In this chapter we examine this tradeoff more closely. The relationship between inflation and unemployment is a topic that has attracted the attention of some of the most important economists of the last half century. The best way to understand this relationship is to see how thinking about it has evolved over time.
Trang 1Review of the previous lecture
¢ The natural rate of unemployment
Vv the long-run average or “steady state” rate of unemployment Y depends on the rates of job separation and job finding
¢ Frictional unemployment
Trang 2Review of the previous lecture
¢ Duration of unemployment Vv most spells are short term
Trang 3Lecture 18 - Lưng Pitre ory be =) e@eenre 3 / +: vse ie li ase xa) 2s: he Ề mố * - _ Ty -
~ Unemployment and Inflation
Trang 5Unemployment 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
¢The inflation rate depends primarily on growth in the quantity of money, controlled by the Fed
*Society faces a short-run tradeoff between unemployment and inflation lf policymakers expand aggregate demand, they can lower unemployment, but only at the cost of higher inflation
Trang 6The Phillips Curve
Trang 7The Phillips Curve
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
The greater the aggregate demand for goods and services, the greater is the economy’s output, and the higher is the overall price level
Trang 8The Phillips Curve
Trang 9The Phillips Curve
Shifts In The Phillips Curve: The Role Of Expectations
¢The Phillips curve seems to offer policymakers a menu of possible inflation and unemployment outcomes
The Long-Run Phillips Curve
eIn the 1960s, Friedman and Phelps concluded that inflation and unemployment are unrelated in the long run
¢ Asaresult, the long-run Phillips curve is vertical at the natural rate of unemployment
Trang 101 When the Fed increases the growth rate of the money supply, the rate of inflation increases
The Phillips Curve
Long-Run Phillips Curve Long-run Phillips curve A 2 but unemployment remains at its natural rate inthe long run
Trang 11The Phillips Curve
How the Phillips Curve is Related to Aggregate Demand and Aggregate Supply (a) The Model of Aggregate Demand and Aggregate Supply (b) The Phillips Curve
oe Long.run aggregate Inflation Long+un Philips
Level supply Rate "uwe 1 Anineae in J and
the money supply Increases the
increases aggregate inflation rate P, nu eeeooooooooooool demand _ 7 NGG00000000000000000000000000000006 H 2 faiSes N the price | level Pye ole A Aggregate demand, AD,
0 Natural rate Quantity 0 Natural rate of Unemployment
of output of Output unemployment Rate
4 but leaves oufput and unemployment
Trang 12The Phillips Curve
Expectations and the Short-Run Phillips Curve
*Expected inflation measures how much people expect the overall price level to change
eIn 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
Unemployment Rate =
` Expected
| C1 |
Natural rate of unemployment a ilat relation
Trang 13The Phillips Curve
How Expected Inflation Shifts the Short-Run Phillips Curve
Inflation Rate
2 butinthe long run, expected inflation rises, and the short-run Phillips curve shifts to the right Long-run Phillips curve E>—-——¬—=—
Short-run Philllbs curve with high expected
inflation
short-run Phillips curve with low expected
inflation 1 Expansionary policy moves
the economy up along the Short-run Phillips curve
Trang 14
The Phillips Curve
The Natural Experiment for the 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
Trang 15The Phillips Curve
High inflation and high unemployment
Trang 16The Phillips Curve
Shifts 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
¢ 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
°A supply shock Is an event that directly alters the firms’ costs, and, as a result, the prices they charge
Trang 17The Phillips Curve
An Adverse Shock to Aggregate Supply
(a) The Model of Aggregate Demand and Aggregate Supply (b) The Phillips Curve
Price Inflation ¬-
Level AS, Rate 4 giving policymakers a less favorable tradeotf between unemployment and inflation Aggregate supply, AS, —————* BỊ ~ 3 8H, | 1 An adverse faises | : shift in aggregate hee a ————r—^2 Supp level 3 | PC, Aggregate
| | dernand Phillips curve, PC,
() V,«—Y, Quantity () Unemployment
" of Output Rate
Trang 18The Cost Of Reducing Inflation
°Tïo 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
Trang 19The Cost Of Reducing Inflation
Disinflationary Monetary Policy in the Short Run and the Long Run Inflation
Rate
1 Contractionary policy moves the economy down along the
Long-run short-run Phillips curve Phillips curve
Short-run Phillips curve with high expected
inflation
ea a ea a —— ‹“M— ss
short-run Phillips curve with low expected
inflation
Natural rate of \ Unemployment
unemployment 9 but in the long run, expected Rate
inflation falls, and the short-run
Trang 20The Cost Of Reducing Inflation
*Tïo 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
Trang 21
Summary
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 temporarily higher unemployment
The Phillips curve illustrates the short-run relationship between inflation and unemployment
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
Trang 22Summary
The view that unemployment eventually returns to its natural rate, regardless of the rate of inflation, is called the natural-rate hypothesis To reduce inflation, the Fed has to pursue contractionary monetary policy To reduce inflation, an economy must endure a period of high