SlideShare a Scribd company logo
1 of 42
Download to read offline
Copyright © 2004 South-Western
3535The Short-Run
Tradeoff between
Inflation and
Unemployment
Copyright © 2004 South-Western
Unemployment and Inflation
• The natural rate of unemployment depends on
various features of the labor market.
• Examples include minimum-wage laws, the
market power of unions, the role of efficiency
wages, and the effectiveness of job search.
• The inflation rate depends primarily on growth
in the quantity of money, controlled by the Fed.
Copyright © 2004 South-Western
Unemployment and Inflation
• Society faces a short-run tradeoff between
unemployment and inflation.
• If policymakers expand aggregate demand, they
can lower unemployment, but only at the cost
of higher inflation.
• If they contract aggregate demand, they can
lower inflation, but at the cost of temporarily
higher unemployment.
Copyright © 2004 South-Western
THE PHILLIPS CURVE
• The Phillips curve illustrates the short-run
relationship between inflation and
unemployment.
Figure 1 The Phillips Curve
Unemployment
Rate (percent)
0
Inflation
Rate
(percent
per year)
Phillips curve
4
B6
7
A
2
Copyright © 2004 South-Western
Copyright © 2004 South-Western
Aggregate Demand, Aggregate Supply, and
the Phillips Curve
• The Phillips curve shows the short-run
combinations of unemployment and inflation
that arise as shifts in the aggregate demand
curve move the economy along the short-run
aggregate supply curve.
Copyright © 2004 South-Western
Aggregate Demand, Aggregate Supply, and
the Phillips Curve
• The greater the aggregate demand for goods
and services, the greater is the economy’s
output, and the higher is the overall price level.
• A higher level of output results in a lower level
of unemployment.
Figure 2 How the Phillips Curve is Related to
Aggregate Demand and Aggregate Supply
Quantity
of Output
0
Short-run
aggregate
supply
(a) The Model of Aggregate Demand and Aggregate Supply
Unemployment
Rate (percent)
0
Inflation
Rate
(percent
per year)
Price
Level
(b) The Phillips Curve
Phillips curve
Low aggregate
demand
High
aggregate demand
(output is
8,000)
B
4
6
(output is
7,500)
A
7
2
8,000
(unemployment
is 4%)
106 B
(unemployment
is 7%)
7,500
102 A
Copyright © 2004 South-Western
Copyright © 2004 South-Western
SHIFTS IN THE PHILLIPS CURVE:
THE ROLE OF EXPECTATIONS
• The Phillips curve seems to offer policymakers
a menu of possible inflation and unemployment
outcomes.
Copyright © 2004 South-Western
The Long-Run Phillips Curve
• In the 1960s, Friedman and Phelps concluded
that inflation and unemployment are unrelated
in the long run.
• As a result, the long-run Phillips curve is vertical at
the natural rate of unemployment.
• Monetary policy could be effective in the short run
but not in the long run.
Figure 3 The Long-Run Phillips Curve
Unemployment
Rate
0 Natural rate of
unemployment
Inflation
Rate Long-run
Phillips curve
BHigh
inflation
Low
inflation
A
2. . . . but unemployment
remains at its natural rate
in the long run.
1. When the
Fed increases
the growth rate
of the money
supply, the
rate of inflation
increases . . .
Copyright © 2004 South-Western
Figure 4 How the Phillips Curve is Related to
Aggregate Demand and Aggregate Supply
Quantity
of Output
Natural rate
of output
Natural rate of
unemployment
0
Price
Level
P
Aggregate
demand, AD
Long-run aggregate
supply
Long-run Phillips
curve
(a) The Model of Aggregate Demand and Aggregate Supply
Unemployment
Rate
0
Inflation
Rate
(b) The Phillips Curve
2. . . . raises
the price
level . . .
1. An increase in
the money supply
increases aggregate
demand . . .
A
AD2
B
A
4. . . . but leaves output and unemployment
at their natural rates.
3. . . . and
increases the
inflation rate . . .
P2
B
Copyright © 2004 South-Western
Copyright © 2004 South-Western
Expectations and the Short-Run Phillips
Curve
• Expected inflation measures how much people
expect the overall price level to change.
Copyright © 2004 South-Western
Expectations and the Short-Run Phillips
Curve
• In the long run, expected inflation adjusts to
changes in actual inflation.
• The Fed’s ability to create unexpected inflation
exists only in the short run.
• Once people anticipate inflation, the only way to get
unemployment below the natural rate is for actual
inflation to be above the anticipated rate.
Copyright © 2004 South-Western
• This equation relates the unemployment rate to
the natural rate of unemployment, actual
inflation, and expected inflation.
Expectations and the Short-Run Phillips
Curve
( )N a t u r a l r a t e o f u n e m p l o y m e n t - a A c t u a l
i n f l a t i o n
E x p e c t e d
i n f l a t i o n−
Unemployment Rate =
Figure 5 How Expected Inflation Shifts the Short-
Run Phillips Curve
Unemployment
Rate
0 Natural rate of
unemployment
Inflation
Rate Long-run
Phillips curve
Short-run Phillips curve
with high expected
inflation
Short-run Phillips curve
with low expected
inflation
1. Expansionary policy moves
the economy up along the
short-run Phillips curve . . .
2. . . . but in the long run, expected
inflation rises, and the short-run
Phillips curve shifts to the right.
C
B
A
Copyright © 2004 South-Western
Copyright © 2004 South-Western
The Natural Experiment for the Natural-Rate
Hypothesis
• The view that unemployment eventually returns
to its natural rate, regardless of the rate of
inflation, is called the natural-rate hypothesis.
• Historical observations support the natural-rate
hypothesis.
Copyright © 2004 South-Western
The Natural Experiment for the Natural Rate
Hypothesis
• The concept of a stable Phillips curve broke
down in the in the early ’70s.
• During the ’70s and ’80s, the economy
experienced high inflation and high
unemployment simultaneously.
Figure 6 The Phillips Curve in the 1960s
1 2 3 4 5 6 7 8 9 100
2
4
6
8
10
Unemployment
Rate (percent)
Inflation Rate
(percent per year)
1968
1966
1961
1962
1963
1967
1965
1964
Copyright © 2004 South-Western
Figure 7 The Breakdown of the Phillips Curve
1 2 3 4 5 6 7 8 9 100
2
4
6
8
10
Unemployment
Rate (percent)
Inflation Rate
(percent per year)
1973
1966
1972
1971
1961
1962
1963
1967
1968
1969 1970
1965
1964
Copyright © 2004 South-Western
Copyright © 2004 South-Western
SHIFTS IN THE PHILLIPS CURVE:
THE ROLE OF SUPPLY SHOCKS
• Historical events have shown that the short-run
Phillips curve can shift due to changes in
expectations.
Copyright © 2004 South-Western
SHIFTS IN THE PHILLIPS CURVE:
