WEBVTT 00:00:00.000 --> 00:00:02.958 align:middle line:90% [SQUEAKING] 00:00:02.958 --> 00:00:04.930 align:middle line:90% [RUSTLING] 00:00:04.930 --> 00:00:07.395 align:middle line:90% [CLICKING] 00:00:07.395 --> 00:00:15.973 align:middle line:90% 00:00:15.973 --> 00:00:18.140 align:middle line:84% RICARDO CABALLERO: So today we're going to look at-- 00:00:18.140 --> 00:00:21.620 align:middle line:84% we're going to start looking into the labor market. 00:00:21.620 --> 00:00:25.250 align:middle line:84% Now, the labor market is very interesting for a wide variety 00:00:25.250 --> 00:00:27.405 align:middle line:84% of reasons that we will not discuss in this course, 00:00:27.405 --> 00:00:29.030 align:middle line:84% because it's not about labor economics, 00:00:29.030 --> 00:00:30.890 align:middle line:90% it's about macroeconomics. 00:00:30.890 --> 00:00:33.290 align:middle line:84% But there are at least two reasons 00:00:33.290 --> 00:00:38.840 align:middle line:84% why labor markets are very important in macro. 00:00:38.840 --> 00:00:42.920 align:middle line:84% One is because things like unemployment rate 00:00:42.920 --> 00:00:48.560 align:middle line:84% is a very important indicator of the macroeconomic health 00:00:48.560 --> 00:00:51.020 align:middle line:90% of a country or an economy. 00:00:51.020 --> 00:00:54.740 align:middle line:84% And the second one, which is quite relevant these days, 00:00:54.740 --> 00:00:58.850 align:middle line:90% is that the inflation rate is-- 00:00:58.850 --> 00:01:01.310 align:middle line:84% one of the main drivers of the inflation rate 00:01:01.310 --> 00:01:04.980 align:middle line:84% is what is going on in the labor market. 00:01:04.980 --> 00:01:08.750 align:middle line:84% And we will try to understand this mechanism 00:01:08.750 --> 00:01:12.330 align:middle line:90% in the next couple of lectures. 00:01:12.330 --> 00:01:16.080 align:middle line:84% But you have there is the inflation rate in the US. 00:01:16.080 --> 00:01:18.960 align:middle line:84% And I'm showing you this picture several times 00:01:18.960 --> 00:01:22.800 align:middle line:84% after going through a long period in which the inflation 00:01:22.800 --> 00:01:26.460 align:middle line:84% rate hovered around 2% with cycles. 00:01:26.460 --> 00:01:31.050 align:middle line:84% We are experiencing an episode of very high inflation. 00:01:31.050 --> 00:01:32.050 align:middle line:90% Things are coming down. 00:01:32.050 --> 00:01:35.100 align:middle line:84% But they are still at extremely high levels, 6% or so. 00:01:35.100 --> 00:01:37.110 align:middle line:84% And actually, very recently these numbers 00:01:37.110 --> 00:01:38.910 align:middle line:90% have picked up again a little. 00:01:38.910 --> 00:01:43.560 align:middle line:84% And so that's very high inflation rate-- way 00:01:43.560 --> 00:01:47.010 align:middle line:84% too high for an economy like the US to feel comfortable with. 00:01:47.010 --> 00:01:56.010 align:middle line:84% And whenever some member of the FOMC comes out and explains 00:01:56.010 --> 00:01:59.280 align:middle line:84% why interest rates are so high at this moment 00:01:59.280 --> 00:02:02.700 align:middle line:84% and explains why they are likely to remain high for quite a 00:02:02.700 --> 00:02:07.650 align:middle line:84% while, they say, well, look, inflation is uncomfortably 00:02:07.650 --> 00:02:14.600 align:middle line:84% at high levels and labor market conditions are very tight. 00:02:14.600 --> 00:02:18.260 align:middle line:84% And that suggests that the inflation problem is not 00:02:18.260 --> 00:02:22.730 align:middle line:84% likely to go away in the near future. 00:02:22.730 --> 00:02:24.980 align:middle line:84% So that's something we need to understand in macro. 00:02:24.980 --> 00:02:27.770 align:middle line:84% Why is it that the labor market being tight 00:02:27.770 --> 00:02:31.113 align:middle line:84% says anything about the inflation rate, for example? 00:02:31.113 --> 00:02:32.780 align:middle line:84% And that's the kind of things that we're 00:02:32.780 --> 00:02:37.220 align:middle line:84% going to discuss in particular on the Monday lecture. 00:02:37.220 --> 00:02:43.430 align:middle line:84% Now today we're going to start with more basics of the labor 00:02:43.430 --> 00:02:48.380 align:middle line:84% market and at the same time, we're 00:02:48.380 --> 00:02:51.350 align:middle line:84% going to begin a transition in the course in which we have been 00:02:51.350 --> 00:02:54.620 align:middle line:84% focusing on things that are in the very short run 00:02:54.620 --> 00:02:57.770 align:middle line:90% into things that take more time. 00:02:57.770 --> 00:03:00.530 align:middle line:84% Because many of the things that we're going to discuss today 00:03:00.530 --> 00:03:03.170 align:middle line:84% are things that you're not likely to see 00:03:03.170 --> 00:03:04.910 align:middle line:90% in every single quarter. 00:03:04.910 --> 00:03:08.030 align:middle line:84% But there are things that you're likely to see over 00:03:08.030 --> 00:03:11.330 align:middle line:84% averages over several quarters, several months. 00:03:11.330 --> 00:03:13.770 align:middle line:84% That's what we're going to look at today. 00:03:13.770 --> 00:03:16.910 align:middle line:84% So remember-- let me just recap a little bit what 00:03:16.910 --> 00:03:20.390 align:middle line:90% we have been doing up to now. 00:03:20.390 --> 00:03:22.430 align:middle line:84% We have been looking at this IS-LM 00:03:22.430 --> 00:03:24.860 align:middle line:90% model, which is a great model. 00:03:24.860 --> 00:03:29.840 align:middle line:84% It is a very good model to build on. 00:03:29.840 --> 00:03:32.300 align:middle line:84% But it's a very nice model, starting point, 00:03:32.300 --> 00:03:35.450 align:middle line:84% to understand what happens during a recession 00:03:35.450 --> 00:03:42.560 align:middle line:84% and what are the likely impact of the different macroeconomic 00:03:42.560 --> 00:03:46.220 align:middle line:84% policies, monetary policy, fiscal policy, and so on. 00:03:46.220 --> 00:03:52.550 align:middle line:84% It is not such a great model once the aggregate supply 00:03:52.550 --> 00:03:55.550 align:middle line:84% side of the economy, something we have completely ignored, 00:03:55.550 --> 00:03:58.400 align:middle line:90% starts becoming binding. 00:03:58.400 --> 00:04:00.470 align:middle line:84% Remember that to now in the IS-LM model 00:04:00.470 --> 00:04:05.160 align:middle line:84% we had basically, as a model, we had two assumptions, 00:04:05.160 --> 00:04:06.180 align:middle line:90% related assumptions. 00:04:06.180 --> 00:04:08.220 align:middle line:90% One, prices were fully sticky. 00:04:08.220 --> 00:04:10.420 align:middle line:90% They didn't move at all. 00:04:10.420 --> 00:04:14.920 align:middle line:84% Second, that output was aggregate demand determined. 00:04:14.920 --> 00:04:16.800 align:middle line:84% So whatever aggregate demand wanted, 00:04:16.800 --> 00:04:22.060 align:middle line:84% producers found a way to produce it at some given price. 00:04:22.060 --> 00:04:28.300 align:middle line:84% That combination is unlikely to happen when, 00:04:28.300 --> 00:04:32.680 align:middle line:84% for example, when firms are finding trouble 00:04:32.680 --> 00:04:33.760 align:middle line:90% finding new workers. 00:04:33.760 --> 00:04:35.467 align:middle line:84% Because there may be more demand, 00:04:35.467 --> 00:04:36.550 align:middle line:90% more demand for its goods. 00:04:36.550 --> 00:04:40.880 align:middle line:84% But the firm may find it hard to expand production. 00:04:40.880 --> 00:04:43.960 align:middle line:84% And it is also highly likely that in a situation like that, 00:04:43.960 --> 00:04:46.600 align:middle line:84% firms are going to want to keep prices constant. 00:04:46.600 --> 00:04:48.640 align:middle line:84% At some point they will, look, you 00:04:48.640 --> 00:04:50.320 align:middle line:84% have lots of meals at my restaurant. 00:04:50.320 --> 00:04:52.280 align:middle line:84% I cannot find people to work at my restaurant. 00:04:52.280 --> 00:04:56.470 align:middle line:84% I'll hide the prices so at least fewer tables 00:04:56.470 --> 00:04:58.970 align:middle line:84% and I can manage one way or the other. 00:04:58.970 --> 00:05:03.340 align:middle line:84% So we're going to start building a model that 00:05:03.340 --> 00:05:05.170 align:middle line:84% takes those things into consideration, 00:05:05.170 --> 00:05:08.650 align:middle line:84% what is the impact of a tight supply 00:05:08.650 --> 00:05:10.930 align:middle line:90% side of the economy on prices? 00:05:10.930 --> 00:05:15.250 align:middle line:84% And how that starts affecting, feeds back 00:05:15.250 --> 00:05:19.140 align:middle line:84% into equilibrium output eventually. 00:05:19.140 --> 00:05:21.540 align:middle line:84% And so the main thing I would say we're 00:05:21.540 --> 00:05:25.930 align:middle line:84% going to do, really, relative to the model in the next two, 00:05:25.930 --> 00:05:29.010 align:middle line:84% three lectures is endogenize the inflation rate. 00:05:29.010 --> 00:05:31.180 align:middle line:90% We have kept prices fixed. 00:05:31.180 --> 00:05:34.700 align:middle line:90% But now we're on endogenize. 00:05:34.700 --> 00:05:39.000 align:middle line:84% And the story of that endogenization of inflation 00:05:39.000 --> 00:05:40.470 align:middle line:90% starts from the labor market. 00:05:40.470 --> 00:05:42.012 align:middle line:84% And that's the reason why we're going 00:05:42.012 --> 00:05:44.460 align:middle line:84% to start looking at the labor market today. 00:05:44.460 --> 00:05:46.680 align:middle line:84% Now, let me remind you a few things 00:05:46.680 --> 00:05:49.140 align:middle line:84% that I think we discussed in the first lecture 00:05:49.140 --> 00:05:51.180 align:middle line:84% or so or maybe second, I don't remember. 00:05:51.180 --> 00:05:55.275 align:middle line:90% 00:05:55.275 --> 00:05:57.150 align:middle line:84% Let me give you a picture of the labor market 00:05:57.150 --> 00:06:01.290 align:middle line:84% and some variables, important statistics of the labor market, 00:06:01.290 --> 00:06:08.320 align:middle line:84% that matter for understanding inflation and so on. 00:06:08.320 --> 00:06:11.040 align:middle line:84% So this is a picture that's the one 00:06:11.040 --> 00:06:16.110 align:middle line:84% that you have in the book of the labor market. 00:06:16.110 --> 00:06:18.990 align:middle line:84% It's a picture of the labor market at some point in 2018. 00:06:18.990 --> 00:06:20.160 align:middle line:90% I don't know when. 00:06:20.160 --> 00:06:23.190 align:middle line:90% This is a picture at one point. 00:06:23.190 --> 00:06:26.610 align:middle line:84% And that says that at that time the US had about 330 00:06:26.610 --> 00:06:30.750 align:middle line:84% million people, that the noninstitutional civilian 00:06:30.750 --> 00:06:31.290 align:middle line:90% population. 00:06:31.290 --> 00:06:34.830 align:middle line:84% That is, those people that in principle could work, 00:06:34.830 --> 00:06:37.320 align:middle line:90% were about 260 million. 00:06:37.320 --> 00:06:40.650 align:middle line:84% That excludes people under 16 years old, 00:06:40.650 --> 00:06:42.840 align:middle line:84% people that are incarcerated, people 00:06:42.840 --> 00:06:45.270 align:middle line:90% that are in the armed forces. 00:06:45.270 --> 00:06:47.490 align:middle line:90% Those are excluded from-- 00:06:47.490 --> 00:06:48.480 align:middle line:90% that's the difference. 