Inflation and Unemployment The Phillips Curve Module 34

Inflation and Unemployment Inflation problems ◦ Inflation Tax  Because we use fiat money, gov’t can print money to pay of debts (seigniorage)  Ex – US gov’t debt purchased by the Fed

Inflation and Unemployment In times of hyperinflation ◦ ppl hold less money ◦ Causes more shortages ◦ Less money transactions  Gov’t turns to seigniorage, prints more, leading to more issues Who pays for inflation ◦ People who currently hold money – inflation tax

Inflation and Unemployment Cost-Push inflation ◦ Caused by dramatic spike in price of input/commodity  1970s oil crisis Demand-Pull inflation ◦ Inflation caused by increase in AD  “Too much money chasing too few goods”

The Short Run Phillips Curve Negative relationship btw inflation rates and unemployment Factors: supply shocks, expected inflation (1960s) Used often in 50s and 60s to help determine economic policy Initially, some people believed accepting high inflation = low unemployment

Where the Phillips Curve fails:

Still the Phillips Curve Long-Run Phillips Curve (LRPC) ◦ Policy makers have two choices: unemployment or inflation? Not so much

Natural Rate of Unemployment Natural Rate Hypothesis ◦ Reminder: Natural Rate = Structural + Frictional ◦ Unemployment rate must be high enough that the actual rate of inflation matches the expected rate of inflation  If unemployment BELOW natural rate, inflation ever accelerates  Rate ABOVE natural rate, decelerating inflation ◦ NAIRU (Non-Accelerating Rate of Unemployment)

Long-Run Phillips Curve Relationship between unemployment and inflation in LR ◦ After expectations of inflation have had time to adjust ◦ Normal Human Terms: it is vertical, the LRPC shows limits to expansionary policies ◦ Any rate ABOVE, leads to decelerating inflation

Inflation and Unemployment Disinflation and Deflation ◦ Disinflation – process of bringing down inflation that has become embedded in expectations ◦ Deflation – fall in the overall level of prices ◦ Monetary Shortcomings  Zero Bound  Liquidity Trap

Zero Bound causes Liquid Trap