THE ROLE OF SUPPLY SHOCKS
• The short-run Phillips curve also shifts because
of shocks to aggregate supply.
• Major adverse changes in aggregate supply can
worsen the short-run tradeoff between
unemployment and inflation.
• An adverse supply shock gives policymakers a less
favorable tradeoff between inflation and
unemployment.
Copyright © 2004 South-Western
SHIFTS IN THE PHILLIPS CURVE:
THE ROLE OF SUPPLY SHOCKS
• A supply shock is an event that directly alters
the firms’ costs, and, as a result, the prices they
charge.
• This shifts the economy’s aggregate supply
curve. . .
• . . . and as a result, the Phillips curve.
Figure 8 An Adverse Shock to Aggregate Supply
Quantity
of Output
0
Price
Level
Aggregate
demand
(a) The Model of Aggregate Demand and Aggregate Supply
Unemployment
Rate
0
Inflation
Rate
(b) The Phillips Curve
3. . . . and
raises
the price
level . . .
AS2
Aggregate
supply, AS
A
1. An adverse
shift in aggregate
supply . . .
4. . . . giving policymakers
a less favorable tradeoff
between unemployment
and inflation.
BP2
Y2
P
A
Y
Phillips curve,PC
2. . . . lowers output . . .
PC2
B
Copyright © 2004 South-Western
Copyright © 2004 South-Western
SHIFTS IN THE PHILLIPS CURVE:
THE ROLE OF SUPPLY SHOCKS
• In the 1970s, policymakers faced two choices
when OPEC cut output and raised worldwide
prices of petroleum.
• Fight the unemployment battle by expanding
aggregate demand and accelerate inflation.
• Fight inflation by contracting aggregate demand
and endure even higher unemployment.
Figure 9 The Supply Shocks of the 1970s
1 2 3 4 5 6 7 8 9 100
2
4
6
8
10
Unemployment
Rate (percent)
Inflation Rate
(percent per year)
1972
19751981
1976
1978
1979
1980
1973
1974
1977
Copyright © 2004 South-Western
Copyright © 2004 South-Western
THE COST OF REDUCING
INFLATION
• To reduce inflation, the Fed has to pursue
contractionary monetary policypolicy.
• When the Fed slows the rate of money growth,
it contracts aggregate demand.
• This reduces the quantity of goods and services
that firms produce.
• This leads to a rise in unemployment.
Figure 10 Disinflationary Monetary Policy in the
Short Run and the Long Run
Unemployment
Rate
0 Natural rate of
unemployment
Inflation
Rate
Long-run
Phillips curve
Short-run Phillips curve
with high expected
inflation
Short-run Phillips curve
with low expected
inflation
1. Contractionary policy moves
the economy down along the
short-run Phillips curve . . .
2. . . . but in the long run, expected
inflation falls, and the short-run
Phillips curve shifts to the left.
BC
A
Copyright © 2004 South-Western
Copyright © 2004 South-Western
THE COST OF REDUCING
INFLATION
• To reduce inflation, an economy must endure a
period of high unemployment and low output.
• When the Fed combats inflation, the economy
moves down the short-run Phillips curve.
• The economy experiences lower inflation but at the
cost of higher unemployment.
Copyright © 2004 South-Western
THE COST OF REDUCING
INFLATION
• The sacrifice ratio is the number of percentage
points of annual output that is lost in the
process of reducing inflation by one percentage
point.
• An estimate of the sacrifice ratio is five.
• To reduce inflation from about 10% in 1979-1981
to 4% would have required an estimated sacrifice of
30% of annual output!
Copyright © 2004 South-Western
Rational Expectations and the Possibility of
Costless Disinflation
• The theory of rational expectations suggests
that people optimally use all the information
they have, including information about
government policies, when forecasting the
future.
Copyright © 2004 South-Western
Rational Expectations and the Possibility of
Costless Disinflation
• Expected inflation explains why there is a
tradeoff between inflation and unemployment
in the short run but not in the long run.
• How quickly the short-run tradeoff disappears
depends on how quickly expectations adjust.
Copyright © 2004 South-Western
Rational Expectations and the Possibility of
Costless Disinflation
• The theory of rational expectations suggests
that the sacrifice-ratio could be much smaller
than estimated.
Copyright © 2004 South-Western
The Volcker Disinflation
• When Paul Volcker was Fed chairman in the
1970s, inflation was widely viewed as one of
the nation’s foremost problems.
• Volcker succeeded in reducing inflation (from
10 percent to 4 percent), but at the cost of high
employment (about 10 percent in 1983).
Figure 11 The Volcker Disinflation
1 2 3 4 5 6 7 8 9 100
2
4
6
8
10
Unemployment
Rate (percent)
Inflation Rate
(percent per year)
1980 1981
1982
1984
1986
1985
1979
A
1983
B
1987
C
Copyright © 2004 South-Western
Copyright © 2004 South-Western
The Greenspan Era
• Alan Greenspan’s term as Fed chairman began
with a favorable supply shock.
• In 1986, OPEC members abandoned their
agreement to restrict supply.
• This led to falling inflation and falling
unemployment.
Figure 12 The Greenspan Era
1 2 3 4 5 6 7 8 9 100
2
4
6
8
10
Unemployment
Rate (percent)
Inflation Rate
(percent per year)
1984
1991
1985
1992
1986
1993
1994
1988
1987
1995
1996
20021998
1999
2000
2001
1989
1990
1997
Copyright © 2004 South-Western
Copyright © 2004 South-Western
The Greenspan Era
• Fluctuations in inflation and unemployment in
recent years have been relatively small due to
the Fed’s actions.
Copyright © 2004 South-Western
Summary
• The Phillips curve describes a negative
relationship between inflation and
unemployment.
• By expanding aggregate demand, policymakers
can choose a point on the Phillips curve with
higher inflation and lower unemployment.
• By contracting aggregate demand,
policymakers can choose a point on the Phillips
curve with lower inflation and higher
unemployment.
Copyright © 2004 South-Western
Summary
• The tradeoff between inflation and
unemployment described by the Phillips curve
holds only in the short run.
• The long-run Phillips curve is vertical at the
natural rate of unemployment.
Copyright © 2004 South-Western
Summary
• The short-run Phillips curve also shifts because
of shocks to aggregate supply.
• An adverse supply shock gives policymakers a
less favorable tradeoff between inflation and
unemployment.
Copyright © 2004 South-Western
Summary
• When the Fed contracts growth in the money
supply to reduce inflation, it moves the
economy along the short-run Phillips curve.
• This results in temporarily high unemployment.
• The cost of disinflation depends on how
quickly expectations of inflation fall.