00:06:48.480 --> 00:06:50.938 align:middle line:84% That's the reason you have such a big gap between these two 00:06:50.938 --> 00:06:51.960 align:middle line:90% numbers. 00:06:51.960 --> 00:06:55.620 align:middle line:84% Now, out of this people that potentially could work, 00:06:55.620 --> 00:06:58.690 align:middle line:90% some of them want to work. 00:06:58.690 --> 00:07:01.230 align:middle line:84% And that's what we call the civilian labor force. 00:07:01.230 --> 00:07:04.770 align:middle line:84% And then some of them are out of the labor force-- 00:07:04.770 --> 00:07:06.180 align:middle line:90% again, at one point in time. 00:07:06.180 --> 00:07:07.830 align:middle line:84% It doesn't mean that these people are permanently out 00:07:07.830 --> 00:07:08.622 align:middle line:90% of the labor force. 00:07:08.622 --> 00:07:11.140 align:middle line:84% They may be temporarily out of the labor force, and so on. 00:07:11.140 --> 00:07:15.930 align:middle line:84% But we started with about 330 million. 00:07:15.930 --> 00:07:18.450 align:middle line:84% And by the time that we look at the people that really want 00:07:18.450 --> 00:07:21.780 align:middle line:84% to work at that point when the picture was taken, 00:07:21.780 --> 00:07:27.030 align:middle line:84% was about half of that, 162 million people. 00:07:27.030 --> 00:07:32.490 align:middle line:84% Now, these 162 million people, the great majority of them 00:07:32.490 --> 00:07:34.050 align:middle line:90% are typically employed. 00:07:34.050 --> 00:07:36.030 align:middle line:90% They have a job. 00:07:36.030 --> 00:07:38.370 align:middle line:84% And then there is a group of people 00:07:38.370 --> 00:07:39.678 align:middle line:90% that would want to have a job-- 00:07:39.678 --> 00:07:42.220 align:middle line:84% that's the reason they are part of the civilian labor force-- 00:07:42.220 --> 00:07:43.660 align:middle line:90% but do not have one. 00:07:43.660 --> 00:07:47.850 align:middle line:84% And that's about 6 million in that picture there. 00:07:47.850 --> 00:07:51.720 align:middle line:84% So when you hear the unemployment or the unemployment 00:07:51.720 --> 00:07:55.910 align:middle line:84% rate, you're really talking about these people here. 00:07:55.910 --> 00:07:58.030 align:middle line:84% And when you hear about the unemployment rate 00:07:58.030 --> 00:08:00.970 align:middle line:84% is these people not divided over total population, 00:08:00.970 --> 00:08:04.300 align:middle line:84% but is these people divided by the civilian labor force. 00:08:04.300 --> 00:08:05.470 align:middle line:90% OK, so that's a picture. 00:08:05.470 --> 00:08:08.590 align:middle line:90% 00:08:08.590 --> 00:08:11.800 align:middle line:84% The most recent numbers we have about that kind of statistics 00:08:11.800 --> 00:08:15.310 align:middle line:90% is here you have them. 00:08:15.310 --> 00:08:19.400 align:middle line:84% I mean, the unemployment rate in the US today is about 3.4%. 00:08:19.400 --> 00:08:20.140 align:middle line:90% That's very low. 00:08:20.140 --> 00:08:23.800 align:middle line:84% I'll show you historical data in a minute and a half shown 00:08:23.800 --> 00:08:27.640 align:middle line:84% you historical data in the recent past. 00:08:27.640 --> 00:08:30.370 align:middle line:84% But this number is very, very low. 00:08:30.370 --> 00:08:35.179 align:middle line:84% The change in the unemployment level-- 00:08:35.179 --> 00:08:36.679 align:middle line:90% this is for January-- 00:08:36.679 --> 00:08:38.480 align:middle line:90% was a reduction. 00:08:38.480 --> 00:08:39.600 align:middle line:90% This is not rate. 00:08:39.600 --> 00:08:44.393 align:middle line:84% This is number of people that were-- 00:08:44.393 --> 00:08:46.310 align:middle line:84% it's not number of people that were unemployed 00:08:46.310 --> 00:08:47.240 align:middle line:90% that are no longer so. 00:08:47.240 --> 00:08:50.240 align:middle line:84% You look at the total stock of unemployed in December and then 00:08:50.240 --> 00:08:54.170 align:middle line:84% you look at the total stock of unemployed in January 2023, 00:08:54.170 --> 00:08:58.400 align:middle line:84% the difference between these two is 28,000 workers. 00:08:58.400 --> 00:09:03.080 align:middle line:84% So 28,000 less workers are in the unemployment pool. 00:09:03.080 --> 00:09:06.110 align:middle line:84% Now notice that how this number is made. 00:09:06.110 --> 00:09:11.790 align:middle line:84% It's not that you 25,000, 28,000 people just gain a job. 00:09:11.790 --> 00:09:13.040 align:middle line:90% That's not what happened. 00:09:13.040 --> 00:09:19.340 align:middle line:84% What happens is first employment, 895,000, 00:09:19.340 --> 00:09:22.020 align:middle line:90% 894,000 people got a job-- 00:09:22.020 --> 00:09:23.390 align:middle line:90% much bigger number. 00:09:23.390 --> 00:09:33.650 align:middle line:84% But also, the civilian labor force went up by 866,000 people. 00:09:33.650 --> 00:09:36.870 align:middle line:84% So if you go back to this picture, 00:09:36.870 --> 00:09:40.580 align:middle line:84% what you have in January, or the numbers reported in January-- 00:09:40.580 --> 00:09:43.460 align:middle line:84% I do not know which month they correspond to exactly-- 00:09:43.460 --> 00:09:47.180 align:middle line:90% is that yes, this decline. 00:09:47.180 --> 00:09:52.730 align:middle line:84% But that decline was made of a big increase in employment 00:09:52.730 --> 00:09:56.060 align:middle line:84% together with a big increase in the civilian labor force. 00:09:56.060 --> 00:09:59.000 align:middle line:84% So that must have been mostly movement out of the labor force 00:09:59.000 --> 00:10:01.250 align:middle line:84% and probably had something to do-- well, 00:10:01.250 --> 00:10:02.940 align:middle line:84% I'm not going to get into that here. 00:10:02.940 --> 00:10:08.150 align:middle line:84% But all these numbers are seasonally adjusted. 00:10:08.150 --> 00:10:10.700 align:middle line:84% So they are corrected relative to what happens normally 00:10:10.700 --> 00:10:12.170 align:middle line:90% in January and so on. 00:10:12.170 --> 00:10:16.628 align:middle line:84% And COVID and weather can derail a lot 00:10:16.628 --> 00:10:18.170 align:middle line:84% what happens in January and February. 00:10:18.170 --> 00:10:19.910 align:middle line:90% Numbers tend to be very noisy. 00:10:19.910 --> 00:10:21.470 align:middle line:84% Since COVID they have been very noisy 00:10:21.470 --> 00:10:23.690 align:middle line:84% because the seasonal adjustments are different. 00:10:23.690 --> 00:10:26.840 align:middle line:84% And also, weather matters a lot in January and February, 00:10:26.840 --> 00:10:27.340 align:middle line:90% and so on. 00:10:27.340 --> 00:10:29.007 align:middle line:84% So you can get pretty large fluctuations 00:10:29.007 --> 00:10:31.550 align:middle line:84% which are really not that interesting to macroeconomists. 00:10:31.550 --> 00:10:34.130 align:middle line:84% But anyways, those are the numbers. 00:10:34.130 --> 00:10:36.680 align:middle line:84% You look at the civilian labor force participation. 00:10:36.680 --> 00:10:39.830 align:middle line:90% Then it was about 62%, 62.5%. 00:10:39.830 --> 00:10:44.540 align:middle line:84% And the employment population ratio is of the order of 60%. 00:10:44.540 --> 00:10:46.220 align:middle line:84% So the employment population ratio 00:10:46.220 --> 00:10:50.780 align:middle line:84% is just this divided by total population. 00:10:50.780 --> 00:10:53.570 align:middle line:90% 00:10:53.570 --> 00:10:57.330 align:middle line:90% And those are the averages. 00:10:57.330 --> 00:10:59.640 align:middle line:84% The number of unemployed in 2022, 00:10:59.640 --> 00:11:04.300 align:middle line:84% about 6 million people that's unemployed. 00:11:04.300 --> 00:11:07.240 align:middle line:84% So there you have the unemployment rate. 00:11:07.240 --> 00:11:08.890 align:middle line:84% And it moves, as you would expect it. 00:11:08.890 --> 00:11:11.860 align:middle line:84% It typically goes up in recessions. 00:11:11.860 --> 00:11:15.430 align:middle line:84% The last sort of large recession we had big swings. 00:11:15.430 --> 00:11:18.040 align:middle line:84% One thing that was interesting, and we couldn't quite 00:11:18.040 --> 00:11:20.560 align:middle line:84% understand what was going on, is that we noticed right 00:11:20.560 --> 00:11:22.600 align:middle line:84% before COVID the unemployment rate had already 00:11:22.600 --> 00:11:24.530 align:middle line:90% declined to very low levels. 00:11:24.530 --> 00:11:26.590 align:middle line:84% And so people were wondering whether something 00:11:26.590 --> 00:11:28.960 align:middle line:84% was going to talk about later in this lecture, 00:11:28.960 --> 00:11:30.790 align:middle line:84% whether the natural rate of unemployment 00:11:30.790 --> 00:11:34.310 align:middle line:90% had changed for some reason. 00:11:34.310 --> 00:11:36.020 align:middle line:90% We'll come back to that. 00:11:36.020 --> 00:11:40.520 align:middle line:84% Then we got COVID, obviously a very recessionary shock 00:11:40.520 --> 00:11:43.410 align:middle line:84% initially, massive unemployment and so on. 00:11:43.410 --> 00:11:45.110 align:middle line:84% But then it came back very quickly. 00:11:45.110 --> 00:11:48.320 align:middle line:84% And today we have record low levels of unemployment. 00:11:48.320 --> 00:11:52.460 align:middle line:84% We haven't seen numbers like this since the '60s really-- 00:11:52.460 --> 00:11:54.110 align:middle line:90% very low levels of unemployment. 00:11:54.110 --> 00:11:59.210 align:middle line:84% So one of the things that when you hear the FOMC 00:11:59.210 --> 00:12:02.570 align:middle line:84% members talking about the labor markets being very tight, 00:12:02.570 --> 00:12:04.910 align:middle line:84% well, one of the things they're looking at is this one. 00:12:04.910 --> 00:12:06.827 align:middle line:84% There are other statistics that I'll show you. 00:12:06.827 --> 00:12:08.330 align:middle line:90% But this is one of them. 00:12:08.330 --> 00:12:10.310 align:middle line:84% Unemployment rate is really, really low. 00:12:10.310 --> 00:12:12.890 align:middle line:90% 00:12:12.890 --> 00:12:16.670 align:middle line:84% Sometimes, again, especially post-COVID because of movements 00:12:16.670 --> 00:12:21.020 align:middle line:84% in and out of the labor force, the unemployment rate 00:12:21.020 --> 00:12:23.960 align:middle line:84% is not such a great statistic, not as reliable 00:12:23.960 --> 00:12:25.860 align:middle line:84% because many people left the labor force. 00:12:25.860 --> 00:12:28.910 align:middle line:84% So people look a lot at the employment rate. 00:12:28.910 --> 00:12:32.000 align:middle line:90% 00:12:32.000 --> 00:12:35.190 align:middle line:84% This is not the employment population ratio. 00:12:35.190 --> 00:12:37.430 align:middle line:84% Its employment rate-- so employed 00:12:37.430 --> 00:12:42.260 align:middle line:84% over the non civilian population. 00:12:42.260 --> 00:12:45.080 align:middle line:90% 00:12:45.080 --> 00:12:49.610 align:middle line:84% And that number, you can see, we have discussed this before, 00:12:49.610 --> 00:12:52.130 align:middle line:84% was trending up here because of the increase in the labor 00:12:52.130 --> 00:12:54.470 align:middle line:84% participation of women, then it came down, 00:12:54.470 --> 00:12:57.560 align:middle line:84% had a lot to do with the students and things like that, 00:12:57.560 --> 00:12:58.370 align:middle line:90% systematically. 00:12:58.370 --> 00:13:00.140 align:middle line:84% But then it was climbing up enormously. 