MODULE 34 INFLATION AND UNEMPLOYEMENT THE PHILLIPS CURVE

Lower unemployment tends to lead to higher periods of inflation… wonder why? THESE RULES ARE USUALLY REPRESENTED BY A GRAPH KNOWN AS THE PHILLIPS CURVE

 When SRAS increases along the AD, both the unemployment and inflation rates fall. This is seen as a downward shift of the SRPC.  When SRAS decreases along the AD, both the unemployment and inflation rates rise. This is seen as an upward shift of the SRPC.

Who is this man and why is he important? William Phillips

Short-Run Phillips Curve Positive Supply Shock brings both lower inflation lower unemployment A Negative Supply Shock will bring higher inflation and higher unemployment---- this is what economists call stagflation. Your point would be out to the right of the SRPC.

The Short-Run Phillips Curve and Supply Shocks

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Expected real inflation rate (the one we expect in the near future) impacts us today This impacts the short –run trade off between UE and inflation, shifting the SRPC Inflation expectations

Do you care about inflation? Why?

If there is an increase in expected inflation, the SRPC shifts upward: the actual rate of inflation at any given UE rate is higher when the expected inflation rate is higher. They go hand in hand….. Expected inflation leads to an actual inflation rise by the same percent And vice versa…

Inflation and Unemployment in the Long Run Most macroeconomists believe that there is no long-run trade-off between lower unemployment rates and higher inflation rates. That is, it is not possible to achieve lower unemployment in the long run by accepting higher inflation. Draw the AD/AS model in long – run equilibrium again Increase AD and then explain what happens in the long run—this time include unemployment and inflation!

The Long-Run Phillips Curve Predictions?

Inflation and Unemployment in the Long RunLong Run The long-run Phillips curve shows the relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience. To avoid accelerating inflation over time, the unemployment rate must be high enough that the actual rate of inflation matches the expected rate of inflation. The nonaccelerating inflation rate of unemployment, or NAIRU, is the unemployment rate at which inflation does not change over time. 14 of 22

The NAIRU and the Long-Run Phillips Curve 8% –1 –2 –3 8%76543 SRPC 0 E 0 Inflation rate Unemployment rate Nonaccelerating inflation rate of unemployment, NAIRU SRPC 2 4 E 2 E 4 C B A 15 of 22

NAIRU LRPC Natural Rate Hypothesis Natural Rate = NAIRU LONG RUN PHILLIPS CURVE

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