More Related Content

What's hot

Supply side policies
Supply side policiesSupply side policies
Supply side policiesmattbentley34
 
Consumers, Producers, and the Efficiency of Markets
Consumers, Producers, and the Efficiency of MarketsConsumers, Producers, and the Efficiency of Markets
Consumers, Producers, and the Efficiency of MarketsChris Thomas
 
Saving, Investment, and the Financial System
Saving, Investment, and the Financial SystemSaving, Investment, and the Financial System
Saving, Investment, and the Financial SystemChris Thomas
 
Production and Growth
Production and GrowthProduction and Growth
Production and GrowthChris Thomas
 
measuring nation's income
measuring nation's incomemeasuring nation's income
measuring nation's incomeitmamul akwan
 
Meeting 4 - Stolper - Samuelson theorem (International Economics)
Meeting 4 - Stolper - Samuelson theorem (International Economics)Meeting 4 - Stolper - Samuelson theorem (International Economics)
Meeting 4 - Stolper - Samuelson theorem (International Economics)Albina Gaisina
 
Demand pull inflation
Demand pull inflationDemand pull inflation
Demand pull inflationRasel Ahamed
 
Measuring a Nation's Income
Measuring a Nation's IncomeMeasuring a Nation's Income
Measuring a Nation's IncomeChris Thomas
 
Unemployment and Its Natural Rate
Unemployment and Its Natural RateUnemployment and Its Natural Rate
Unemployment and Its Natural RateAqib Syed
 
applications intenational trade
applications intenational tradeapplications intenational trade
applications intenational tradeitmamul akwan
 
MUNDELL FLEMING MODEL
MUNDELL FLEMING MODELMUNDELL FLEMING MODEL
MUNDELL FLEMING MODELnosscire.3299
 
Production Possibility Frontier (Revision Presentation)
Production Possibility Frontier (Revision Presentation)Production Possibility Frontier (Revision Presentation)
Production Possibility Frontier (Revision Presentation)tutor2u
 
The Basic tools of Finance
The Basic tools of FinanceThe Basic tools of Finance
The Basic tools of FinanceISYousafzai
 
Income Inequality and Poverty
Income Inequality and PovertyIncome Inequality and Poverty
Income Inequality and PovertyChris Thomas
 

What's hot (20)

Supply side policies
Supply side policiesSupply side policies
Supply side policies
 
Consumers, Producers, and the Efficiency of Markets
Consumers, Producers, and the Efficiency of MarketsConsumers, Producers, and the Efficiency of Markets
Consumers, Producers, and the Efficiency of Markets
 
Philip's Curve
Philip's CurvePhilip's Curve
Philip's Curve
 
Saving, Investment, and the Financial System
Saving, Investment, and the Financial SystemSaving, Investment, and the Financial System
Saving, Investment, and the Financial System
 
Production and Growth
Production and GrowthProduction and Growth
Production and Growth
 
Philips curve
Philips curvePhilips curve
Philips curve
 
measuring nation's income
measuring nation's incomemeasuring nation's income
measuring nation's income
 
Comparison between open economy and close economy
Comparison between open economy and close economy Comparison between open economy and close economy
Comparison between open economy and close economy
 
Meeting 4 - Stolper - Samuelson theorem (International Economics)
Meeting 4 - Stolper - Samuelson theorem (International Economics)Meeting 4 - Stolper - Samuelson theorem (International Economics)
Meeting 4 - Stolper - Samuelson theorem (International Economics)
 
Demand pull inflation
Demand pull inflationDemand pull inflation
Demand pull inflation
 
Measuring a Nation's Income
Measuring a Nation's IncomeMeasuring a Nation's Income
Measuring a Nation's Income
 
Unemployment and Its Natural Rate
Unemployment and Its Natural RateUnemployment and Its Natural Rate
Unemployment and Its Natural Rate
 
applications intenational trade
applications intenational tradeapplications intenational trade
applications intenational trade
 
MUNDELL FLEMING MODEL
MUNDELL FLEMING MODELMUNDELL FLEMING MODEL
MUNDELL FLEMING MODEL
 
Monetary policy
Monetary policyMonetary policy
Monetary policy
 
introduction to macro economics
introduction to macro economicsintroduction to macro economics
introduction to macro economics
 
Fixed and Floating exchange rate
Fixed and Floating exchange rateFixed and Floating exchange rate
Fixed and Floating exchange rate
 
Production Possibility Frontier (Revision Presentation)
Production Possibility Frontier (Revision Presentation)Production Possibility Frontier (Revision Presentation)
Production Possibility Frontier (Revision Presentation)
 
The Basic tools of Finance
The Basic tools of FinanceThe Basic tools of Finance
The Basic tools of Finance
 
Income Inequality and Poverty
Income Inequality and PovertyIncome Inequality and Poverty
Income Inequality and Poverty
 

Similar to The Short-Run Trade-off between Inflation and Unemployment

Module 34 inflation and umemployment the phillips curve
Module 34 inflation and umemployment the phillips curveModule 34 inflation and umemployment the phillips curve
Module 34 inflation and umemployment the phillips curveAmerican School of Guatemala
 
20121125 mankiw economics chapter35
20121125 mankiw economics chapter3520121125 mankiw economics chapter35
20121125 mankiw economics chapter35FED事務局
 
Meeting 4 - Phillips curve (Macroeconomics)
Meeting 4 - Phillips curve (Macroeconomics)Meeting 4 - Phillips curve (Macroeconomics)
Meeting 4 - Phillips curve (Macroeconomics)Albina Gaisina
 
Chapter 5 Macroeconomy Policy Practice s
Chapter 5 Macroeconomy Policy Practice sChapter 5 Macroeconomy Policy Practice s
Chapter 5 Macroeconomy Policy Practice sSabrina377028
 