00:13:00.140 --> 00:13:02.330 align:middle line:90% It collapsed during COVID. 00:13:02.330 --> 00:13:09.230 align:middle line:84% That's mostly unemployment and people out of the labor force. 00:13:09.230 --> 00:13:10.850 align:middle line:90% And then recovery. 00:13:10.850 --> 00:13:14.040 align:middle line:84% But the recovery has not picked up to back to the trend. 00:13:14.040 --> 00:13:18.140 align:middle line:84% So we are back to more or less the levels we had before COVID, 00:13:18.140 --> 00:13:20.228 align:middle line:84% but we're certainly off the trend. 00:13:20.228 --> 00:13:22.520 align:middle line:84% And one of the reasons the labor markets are very tight 00:13:22.520 --> 00:13:28.700 align:middle line:84% is that we haven't recovered the employment 00:13:28.700 --> 00:13:31.520 align:middle line:90% rate that we used to have. 00:13:31.520 --> 00:13:35.840 align:middle line:84% This has to do with migration flows, with a variety of things. 00:13:35.840 --> 00:13:38.720 align:middle line:90% But that's the issue. 00:13:38.720 --> 00:13:41.120 align:middle line:90% OK, so that's sort of-- 00:13:41.120 --> 00:13:43.730 align:middle line:84% those are very static pictures of the labor market. 00:13:43.730 --> 00:13:45.740 align:middle line:84% What is the stock of unemployment at one point? 00:13:45.740 --> 00:13:48.570 align:middle line:84% What is the unemployment rate, and so on and so forth. 00:13:48.570 --> 00:13:50.840 align:middle line:84% But the truth is that labor markets 00:13:50.840 --> 00:13:56.080 align:middle line:84% are very dynamic, especially in an economy like the US. 00:13:56.080 --> 00:13:58.100 align:middle line:90% The flows are very large. 00:13:58.100 --> 00:14:00.430 align:middle line:84% So what I have there-- and I don't know for which state 00:14:00.430 --> 00:14:03.730 align:middle line:84% this is in the book-- but the pictures look more or less 00:14:03.730 --> 00:14:05.800 align:middle line:84% the same for the point I want to make. 00:14:05.800 --> 00:14:08.530 align:middle line:90% This is monthly labor flows. 00:14:08.530 --> 00:14:10.750 align:middle line:84% And this has happened in some months-- 00:14:10.750 --> 00:14:13.720 align:middle line:84% I don't care, 2018, at some point. 00:14:13.720 --> 00:14:16.110 align:middle line:90% Look at what happened there. 00:14:16.110 --> 00:14:16.890 align:middle line:90% You have this. 00:14:16.890 --> 00:14:18.600 align:middle line:84% We're talking about the stocks recently. 00:14:18.600 --> 00:14:21.570 align:middle line:84% So employment in that month was of the order 00:14:21.570 --> 00:14:27.200 align:middle line:90% of 132 million people. 00:14:27.200 --> 00:14:29.960 align:middle line:84% Out of the labor force, about 79 million people. 00:14:29.960 --> 00:14:32.745 align:middle line:90% Unemployed, about 8.6 million. 00:14:32.745 --> 00:14:33.620 align:middle line:90% Those are the stocks. 00:14:33.620 --> 00:14:37.550 align:middle line:84% Those were the type of numbers I was showing you before. 00:14:37.550 --> 00:14:39.800 align:middle line:90% But look at these arrows. 00:14:39.800 --> 00:14:41.010 align:middle line:90% These are flows. 00:14:41.010 --> 00:14:44.390 align:middle line:84% So in every single month, you see in the US 00:14:44.390 --> 00:14:47.600 align:middle line:84% about 3 million people that move from one job to another. 00:14:47.600 --> 00:14:50.010 align:middle line:90% So employment to employment. 00:14:50.010 --> 00:14:53.490 align:middle line:84% You see about 1.8 million that moved from employment 00:14:53.490 --> 00:14:57.250 align:middle line:84% to unemployment and about 2 million people 00:14:57.250 --> 00:15:02.530 align:middle line:84% that move from unemployment to employment, large flows. 00:15:02.530 --> 00:15:05.650 align:middle line:84% Not only so, not everything goes to unemployment to employment. 00:15:05.650 --> 00:15:08.200 align:middle line:84% There are people are also moving out of the labor force 00:15:08.200 --> 00:15:11.950 align:middle line:84% and into the labor force into an employment, into employment. 00:15:11.950 --> 00:15:14.950 align:middle line:84% Here in this particular case, out the flow, 00:15:14.950 --> 00:15:18.930 align:middle line:84% out of the labor force into employment is 3.4 million. 00:15:18.930 --> 00:15:22.190 align:middle line:84% Flows from employment, without going through unemployment 00:15:22.190 --> 00:15:25.850 align:middle line:84% without the labor force, 3.7 million. 00:15:25.850 --> 00:15:29.690 align:middle line:84% During COVID, this must have been a very thick arrow, 00:15:29.690 --> 00:15:32.840 align:middle line:84% lots of people move out from employment to out of the labor 00:15:32.840 --> 00:15:34.490 align:middle line:90% force. 00:15:34.490 --> 00:15:36.740 align:middle line:84% And one of the problems the economy has 00:15:36.740 --> 00:15:39.290 align:middle line:84% had in the recovery on the labor market side 00:15:39.290 --> 00:15:44.150 align:middle line:84% is that this arrow hasn't been as strong as we would want it. 00:15:44.150 --> 00:15:47.540 align:middle line:84% This arrow or this arrow for that matter of fact-- people 00:15:47.540 --> 00:15:49.580 align:middle line:84% coming out of the labor force into unemployment. 00:15:49.580 --> 00:15:50.780 align:middle line:90% That's also a big flow. 00:15:50.780 --> 00:15:52.590 align:middle line:84% Sometimes people are not working. 00:15:52.590 --> 00:15:55.310 align:middle line:84% And then they decide they run out of unemployment insurance 00:15:55.310 --> 00:15:56.340 align:middle line:90% or something like that. 00:15:56.340 --> 00:15:58.280 align:middle line:84% And so they decide to start looking. 00:15:58.280 --> 00:16:04.220 align:middle line:84% And they move into unemployment here, or they run out of savings 00:16:04.220 --> 00:16:06.440 align:middle line:90% and they have to come back. 00:16:06.440 --> 00:16:08.150 align:middle line:84% And they may not find a job initially. 00:16:08.150 --> 00:16:10.940 align:middle line:84% They have to go through unemployment. 00:16:10.940 --> 00:16:14.570 align:middle line:84% So point is that these flows are very large. 00:16:14.570 --> 00:16:21.240 align:middle line:84% And these flows matter a lot for the kind 00:16:21.240 --> 00:16:24.210 align:middle line:84% of things we want to talk about in this course. 00:16:24.210 --> 00:16:26.710 align:middle line:90% Look at what we have here. 00:16:26.710 --> 00:16:28.830 align:middle line:84% The red line is the unemployment rate 00:16:28.830 --> 00:16:32.220 align:middle line:84% and it's measured on the left axis. 00:16:32.220 --> 00:16:34.430 align:middle line:84% And what we have here in the blue line 00:16:34.430 --> 00:16:37.220 align:middle line:90% is measured in an inverse scale. 00:16:37.220 --> 00:16:41.030 align:middle line:84% Look at this-- this goes up as you go down-- 00:16:41.030 --> 00:16:46.365 align:middle line:84% is the percentage of unemployed workers becoming employed. 00:16:46.365 --> 00:16:48.910 align:middle line:90% 00:16:48.910 --> 00:16:51.140 align:middle line:84% So it's the job finding rate from unemployment. 00:16:51.140 --> 00:16:52.910 align:middle line:90% So you have unemployed people. 00:16:52.910 --> 00:16:55.217 align:middle line:90% And they will be finding jobs. 00:16:55.217 --> 00:16:56.300 align:middle line:90% They are looking for jobs. 00:16:56.300 --> 00:16:57.880 align:middle line:90% And they will be finding jobs. 00:16:57.880 --> 00:17:03.040 align:middle line:84% This number here, this blue line here, shows you the likelihood 00:17:03.040 --> 00:17:07.020 align:middle line:84% that they'll find a job in inverted scale. 00:17:07.020 --> 00:17:10.970 align:middle line:84% OK, so what correlation do you notice there? 00:17:10.970 --> 00:17:17.940 align:middle line:90% 00:17:17.940 --> 00:17:21.540 align:middle line:84% I mean, you know, it's very tight. 00:17:21.540 --> 00:17:22.319 align:middle line:90% Yeah. 00:17:22.319 --> 00:17:24.150 align:middle line:84% AUDIENCE: There's a percent of people 00:17:24.150 --> 00:17:27.010 align:middle line:84% that get a job each month is smaller, 00:17:27.010 --> 00:17:28.995 align:middle line:84% there's more people without a job. 00:17:28.995 --> 00:17:30.120 align:middle line:90% RICARDO CABALLERO: Exactly. 00:17:30.120 --> 00:17:33.890 align:middle line:84% That means when the unemployment rate is high, 00:17:33.890 --> 00:17:37.590 align:middle line:84% it is harder for unemployed workers to find a job. 00:17:37.590 --> 00:17:40.080 align:middle line:84% Or another way of a direct implication 00:17:40.080 --> 00:17:42.060 align:middle line:84% of that is the typical unemployed worker 00:17:42.060 --> 00:17:43.707 align:middle line:84% will spend more time in unemployment, 00:17:43.707 --> 00:17:45.540 align:middle line:84% because they're going to be looking for jobs 00:17:45.540 --> 00:17:47.513 align:middle line:90% and it's harder to get a job. 00:17:47.513 --> 00:17:49.680 align:middle line:84% So you're going to be looking for a job for a longer 00:17:49.680 --> 00:17:51.320 align:middle line:90% period of time. 00:17:51.320 --> 00:17:53.470 align:middle line:84% Why are we talking about these things? 00:17:53.470 --> 00:17:57.910 align:middle line:84% Well, because of these type of reasons. 00:17:57.910 --> 00:18:00.850 align:middle line:84% Well, this means that when unemployment is high, 00:18:00.850 --> 00:18:04.648 align:middle line:84% workers are worse off in at least two ways. 00:18:04.648 --> 00:18:06.190 align:middle line:84% And there are two ways that are going 00:18:06.190 --> 00:18:08.540 align:middle line:84% to be important for what I'll say next. 00:18:08.540 --> 00:18:11.627 align:middle line:84% One is that the employed workers face a higher 00:18:11.627 --> 00:18:12.710 align:middle line:90% probability of losing job. 00:18:12.710 --> 00:18:14.793 align:middle line:84% That's what happens when unemployment-- the reason 00:18:14.793 --> 00:18:18.050 align:middle line:84% unemployment gets to be high is because firms are firing 00:18:18.050 --> 00:18:20.690 align:middle line:90% workers and so on and so forth. 00:18:20.690 --> 00:18:25.370 align:middle line:84% And so when unemployment is high, 00:18:25.370 --> 00:18:27.260 align:middle line:84% the first thing the workers know is 00:18:27.260 --> 00:18:29.870 align:middle line:84% that it's very likely that they'll lose their job, 00:18:29.870 --> 00:18:33.690 align:middle line:84% more likely that they'll lose their job. 00:18:33.690 --> 00:18:36.350 align:middle line:84% But the second channel, which is what this picture highlights 00:18:36.350 --> 00:18:38.930 align:middle line:84% here, is that if you fall unemployment, 00:18:38.930 --> 00:18:43.310 align:middle line:84% it's going to be a lot harder to get out of unemployment. 00:18:43.310 --> 00:18:45.470 align:middle line:84% So when unemployment is high, it's 00:18:45.470 --> 00:18:47.490 align:middle line:84% scary for workers for two reasons. 00:18:47.490 --> 00:18:50.210 align:middle line:84% One, you're more likely to lose a job because you're 00:18:50.210 --> 00:18:51.920 align:middle line:84% capturing recessionary conditions and so 00:18:51.920 --> 00:18:52.700 align:middle line:90% on in the economy. 00:18:52.700 --> 00:18:54.860 align:middle line:84% But second, if you end up in unemployment, 00:18:54.860 --> 00:18:59.620 align:middle line:84% it's going to be hard to get out of it 00:18:59.620 --> 00:19:02.610 align:middle line:84% And later on, this unemployment rate 00:19:02.610 --> 00:19:05.610 align:middle line:84% is going to show up in wage bargaining. 