Parts 10-11: Economic Stability Policy Debate and Inflation (Ch30-Ch32)

Part 10. Theory of Economic Stabilization Policy

Chapter 30. Debates Surrounding Economic Stabilization Policy

1. Macroeconomic School Development Genealogy (Must-Memorize for Exams)

School	Formation Background / Core Theory	Government vs. Market Perspective
Classical (Marshall, Pigou)	Say’s Law / Price Flexibility	Market is complete, no involuntary unemployment exists
Keynesian (Keynes)	1930s Great Depression / Insufficient Effective Demand	Market is incomplete, fiscal policy is essential
Monetarist (Friedman)	New Quantity Theory of Money / K% Rule	Criticizes policy lag errors, emphasizes rules
New Classical (Lucas)	Rational Expectations Theory / Real Business Cycle	Anticipated policy = Zero real effect
New Keynesian (Mankiw)	Menu Cost / Efficiency Wage Theory	Accepts rational expectations + Micro-justification of price stickiness

2. Phillips Curve and Stagflation

The Phillips curve shows the short-run trade-off between the inflation rate and the unemployment rate.

Demand Shock (Expansionary Policy): Movement along the downward-sloping short-run Phillips curve → Price level↑, Unemployment rate↓
Supply Shock (Oil shock, etc.): Upward-rightward shift of the short-run Phillips curve itself → Price level↑, Unemployment rate↑ = Stagflation

3. Natural Rate of Unemployment Hypothesis and the Long-Run Phillips Curve (Friedman)

In the long run, the unemployment rate returns to the “natural rate” level → The long-run Phillips curve is a vertical line.

Short-Run to Long-Run Adjustment Process of the Natural Rate of Unemployment Hypothesis

Part 11. Unemployment and Inflation

Chapter 31. Theory of Unemployment

1. Four Types of Unemployment

Type	Cause	Character
Cyclical Unemployment	Economic slump/recession (deflationary gap)	Involuntary, targeted by Keynes for eradication
Structural Unemployment	Rapid industrial restructuring, technological innovation	Involuntary, requires long-term training
Seasonal Unemployment	Seasonal factors in agriculture, construction, etc.	Involuntary, predictable
Frictional Unemployment	Search period during job turnover/transition	Voluntary, part of natural unemployment

2. New Keynesian Basis for ‘Downward Wage Rigidity’

Efficiency Wage Theory: The idea that wages determine the marginal productivity of labor. Firms voluntarily pay an “efficiency wage” higher than the equilibrium wage to maximize profits.
- Purpose: Prevention of moral hazard, prevention of departure of top talent (adverse selection), reduction of turnover costs.
- Result: Even with excess labor supply (= involuntary unemployment), market wages do not fall.

Chapter 32. Spillover Effects of Inflation

1. Demand-Pull vs. Cost-Push Inflation

Classification	Demand-Pull	Cost-Push
Main Causes	Excessive money supply, explosive fiscal spending	Wage disputes, soaring raw material prices (oil prices)
AD-AS Change	AD curve shifts right	SRAS curve shifts left
National Income Pattern	Price level↑, National income↑ (accompanied by boom)	Price level↑, National income↓ (accompanied by stagflation)
Government Prescription	Aggregate demand suppression policy effective	Difficult to resolve. Structural improvement / exchange rate stabilization urgent

2. Anticipated vs. Unanticipated Inflation Costs

Costs incurred by anticipated inflation:

Shoe-leather cost: The trouble cost of frequent visits to the bank to reduce held cash.
Menu cost: Physical costs of having to update continuous price change notifications.

Unanticipated inflation → Forced redistribution of wealth:

Gainer Groups	Loser Groups
Debtors (debt burden eased)	Creditors (collapse of currency value)
Real estate / real asset holders	Fixed-income / pension recipients
Government (real tax revenue increases)	Salaried workers (real wages decline)

When the central bank over-issues currency as an excessive fiscal expansion measure, it forcibly induces inflation, eroding the private sector’s real purchasing power of money. This is called the Inflation Tax, and the government effectively enjoys collecting taxes through inflation.