items and derived items copyright © 2001 by Harcourt, Inc.The Phillips Curve The Phillips curve illustrates the short-run relationship between inflation and unemployment... items and der
Trang 1Copyright © 2001 by Harcourt, Inc.
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Trang 2Unemployment and Inflation
The natural rate of unemployment depends on various features of the labor market.
Examples include minimum-wage laws, the market power of unions, the role of efficiency wages, and the effectiveness
of job search.
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Unemployment and Inflation
The inflation rate depends primarily
on growth in the quantity of money, controlled by the Fed.
The misery index, one measure of the
“health” of the economy, adds together the inflation rate and unemployment rate.
Trang 4Unemployment and Inflation
Society faces a short-run tradeoff between unemployment and inflation.
If policymakers expand aggregate
demand, they can lower unemployment, but only at the cost of higher inflation.
If they contract aggregate demand, they can lower inflation, but at the cost of
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The Phillips Curve
The Phillips curve illustrates the short-run relationship between inflation and unemployment.
Trang 6The Phillips Curve
A 2
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Aggregate Demand, Aggregate Supply, and the Phillips Curve
The Phillips curve shows the short-run combinations of unemployment and
inflation that arise as shifts in the aggregate demand curve move the economy along the short-run aggregate supply curve.
Trang 8Aggregate Demand, Aggregate Supply, and the Phillips Curve
The greater the aggregate demand for
goods and services, the greater is the economy’s output, and the higher is the overall price level.
A higher level of output results in a lower level of unemployment.
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How the Phillips Curve is Related to the Model
of Aggregate Demand and Aggregate Supply
Phillips curve
0
(b) The Phillips Curve
Inflation Rate (percent per
year)
Unemployment Rate (percent)
A
7
2
(output is 7,500)
Trang 10Shifts in the Phillips Curve: The Role of Expectations
The Phillips curve seems to offer policymakers a menu of possible inflation and unemployment outcomes.
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The Long-Run Phillips Curve
In the 1960s, Friedman and Phelps
concluded that inflation and unemployment are unrelated in the long run.
As a result, the long-run Phillips curve is vertical at the natural rate of unemployment.
Monetary policy could be effective in the short run but not in the long run.
Trang 12The Long-Run Phillips Curve
Inflation
Phillips curve B
High inflation
in the long run.
A
Low inflation
Trang 13Natural rate of unemployment
A
Natural rate of output
(a) The Model of Aggregate
Demand and Aggregate Supply
Price
Level
4 …but leaves output and unemployment
at their natural rates.
How the Phillips Curve is Related to the
Model of Aggregate Demand and
1 An increase in the money supply increases aggregate demand…
AD 2
B
3 …and increases the inflation rate… Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc.
Trang 14Expectations and the Short-Run Phillips Curve
Expected inflation measures how much people expect the overall price level to change.
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Expectations and the Short-Run Phillips Curve
In the long run, expected inflation
adjusts to changes in actual inflation.
The Fed’s ability to create unexpected
inflation exists only in the short run.
Once people anticipate inflation, the only way to get unemployment below the natural rate is for actual inflation to be above the anticipated rate.
Trang 16Expectations and the Short-Run Phillips Curve
Unemployment
Rate = unemployment Natural rate of - a Actual Expected ( inflation inflation- )
This equation relates the unemployment rate to the natural
rate of unemployment, actual inflation, and expected inflation.
Trang 17How Expected Inflation Shifts the
Short-Run Phillips Curve
Long-run Phillips curve
curve
2 …but in the long-run, expected inflation rises, and the short-run Phillips curve shifts to the right.
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Trang 18The Natural-Rate Hypothesis
The view that unemployment eventually returns to its natural rate, regardless of the rate of inflation, is called the natural-rate hypothesis.
Historical observations support the natural-rate hypothesis.
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The Natural Experiment for the
Natural Rate Hypothesis
The concept of a stable Phillips curve
broke down in the in the early ’70s.