00:19:05.610 --> 00:19:09.880 align:middle line:84% And the main reason is going to show up is of this kind. 00:19:09.880 --> 00:19:11.932 align:middle line:84% And also think about the other side. 00:19:11.932 --> 00:19:14.140 align:middle line:84% When there's bargaining, there's two in a bargaining. 00:19:14.140 --> 00:19:16.630 align:middle line:84% There's going to be firm and workers. 00:19:16.630 --> 00:19:20.230 align:middle line:84% From the firm point of view if there's a lot of unemployment, 00:19:20.230 --> 00:19:24.850 align:middle line:84% do you think it's hard or easy to find a worker, 00:19:24.850 --> 00:19:30.200 align:middle line:84% to replace a worker that decides to leave for whatever reason? 00:19:30.200 --> 00:19:30.787 align:middle line:90% Yes. 00:19:30.787 --> 00:19:32.370 align:middle line:84% We have lots of people to choose from. 00:19:32.370 --> 00:19:33.630 align:middle line:90% So it becomes easy. 00:19:33.630 --> 00:19:38.890 align:middle line:84% So unemployment is high, workers are more scared. 00:19:38.890 --> 00:19:42.700 align:middle line:84% If they get out, they're scared of losing the job. 00:19:42.700 --> 00:19:45.740 align:middle line:84% If they get out, it's hard to get a job. 00:19:45.740 --> 00:19:48.520 align:middle line:84% And on the other side, the firms, for the firms, 00:19:48.520 --> 00:19:51.220 align:middle line:84% it's not that scary to lose a worker because it's fairly 00:19:51.220 --> 00:19:53.490 align:middle line:90% easy to replace that worker. 00:19:53.490 --> 00:19:56.880 align:middle line:84% Today, firms are very worried about losing their workers 00:19:56.880 --> 00:19:57.990 align:middle line:90% in some sectors. 00:19:57.990 --> 00:19:59.970 align:middle line:84% In some sectors are getting rid of workers. 00:19:59.970 --> 00:20:02.340 align:middle line:84% But if you run a restaurant, you're 00:20:02.340 --> 00:20:05.572 align:middle line:84% very scared of losing your workers 00:20:05.572 --> 00:20:07.530 align:middle line:84% because it's going to be very difficult to find 00:20:07.530 --> 00:20:09.390 align:middle line:90% a replacement for that worker. 00:20:09.390 --> 00:20:13.050 align:middle line:84% Surprise, surprise, wages in that industry 00:20:13.050 --> 00:20:16.550 align:middle line:90% are going up a lot. 00:20:16.550 --> 00:20:17.880 align:middle line:90% We're going to get there. 00:20:17.880 --> 00:20:21.470 align:middle line:84% So that's what comes next-- wage determination. 00:20:21.470 --> 00:20:23.660 align:middle line:84% Look at what I'm trying to build here. 00:20:23.660 --> 00:20:25.280 align:middle line:84% I'm starting from telling you stories 00:20:25.280 --> 00:20:28.550 align:middle line:84% about the labor market, what things are important for workers 00:20:28.550 --> 00:20:29.550 align:middle line:90% and so on. 00:20:29.550 --> 00:20:31.970 align:middle line:84% Now I'm going to get into wage determination. 00:20:31.970 --> 00:20:34.070 align:middle line:84% And obviously the variables I talked 00:20:34.070 --> 00:20:36.920 align:middle line:84% about are going to be important in this way determination. 00:20:36.920 --> 00:20:39.690 align:middle line:84% But my ultimate goal is to talk about inflation. 00:20:39.690 --> 00:20:40.800 align:middle line:90% So the next step-- 00:20:40.800 --> 00:20:43.110 align:middle line:84% so I'm going to talk about wage determination here. 00:20:43.110 --> 00:20:44.840 align:middle line:84% And then we want to talk about prices. 00:20:44.840 --> 00:20:47.510 align:middle line:84% And there we're going to be one step closer 00:20:47.510 --> 00:20:49.010 align:middle line:90% to talking about inflation 00:20:49.010 --> 00:20:52.010 align:middle line:84% OK, so let's go through the intermediate step, wage 00:20:52.010 --> 00:20:54.510 align:middle line:90% determination. 00:20:54.510 --> 00:20:58.280 align:middle line:84% And so just to give you a little background, 00:20:58.280 --> 00:21:04.070 align:middle line:84% sometimes wages are set by collective bargaining, unions, 00:21:04.070 --> 00:21:05.030 align:middle line:90% in particular. 00:21:05.030 --> 00:21:08.343 align:middle line:84% Now, in the US unions are not a big thing. 00:21:08.343 --> 00:21:10.010 align:middle line:84% They were a much bigger thing many years 00:21:10.010 --> 00:21:13.040 align:middle line:90% back than they are today. 00:21:13.040 --> 00:21:17.150 align:middle line:84% In other economies they are a big thing-- 00:21:17.150 --> 00:21:21.280 align:middle line:90% Japan and Europe. 00:21:21.280 --> 00:21:24.160 align:middle line:84% And the unions can happen at different levels of aggregation, 00:21:24.160 --> 00:21:26.800 align:middle line:84% at the level of the firm, at the level of the sector, 00:21:26.800 --> 00:21:31.650 align:middle line:90% and you name it. 00:21:31.650 --> 00:21:34.830 align:middle line:84% In general, regardless of the level of unionization 00:21:34.830 --> 00:21:38.100 align:middle line:84% you have in a country or in a sector, 00:21:38.100 --> 00:21:40.740 align:middle line:84% the higher the skill needed to do a job, the more likely 00:21:40.740 --> 00:21:43.800 align:middle line:84% it is that bargaining takes place between an individual, 00:21:43.800 --> 00:21:47.850 align:middle line:84% between an employer, and an individual, rather than a union, 00:21:47.850 --> 00:21:51.300 align:middle line:84% because it's sort of much more idiosyncratic and customized 00:21:51.300 --> 00:21:52.740 align:middle line:90% and so on. 00:21:52.740 --> 00:21:57.620 align:middle line:84% But either way, regardless of whether wages 00:21:57.620 --> 00:22:01.530 align:middle line:84% are set at a collective level or at an individual level, 00:22:01.530 --> 00:22:07.220 align:middle line:84% the main macroeconomic drivers of wages 00:22:07.220 --> 00:22:09.692 align:middle line:90% are similar across both of them. 00:22:09.692 --> 00:22:11.900 align:middle line:84% Of course, the particulars are going to be different. 00:22:11.900 --> 00:22:15.090 align:middle line:84% Even the dynamics can be different and so on. 00:22:15.090 --> 00:22:17.960 align:middle line:84% But the big drivers, the big macro drivers, 00:22:17.960 --> 00:22:20.270 align:middle line:84% are similar, regardless of the bargaining 00:22:20.270 --> 00:22:22.793 align:middle line:84% mode you have at the level which happens, and so on. 00:22:22.793 --> 00:22:25.085 align:middle line:84% And those are the things we're going to highlight here. 00:22:25.085 --> 00:22:28.520 align:middle line:90% 00:22:28.520 --> 00:22:34.070 align:middle line:84% So a fact of life is that workers' wages typically 00:22:34.070 --> 00:22:36.790 align:middle line:90% exceed the reservation wage. 00:22:36.790 --> 00:22:39.040 align:middle line:84% Now, what does it mean the reservation wage? 00:22:39.040 --> 00:22:40.972 align:middle line:84% The reservation wage is a wage that 00:22:40.972 --> 00:22:43.430 align:middle line:84% would leave you indifferent between employed or unemployed. 00:22:43.430 --> 00:22:45.850 align:middle line:84% It doesn't mean, it's a nice wage or anything. 00:22:45.850 --> 00:22:48.082 align:middle line:90% 00:22:48.082 --> 00:22:50.040 align:middle line:84% And certainly it doesn't mean that you wouldn't 00:22:50.040 --> 00:22:51.780 align:middle line:90% prefer to have a higher wage. 00:22:51.780 --> 00:22:54.960 align:middle line:84% But it tells you that, look, at that wage you'd rather 00:22:54.960 --> 00:22:57.530 align:middle line:90% be employed than unemployed. 00:22:57.530 --> 00:22:59.930 align:middle line:84% And there is a way, long list of reasons 00:22:59.930 --> 00:23:03.585 align:middle line:84% why that ends up being the equilibrium type wage. 00:23:03.585 --> 00:23:05.210 align:middle line:84% And I'm not going to discuss them here. 00:23:05.210 --> 00:23:08.810 align:middle line:90% But take it as a fact for now. 00:23:08.810 --> 00:23:12.110 align:middle line:84% So workers preferred to be employed. 00:23:12.110 --> 00:23:14.030 align:middle line:84% They may take the risk of becoming unemployed. 00:23:14.030 --> 00:23:18.510 align:middle line:84% But they typically prefer to be employed. 00:23:18.510 --> 00:23:24.710 align:middle line:84% And now wages-- and this is where it becomes important, 00:23:24.710 --> 00:23:26.540 align:middle line:90% interesting for us in macro-- 00:23:26.540 --> 00:23:30.560 align:middle line:84% is the wages that are finally set 00:23:30.560 --> 00:23:34.380 align:middle line:84% depend on labor market conditions. 00:23:34.380 --> 00:23:39.140 align:middle line:84% So very clearly, the lowest unemployment rate, the higher 00:23:39.140 --> 00:23:41.150 align:middle line:90% the wages will tend to be. 00:23:41.150 --> 00:23:42.493 align:middle line:90% And you're seeing it now. 00:23:42.493 --> 00:23:43.910 align:middle line:84% The unemployment rate is very low. 00:23:43.910 --> 00:23:46.830 align:middle line:90% Wages are rising a lot. 00:23:46.830 --> 00:23:50.250 align:middle line:84% And workers' bargaining power depends, 00:23:50.250 --> 00:23:52.590 align:middle line:84% again, there's a huge literature on these things 00:23:52.590 --> 00:23:58.520 align:middle line:84% and just compressing it into the bare minimum. 00:23:58.520 --> 00:24:00.350 align:middle line:84% And the bargaining power of our workers 00:24:00.350 --> 00:24:02.000 align:middle line:84% are things that we already discuss. 00:24:02.000 --> 00:24:04.100 align:middle line:84% Well, it depends on how costly for the firm 00:24:04.100 --> 00:24:05.120 align:middle line:90% to find the workers. 00:24:05.120 --> 00:24:07.040 align:middle line:84% So obviously, if unemployment is very high, 00:24:07.040 --> 00:24:09.590 align:middle line:84% it's very easy for firms to find a worker. 00:24:09.590 --> 00:24:11.690 align:middle line:84% That's not good for the bargaining of a worker. 00:24:11.690 --> 00:24:13.830 align:middle line:84% If you want to bargain with your employer 00:24:13.830 --> 00:24:17.045 align:middle line:84% and there lots of people like you out there, 00:24:17.045 --> 00:24:19.170 align:middle line:84% you're not going to have a lot of bargaining power. 00:24:19.170 --> 00:24:21.045 align:middle line:84% So it's unlikely that you're going to come up 00:24:21.045 --> 00:24:23.660 align:middle line:90% with a very high wage. 00:24:23.660 --> 00:24:25.370 align:middle line:84% And it's also, the other side of it 00:24:25.370 --> 00:24:27.890 align:middle line:84% is how hard is for workers to find another job if they 00:24:27.890 --> 00:24:29.120 align:middle line:90% were to leave the firms. 00:24:29.120 --> 00:24:31.620 align:middle line:84% I mean, if you know that there are lots of jobs like the one 00:24:31.620 --> 00:24:34.850 align:middle line:84% you currently have out there, which are not occupied-- 00:24:34.850 --> 00:24:37.017 align:middle line:90% so there's empty, vacant, jobs-- 00:24:37.017 --> 00:24:39.350 align:middle line:84% then you probably are going to have a much stronger hand 00:24:39.350 --> 00:24:41.370 align:middle line:84% with your employer because you can say, OK, 00:24:41.370 --> 00:24:44.510 align:middle line:84% if you don't pay me what I want, I move to the next door. 00:24:44.510 --> 00:24:46.670 align:middle line:84% And in terms of the macroeconomic variables 00:24:46.670 --> 00:24:49.010 align:middle line:84% we care about, a situation like that 00:24:49.010 --> 00:24:51.050 align:middle line:84% is very likely to happen when unemployment 00:24:51.050 --> 00:24:57.560 align:middle line:84% is very low because that means that other jobs are 00:24:57.560 --> 00:25:00.827 align:middle line:84% unlikely to be filled because there are lots of people looking 00:25:00.827 --> 00:25:02.660 align:middle line:84% for things, but it's difficult for the firms 00:25:02.660 --> 00:25:04.610 align:middle line:90% to find the workers. 