Macro Economics: Phillips Curve, Inflation and Interest Rate
Macro Economics: Phillips Curve, Inflation and Interest RateMacro Economics: Phillips Curve, Inflation and Interest Rate
Macro Economics: Phillips Curve, Inflation and Interest RateZeeshan Ali
 
Inflation and phillips curve
Inflation and phillips curveInflation and phillips curve
Inflation and phillips curveanjali paurush
 
AN EASSAY ON PHILLIPS CURVE
AN EASSAY ON PHILLIPS CURVEAN EASSAY ON PHILLIPS CURVE
AN EASSAY ON PHILLIPS CURVEShubham Soni
 
Meeting 5 - Phillips curve 2 (Macroeconomics)
Meeting 5 - Phillips curve 2 (Macroeconomics)Meeting 5 - Phillips curve 2 (Macroeconomics)
Meeting 5 - Phillips curve 2 (Macroeconomics)Albina Gaisina
 
Topic 6 - Unemployment & Inflation
Topic 6 - Unemployment & InflationTopic 6 - Unemployment & Inflation
Topic 6 - Unemployment & InflationFatin Nazihah Aziz
 
Philips curve by nino bazhunaishvili
Philips curve  by nino bazhunaishviliPhilips curve  by nino bazhunaishvili
Philips curve by nino bazhunaishviliNino Bazhunaishvili
 
Phillip Curve(1).pptx
Phillip Curve(1).pptxPhillip Curve(1).pptx
Phillip Curve(1).pptxVinodha Devi
 
Natural rate of unemploymenty
Natural rate of unemploymentyNatural rate of unemploymenty
Natural rate of unemploymentyJijikumari
 
Aggregate demand and supply
Aggregate demand and supplyAggregate demand and supply
Aggregate demand and supplyDr Siddiqui
 
Inflation & unemployment
Inflation & unemploymentInflation & unemployment
Inflation & unemploymentKinnar Majithia
 

Similar to The Short-Run Trade-off between Inflation and Unemployment (20)

35
3535
35
 
Module 34 inflation and umemployment the phillips curve
Module 34 inflation and umemployment the phillips curveModule 34 inflation and umemployment the phillips curve
Module 34 inflation and umemployment the phillips curve
 
20121125 mankiw economics chapter35
20121125 mankiw economics chapter3520121125 mankiw economics chapter35
20121125 mankiw economics chapter35
 
Meeting 4 - Phillips curve (Macroeconomics)
Meeting 4 - Phillips curve (Macroeconomics)Meeting 4 - Phillips curve (Macroeconomics)
Meeting 4 - Phillips curve (Macroeconomics)
 
2006policy.ppt
2006policy.ppt2006policy.ppt
2006policy.ppt
 
Chapter 5 Macroeconomy Policy Practice s
Chapter 5 Macroeconomy Policy Practice sChapter 5 Macroeconomy Policy Practice s
Chapter 5 Macroeconomy Policy Practice s
 
Macro Economics: Phillips Curve, Inflation and Interest Rate
Macro Economics: Phillips Curve, Inflation and Interest RateMacro Economics: Phillips Curve, Inflation and Interest Rate
Macro Economics: Phillips Curve, Inflation and Interest Rate
 
Inflation and phillips curve
Inflation and phillips curveInflation and phillips curve
Inflation and phillips curve
 
AN EASSAY ON PHILLIPS CURVE
AN EASSAY ON PHILLIPS CURVEAN EASSAY ON PHILLIPS CURVE
AN EASSAY ON PHILLIPS CURVE
 
Meeting 5 - Phillips curve 2 (Macroeconomics)
Meeting 5 - Phillips curve 2 (Macroeconomics)Meeting 5 - Phillips curve 2 (Macroeconomics)
Meeting 5 - Phillips curve 2 (Macroeconomics)
 
Topic 6 - Unemployment & Inflation
Topic 6 - Unemployment & InflationTopic 6 - Unemployment & Inflation
Topic 6 - Unemployment & Inflation
 
12 aggregate demand
12 aggregate demand12 aggregate demand
12 aggregate demand
 
Philips curve by nino bazhunaishvili
Philips curve  by nino bazhunaishviliPhilips curve  by nino bazhunaishvili
Philips curve by nino bazhunaishvili
 
8 3 phillips curve-nairu
8 3 phillips curve-nairu8 3 phillips curve-nairu
8 3 phillips curve-nairu
 
Inflationunemployment 120127094754-phpapp02
Inflationunemployment 120127094754-phpapp02Inflationunemployment 120127094754-phpapp02
Inflationunemployment 120127094754-phpapp02
 
Inflationunemployment 120127094754-phpapp02
Inflationunemployment 120127094754-phpapp02Inflationunemployment 120127094754-phpapp02
Inflationunemployment 120127094754-phpapp02
 
Phillip Curve(1).pptx
Phillip Curve(1).pptxPhillip Curve(1).pptx
Phillip Curve(1).pptx
 
Natural rate of unemploymenty
Natural rate of unemploymentyNatural rate of unemploymenty
Natural rate of unemploymenty
 
Aggregate demand and supply
Aggregate demand and supplyAggregate demand and supply
Aggregate demand and supply
 
Inflation & unemployment
Inflation & unemploymentInflation & unemployment
Inflation & unemployment
 

More from Chris Thomas

Civil Rights: Equal Justice Under Law
Civil Rights: Equal Justice Under LawCivil Rights: Equal Justice Under Law
Civil Rights: Equal Justice Under LawChris Thomas
 
Civil Liberties: Protecting Individual Rights
Civil Liberties: Protecting Individual RightsCivil Liberties: Protecting Individual Rights
Civil Liberties: Protecting Individual RightsChris Thomas
 
The Federal Court System
The Federal Court SystemThe Federal Court System
The Federal Court SystemChris Thomas
 
Foreign Policy and National Defense
Foreign Policy and National DefenseForeign Policy and National Defense
Foreign Policy and National DefenseChris Thomas
 
Financing Government
Financing GovernmentFinancing Government
Financing GovernmentChris Thomas
 
Government at Work: The Bureaucracy
Government at Work: The BureaucracyGovernment at Work: The Bureaucracy
Government at Work: The BureaucracyChris Thomas
 
Congress in Action
Congress in ActionCongress in Action
Congress in ActionChris Thomas
 
The Electoral Process
The Electoral ProcessThe Electoral Process
The Electoral ProcessChris Thomas
 
Voters and Voter Behavior
Voters and Voter BehaviorVoters and Voter Behavior
Voters and Voter BehaviorChris Thomas
 
