Cant make head or tail of the following sentence in Schweser on page 173
"When a central bank unexpectedly decreases the rate of money supply growth to reduce inflation, the initial effect is to decrease aggregate supply as real wages rise resulting in a short run decrease in both GDP and employment. In this case, actual inflation is less than anticipated inflation and unemployment increases as a result"
My thinking:
When money supply decreases, interest rates rise, and aggregate demand falls. This reduces prices (inflation) and increases unemployment.
Anyway If I were to accept that a change in aggregate supply is the "initial effect", how ther hell is actual inflation less? Prices RISE when aggregate supply falls.
Anybody?作者: Londonrocks 时间: 2011-7-13 15:22
the absolute distance between your real GDP and potential GDP is going to reduce and hence the natural unemployment increases.作者: Kiakaha 时间: 2011-7-13 15:22
"My thinking:
When money supply decreases, interest rates rise, and aggregate demand falls. This reduces prices (inflation) and increases unemployment. "
When money supply decreases = consumers will spend less = producers will seek to hire less & produce less = decrease in aggregate supply.
A reduction in prices is not inflation, rather it is deflation. << I assume you know that.作者: pacmandefense 时间: 2011-7-13 15:22
Damil:
When money supply decreases = consumers will spend less = producers will seek to hire less & produce less = decrease in aggregate supply. << I don't think so. When consumption expenditure falls, aggregate demand falls. You can say that aggregate supply falls when aggregate demand falls. There's just a movement along the agregate supply curve to a lower price level with higher unemployment.
Schweser is totally wrong here. The only effects of an increase in real interest rates on agregate supply is that agregate supply INCREASES (not decreases as schweser insists). See- real business cycle theory from the curriculum.
Any helpers?作者: Flok 时间: 2011-7-13 15:22
It is a matter of expectations versus actual. Their is an unexpected decrease in the money supply growth. The wages in the short run are fixed and based upon the expected inflation being higher than actual inflation due to the unexpected decrease in money supply growth. The workers benefit relative to the firm. Their real wages increase. Because real wages increase, supply (of labor) will decrease, increasing unemployment.作者: lc26mizzou 时间: 2011-7-13 15:22
"Because real wages increase, supply (of labor) will decrease, increasing unemployment."
<<< When real wages increase, labor supply increases (upward sloping supply curve)
I think the point you're trying to make is that more people are willing to work and this increases unemplyoment.
Either way, why does agregate supply fall? (see quote from schweser above)作者: dece2011 时间: 2011-7-13 15:22
I think AndrewP has got it correctly, except his last line.
"It is a matter of expectations versus actual. Their is an unexpected decrease in the money supply growth. The wages in the short run are fixed and based upon the expected inflation being higher than actual inflation due to the unexpected decrease in money supply growth. The workers benefit relative to the firm. Their real wages increase. Because real wages increase, supply (of labor) will decrease, increasing unemployment."
Last line should have been, "Because real wages increase, demand (of labor) will decrease, increasing unemployment."作者: mnieman 时间: 2011-7-13 15:22
Ok I understand AndrewP's point now rus, but the questions remains:
"When a central bank unexpectedly decreases the rate of money supply growth to reduce inflation, the initial effect is to decrease aggregate supply as real wages rise." HOW??
Monetary policy has an effect on aggregate demand. I haven't read of any supply side effects on monetary policy.作者: Finalnub 时间: 2011-7-13 15:22
akshayj,
----
>"When a central bank unexpectedly decreases the rate of money supply growth to >reduce inflation, the initial effect is to decrease aggregate supply as real wages rise." >HOW
----
The key here is 'unexpected' decrease of money supply.
See, 'unexpected' or 'expected', decrease in money supply will reduce inflation, right?
But, had the reduction in inflation been anticipated, say months in advance, then companies would have reduced nominal wages of their workers accordingly (not affecting their real wages though) and would have kept the same level of employment.
Since, here the reduction in inflation is 'unexpected', in the short term companies cannot reduce nominal wages quickly, meaning there is a raise in real wages of employees. Now, there are 2 ways of coping this by companies. 1) Reduce nominal wages, which they cannot as this has come unexpectedly. 2) Retrench. They would go for 2nd option in short term and hence an increase in unemployment along with decrease in GDP.
So, 'unexpected' reduction in money supply will also affect the supply side in such manner.
Hope this helps.作者: homie 时间: 2011-7-13 15:22
I see your point. But its only a movement along the supply curve then. Calling it a shift in aggregate supply (which I think Schweser is implying) would be wrong....作者: Jolyn 时间: 2011-7-13 15:22
akshayj, this is a movement along the DEMAND curve of LABOR and NOT along firm's SUPPLY curve. With lower demand for labor (along the demand curve of labor), firm's supply curve will SHIFT.