00:25:04.610 --> 00:25:08.030 align:middle line:84% And therefore, you're going to be a lot more attractive 00:25:08.030 --> 00:25:11.330 align:middle line:90% to that labor market. 00:25:11.330 --> 00:25:15.770 align:middle line:84% So in summary, at the aggregate level, 00:25:15.770 --> 00:25:20.820 align:middle line:84% we can write a wage setting equation of this form. 00:25:20.820 --> 00:25:24.380 align:middle line:84% So the wage-- and this is a nominal wage-- 00:25:24.380 --> 00:25:29.990 align:middle line:84% can be written as an increasing function of the expected price, 00:25:29.990 --> 00:25:33.290 align:middle line:84% meaning wages are not set, in most professions, 00:25:33.290 --> 00:25:35.030 align:middle line:84% they are not set second by second. 00:25:35.030 --> 00:25:37.260 align:middle line:84% You bargain for a wage and so on. 00:25:37.260 --> 00:25:42.840 align:middle line:84% And that thing sticks for a year or so at least. 00:25:42.840 --> 00:25:48.480 align:middle line:84% Well, obviously if you expect, if inflation is zero, 00:25:48.480 --> 00:25:51.870 align:middle line:84% you're going to demand a wage that is more or less what 00:25:51.870 --> 00:25:54.130 align:middle line:90% you need today. 00:25:54.130 --> 00:25:58.060 align:middle line:84% If inflation is 10%, you say, well, I'm 00:25:58.060 --> 00:26:00.820 align:middle line:84% going to have to demand a higher wage because I have 00:26:00.820 --> 00:26:02.290 align:middle line:84% to live with this wage for a year 00:26:02.290 --> 00:26:06.550 align:middle line:84% and prices are going to be rising when I have this wage. 00:26:06.550 --> 00:26:08.410 align:middle line:84% So if they expect lots of inflation, 00:26:08.410 --> 00:26:11.110 align:middle line:84% if I expect prices to be high in the future, 00:26:11.110 --> 00:26:13.120 align:middle line:84% then I'm going to ask for a higher nominal wage 00:26:13.120 --> 00:26:15.130 align:middle line:84% today because I'm going to have to live 00:26:15.130 --> 00:26:19.960 align:middle line:84% with that wage on average for the next year or so. 00:26:19.960 --> 00:26:22.072 align:middle line:84% So that's the first thing, and it's 00:26:22.072 --> 00:26:23.530 align:middle line:84% going to play an important role, is 00:26:23.530 --> 00:26:26.680 align:middle line:84% that wages are an increasing function on the price level 00:26:26.680 --> 00:26:27.880 align:middle line:90% workers expect. 00:26:27.880 --> 00:26:30.010 align:middle line:84% They expect a higher price level in the future 00:26:30.010 --> 00:26:32.120 align:middle line:84% or during the life of the wage contract, 00:26:32.120 --> 00:26:35.020 align:middle line:84% then they obviously are going to demand a higher wage, 00:26:35.020 --> 00:26:36.220 align:middle line:90% other things equal. 00:26:36.220 --> 00:26:37.630 align:middle line:90% What are other things? 00:26:37.630 --> 00:26:40.840 align:middle line:84% Well, the arguments of this function here-- 00:26:40.840 --> 00:26:43.540 align:middle line:90% unemployment. 00:26:43.540 --> 00:26:47.590 align:middle line:84% For any given expected price, if the unemployment rate is high, 00:26:47.590 --> 00:26:50.000 align:middle line:84% workers are going to demand a lower wage. 00:26:50.000 --> 00:26:50.860 align:middle line:90% Why is that? 00:26:50.860 --> 00:26:57.630 align:middle line:90% 00:26:57.630 --> 00:27:00.330 align:middle line:84% AUDIENCE: Because it's going to be harder for them to find a job 00:27:00.330 --> 00:27:01.788 align:middle line:84% so they have less bargaining power. 00:27:01.788 --> 00:27:04.610 align:middle line:84% RICARDO CABALLERO: And they have less bargaining power, exactly. 00:27:04.610 --> 00:27:07.670 align:middle line:84% And so they're going to demand a lower wage. 00:27:07.670 --> 00:27:14.330 align:middle line:84% This variable, z, here is a catch all variable for strength, 00:27:14.330 --> 00:27:17.300 align:middle line:84% workers' strength in the bargaining position situation, 00:27:17.300 --> 00:27:18.330 align:middle line:90% something like that. 00:27:18.330 --> 00:27:25.790 align:middle line:84% So for example, this is things like employment protection 00:27:25.790 --> 00:27:29.150 align:middle line:90% laws, firing costs. 00:27:29.150 --> 00:27:30.980 align:middle line:84% If it's difficult to fire someone, 00:27:30.980 --> 00:27:33.390 align:middle line:90% the z will tend to be high. 00:27:33.390 --> 00:27:36.770 align:middle line:84% So this only tells you that given the level of unemployment, 00:27:36.770 --> 00:27:40.130 align:middle line:84% if it is very hard to fire someone, 00:27:40.130 --> 00:27:46.400 align:middle line:84% workers are going to be very likely to demand a higher wage. 00:27:46.400 --> 00:27:48.260 align:middle line:90% It's hard for you to fire me. 00:27:48.260 --> 00:27:50.960 align:middle line:84% I'm going to bargain hard for my wage. 00:27:50.960 --> 00:27:54.530 align:middle line:84% And these type of institutional factors 00:27:54.530 --> 00:27:58.785 align:middle line:84% play a huge role in Europe, much more than in the US. 00:27:58.785 --> 00:28:01.640 align:middle line:90% 00:28:01.640 --> 00:28:02.160 align:middle line:90% Good. 00:28:02.160 --> 00:28:04.370 align:middle line:84% But as a matter of definition, we're 00:28:04.370 --> 00:28:07.520 align:middle line:84% going to say an increase in z, z is 00:28:07.520 --> 00:28:11.450 align:middle line:84% something that increases the bargaining power of workers. 00:28:11.450 --> 00:28:13.520 align:middle line:84% And therefore, for any given level 00:28:13.520 --> 00:28:15.530 align:middle line:84% of unemployment and expected prices, 00:28:15.530 --> 00:28:17.690 align:middle line:84% they're going to lead to a higher wage demand. 00:28:17.690 --> 00:28:21.010 align:middle line:84% This is the workers' demand in a wage. 00:28:21.010 --> 00:28:23.240 align:middle line:84% We have to figure out what happens in equilibrium. 00:28:23.240 --> 00:28:25.660 align:middle line:84% But this is what the workers are demanding. 00:28:25.660 --> 00:28:28.980 align:middle line:90% 00:28:28.980 --> 00:28:30.690 align:middle line:90% Is it clear what we have here? 00:28:30.690 --> 00:28:36.170 align:middle line:90% 00:28:36.170 --> 00:28:39.040 align:middle line:84% So let's now move to the other side. 00:28:39.040 --> 00:28:40.750 align:middle line:84% So that's one side of the scissor. 00:28:40.750 --> 00:28:41.800 align:middle line:90% We have the workers. 00:28:41.800 --> 00:28:45.220 align:middle line:84% And they given certain macroeconomic conditions 00:28:45.220 --> 00:28:48.190 align:middle line:84% summarized by the unemployment rate and expected prices. 00:28:48.190 --> 00:28:49.930 align:middle line:90% They demand certain wages. 00:28:49.930 --> 00:28:52.000 align:middle line:84% Now, we can find the equilibrium wage 00:28:52.000 --> 00:28:54.070 align:middle line:84% until we don't see the other side, what firms 00:28:54.070 --> 00:28:55.910 align:middle line:90% are willing to pay and so on. 00:28:55.910 --> 00:28:58.300 align:middle line:84% So we need to explore this other side. 00:28:58.300 --> 00:29:01.570 align:middle line:84% And the starting point of that other side 00:29:01.570 --> 00:29:07.930 align:middle line:84% is the production function, meaning firms 00:29:07.930 --> 00:29:10.180 align:middle line:84% are going to end up setting prices for goods. 00:29:10.180 --> 00:29:13.750 align:middle line:84% But producing those goods will take factors of production. 00:29:13.750 --> 00:29:17.750 align:middle line:84% They're going to have to use something to produce that. 00:29:17.750 --> 00:29:20.780 align:middle line:84% And the cost of that something will determine, importantly, 00:29:20.780 --> 00:29:23.350 align:middle line:84% what is the price they end up charging. 00:29:23.350 --> 00:29:26.140 align:middle line:84% I'm going to simplify things a lot here. 00:29:26.140 --> 00:29:28.080 align:middle line:84% I'm going to assume the production function is 00:29:28.080 --> 00:29:31.530 align:middle line:84% first linear and linear only on labels, so no other factors 00:29:31.530 --> 00:29:32.490 align:middle line:90% of production. 00:29:32.490 --> 00:29:35.190 align:middle line:84% Meaning this says that to produce 00:29:35.190 --> 00:29:39.670 align:middle line:84% one unit of the aggregate good, you need-- 00:29:39.670 --> 00:29:46.350 align:middle line:84% well, this says that if you add an extra worker 00:29:46.350 --> 00:29:49.560 align:middle line:84% to the big production function of the economy, then 00:29:49.560 --> 00:29:53.380 align:middle line:84% you're going to get A more units of output. 00:29:53.380 --> 00:29:55.130 align:middle line:90% That's what this says. 00:29:55.130 --> 00:29:58.570 align:middle line:84% So Y is output, the output we've been talking about, 00:29:58.570 --> 00:30:00.940 align:middle line:84% measuring the way we have been talking about, and so on. 00:30:00.940 --> 00:30:02.920 align:middle line:90% N is employment. 00:30:02.920 --> 00:30:04.930 align:middle line:90% And A is labor productivity. 00:30:04.930 --> 00:30:07.513 align:middle line:90% That is the output per worker. 00:30:07.513 --> 00:30:08.930 align:middle line:84% I want to make things very simple. 00:30:08.930 --> 00:30:10.720 align:middle line:84% We're going to talk a lot about in the next part of the course 00:30:10.720 --> 00:30:12.820 align:middle line:84% and the part of growth about this A, what 00:30:12.820 --> 00:30:16.120 align:middle line:84% moves this A over time, what it does, and so on. 00:30:16.120 --> 00:30:20.110 align:middle line:84% But I'm going to simplify things a lot here for now. 00:30:20.110 --> 00:30:22.750 align:middle line:84% And I'm going to set A equal to 1. 00:30:22.750 --> 00:30:25.158 align:middle line:84% So it doesn't get any simpler than this 00:30:25.158 --> 00:30:26.200 align:middle line:90% as a production function. 00:30:26.200 --> 00:30:28.000 align:middle line:84% This production function says you 00:30:28.000 --> 00:30:31.090 align:middle line:84% want to produce one more good, you need one more worker. 00:30:31.090 --> 00:30:34.170 align:middle line:90% 00:30:34.170 --> 00:30:35.520 align:middle line:90% This is what this says. 00:30:35.520 --> 00:30:38.730 align:middle line:84% If you have 10 workers, you produce 10 units of good. 00:30:38.730 --> 00:30:41.790 align:middle line:84% If you have 11 workers, you produce 11 units of goods. 00:30:41.790 --> 00:30:46.245 align:middle line:84% To produce one more unit of good, you need one worker more. 00:30:46.245 --> 00:30:48.970 align:middle line:90% 00:30:48.970 --> 00:30:53.320 align:middle line:84% Now, why do you think I'm simplifying it so much 00:30:53.320 --> 00:30:57.310 align:middle line:84% and I'm even repeating this idea that one more worker one more 00:30:57.310 --> 00:31:00.150 align:middle line:90% unit of good? 00:31:00.150 --> 00:31:04.470 align:middle line:84% That tells you that how much does it cost to the firm, 00:31:04.470 --> 00:31:07.020 align:middle line:84% to the firm that has this production function, 00:31:07.020 --> 00:31:12.300 align:middle line:84% to produce one extra unit of workers, of one 00:31:12.300 --> 00:31:14.522 align:middle line:90% extra unit of goods. 