲击 shifts the SRPC (a negative shock moves it right – worse inflation and unemployment, i.e. stagflation 滞胀). A change in expected inflation 预期通货膨胀 also shifts the SRPC.

Exam skill: link the AD-AS and Phillips graphs – a recessionary gap in AD-AS corresponds to a point on the SRPC to the right of the natural rate; know what shifts SRPC versus moves along it.

In the long run, inflation is a monetary phenomenon. The quantity theory of money 货币数量论 states $M\times V = P\times Y$ (money supply $\times$ velocity $=$ price level $\times$ real output). In the long run velocity $V$ is roughly stable and real output $Y$ grows at its own pace, set by real resources and technology, not by money. So growth in the money supply above output growth translates almost one-for-one into inflation: inflation $\approx$ money growth $-$ real output growth. Printing money faster than the economy grows raises the price level, not real output – the root of high inflation and, in the extreme, hyperinflation 恶性通货膨胀.

Worked example. An economy has a money supply of $2 trillion, velocity of 5 and real output of $5 trillion. Then $P=\dfrac{M\times V}{Y}=\dfrac{2\times5}{5}=2$. Next year the money supply grows by 8 %, real output grows by 3 % and velocity does not change. Inflation $\approx8\%-3\%=5\%$, so the price level rises to about $2\times1.05=2.10$. Check: $\dfrac{2.16\times5}{5.15}\approx2.10$.

A real example. Zimbabwe's government financed its spending by printing money in the 2000s. By late 2008 monthly inflation was in the billions of percent, and in 2009 the country stopped using its own currency and switched to the U.S. dollar and other foreign currencies.

Worked example. Suppose the money supply grows $8\%$ per year while real output $Y$ grows $3\%$ and velocity $V$ is stable. Rearranging $M\times V=P\times Y$ into growth rates, inflation $\approx 8\%-3\%=5\%$. The $5\%$ of money growth not matched by extra output simply becomes higher prices.

A budget deficit 预算赤字 occurs when government spending exceeds tax revenue in a year (a budget surplus 预算盈余 is the reverse). The accumulated total of past deficits is the national debt 国债. Deficits are financed by borrowing – selling government bonds 政府债券 – which adds to the debt and to future interest payments. Persistent deficits raise concerns about crowding out and the burden of servicing the debt.

Crowding out 挤出效应 is the main long-run cost of deficit-financed fiscal policy. When the government borrows heavily, it increases the demand for loanable funds 可贷资金需求, raising the real interest rate 实际利率. Higher rates reduce private investment (and interest-sensitive consumption). So expansionary fiscal policy partly cancels itself: the AD boost is offset by weaker investment. Worse, less investment today means a smaller capital stock and slower long-run growth.

Exam skill: show crowding out on the loanable funds graph – government borrowing shifts demand right, the real interest rate rises, and private investment falls.

Worked example. A government borrows $\$500$ billion to finance a deficit. On the loanable funds market this shifts the demand for funds right, pushing the real interest rate up (say from $3\%$ to $4\%$). At the higher rate firms scale back investment – perhaps by $\$150$ billion – so the net boost to AD is smaller than the $\$500$ billion, and the lost investment slows long-run growth.

Economic growth 经济增长 is a sustained rise in real GDP per capita 人均实际国内生产总值 – the true source of higher living standards. It comes from more or better resources and is shown as a rightward shift of LRAS (and an outward shift of the PPC). Its main drivers:

• physical capital 实物资本 (more tools and machines per worker),
• human capital 人力资本 (education, skills, health),
• technology 技术 and innovation,
• productivity 生产率 (output per worker) growth, the deepest driver.

Governments can raise long-run growth by policies that build capital and productivity: investment in infrastructure 基础设施 and education, research and development 研究与开发 incentives, protecting property rights 产权 and the rule of law 法治, encouraging saving and investment (which finances capital), and keeping inflation low and stable. The recurring long-run theme: policies that crowd out or discourage investment slow growth, while those that encourage capital formation speed it up.

An economy is in long-run equilibrium with an unemployment rate of 5 % and an inflation rate of 2 %.

(a) Draw a correctly labeled graph of the short-run and long-run Phillips curves. Label the current point A. Label the axes inflation rate (vertical) and unemployment rate (horizontal). Draw a downward-sloping SRPC and a vertical LRPC at 5 %. A is where they cross, at (5 %, 2 %).

(b) The government increases spending. Show the short-run effect as point B. AD shifts right, so unemployment falls below 5 % and inflation rises. B is up-left of A on the same SRPC.

(c) Over time, people expect the higher inflation. What happens to the SRPC? Where does unemployment end up? Higher expected inflation shifts the SRPC up (right). Unemployment returns to the natural rate, 5 %, at a higher inflation rate (point C on the LRPC). This is the same story as SRAS shifting left back to LRAS.

(d) Instead, a sharp rise in oil prices hits the economy at A. What happens to the SRPC? It is a negative supply shock: SRAS shifts left, so the SRPC shifts right. Unemployment and inflation both rise (stagflation).

Common ways to lose the mark: swapping the axes; drawing the LRPC at an unemployment rate other than the natural rate; shifting the SRPC for a demand shock (a demand shock is a movement along it); putting the long-run point anywhere but on the LRPC.

• The short-run Phillips curve shows the inflation–unemployment trade-off; the long-run curve is vertical at the natural rate.
• In the long run inflation is a monetary phenomenon (money growth beyond output growth → inflation).
• Show crowding out on the loanable-funds graph: government borrowing raises the real rate and cuts private investment.
• Growth comes from more/better resources — physical capital, human capital, technology — shifting LRAS right.
• A supply shock moves inflation and unemployment the same way (stagflation), unlike a demand shock.