During the ’70s and ’80s, the economy experienced high inflation and high
unemployment simultaneously.
Trang 20The Phillips Curve in the 1960s
Inflation Rate (percent per year)
4 6 8 10
1968 1966
1961 1962
1967
1965
1964
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The Breakdown of the Phillips Curve
Unemployment Rate (percent)
Inflation Rate (percent per year)
0 1 2 3 4 5 6 7 8 9 10 2
4 6 8 10
1973
1971 1969
1970 1968
1966
1961
1962 1963
1967
1965
1964
1972
Trang 22Shifts in the Phillips Curve: The Role of Supply Shocks
Historical events have shown that the
short-run Phillips curve can shift due to changes in expectations
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Shifts in the Phillips Curve:
The Role of Supply Shocks
The short-run Phillips curve also shifts because of shocks to aggregate supply
Major adverse changes in aggregate supply can worsen the short-run tradeoff between unemployment and inflation.
An adverse supply shock gives policymakers
a less favorable tradeoff between inflation and unemployment.
Trang 24Shifts in the Phillips Curve:
The Role of Supply Shocks
A supply shock is an event that directly affects firms’ costs of production and thus the prices they charge
It shifts the economy’s aggregate supply curve
… and as a result, the Phillips curve.
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AS 2
1 An adverse shift in aggregate supply…
An Adverse Shock to Aggregate
Supply
Quantity of Output 0
Price
Level
P 1
Aggregate demand
(a) The Model of Aggregate
Demand and Aggregate Supply
Unemployment Rate 0
(b) The Phillips Curve
A
Inflation Rate
PC 2
Trang 26Shifts in the Phillips Curve:
The Role of Supply Shocks
In the 1970s, policymakers faced two
choices when OPEC cut output and raised worldwide prices of petroleum.
Fight the unemployment battle by expanding aggregate demand and accelerate inflation.
Fight inflation by contracting aggregate demand and endure even higher
Trang 27Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc.
Inflation Rate
(percent per year)
Unemployment Rate (percent)
0 1 2 3 4 5 6 7 8 9 10
2 4 6 8 10
The Supply Shocks of the 1970s
1972
197 5 1981
1976
1978 1979 1980
1973 1974
1977
Trang 28The Cost of Reducing Inflation
To reduce inflation, the Fed has to pursue
contractionary monetary policy
When the Fed slows the rate of money
growth, it contracts aggregate demand.
This reduces the quantity of goods and
services that firms produce.
This leads to a rise in unemployment.
Trang 29Disinflationary Monetary Policy in the
Short Run and the Long Run
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Trang 30The Cost of Reducing Inflation
To reduce inflation, an economy must
endure a period of high unemployment and low output.
When the Fed combats inflation, the economy moves down the short-run Phillips curve.
The economy experiences lower inflation but
at the cost of higher unemployment.
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The Cost of Reducing Inflation
The sacrifice ratio is the number of
percentage points of annual output that is lost in the process of reducing inflation
by one percentage point.
An estimate of the sacrifice ratio is five.
To reduce inflation from about 10% in 1979-1981 to 4% would have required an estimated sacrifice of 30% of annual output!
Trang 32Rational Expectations
The theory of rational expectations
suggests that people optimally use all the information they have, including information about government policies, when forecasting the future.
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How quickly the short-run tradeoff
disappears depends on how quickly expectations adjust.
Trang 34Rational Expectations
The theory of rational expectations
suggests that the sacrifice-ratio could be much smaller than estimated.
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The Volcker Disinflation
When Paul Volcker was Fed chairman in the 1970s, inflation was widely viewed as one of the nation’s foremost problems.
Volcker succeeded in reducing inflation (from 10% to 4%), but at the cost of high employment (about 10% in 1983).
Trang 36Inflation Rate
(percent per year)
2 4 6 8 10
The Volcker Disinflation
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The Greenspan Era
Alan Greenspan’s term as Fed chairman began with a favorable supply shock
In 1986, OPEC members abandoned their agreement to restrict supply.
