Inflation and Unemployment: The Phillips Curve Can Governments Lower Unemployment at No Cost?

The Short-Run Phillips Curve Inflation rate When the unemployment rate is low, inflation is high When the unemployment rate is high, inflation is low Short-run Phillips curve, SRPC Unemployment rate

The Short-Run Phillips Curve and Supply Shocks Inflation rate A negative supply shock shifts SRPC up SRPC1 A positive supply shock shifts SRPC down SRPC0 SRPC2 Unemployment rate

Expected Inflation and the Short-run Phillips Curve Inflation rate SRPC shifts up by the amount of the increase in expected inflation 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% -1% 1 2 3 4 5 6 7 8 9 10 SRPC3 -2% -3% -4% SRPC0 -5% -6% Unemployment rate

The NAIRU and the Long-Run Phillips Curve Long-run Phillips curve, LRPC Suppose the government attempts to push unemployment down, at the cost of higher inflation. What will happen? Inflation rate 10% 9% 8% 7% C What happens if the government continues on this course (trying to force down unemployment with higher inflation)? 6% 5% B E4 4% 3% A E2 2% 1% E0 -1% 1 2 3 4 5 6 7 8 9 10 -2% Nonaccelerating inflation rate of unemployment, NAIRU SRPC4 -3% -4% SRPC2 -5% -6% SRPC0 Unemployment rate

Phillips Curve Questions Draw a graph AND EXPLAIN what would happen to SRPC in the following scenarios: Government increases spending The price of crude oil and most energy sources increase Inflation expectations rise from 3% to 6% The Fed increases interest rates with contractionary monetary policy Inflation expectations fall from 5% to 2% The government increases income taxes What happens in the LONG RUN in Question #1?