Origins of American Government
Origins of American GovernmentOrigins of American Government
Origins of American GovernmentChris Thomas
 
Principles of Government
Principles of GovernmentPrinciples of Government
Principles of GovernmentChris Thomas
 
Environmental Policy
Environmental PolicyEnvironmental Policy
Environmental PolicyChris Thomas
 
Foreign and Military Policy
Foreign and Military PolicyForeign and Military Policy
Foreign and Military PolicyChris Thomas
 

More from Chris Thomas (20)

Civil Rights: Equal Justice Under Law
Civil Rights: Equal Justice Under LawCivil Rights: Equal Justice Under Law
Civil Rights: Equal Justice Under Law
 
Civil Liberties: Protecting Individual Rights
Civil Liberties: Protecting Individual RightsCivil Liberties: Protecting Individual Rights
Civil Liberties: Protecting Individual Rights
 
The Federal Court System
The Federal Court SystemThe Federal Court System
The Federal Court System
 
Foreign Policy and National Defense
Foreign Policy and National DefenseForeign Policy and National Defense
Foreign Policy and National Defense
 
Financing Government
Financing GovernmentFinancing Government
Financing Government
 
Government at Work: The Bureaucracy
Government at Work: The BureaucracyGovernment at Work: The Bureaucracy
Government at Work: The Bureaucracy
 
The Presidency
The PresidencyThe Presidency
The Presidency
 
Congress in Action
Congress in ActionCongress in Action
Congress in Action
 
Congress
CongressCongress
Congress
 
Interest Groups
Interest GroupsInterest Groups
Interest Groups
 
The Electoral Process
The Electoral ProcessThe Electoral Process
The Electoral Process
 
Voters and Voter Behavior
Voters and Voter BehaviorVoters and Voter Behavior
Voters and Voter Behavior
 
Political Parties
Political PartiesPolitical Parties
Political Parties
 
Federalism
FederalismFederalism
Federalism
 
The Constitution
The ConstitutionThe Constitution
The Constitution
 
Origins of American Government
Origins of American GovernmentOrigins of American Government
Origins of American Government
 
Principles of Government
Principles of GovernmentPrinciples of Government
Principles of Government
 
Environmental Policy
Environmental PolicyEnvironmental Policy
Environmental Policy
 
Foreign and Military Policy
Foreign and Military PolicyForeign and Military Policy
Foreign and Military Policy
 
Social Welfare
Social WelfareSocial Welfare
Social Welfare
 

Recently uploaded

5 charts on South Africa as a source country for international student recrui...
5 charts on South Africa as a source country for international student recrui...5 charts on South Africa as a source country for international student recrui...
5 charts on South Africa as a source country for international student recrui...CaraSkikne1
 
What is the Future of QuickBooks DeskTop?
What is the Future of QuickBooks DeskTop?What is the Future of QuickBooks DeskTop?
What is the Future of QuickBooks DeskTop?TechSoup
 
Vani Magazine - Quarterly Magazine of Seshadripuram Educational Trust
Vani Magazine - Quarterly Magazine of Seshadripuram Educational TrustVani Magazine - Quarterly Magazine of Seshadripuram Educational Trust
Vani Magazine - Quarterly Magazine of Seshadripuram Educational TrustSavipriya Raghavendra
 
In - Vivo and In - Vitro Correlation.pptx
In - Vivo and In - Vitro Correlation.pptxIn - Vivo and In - Vitro Correlation.pptx
In - Vivo and In - Vitro Correlation.pptxAditiChauhan701637
 
CapTechU Doctoral Presentation -March 2024 slides.pptx
CapTechU Doctoral Presentation -March 2024 slides.pptxCapTechU Doctoral Presentation -March 2024 slides.pptx
CapTechU Doctoral Presentation -March 2024 slides.pptxCapitolTechU
 
How to Show Error_Warning Messages in Odoo 17
How to Show Error_Warning Messages in Odoo 17How to Show Error_Warning Messages in Odoo 17
How to Show Error_Warning Messages in Odoo 17Celine George
 
How to Add a New Field in Existing Kanban View in Odoo 17
How to Add a New Field in Existing Kanban View in Odoo 17How to Add a New Field in Existing Kanban View in Odoo 17
How to Add a New Field in Existing Kanban View in Odoo 17Celine George
 
A gentle introduction to Artificial Intelligence
A gentle introduction to Artificial IntelligenceA gentle introduction to Artificial Intelligence
A gentle introduction to Artificial IntelligenceApostolos Syropoulos
 
10 Topics For MBA Project Report [HR].pdf
10 Topics For MBA Project Report [HR].pdf10 Topics For MBA Project Report [HR].pdf
10 Topics For MBA Project Report [HR].pdfJayanti Pande
 
2024.03.23 What do successful readers do - Sandy Millin for PARK.pptx
2024.03.23 What do successful readers do - Sandy Millin for PARK.pptx2024.03.23 What do successful readers do - Sandy Millin for PARK.pptx
2024.03.23 What do successful readers do - Sandy Millin for PARK.pptxSandy Millin
 
HED Office Sohayok Exam Question Solution 2023.pdf
HED Office Sohayok Exam Question Solution 2023.pdfHED Office Sohayok Exam Question Solution 2023.pdf
HED Office Sohayok Exam Question Solution 2023.pdfMohonDas
 
The basics of sentences session 10pptx.pptx
The basics of sentences session 10pptx.pptxThe basics of sentences session 10pptx.pptx
The basics of sentences session 10pptx.pptxheathfieldcps1
 
DUST OF SNOW_BY ROBERT FROST_EDITED BY_ TANMOY MISHRA
DUST OF SNOW_BY ROBERT FROST_EDITED BY_ TANMOY MISHRADUST OF SNOW_BY ROBERT FROST_EDITED BY_ TANMOY MISHRA
DUST OF SNOW_BY ROBERT FROST_EDITED BY_ TANMOY MISHRATanmoy Mishra
 
Diploma in Nursing Admission Test Question Solution 2023.pdf
Diploma in Nursing Admission Test Question Solution 2023.pdfDiploma in Nursing Admission Test Question Solution 2023.pdf
Diploma in Nursing Admission Test Question Solution 2023.pdfMohonDas
 
Department of Health Compounder Question ‍Solution 2022.pdf
Department of Health Compounder Question ‍Solution 2022.pdfDepartment of Health Compounder Question ‍Solution 2022.pdf
Department of Health Compounder Question ‍Solution 2022.pdfMohonDas
 
