The Phillips Curve Intro to Phillips Curve There

The Phillips Curve

Intro to Phillips Curve There is a short-run trade-off between unemployment and inflation Lower unemployment leads to higher inflation Higher unemployment leads to lower inflation This is inverse relationship is represented by the Phillips Curve!

Short Run Phillips Curve

Short-Run Phillips Curve Demand shocks result in movement along SRPC When AD increases along SRAS, unemployment rate ↓ and inflation rate ↑ When AD decreases along SRAS, unemployment rate ↑ and inflation rate ↓ Supply shocks result in shift of SRPC When SRAS increases along AD, both unemployment and inflation rates ↓ (downward shift) When SRAS decreases along AD, both unemployment and inflation rates ↑(upward shift) SRPC can extend below the horizontal axis (in times of deflation)

Inflation Expectations Expected rate of inflation: rate of inflation employers and workers expect in the near future Affect short-run trade-off between unemployment and inflation Matters because no one wants to lose purchasing power due to future inflation An increase in expected inflation shifts SRPC upward Relationship between changes in expected inflation and actual is one-to-one (will rise by the same amount)

Long-Run Phillips Curve Most macroeconomists believe there is no long-run trade-off between lower unemployment rates and higher inflation rates. It is not possible to achieve lower unemployment in the long run by accepting higher inflation. Let’s see why!

Natural Rate of Unemployment Revisited Non-accelerating inflation rate of unemployment: represents the unemployment rate at which inflation does not change over time (NAIRU) Keeping unemployment below NAIRU leads to ever-accelerating inflation—cannot be maintained NAIRU Level is another name for natural rate of unemployment needed in order to avoid accelerating inflation

Long Run Phillips Curve Vertical curve set at NAIRU The relationship between unemployment and inflation in the long run, after expectations of inflation have had time to adjust to experience. Proves there are limits to expansionary policies when already at full employment