ModuleInflation andUnemployment:The Phillips Curve

KRUGMAN'SMACROECONOMICS for AP*

34

Margaret Ray and David Anderson

What you will learnWhat you will learn

in thisin this ModuleModule::• What the Phillips curve is and the nature of the

short-run trade-off between inflation and unemployment

• Why there is no long-run trade-off between inflation and unemployment

• Why expansionary policies are limited due to the effects of expected inflation

• Why even moderate levels of inflation can be hard to end

• Why deflation is a problem for economic policy and leads policy makers to prefer a low but positive inflation rate

The Short-Run Phillips CurveThe Short-Run Phillips Curve

•Phillips Curve – trade-off between unemployment and inflation.

•Short-Run Phillips Curve• When AD increases along the

SRAS• U falls• Inflation Rate rises

• When AD decreases along the SRAS

• U rises• Inflation Rate falls

• A shift in AD will cause movement along the SRPC

•Watch how supply shocks shift SRPC

Inflation Expectations and theInflation Expectations and the Short-Run Phillips Curve Short-Run Phillips Curve

•Expected Inflation – rate of inflation employers and workers expect in the near future.

•Relationship between actual and expected inflation – one-to-one – when expected inflation increases by 3%, actual inflation increases by 3%

Inflation and Unemployment Inflation and Unemployment in the Long Runin the Long Run

• The SRPC of the 1960s

• The experience of the 1970s

• The trade-off between inflation and unemployment

•The short run and long run effects of expansionary policies

The Long-Run Phillips CurveThe Long-Run Phillips Curve

The Long-Run Phillips CurveThe Long-Run Phillips Curve

•NAIRU – non-accelerating inflation rate of unemployment

•Natural Rate = NAIRU

•The prior slide shows how the SRPC ‘creates’ the LRPC

The Costs of DisinflationThe Costs of Disinflation

Government creates a Situation, thru contractionary fiscal/monetary policy, where U rate is ABOVE NAIRU. This induces a recession. Inflation rate decreases until SRPC Shift downward. The problem is there will be a long period of high Unemployment.

Watch the shifting of the curves.

DeflationDeflation

• Deflation – a falling aggregate price level