00:31:14.522 --> 00:31:16.230 align:middle line:84% Well, you have to ask the question, well, 00:31:16.230 --> 00:31:18.120 align:middle line:90% what will the firm have to do? 00:31:18.120 --> 00:31:20.660 align:middle line:84% Well, the first-- so suppose a firm 00:31:20.660 --> 00:31:22.580 align:middle line:84% wants to produce one more unit of goods. 00:31:22.580 --> 00:31:25.382 align:middle line:90% What is it that it needs to do? 00:31:25.382 --> 00:31:26.632 align:middle line:90% AUDIENCE: Hire another worker. 00:31:26.632 --> 00:31:28.757 align:middle line:84% RICARDO CABALLERO: It needs to hire another worker. 00:31:28.757 --> 00:31:30.065 align:middle line:90% How much will that cost? 00:31:30.065 --> 00:31:36.578 align:middle line:90% 00:31:36.578 --> 00:31:37.370 align:middle line:90% AUDIENCE: The wage. 00:31:37.370 --> 00:31:38.000 align:middle line:90% RICARDO CABALLERO: The wage. 00:31:38.000 --> 00:31:38.840 align:middle line:90% Exactly. 00:31:38.840 --> 00:31:40.490 align:middle line:84% So now we're beginning to [INAUDIBLE].. 00:31:40.490 --> 00:31:42.200 align:middle line:84% So this is the wage, in this case 00:31:42.200 --> 00:31:44.660 align:middle line:84% is the cost per unit of production for this guy. 00:31:44.660 --> 00:31:48.110 align:middle line:84% So the marginal cost of production for this firm 00:31:48.110 --> 00:31:49.400 align:middle line:90% is the wage. 00:31:49.400 --> 00:31:52.280 align:middle line:84% All the rest, intermediate inputs, is all summarized. 00:31:52.280 --> 00:31:56.290 align:middle line:84% This value added is built on something else. 00:31:56.290 --> 00:31:58.590 align:middle line:84% So this production function, as simple as it is, 00:31:58.590 --> 00:31:59.400 align:middle line:90% says exactly that. 00:31:59.400 --> 00:32:03.390 align:middle line:84% The marginal cost of production is equal to the wage. 00:32:03.390 --> 00:32:08.440 align:middle line:84% So now I'm going to come up with a pricing model, a price setting 00:32:08.440 --> 00:32:08.940 align:middle line:90% rules. 00:32:08.940 --> 00:32:11.510 align:middle line:84% Firms that understand how much more it 00:32:11.510 --> 00:32:14.540 align:middle line:84% costs to produce an extra unit of good 00:32:14.540 --> 00:32:16.430 align:middle line:84% now have to decide the price they 00:32:16.430 --> 00:32:20.680 align:middle line:84% want to charge for that extra unit of the good. 00:32:20.680 --> 00:32:24.070 align:middle line:84% There is a lot that comes into that decision. 00:32:24.070 --> 00:32:27.560 align:middle line:84% But we're going to summarize it with a markup, very simple. 00:32:27.560 --> 00:32:30.430 align:middle line:84% I'm going to say, look, the firm will do the following. 00:32:30.430 --> 00:32:33.310 align:middle line:84% We'll say, it costs me one worker 00:32:33.310 --> 00:32:36.940 align:middle line:84% to produce one unit of extra of good. 00:32:36.940 --> 00:32:39.640 align:middle line:84% A worker costs me W. So the price 00:32:39.640 --> 00:32:44.050 align:middle line:84% I want to charge is 1 plus is M. M is a positive number times W. 00:32:44.050 --> 00:32:46.340 align:middle line:90% So M is a number like 0.2. 00:32:46.340 --> 00:32:49.420 align:middle line:90% So you pay 100 in the wage. 00:32:49.420 --> 00:32:51.340 align:middle line:90% Then you're going to charge-- 00:32:51.340 --> 00:32:54.010 align:middle line:90% and suppose the wage is 100. 00:32:54.010 --> 00:32:59.500 align:middle line:84% If the markup is 20%, you're going to set a price of $120. 00:32:59.500 --> 00:33:03.400 align:middle line:84% That's the price setting rule that we're going to adopt. 00:33:03.400 --> 00:33:07.750 align:middle line:90% And again, it's not that crazy. 00:33:07.750 --> 00:33:10.010 align:middle line:90% Simple, but not that crazy. 00:33:10.010 --> 00:33:14.210 align:middle line:84% So thus, we call this the price setting equation. 00:33:14.210 --> 00:33:16.340 align:middle line:84% The firm takes the wage because that's 00:33:16.340 --> 00:33:21.260 align:middle line:84% the marginal cost of production and then adds a markup. 00:33:21.260 --> 00:33:23.980 align:middle line:90% And that's the final price. 00:33:23.980 --> 00:33:28.540 align:middle line:84% Now, we can rewrite this price setting equation 00:33:28.540 --> 00:33:31.540 align:middle line:84% as a wage equation in the following sense. 00:33:31.540 --> 00:33:33.190 align:middle line:84% It's still a price setting equation. 00:33:33.190 --> 00:33:39.400 align:middle line:84% But all that I've done here is I divided by P, by P and 1 plus M. 00:33:39.400 --> 00:33:42.940 align:middle line:84% And I get that the wage, the real wage 00:33:42.940 --> 00:33:46.180 align:middle line:84% the firm is willing to pay, is equal to 1 over 1 00:33:46.180 --> 00:33:47.200 align:middle line:90% plus the market. 00:33:47.200 --> 00:33:48.950 align:middle line:90% That's another way of saying it. 00:33:48.950 --> 00:33:49.660 align:middle line:90% It's the same. 00:33:49.660 --> 00:33:51.500 align:middle line:84% I took this price setting equation. 00:33:51.500 --> 00:33:53.110 align:middle line:90% And I just rewrote it. 00:33:53.110 --> 00:33:56.050 align:middle line:84% I rewrote it this way because then when 00:33:56.050 --> 00:33:57.550 align:middle line:84% I look at the wage setting equation, 00:33:57.550 --> 00:34:01.240 align:middle line:84% I also wrote it that way, W over something. 00:34:01.240 --> 00:34:03.400 align:middle line:84% I want to write the price setting equation 00:34:03.400 --> 00:34:06.740 align:middle line:84% in the same sort of units as my wage setting equation 00:34:06.740 --> 00:34:10.510 align:middle line:84% so then I can use one diagram, put them together easily, 00:34:10.510 --> 00:34:16.110 align:middle line:84% and find an equilibrium of something. 00:34:16.110 --> 00:34:19.920 align:middle line:84% So what you see here is, for example is that the higher is 00:34:19.920 --> 00:34:23.060 align:middle line:84% the markup, the lower is the real wage 00:34:23.060 --> 00:34:25.800 align:middle line:90% the firm is willing to offer. 00:34:25.800 --> 00:34:26.863 align:middle line:90% You see that? 00:34:26.863 --> 00:34:29.280 align:middle line:84% And this is an equilibrium at the level of the economists, 00:34:29.280 --> 00:34:30.600 align:middle line:90% not you individually. 00:34:30.600 --> 00:34:32.670 align:middle line:84% But on average, that's what ends up happening. 00:34:32.670 --> 00:34:35.429 align:middle line:84% Firms, on average, end up charging a higher markup. 00:34:35.429 --> 00:34:39.780 align:middle line:84% It has to be the case that in equilibrium the real wage 00:34:39.780 --> 00:34:43.040 align:middle line:90% offer by the firms is lower. 00:34:43.040 --> 00:34:45.820 align:middle line:90% That's what this is. 00:34:45.820 --> 00:34:49.120 align:middle line:84% So if we're in a situation where the markup was 0 00:34:49.120 --> 00:34:52.179 align:middle line:84% and now all of a sudden because of imperfect 00:34:52.179 --> 00:34:55.870 align:middle line:84% competition or perhaps some price of a key input went up 00:34:55.870 --> 00:35:00.160 align:middle line:84% and it's not well measured in value added or whatever, 00:35:00.160 --> 00:35:05.270 align:middle line:84% if the market goes to 1, then the real wage in equilibrium 00:35:05.270 --> 00:35:09.110 align:middle line:84% will fall to half what it used to be. 00:35:09.110 --> 00:35:13.100 align:middle line:84% That's what the firms will offer. 00:35:13.100 --> 00:35:15.380 align:middle line:84% Well, that's an equilibrium or not, we shall see. 00:35:15.380 --> 00:35:17.600 align:middle line:84% Or how do we get that to be an equilibrium? 00:35:17.600 --> 00:35:18.498 align:middle line:90% We shall see. 00:35:18.498 --> 00:35:20.040 align:middle line:84% But that's what the firms will offer. 00:35:20.040 --> 00:35:21.980 align:middle line:84% That's what the price setting equation says. 00:35:21.980 --> 00:35:24.902 align:middle line:84% In fact, you already know from this equation 00:35:24.902 --> 00:35:26.360 align:middle line:84% that that's what the real wage will 00:35:26.360 --> 00:35:31.322 align:middle line:84% be because there is no variable here that can adjust to that. 00:35:31.322 --> 00:35:32.780 align:middle line:84% What happens is something else will 00:35:32.780 --> 00:35:34.020 align:middle line:90% have to give in the economy. 00:35:34.020 --> 00:35:37.220 align:middle line:84% So this ends up being the equilibrium wage. 00:35:37.220 --> 00:35:39.320 align:middle line:84% But you'll understand that a little later, 00:35:39.320 --> 00:35:41.240 align:middle line:84% or you'll understand it better a little later. 00:35:41.240 --> 00:35:44.050 align:middle line:90% 00:35:44.050 --> 00:35:47.500 align:middle line:84% So now, we're almost ready to come up with-- 00:35:47.500 --> 00:35:52.260 align:middle line:84% to discuss a very important concept in macroeconomics. 00:35:52.260 --> 00:35:56.920 align:middle line:84% And that's the concept of the natural rate of unemployment. 00:35:56.920 --> 00:35:59.040 align:middle line:84% Now, the first warning is that there 00:35:59.040 --> 00:36:02.130 align:middle line:84% is nothing natural about the natural rate of unemployment. 00:36:02.130 --> 00:36:07.950 align:middle line:84% It's not something that God gave us or anything like that. 00:36:07.950 --> 00:36:12.510 align:middle line:84% I'll say for us, and what typically means 00:36:12.510 --> 00:36:14.700 align:middle line:84% the natural rate of unemployment, 00:36:14.700 --> 00:36:19.830 align:middle line:84% simply means what I wrote there, which is the unemployment that 00:36:19.830 --> 00:36:26.930 align:middle line:84% takes place when the expected price is equal to actual prices. 00:36:26.930 --> 00:36:31.250 align:middle line:84% That's what we'll define for this class, for this course, 00:36:31.250 --> 00:36:33.260 align:middle line:84% we'll define the natural rate of unemployment. 00:36:33.260 --> 00:36:35.270 align:middle line:84% The natural rate of unemployment is 00:36:35.270 --> 00:36:38.540 align:middle line:84% when the expected price is equal to P. That's what we mean. 00:36:38.540 --> 00:36:41.610 align:middle line:84% If we ask you any question about the natural rate employment, 00:36:41.610 --> 00:36:43.760 align:middle line:84% we don't mean that that's what is good, 00:36:43.760 --> 00:36:46.100 align:middle line:84% that that's what is bad, that that's what God decided 00:36:46.100 --> 00:36:47.690 align:middle line:90% or someone else decided. 00:36:47.690 --> 00:36:51.350 align:middle line:84% This is all that it means, is that in any equation where 00:36:51.350 --> 00:36:54.830 align:middle line:84% you have P, you can stick in P and then solve for equilibrium. 00:36:54.830 --> 00:36:57.110 align:middle line:84% And the unemployment rate that comes from that 00:36:57.110 --> 00:37:00.420 align:middle line:84% is what we call the natural rate of unemployment. 00:37:00.420 --> 00:37:04.980 align:middle line:84% Because of this, you can also think of that unemployment rate 00:37:04.980 --> 00:37:09.360 align:middle line:84% as a good proxy for what is likely to be 00:37:09.360 --> 00:37:13.560 align:middle line:84% the average rate of unemployment of an economy over a longer 00:37:13.560 --> 00:37:15.090 align:middle line:90% period of time. 00:37:15.090 --> 00:37:17.160 align:middle line:84% Because people are unlikely to be fooled 00:37:17.160 --> 00:37:18.640 align:middle line:84% all the time in the same direction. 