Also, in addition to labor, second factor of production is CAPITAL. When there is shortage of Money Supply, Interest Rates will rise and cost of CAPITAL will also rise. This will also affect Firm's supply curve causing the firm's supply curve to shift to left.
Also know that aggregate supply curve is a function of prices of PRODUCED item and output quantity only. When prices of produced item go down, its supply goes down. That will be a movement along supply curve. But here prices of FACTORS OF PRODUCTION are changing. Whenever, cost of factors of production (labor and/or capital) changes, affect will be SHIFT in aggregate supply curve (and not movement along aggregate supply).
Hope it helps.作者: Maddin 时间: 2011-7-13 15:22
I'll just say that the Schweser explanation is not exactly the best one around. My personal opinion is that the Philips curve is derived with shifts in the AD curve, which causes changes in equlibrium along the AS curve.
The TB seems to agree with me. pg 393 Vol 2 clearly states that "a movement ALONG the SAS curve that brings a higher price level and an increase in real GDP is equivalent to a movement along the short run Philips curve from A to B that brings an increase in the inflation rate and a decrease in the unemployment rate."
AkshayJ I suggest you read it from the TB, which I think does confirm what you are trying to say. Are you an econ major?作者: Bulla564 时间: 2011-7-13 15:23
I see your point akshayj and beatthecfa.
But this is quite simple if you ponder over and comprehend a basic fundamental. Which is:
a) Demand and Supply curves are functions of Price of Produced/Consumed Item and Produced/Consumed Quantity ONLY. Produced/Consumed Item Price being on Y axis and Quantity on X axis.
b) If there are any changes in these parameters, resulting movement will be ALONG the AD/SAS curves.
c) But if there are External factors (other than Price of Produced/Consumed Item) influencing Quantity or vice versa, result will be SHIFT in the curve.
Examples of External Factors influencing Quantity demanded/produced could be:
i) Higher Interest Rates. Supply curve shifts to left as CAPITAL (an input to production function) becomes scarce. Demand curve shifts to left with lower availability of consumer credit.
ii) Earthquake destroying production facilities. SAS shifts to left.
iii) Sudden increase in working migrant population. SAS shifts to right.
Now, to answer your first posted question. “Anyway If I were to accept that a change in aggregate supply is the "initial effect", how the hell is actual inflation less? Prices RISE when aggregate supply falls.”
Yes, Prices will initially rise as the supply reduces. Supply curve shifts to left and the transit equilibrium is at higher prices. But tight money policy also reduces consumer credit availability and demand curve shifts to left too. In the new equilibrium, Prices come back down. (If you actually draw and move these curves on paper, you could see how equilibrium price is changing with shifts in these curves).
Now, whether Prices come down lower than the pre-monetary policy levels will depend upon which curve has had a greater shift. If Demand has reduced more than Supply (that is, shift in demand curve is more than that for supply curve), Prices will come down from pre-monetary policy levels, but if Supply is more affected than Demand, new Prices will still be above pre-monetary policy levels.
See TB as beatthecfa has suggested and if you understand it differently, please correct me.作者: FVPV 时间: 2011-7-13 15:23
Thanks so much for trying to get this through to me rusbus1. You really are a wonderful resource to this forum.
I just referred to the Elanguides sample chapter on this reading. Its currently on their website on the samples page. It really cleared it up for me. I think theyre basically saying what I thought all along. Check it out if you want. Frankly though the way you're dealing with questions all over the forum I dont think you need to worry about it too much.
Im going to give up trying to make sense of the Schweser statement and focus on what the TB says.作者: ftwcfa 时间: 2011-7-13 15:23
Thanks akshayj for nice words. I have cleared L1 this Jun and dont want to start for L2 this soon. In the meantime, I am revising my base by trying to be help to Dec L1 takers.
I will surely take a look into Elanguides for this stuff.作者: shootingstar 时间: 2011-7-13 15:23
Rusbus1,
You do know your stuff quite well. Where are you from?作者: Bluetick1010 时间: 2011-7-13 15:23
beatthecfa,
I am from India but have been working away from India for quite some time now. Currently in Singapore for last 2 years and before that in the US for 7 years.
I am an IT professional but mostly in Finance domain. IT is my profession but finance has been my passion. I was one of those who went with the herd when IT was beginning to boom. Also, had been too lazy to get away from it, when things were automatically falling in place for me.
Anyways, now I am trying to change that and I thought CFA could be very good in that direction. I thoroughly enjoyed reading L1 material, as so many things I wanted to know for long were all consolidated at one place.
Where are you from? I have admired your posts for your level of understanding.作者: dece2011 时间: 2011-7-13 15:23
Thanks rus,
I have been a CFA tutor for three years now. I just wander around the forum to maintain my 'edge'.