Patient Counselling. Definition of patient counseling; steps involved in pati...
Patient Counselling. Definition of patient counseling; steps involved in pati...Patient Counselling. Definition of patient counseling; steps involved in pati...
Patient Counselling. Definition of patient counseling; steps involved in pati...raviapr7
 
How to Add Existing Field in One2Many Tree View in Odoo 17
How to Add Existing Field in One2Many Tree View in Odoo 17How to Add Existing Field in One2Many Tree View in Odoo 17
How to Add Existing Field in One2Many Tree View in Odoo 17Celine George
 
SOLIDE WASTE in Cameroon,,,,,,,,,,,,,,,,,,,,,,,,,,,.pptx
SOLIDE WASTE in Cameroon,,,,,,,,,,,,,,,,,,,,,,,,,,,.pptxSOLIDE WASTE in Cameroon,,,,,,,,,,,,,,,,,,,,,,,,,,,.pptx
SOLIDE WASTE in Cameroon,,,,,,,,,,,,,,,,,,,,,,,,,,,.pptxSyedNadeemGillANi
 
3.21.24 The Origins of Black Power.pptx
3.21.24  The Origins of Black Power.pptx3.21.24  The Origins of Black Power.pptx
3.21.24 The Origins of Black Power.pptxmary850239
 

Recently uploaded (20)

5 charts on South Africa as a source country for international student recrui...
5 charts on South Africa as a source country for international student recrui...5 charts on South Africa as a source country for international student recrui...
5 charts on South Africa as a source country for international student recrui...
 
What is the Future of QuickBooks DeskTop?
What is the Future of QuickBooks DeskTop?What is the Future of QuickBooks DeskTop?
What is the Future of QuickBooks DeskTop?
 
Vani Magazine - Quarterly Magazine of Seshadripuram Educational Trust
Vani Magazine - Quarterly Magazine of Seshadripuram Educational TrustVani Magazine - Quarterly Magazine of Seshadripuram Educational Trust
Vani Magazine - Quarterly Magazine of Seshadripuram Educational Trust
 
In - Vivo and In - Vitro Correlation.pptx
In - Vivo and In - Vitro Correlation.pptxIn - Vivo and In - Vitro Correlation.pptx
In - Vivo and In - Vitro Correlation.pptx
 
CapTechU Doctoral Presentation -March 2024 slides.pptx
CapTechU Doctoral Presentation -March 2024 slides.pptxCapTechU Doctoral Presentation -March 2024 slides.pptx
CapTechU Doctoral Presentation -March 2024 slides.pptx
 
How to Show Error_Warning Messages in Odoo 17
How to Show Error_Warning Messages in Odoo 17How to Show Error_Warning Messages in Odoo 17
How to Show Error_Warning Messages in Odoo 17
 
How to Add a New Field in Existing Kanban View in Odoo 17
How to Add a New Field in Existing Kanban View in Odoo 17How to Add a New Field in Existing Kanban View in Odoo 17
How to Add a New Field in Existing Kanban View in Odoo 17
 
A gentle introduction to Artificial Intelligence
A gentle introduction to Artificial IntelligenceA gentle introduction to Artificial Intelligence
A gentle introduction to Artificial Intelligence
 
10 Topics For MBA Project Report [HR].pdf
10 Topics For MBA Project Report [HR].pdf10 Topics For MBA Project Report [HR].pdf
10 Topics For MBA Project Report [HR].pdf
 
2024.03.23 What do successful readers do - Sandy Millin for PARK.pptx
2024.03.23 What do successful readers do - Sandy Millin for PARK.pptx2024.03.23 What do successful readers do - Sandy Millin for PARK.pptx
2024.03.23 What do successful readers do - Sandy Millin for PARK.pptx
 
HED Office Sohayok Exam Question Solution 2023.pdf
HED Office Sohayok Exam Question Solution 2023.pdfHED Office Sohayok Exam Question Solution 2023.pdf
HED Office Sohayok Exam Question Solution 2023.pdf
 
The basics of sentences session 10pptx.pptx
The basics of sentences session 10pptx.pptxThe basics of sentences session 10pptx.pptx
The basics of sentences session 10pptx.pptx
 
DUST OF SNOW_BY ROBERT FROST_EDITED BY_ TANMOY MISHRA
DUST OF SNOW_BY ROBERT FROST_EDITED BY_ TANMOY MISHRADUST OF SNOW_BY ROBERT FROST_EDITED BY_ TANMOY MISHRA
DUST OF SNOW_BY ROBERT FROST_EDITED BY_ TANMOY MISHRA
 
Prelims of Kant get Marx 2.0: a general politics quiz
Prelims of Kant get Marx 2.0: a general politics quizPrelims of Kant get Marx 2.0: a general politics quiz
Prelims of Kant get Marx 2.0: a general politics quiz
 
Diploma in Nursing Admission Test Question Solution 2023.pdf
Diploma in Nursing Admission Test Question Solution 2023.pdfDiploma in Nursing Admission Test Question Solution 2023.pdf
Diploma in Nursing Admission Test Question Solution 2023.pdf
 
Department of Health Compounder Question ‍Solution 2022.pdf
Department of Health Compounder Question ‍Solution 2022.pdfDepartment of Health Compounder Question ‍Solution 2022.pdf
Department of Health Compounder Question ‍Solution 2022.pdf
 
Patient Counselling. Definition of patient counseling; steps involved in pati...
Patient Counselling. Definition of patient counseling; steps involved in pati...Patient Counselling. Definition of patient counseling; steps involved in pati...
Patient Counselling. Definition of patient counseling; steps involved in pati...
 