00:37:18.640 --> 00:37:19.800 align:middle line:84% So sometimes they're going to expect 00:37:19.800 --> 00:37:22.342 align:middle line:84% a higher price [INAUDIBLE],, sometimes it's lower, and so on. 00:37:22.342 --> 00:37:25.650 align:middle line:84% On average, unless there is something very weird going on, 00:37:25.650 --> 00:37:27.573 align:middle line:84% they're going to get right, because you 00:37:27.573 --> 00:37:30.240 align:middle line:84% know more or less what the level of inflation of the economy is. 00:37:30.240 --> 00:37:31.230 align:middle line:90% Sometimes you miss up. 00:37:31.230 --> 00:37:32.280 align:middle line:90% Sometimes you miss down. 00:37:32.280 --> 00:37:33.990 align:middle line:84% But on average, you're going to be right 00:37:33.990 --> 00:37:36.760 align:middle line:84% if you take an average over a long period of time. 00:37:36.760 --> 00:37:39.810 align:middle line:84% So for that reason, you can also interpret this natural rate 00:37:39.810 --> 00:37:41.700 align:middle line:84% of unemployment as the unemployment 00:37:41.700 --> 00:37:43.387 align:middle line:84% rate of the medium run, if you will-- 00:37:43.387 --> 00:37:44.970 align:middle line:84% so when you have collected enough data 00:37:44.970 --> 00:37:49.652 align:middle line:84% and positive errors are balanced with negative errors, and so on. 00:37:49.652 --> 00:37:51.610 align:middle line:84% But that's all that we mean by the natural rate 00:37:51.610 --> 00:37:54.120 align:middle line:90% of unemployment. 00:37:54.120 --> 00:37:57.510 align:middle line:84% Now, notice that with this assumption, that Pe 00:37:57.510 --> 00:38:01.260 align:middle line:84% is equal to P. I can go back to my wage setting equation, which 00:38:01.260 --> 00:38:04.920 align:middle line:90% was W over Pe equal to F that. 00:38:04.920 --> 00:38:08.440 align:middle line:84% I don't remember what I had divided by P. But I had P there. 00:38:08.440 --> 00:38:11.610 align:middle line:84% And when I divide by P both sides, and then 00:38:11.610 --> 00:38:14.130 align:middle line:84% I'm going to set Pe equal to P. And now 00:38:14.130 --> 00:38:16.530 align:middle line:84% I have that my wage setting equation 00:38:16.530 --> 00:38:17.940 align:middle line:90% can be written this way. 00:38:17.940 --> 00:38:20.280 align:middle line:84% And notice that the unemployment rate I put here 00:38:20.280 --> 00:38:24.400 align:middle line:84% is N. It's a natural rate of unemployment. 00:38:24.400 --> 00:38:27.280 align:middle line:84% Because once I have a model in which I assume 00:38:27.280 --> 00:38:29.230 align:middle line:84% that Pe is equal to P, the unemployment rate 00:38:29.230 --> 00:38:33.270 align:middle line:84% that comes out of that is a natural rate of unemployment. 00:38:33.270 --> 00:38:34.800 align:middle line:90% That's all that it just means. 00:38:34.800 --> 00:38:38.520 align:middle line:84% It says OK, you allow me to replace Pe by P, well, 00:38:38.520 --> 00:38:41.250 align:middle line:84% then I can call my unemployment rate here the natural rate 00:38:41.250 --> 00:38:42.549 align:middle line:90% of unemployment. 00:38:42.549 --> 00:38:46.950 align:middle line:90% 00:38:46.950 --> 00:38:48.780 align:middle line:90% And it has lots of names-- 00:38:48.780 --> 00:38:51.570 align:middle line:84% natural rate, structural rate of unemployment, and so on. 00:38:51.570 --> 00:38:54.670 align:middle line:90% 00:38:54.670 --> 00:38:56.940 align:middle line:90% Now what this tells you-- 00:38:56.940 --> 00:39:00.772 align:middle line:84% I mean, you can see the slope of this function. 00:39:00.772 --> 00:39:02.230 align:middle line:84% If the natural rate of unemployment 00:39:02.230 --> 00:39:05.410 align:middle line:84% is higher in this economy, what is 00:39:05.410 --> 00:39:09.540 align:middle line:84% the real wage that comes from the wage setting equation? 00:39:09.540 --> 00:39:10.860 align:middle line:90% Lower. 00:39:10.860 --> 00:39:14.040 align:middle line:84% It's a downward sloping curve in the space of wages to real wages 00:39:14.040 --> 00:39:15.150 align:middle line:90% to unemployment. 00:39:15.150 --> 00:39:17.070 align:middle line:84% So the natural rate of unemployment 00:39:17.070 --> 00:39:19.230 align:middle line:84% is a downward sloping curve for the reasons 00:39:19.230 --> 00:39:21.810 align:middle line:84% we discussed before-- bargaining power and so on. 00:39:21.810 --> 00:39:26.190 align:middle line:84% OK, so I can put together-- remember, the price setting 00:39:26.190 --> 00:39:28.620 align:middle line:84% equation led me to also an equation 00:39:28.620 --> 00:39:31.468 align:middle line:84% the real wage, which was not a function of anything. 00:39:31.468 --> 00:39:33.010 align:middle line:84% It was only a function of parameters. 00:39:33.010 --> 00:39:36.720 align:middle line:84% So that's a horizontal curve in the space of real wages 00:39:36.720 --> 00:39:38.940 align:middle line:84% and unemployment, natural rate of unemployment. 00:39:38.940 --> 00:39:41.560 align:middle line:84% Here we have a downward sloping curve. 00:39:41.560 --> 00:39:44.190 align:middle line:84% And the intersection of these two curves 00:39:44.190 --> 00:39:47.070 align:middle line:84% is the natural rate of unemployment. 00:39:47.070 --> 00:39:49.780 align:middle line:84% So this was the price setting relation. 00:39:49.780 --> 00:39:53.640 align:middle line:84% Remember, it's 1 over 1 plus M. This is the wage setting 00:39:53.640 --> 00:40:00.610 align:middle line:84% equation with the assumption that Pe is equal to P. 00:40:00.610 --> 00:40:04.243 align:middle line:84% And thus, the natural rate of unemployment. 00:40:04.243 --> 00:40:05.660 align:middle line:84% And here you can understand what I 00:40:05.660 --> 00:40:10.100 align:middle line:84% said before is that you see, in this economy, the real wage, 00:40:10.100 --> 00:40:12.890 align:middle line:84% because this price setting equation is flat 00:40:12.890 --> 00:40:17.310 align:middle line:84% in this simple economy, the real wage is pinned down by the firm, 00:40:17.310 --> 00:40:19.560 align:middle line:90% by the firms collectively-- 00:40:19.560 --> 00:40:24.425 align:middle line:84% and not collectively in an oligopsonistic way. 00:40:24.425 --> 00:40:28.360 align:middle line:84% It's what happens in equilibrium. 00:40:28.360 --> 00:40:29.940 align:middle line:84% But the equilibrium unemployment, 00:40:29.940 --> 00:40:31.830 align:middle line:84% natural rate of unemployment, is intersection 00:40:31.830 --> 00:40:36.360 align:middle line:84% of the real wage set by the firms and the wage setting 00:40:36.360 --> 00:40:40.070 align:middle line:90% relationship. 00:40:40.070 --> 00:40:46.500 align:middle line:84% So what happens to a point, say to the right? 00:40:46.500 --> 00:40:48.480 align:middle line:90% What happens in this point here? 00:40:48.480 --> 00:40:50.010 align:middle line:90% What is the situation we have? 00:40:50.010 --> 00:40:57.600 align:middle line:90% 00:40:57.600 --> 00:41:00.660 align:middle line:84% Well, at that high level of unemployment, 00:41:00.660 --> 00:41:03.933 align:middle line:84% workers are willing to work for much lower real wages 00:41:03.933 --> 00:41:05.100 align:middle line:90% than the firms are offering. 00:41:05.100 --> 00:41:08.390 align:middle line:90% 00:41:08.390 --> 00:41:10.700 align:middle line:84% This is what workers, at this level of unemployment, 00:41:10.700 --> 00:41:14.420 align:middle line:84% very high level of unemployment, workers would be fine with this. 00:41:14.420 --> 00:41:15.830 align:middle line:90% Firms are paying that. 00:41:15.830 --> 00:41:18.470 align:middle line:90% 00:41:18.470 --> 00:41:21.350 align:middle line:84% So unemployment is very likely to be 00:41:21.350 --> 00:41:24.020 align:middle line:84% falling because workers are not demanding a lot 00:41:24.020 --> 00:41:28.130 align:middle line:84% and firms are going to hire all these workers. 00:41:28.130 --> 00:41:30.410 align:middle line:90% The opposite here. 00:41:30.410 --> 00:41:32.900 align:middle line:84% If here, workers are demanding a wage that 00:41:32.900 --> 00:41:36.440 align:middle line:84% is much higher than firms are willing to pay, 00:41:36.440 --> 00:41:38.240 align:middle line:84% that's likely to lead to more unemployment 00:41:38.240 --> 00:41:41.300 align:middle line:84% because firms are going to be very reluctant to hire 00:41:41.300 --> 00:41:43.670 align:middle line:90% these very expensive workers. 00:41:43.670 --> 00:41:47.690 align:middle line:84% So that's going to be unemployment in this direction. 00:41:47.690 --> 00:41:48.530 align:middle line:90% Good. 00:41:48.530 --> 00:41:51.200 align:middle line:84% So that's the natural rate of unemployment. 00:41:51.200 --> 00:41:53.450 align:middle line:84% Again, nothing natural about it is the equilibrium 00:41:53.450 --> 00:41:56.880 align:middle line:84% when you assume the expected price is equal to price. 00:41:56.880 --> 00:42:00.300 align:middle line:84% So there are some important parameters in this diagram here. 00:42:00.300 --> 00:42:03.290 align:middle line:90% One is this M, the market. 00:42:03.290 --> 00:42:05.720 align:middle line:84% That's a parameter, very important markup here. 00:42:05.720 --> 00:42:09.590 align:middle line:84% See, if the markup changes, the natural rate of unemployment 00:42:09.590 --> 00:42:11.570 align:middle line:90% will change. 00:42:11.570 --> 00:42:15.170 align:middle line:84% There's another set of parameter here, which is z. 00:42:15.170 --> 00:42:16.970 align:middle line:84% We took as given the institutions 00:42:16.970 --> 00:42:20.780 align:middle line:84% that protect the bargaining power of workers institutions, 00:42:20.780 --> 00:42:23.690 align:middle line:90% supporting institutions, the z. 00:42:23.690 --> 00:42:24.950 align:middle line:90% That's a parameter here. 00:42:24.950 --> 00:42:27.170 align:middle line:84% If that changes, the natural rate of unemployment 00:42:27.170 --> 00:42:30.070 align:middle line:84% will change, which is, again, something 00:42:30.070 --> 00:42:31.720 align:middle line:84% that confirms that there is nothing 00:42:31.720 --> 00:42:34.690 align:middle line:84% natural about the natural rate of unemployment. 00:42:34.690 --> 00:42:37.620 align:middle line:84% So let me just do it in equations very quickly 00:42:37.620 --> 00:42:43.920 align:middle line:84% and then I'll do a couple of important shifts. 00:42:43.920 --> 00:42:46.600 align:middle line:84% So in terms of equation, all that I did is says, 00:42:46.600 --> 00:42:49.710 align:middle line:84% look, the wage setting equation, the price setting equation 00:42:49.710 --> 00:42:50.790 align:middle line:90% gives us that. 00:42:50.790 --> 00:42:53.340 align:middle line:84% The wage setting equation gives us that. 00:42:53.340 --> 00:42:56.250 align:middle line:84% Therefore, that equal to that, that's a point we found. 00:42:56.250 --> 00:42:58.530 align:middle line:84% That's the natural rate of unemployment 00:42:58.530 --> 00:43:02.170 align:middle line:84% So from here, that's when the two are equal. 00:43:02.170 --> 00:43:03.390 align:middle line:90% This was the flat curve. 00:43:03.390 --> 00:43:05.160 align:middle line:84% This was the downward sloping curve. 00:43:05.160 --> 00:43:10.760 align:middle line:84% Well, these two are equal when these two things are equal. 00:43:10.760 --> 00:43:12.010 align:middle line:90% And that's what you get there. 00:43:12.010 --> 00:43:15.650 align:middle line:84% So from there you solve the natural rate of unemployment. 