Module Inflation and Unemployment: The Phillips Curve KRUGMAN'S MACROECONOMICS for AP* 34 Margaret Ray and David Anderson

What you will learn in this Module : 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 Curve The 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 the Short-Run Phillips Curve Inflation Expectations and the 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 in 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 Curve The 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 Disinflation The 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.

Deflation Deflation – a falling aggregate price level