How to Add Existing Field in One2Many Tree View in Odoo 17
How to Add Existing Field in One2Many Tree View in Odoo 17How to Add Existing Field in One2Many Tree View in Odoo 17
How to Add Existing Field in One2Many Tree View in Odoo 17
 
SOLIDE WASTE in Cameroon,,,,,,,,,,,,,,,,,,,,,,,,,,,.pptx
SOLIDE WASTE in Cameroon,,,,,,,,,,,,,,,,,,,,,,,,,,,.pptxSOLIDE WASTE in Cameroon,,,,,,,,,,,,,,,,,,,,,,,,,,,.pptx
SOLIDE WASTE in Cameroon,,,,,,,,,,,,,,,,,,,,,,,,,,,.pptx
 
3.21.24 The Origins of Black Power.pptx
3.21.24  The Origins of Black Power.pptx3.21.24  The Origins of Black Power.pptx
3.21.24 The Origins of Black Power.pptx
 

The Short-Run Trade-off between Inflation and Unemployment

  • 1. Copyright © 2004 South-Western 3535The Short-Run Tradeoff between Inflation and Unemployment
  • 2. Copyright © 2004 South-Western Unemployment and Inflation • The natural rate of unemployment depends on various features of the labor market. • Examples include minimum-wage laws, the market power of unions, the role of efficiency wages, and the effectiveness of job search. • The inflation rate depends primarily on growth in the quantity of money, controlled by the Fed.
  • 3. Copyright © 2004 South-Western Unemployment and Inflation • Society faces a short-run tradeoff between unemployment and inflation. • If policymakers expand aggregate demand, they can lower unemployment, but only at the cost of higher inflation. • If they contract aggregate demand, they can lower inflation, but at the cost of temporarily higher unemployment.
  • 4. Copyright © 2004 South-Western THE PHILLIPS CURVE • The Phillips curve illustrates the short-run relationship between inflation and unemployment.
  • 5. Figure 1 The Phillips Curve Unemployment Rate (percent) 0 Inflation Rate (percent per year) Phillips curve 4 B6 7 A 2 Copyright © 2004 South-Western
  • 6. Copyright © 2004 South-Western Aggregate Demand, Aggregate Supply, and the Phillips Curve • The Phillips curve shows the short-run combinations of unemployment and inflation that arise as shifts in the aggregate demand curve move the economy along the short-run aggregate supply curve.
  • 7. Copyright © 2004 South-Western Aggregate Demand, Aggregate Supply, and the Phillips Curve • The greater the aggregate demand for goods and services, the greater is the economy’s output, and the higher is the overall price level. • A higher level of output results in a lower level of unemployment.
  • 8. Figure 2 How the Phillips Curve is Related to Aggregate Demand and Aggregate Supply Quantity of Output 0 Short-run aggregate supply (a) The Model of Aggregate Demand and Aggregate Supply Unemployment Rate (percent) 0 Inflation Rate (percent per year) Price Level (b) The Phillips Curve Phillips curve Low aggregate demand High aggregate demand (output is 8,000) B 4 6 (output is 7,500) A 7 2 8,000 (unemployment is 4%) 106 B (unemployment is 7%) 7,500 102 A Copyright © 2004 South-Western
  • 9. Copyright © 2004 South-Western SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF EXPECTATIONS • The Phillips curve seems to offer policymakers a menu of possible inflation and unemployment outcomes.
  • 10. Copyright © 2004 South-Western The Long-Run Phillips Curve • In the 1960s, Friedman and Phelps concluded that inflation and unemployment are unrelated in the long run. • As a result, the long-run Phillips curve is vertical at the natural rate of unemployment. • Monetary policy could be effective in the short run but not in the long run.
  • 11. Figure 3 The Long-Run Phillips Curve Unemployment Rate 0 Natural rate of unemployment Inflation Rate Long-run Phillips curve BHigh inflation Low inflation A 2. . . . but unemployment remains at its natural rate in the long run. 1. When the Fed increases the growth rate of the money supply, the rate of inflation increases . . . Copyright © 2004 South-Western
  • 12. Figure 4 How the Phillips Curve is Related to Aggregate Demand and Aggregate Supply Quantity of Output Natural rate of output Natural rate of unemployment 0 Price Level P Aggregate demand, AD Long-run aggregate supply Long-run Phillips curve (a) The Model of Aggregate Demand and Aggregate Supply Unemployment Rate 0 Inflation Rate (b) The Phillips Curve 2. . . . raises the price level . . . 1. An increase in the money supply increases aggregate demand . . . A AD2 B A 4. . . . but leaves output and unemployment at their natural rates. 3. . . . and increases the inflation rate . . . P2 B Copyright © 2004 South-Western
  • 13. Copyright © 2004 South-Western Expectations and the Short-Run Phillips Curve • Expected inflation measures how much people expect the overall price level to change.
  • 14. Copyright © 2004 South-Western Expectations and the Short-Run Phillips Curve • In the long run, expected inflation adjusts to changes in actual inflation. • The Fed’s ability to create unexpected inflation exists only in the short run. • Once people anticipate inflation, the only way to get unemployment below the natural rate is for actual inflation to be above the anticipated rate.
  • 15. Copyright © 2004 South-Western • This equation relates the unemployment rate to the natural rate of unemployment, actual inflation, and expected inflation. Expectations and the Short-Run Phillips Curve ( )N a t u r a l r a t e o f u n e m p l o y m e n t - a A c t u a l i n f l a t i o n E x p e c t e d i n f l a t i o n− Unemployment Rate =
  • 16. Figure 5 How Expected Inflation Shifts the Short- Run Phillips Curve Unemployment Rate 0 Natural rate of unemployment Inflation Rate Long-run Phillips curve Short-run Phillips curve with high expected inflation Short-run Phillips curve with low expected inflation 1. Expansionary policy moves the economy up along the short-run Phillips curve . . . 2. . . . but in the long run, expected inflation rises, and the short-run Phillips curve shifts to the right. C B A Copyright © 2004 South-Western
  • 17. Copyright © 2004 South-Western The Natural Experiment for the Natural-Rate Hypothesis • The view that unemployment eventually returns to its natural rate, regardless of the rate of inflation, is called the natural-rate hypothesis. • Historical observations support the natural-rate hypothesis.
  • 18. Copyright © 2004 South-Western The Natural Experiment for the Natural Rate Hypothesis • The concept of a stable Phillips curve broke down in the in the early ’70s. • During the ’70s and ’80s, the economy experienced high inflation and high unemployment simultaneously.
  • 19. Figure 6 The Phillips Curve in the 1960s 1 2 3 4 5 6 7 8 9 100 2 4 6 8 10 Unemployment Rate (percent) Inflation Rate (percent per year) 1968 1966 1961 1962 1963 1967 1965 1964 Copyright © 2004 South-Western
  • 20. Figure 7 The Breakdown of the Phillips Curve 1 2 3 4 5 6 7 8 9 100 2 4 6 8 10 Unemployment Rate (percent) Inflation Rate (percent per year) 1973 1966 1972 1971 1961 1962 1963 1967 1968 1969 1970 1965 1964 Copyright © 2004 South-Western