This led to falling inflation and falling unemployment.
Trang 382 4 6 8 10
Inflation Rate
(percent per year)
The Greenspan Era
1984
1991 1985 1992 1993 1986 1994
1988 1987 1995
1989 1990
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The Greenspan Era
Fluctuations in inflation and
unemployment in recent years have been relatively small due to the Fed’s actions.
Trang 40 The Phillips curve describes a negative
relationship between inflation and
unemployment.
By expanding aggregate demand,
policymakers can choose a point on the
Phillips curve with higher inflation and lower unemployment.
By contracting aggregate demand,
policymakers can choose a point on the
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Summary
The tradeoff between inflation and
unemployment described by the Phillips curve holds only in the short run.
The long-run Phillips curve is vertical at the natural rate of unemployment.
Trang 42 The short-run Phillips curve also shifts because of shocks to aggregate supply.
An adverse supply shock gives
policymakers a less favorable tradeoff between inflation and unemployment.
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Trang 44 Because monetary and fiscal policy can
influence aggregate demand, the government sometimes uses these policy instruments in an attempt to stabilize the economy.
Changes in attitudes by households and
firms shift aggregate demand; if the government does not respond, the result is undesirable and unnecessary
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Graphical
Review
Trang 46The Phillips Curve
A 2
Trang 47Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc.
How the Phillips Curve is Related to the Model
of Aggregate Demand and Aggregate Supply
Phillips curve
0
(b) The Phillips Curve
Inflation Rate (percent per
year)
Unemployment Rate (percent)
A
7
2
(output is 7,500)
Trang 48The Long-Run Phillips Curve
Inflation
Phillips curve B
High inflation
in the long run.
A
Low inflation
Trang 49How the Phillips Curve is Related to the
Model of Aggregate Demand and
Aggregate Supply…
Natural rate of unemployment
A
Natural rate of output
(a) The Model of Aggregate
Demand and Aggregate Supply
Price
Level
4 …but leaves output and unemployment
at their natural rates.
P 2
2 …raises the
price level…
Quantity of Output Unemploy- ment Rate
1 An increase in the money supply increases aggregate demand…
AD 2
B
3 …and increases the inflation rate… Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc.
Trang 50How Expected Inflation Shifts the
Short-Run Phillips Curve
Inflation
Rate
C B
Long-run Phillips curve
2 …but in the long-run, expected inflation rises, and the short-run Phillips curve shifts to the right.
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Trang 51Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc.
The Phillips Curve in the 1960s
Unemployment Rate (percent)
Inflation Rate (percent per year)
0 1 2 3 4 5 6 7 8 9 10 2
4 6 8 10
1968 1966
1961
1962 1963
1967
1965
1964
Trang 52The Breakdown of the Phillips Curve
Inflation Rate (percent per year)
4 6 8 10
1973
1971 1969
1970 1968
1966
1961 1962
1967
1965
1964
1972
Trang 53Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc.
An Adverse Shock to Aggregate
Supply
AS 2
1 An adverse shift in aggregate supply…
Quantity of Output 0
Price
Level
P 1
Aggregate demand
(a) The Model of Aggregate
Demand and Aggregate Supply
Unemployment Rate 0
(b) The Phillips Curve
A
Inflation Rate
PC 2
Trang 54The Supply Shocks of the 1970s
Inflation Rate
(percent per year)
2 4 6 8 10
1972
197 5 1981
1976
1978 1979 1980
1973 1974
1977
Trang 55Disinflationary Monetary Policy in the
Short Run and the Long Run
Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc.
Trang 56The Volcker Disinflation
Inflation Rate
(percent per year)
2 4 6 8
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The Greenspan Era
Unemployment Rate (percent)
0 1 2 3 4 5 6 7 8 9 10 0
2 4 6 8 10
Inflation Rate
(percent per year)
1984
1991 1985 1992 1993 1986 1994
1988 1987 1995
1989 1990