ModuleInflation andUnemployment:The Phillips Curve
KRUGMAN'SMACROECONOMICS for AP*
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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