00:43:15.650 --> 00:43:18.200 align:middle line:84% What do you think happens to the natural rate of unemployment 00:43:18.200 --> 00:43:19.430 align:middle line:90% is z goes up. 00:43:19.430 --> 00:43:23.480 align:middle line:90% 00:43:23.480 --> 00:43:28.250 align:middle line:84% Let's just be very mechanic at this point, just math. 00:43:28.250 --> 00:43:31.760 align:middle line:84% If z goes up, watch what happens to F? 00:43:31.760 --> 00:43:36.740 align:middle line:90% 00:43:36.740 --> 00:43:39.960 align:middle line:90% Goes up if z was positive. 00:43:39.960 --> 00:43:43.570 align:middle line:84% Well, the right hand side hasn't gone up. 00:43:43.570 --> 00:43:46.240 align:middle line:90% So this went up. 00:43:46.240 --> 00:43:49.930 align:middle line:84% Something has to give, so F comes back down. 00:43:49.930 --> 00:43:52.030 align:middle line:84% And the only thing that can give, the only thing 00:43:52.030 --> 00:43:53.710 align:middle line:84% that's endogenous in that picture 00:43:53.710 --> 00:43:55.930 align:middle line:84% there is a natural rate of unemployment. 00:43:55.930 --> 00:43:57.930 align:middle line:90% So if z goes up, F goes up. 00:43:57.930 --> 00:44:00.480 align:middle line:84% Well, I need to bring F back down because the right hand 00:44:00.480 --> 00:44:03.860 align:middle line:90% side hasn't given an inch. 00:44:03.860 --> 00:44:06.760 align:middle line:84% So what do I have to do to a natural rate of unemployment 00:44:06.760 --> 00:44:10.090 align:middle line:90% for F to come back down? 00:44:10.090 --> 00:44:13.300 align:middle line:84% Rise-- because that's what will weaken bargaining power. 00:44:13.300 --> 00:44:16.610 align:middle line:84% Workers' bargaining power got stronger because increasing z. 00:44:16.610 --> 00:44:18.130 align:middle line:90% Well, I have to weaken it some-- 00:44:18.130 --> 00:44:18.950 align:middle line:90% I don't have to. 00:44:18.950 --> 00:44:20.740 align:middle line:84% Equilibrium will weaken it somehow 00:44:20.740 --> 00:44:22.960 align:middle line:84% so that we end up in the same situation, 00:44:22.960 --> 00:44:25.540 align:middle line:84% with the same real wage that we had before, which 00:44:25.540 --> 00:44:27.930 align:middle line:90% was equal to 1 over 1 plus m. 00:44:27.930 --> 00:44:31.270 align:middle line:90% What happens if m goes up? 00:44:31.270 --> 00:44:37.550 align:middle line:84% Well, if m goes up, markups go up, that means firms real wage-- 00:44:37.550 --> 00:44:41.420 align:middle line:84% the real way to firms offers drops. 00:44:41.420 --> 00:44:44.810 align:middle line:84% So if this right hand side drops, 00:44:44.810 --> 00:44:48.330 align:middle line:84% then I need the left hand side to drop, as well. 00:44:48.330 --> 00:44:50.080 align:middle line:84% And the only thing that is endogenous here 00:44:50.080 --> 00:44:52.860 align:middle line:84% is the natural rate of unemployment. 00:44:52.860 --> 00:44:59.240 align:middle line:84% So I know that I need to drop F, what do I need to do to? 00:44:59.240 --> 00:45:01.340 align:middle line:90% So I need to bring F down. 00:45:01.340 --> 00:45:04.070 align:middle line:84% And the only tool you have is not a tool, 00:45:04.070 --> 00:45:09.100 align:middle line:84% but in equilibrium anything that will can change here is uN. 00:45:09.100 --> 00:45:13.170 align:middle line:84% It will increase uN because that will 00:45:13.170 --> 00:45:14.940 align:middle line:84% reduce bargaining power of workers 00:45:14.940 --> 00:45:17.310 align:middle line:84% and that will reduce the real wage demand. 00:45:17.310 --> 00:45:19.630 align:middle line:84% And therefore, you restore equilibrium that way. 00:45:19.630 --> 00:45:21.900 align:middle line:84% So this environment is a very nasty environment 00:45:21.900 --> 00:45:25.440 align:middle line:84% for workers in a sense because it's always 00:45:25.440 --> 00:45:30.170 align:middle line:84% the escape value is the natural rate of unemployment. 00:45:30.170 --> 00:45:33.020 align:middle line:84% So here you have what I just said in pictures. 00:45:33.020 --> 00:45:37.100 align:middle line:84% So that's example of z going up, bargaining power 00:45:37.100 --> 00:45:38.490 align:middle line:90% of workers going up. 00:45:38.490 --> 00:45:42.150 align:middle line:84% So suppose you start at an equilibrium like this. 00:45:42.150 --> 00:45:45.020 align:middle line:90% And now z goes up. 00:45:45.020 --> 00:45:48.110 align:middle line:84% Well, that means that workers, for any given 00:45:48.110 --> 00:45:50.930 align:middle line:84% level of unemployment, natural rate of unemployment, 00:45:50.930 --> 00:45:55.010 align:middle line:84% want a higher wage because they have more bargaining power. 00:45:55.010 --> 00:45:58.040 align:middle line:84% Well, that higher wage is inconsistent with the wage 00:45:58.040 --> 00:46:00.130 align:middle line:90% that firms want to pay. 00:46:00.130 --> 00:46:02.350 align:middle line:84% What restores equilibrium is unemployment, 00:46:02.350 --> 00:46:06.480 align:middle line:84% the natural rate of unemployment goes up enough so 00:46:06.480 --> 00:46:10.380 align:middle line:84% that the wage demand sort comes down to the same original level 00:46:10.380 --> 00:46:14.340 align:middle line:84% because this price setting equation is completely flat. 00:46:14.340 --> 00:46:16.500 align:middle line:84% So there you have a situation where 00:46:16.500 --> 00:46:20.490 align:middle line:84% bargaining power of workers went up and all that end up happening 00:46:20.490 --> 00:46:23.190 align:middle line:84% is that, in the medium run, at least, 00:46:23.190 --> 00:46:26.920 align:middle line:84% that the natural rate of unemployment went up. 00:46:26.920 --> 00:46:30.340 align:middle line:84% That's very much the story of Europe, by the way, 00:46:30.340 --> 00:46:31.180 align:middle line:90% in the '80s-- 00:46:31.180 --> 00:46:32.530 align:middle line:90% France in particular. 00:46:32.530 --> 00:46:37.100 align:middle line:84% France had major labor reforms, z boosting, if you will, 00:46:37.100 --> 00:46:38.140 align:middle line:90% in the 1980. 00:46:38.140 --> 00:46:39.970 align:middle line:84% Initially it was a great deal for workers. 00:46:39.970 --> 00:46:41.440 align:middle line:90% Real wages went up and so on. 00:46:41.440 --> 00:46:42.460 align:middle line:90% It was wonderful. 00:46:42.460 --> 00:46:44.480 align:middle line:84% But eventually with the passage of time, 00:46:44.480 --> 00:46:46.330 align:middle line:84% they ended up just with a much higher real-- 00:46:46.330 --> 00:46:50.080 align:middle line:84% not a much higher real wage, but a much higher real unemployment 00:46:50.080 --> 00:46:51.020 align:middle line:90% rate. 00:46:51.020 --> 00:46:54.970 align:middle line:84% That went from single digit, low single digits, 00:46:54.970 --> 00:46:58.640 align:middle line:84% to 15% unemployment rates and things like that. 00:46:58.640 --> 00:47:01.630 align:middle line:84% And since then, they have been sort of reforming the labor 00:47:01.630 --> 00:47:04.360 align:middle line:90% market to fix some of that. 00:47:04.360 --> 00:47:08.140 align:middle line:84% But that was very much what happened in continental Europe 00:47:08.140 --> 00:47:10.610 align:middle line:90% in the '80s. 00:47:10.610 --> 00:47:12.890 align:middle line:84% This is the case of a markup increase, 00:47:12.890 --> 00:47:15.350 align:middle line:90% the other one I described. 00:47:15.350 --> 00:47:20.650 align:middle line:84% So if markups go up, then that means firms in equilibrium 00:47:20.650 --> 00:47:24.650 align:middle line:84% are not willing to pay real wages. 00:47:24.650 --> 00:47:27.010 align:middle line:84% They want to pay a lower real wage. 00:47:27.010 --> 00:47:28.720 align:middle line:84% Well, at this level of unemployment, 00:47:28.720 --> 00:47:30.247 align:middle line:84% workers are not going to take it. 00:47:30.247 --> 00:47:32.080 align:middle line:84% The only thing that will restore equilibrium 00:47:32.080 --> 00:47:33.747 align:middle line:84% is that the natural rate of unemployment 00:47:33.747 --> 00:47:36.730 align:middle line:84% goes up that weakens the hand of workers. 00:47:36.730 --> 00:47:39.560 align:middle line:90% And you end up with this. 00:47:39.560 --> 00:47:41.570 align:middle line:84% And again, there is nothing natural about this. 00:47:41.570 --> 00:47:43.120 align:middle line:84% I'm not saying this is good or bad. 00:47:43.120 --> 00:47:45.040 align:middle line:84% I have no idea why the markets went up. 00:47:45.040 --> 00:47:47.410 align:middle line:84% It is just imperfect competition, going up, 00:47:47.410 --> 00:47:49.570 align:middle line:90% that's clearly not a good thing. 00:47:49.570 --> 00:47:51.820 align:middle line:84% But it may have been something else-- the price of oil 00:47:51.820 --> 00:47:53.740 align:middle line:90% went up a lot, I don't know. 00:47:53.740 --> 00:47:56.650 align:middle line:84% It was a war somewhere and then productivity came down, 00:47:56.650 --> 00:47:58.400 align:middle line:90% something of that kind. 00:47:58.400 --> 00:48:00.197 align:middle line:90% So I don't know what it did. 00:48:00.197 --> 00:48:01.780 align:middle line:84% But the only thing I'm describing here 00:48:01.780 --> 00:48:02.620 align:middle line:90% is the mechanics. 00:48:02.620 --> 00:48:06.320 align:middle line:90% 00:48:06.320 --> 00:48:07.850 align:middle line:90% Good. 00:48:07.850 --> 00:48:12.030 align:middle line:90% So the quiz is up to here. 00:48:12.030 --> 00:48:15.740 align:middle line:90% So the quiz ends here. 00:48:15.740 --> 00:48:19.400 align:middle line:84% In the next lecture, we're going to start the Phillips 00:48:19.400 --> 00:48:22.160 align:middle line:84% curve, which is now using this model, 00:48:22.160 --> 00:48:23.990 align:middle line:84% but looking at deviations situations 00:48:23.990 --> 00:48:26.900 align:middle line:84% where the price is not equal to expected price, or the expected 00:48:26.900 --> 00:48:30.230 align:middle line:84% price is not equal to the actual price. 00:48:30.230 --> 00:48:33.685 align:middle line:84% And that's going to lead to interesting situations. 00:48:33.685 --> 00:48:35.810 align:middle line:84% And then we're going to be talking about inflation. 00:48:35.810 --> 00:48:38.238 align:middle line:84% Here, this is not a model to talk about inflation. 00:48:38.238 --> 00:48:40.280 align:middle line:84% I'm talking about what happens in the medium run. 00:48:40.280 --> 00:48:43.070 align:middle line:84% I haven't told you whether the adjustment happens 00:48:43.070 --> 00:48:45.800 align:middle line:84% through the nominal wage, through the prices, or what. 00:48:45.800 --> 00:48:50.130 align:middle line:84% I mean, there are many ways of reaching the same real wage. 00:48:50.130 --> 00:48:53.780 align:middle line:84% You could have it-- you could lower 00:48:53.780 --> 00:49:00.620 align:middle line:84% real wages by increasing wages by 50% and prices by 60, say. 00:49:00.620 --> 00:49:04.490 align:middle line:84% Or you could do it by lowering nominal wages by 10 00:49:04.490 --> 00:49:05.670 align:middle line:90% and not moving prices. 00:49:05.670 --> 00:49:07.128 align:middle line:84% So there are many ways of doing it. 00:49:07.128 --> 00:49:09.930 align:middle line:84% The Phillips curve is going to allow us to get into that part. 00:49:09.930 --> 00:49:12.040 align:middle line:84% But it's not going to be part of your quiz. 00:49:12.040 --> 00:49:14.680 align:middle line:84% The quiz, that's going to be part of the second quiz. 00:49:14.680 --> 00:49:16.170 align:middle line:84% So in the next lecture, I'm going 00:49:16.170 --> 00:49:18.837 align:middle line:84% to talk about the Phillips curve and then on Wednesday a review. 00:49:18.837 --> 00:49:21.680 align:middle line:90% And then you have your quiz. 00:49:21.680 --> 00:49:34.000 align:middle line:90%