  • 21. Copyright © 2004 South-Western SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF SUPPLY SHOCKS • Historical events have shown that the short-run Phillips curve can shift due to changes in expectations.
  • 22. Copyright © 2004 South-Western SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF SUPPLY SHOCKS • The short-run Phillips curve also shifts because of shocks to aggregate supply. • Major adverse changes in aggregate supply can worsen the short-run tradeoff between unemployment and inflation. • An adverse supply shock gives policymakers a less favorable tradeoff between inflation and unemployment.
  • 23. Copyright © 2004 South-Western SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF SUPPLY SHOCKS • A supply shock is an event that directly alters the firms’ costs, and, as a result, the prices they charge. • This shifts the economy’s aggregate supply curve. . . • . . . and as a result, the Phillips curve.
  • 24. Figure 8 An Adverse Shock to Aggregate Supply Quantity of Output 0 Price Level Aggregate demand (a) The Model of Aggregate Demand and Aggregate Supply Unemployment Rate 0 Inflation Rate (b) The Phillips Curve 3. . . . and raises the price level . . . AS2 Aggregate supply, AS A 1. An adverse shift in aggregate supply . . . 4. . . . giving policymakers a less favorable tradeoff between unemployment and inflation. BP2 Y2 P A Y Phillips curve,PC 2. . . . lowers output . . . PC2 B Copyright © 2004 South-Western
  • 25. Copyright © 2004 South-Western SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF SUPPLY SHOCKS • In the 1970s, policymakers faced two choices when OPEC cut output and raised worldwide prices of petroleum. • Fight the unemployment battle by expanding aggregate demand and accelerate inflation. • Fight inflation by contracting aggregate demand and endure even higher unemployment.
  • 26. Figure 9 The Supply Shocks of the 1970s 1 2 3 4 5 6 7 8 9 100 2 4 6 8 10 Unemployment Rate (percent) Inflation Rate (percent per year) 1972 19751981 1976 1978 1979 1980 1973 1974 1977 Copyright © 2004 South-Western
  • 27. Copyright © 2004 South-Western THE COST OF REDUCING INFLATION • To reduce inflation, the Fed has to pursue contractionary monetary policypolicy. • When the Fed slows the rate of money growth, it contracts aggregate demand. • This reduces the quantity of goods and services that firms produce. • This leads to a rise in unemployment.
  • 28. Figure 10 Disinflationary Monetary Policy in the Short Run and the Long Run Unemployment Rate 0 Natural rate of unemployment Inflation Rate Long-run Phillips curve Short-run Phillips curve with high expected inflation Short-run Phillips curve with low expected inflation 1. Contractionary policy moves the economy down along the short-run Phillips curve . . . 2. . . . but in the long run, expected inflation falls, and the short-run Phillips curve shifts to the left. BC A Copyright © 2004 South-Western
  • 29. Copyright © 2004 South-Western THE COST OF REDUCING INFLATION • To reduce inflation, an economy must endure a period of high unemployment and low output. • When the Fed combats inflation, the economy moves down the short-run Phillips curve. • The economy experiences lower inflation but at the cost of higher unemployment.
  • 30. Copyright © 2004 South-Western THE COST OF REDUCING INFLATION • The sacrifice ratio is the number of percentage points of annual output that is lost in the process of reducing inflation by one percentage point. • An estimate of the sacrifice ratio is five. • To reduce inflation from about 10% in 1979-1981 to 4% would have required an estimated sacrifice of 30% of annual output!
  • 31. Copyright © 2004 South-Western Rational Expectations and the Possibility of Costless Disinflation • The theory of rational expectations suggests that people optimally use all the information they have, including information about government policies, when forecasting the future.
  • 32. Copyright © 2004 South-Western Rational Expectations and the Possibility of Costless Disinflation • Expected inflation explains why there is a tradeoff between inflation and unemployment in the short run but not in the long run. • How quickly the short-run tradeoff disappears depends on how quickly expectations adjust.
  • 33. Copyright © 2004 South-Western Rational Expectations and the Possibility of Costless Disinflation • The theory of rational expectations suggests that the sacrifice-ratio could be much smaller than estimated.
  • 34. Copyright © 2004 South-Western The Volcker Disinflation • When Paul Volcker was Fed chairman in the 1970s, inflation was widely viewed as one of the nation’s foremost problems. • Volcker succeeded in reducing inflation (from 10 percent to 4 percent), but at the cost of high employment (about 10 percent in 1983).
  • 35. Figure 11 The Volcker Disinflation 1 2 3 4 5 6 7 8 9 100 2 4 6 8 10 Unemployment Rate (percent) Inflation Rate (percent per year) 1980 1981 1982 1984 1986 1985 1979 A 1983 B 1987 C Copyright © 2004 South-Western
  • 36. Copyright © 2004 South-Western The Greenspan Era • Alan Greenspan’s term as Fed chairman began with a favorable supply shock. • In 1986, OPEC members abandoned their agreement to restrict supply. • This led to falling inflation and falling unemployment.
  • 37. Figure 12 The Greenspan Era 1 2 3 4 5 6 7 8 9 100 2 4 6 8 10 Unemployment Rate (percent) Inflation Rate (percent per year) 1984 1991 1985 1992 1986 1993 1994 1988 1987 1995 1996 20021998 1999 2000 2001 1989 1990 1997 Copyright © 2004 South-Western
  • 38. Copyright © 2004 South-Western The Greenspan Era • Fluctuations in inflation and unemployment in recent years have been relatively small due to the Fed’s actions.
  • 39. Copyright © 2004 South-Western Summary • The Phillips curve describes a negative relationship between inflation and unemployment. • By expanding aggregate demand, policymakers can choose a point on the Phillips curve with higher inflation and lower unemployment. • By contracting aggregate demand, policymakers can choose a point on the Phillips curve with lower inflation and higher unemployment.
  • 40. Copyright © 2004 South-Western Summary • The tradeoff between inflation and unemployment described by the Phillips curve holds only in the short run. • The long-run Phillips curve is vertical at the natural rate of unemployment.
  • 41. Copyright © 2004 South-Western Summary • The short-run Phillips curve also shifts because of shocks to aggregate supply. • An adverse supply shock gives policymakers a less favorable tradeoff between inflation and unemployment.
  • 42. Copyright © 2004 South-Western Summary • When the Fed contracts growth in the money supply to reduce inflation, it moves the economy along the short-run Phillips curve. • This results in temporarily high unemployment. • The cost of disinflation depends on how quickly expectations of inflation fall.