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 2Unemployment and Inflation
• The natural rate of unemployment depends on various features of the labor market
• Examples include minimumwage 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
Trang 3• If they contract aggregate demand, they can
lower inflation, but at the cost of temporarily
higher unemployment
Trang 4THE PHILLIPS CURVE
• The Phillips curve illustrates the shortrun
relationship between inflation and
unemployment
Trang 5Figure 1 The Phillips Curve
Unemployment Rate (percent)
B 6
7
A 2
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Trang 6Aggregate Demand, Aggregate Supply, and the Phillips Curve
• The Phillips curve shows the shortrun
combinations of unemployment and inflation that arise as shifts in the aggregate demand
curve move the economy along the shortrun aggregate supply curve
Trang 8Figure 2 How the Phillips Curve is Related to
Aggregate Demand and Aggregate Supply
Quantity
of Output
0
Short-run aggregate supply
(a) The Model of Aggregate Demand and Aggregate Supply
Unemployment Rate (percent)
0
Inflation Rate (percent per year)
High aggregate demand
(output is 8,000)
B
4 6
(output is 7,500)
A
7
2
8,000 (unemployment
is 4%)
(unemployment
is 7%) 7,500
Trang 9SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF EXPECTATIONS
• The Phillips curve seems to offer policymakers
a menu of possible inflation and unemployment outcomes
Trang 10The 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 longrun 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 11Figure 3 The Long-Run Phillips Curve
inflation
Low inflation
A
2 but unemployment remains at its natural rate
in the long run.
Trang 12Figure 4 How the Phillips Curve is Related to
Aggregate Demand and Aggregate Supply
Long-run Phillips curve
(a) The Model of Aggregate Demand and Aggregate Supply
Unemployment
Rate
0
Inflation Rate
(b) The Phillips Curve
2 raises
the price
level
1 An increase in the money supply increases aggregate demand
A
AD2
B
A
4 but leaves output and unemployment
at their natural rates.
3 and increases the inflation rate
Trang 13Expectations and the Short-Run Phillips
Curve
• Expected inflation measures how much people expect the overall price level to change
Trang 14Expectations 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 15Copyright © 2004 South-Western
• This equation relates the unemployment rate to the natural rate of unemployment, actual
Trang 16Figure 5 How Expected Inflation Shifts the Run Phillips Curve
C B
A
Trang 17The 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 naturalrate hypothesis
• Historical observations support the naturalrate hypothesis
Trang 18The Natural Experiment for the Natural Rate Hypothesis
Trang 19Figure 6 The Phillips Curve in the 1960s
0
2 4 6 8 10
Unemployment Rate (percent)
1963
1967
1965 1964
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Trang 20Figure 7 The Breakdown of the Phillips Curve
2 4 6 8 10
1961 1962
1967
1968
1965 1964
Trang 21SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF SUPPLY SHOCKS
• Historical events have shown that the shortrun Phillips curve can shift due to changes in
expectations.
Trang 22SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF SUPPLY SHOCKS
unemployment.
Trang 23• This shifts the economy’s aggregate supply
curve. . .
• . . and as a result, the Phillips curve
Trang 24Figure 8 An Adverse Shock to Aggregate Supply
(a) The Model of Aggregate Demand and Aggregate Supply
Unemployment
Rate
0
Inflation Rate
(b) The Phillips Curve
4 giving policymakers
a less favorable tradeoff between unemployment and inflation.
Trang 25SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF SUPPLY SHOCKS
• In the 1970s, policymakers faced two choices when OPEC cut output and raised worldwide
Trang 26Figure 9 The Supply Shocks of the 1970s
2 4 6 8 10
Inflation Rate
(percent per year)
1972
1975 1981
1976
1978 1979 1980
1973 1974
1977
Trang 27THE COST OF REDUCING
• This leads to a rise in unemployment
Trang 28Figure 10 Disinflationary Monetary Policy in the
Short Run and the Long Run
B C
A
Trang 29THE 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 shortrun Phillips curve.
• The economy experiences lower inflation but at the cost of higher unemployment.
Trang 30THE 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 19791981
to 4% would have required an estimated sacrifice of 30% of annual output!
Trang 32Rational Expectations and the Possibility of Costless Disinflation
• Expected inflation explains why there is a
tradeoff between inflation and unemployment
in the short run but not in the long run
• How quickly the shortrun tradeoff disappears depends on how quickly expectations adjust
Trang 34The Volcker Disinflation
Trang 35Figure 11 The Volcker Disinflation
0
2 4 6 8 10
Unemployment Rate (percent)
Trang 36The 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 37Figure 12 The Greenspan Era
0 2 4 6 8 10
Unemployment Rate (percent)
Inflation Rate
(percent per year)
1984 1991
1985 1992 1986 1993 1994
1988 1987 1995
1998 1999
1989 1990
1997
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Trang 38The Greenspan Era
• Fluctuations in inflation and unemployment in recent years have been relatively small due to the Fed’s actions
Trang 39• By contracting aggregate demand,
policymakers can choose a point on the Phillips curve with lower inflation and higher
unemployment
Trang 40• The tradeoff between inflation and
unemployment described by the Phillips curve holds only in the short run
• The longrun Phillips curve is vertical at the
natural rate of unemployment
Trang 41unemployment.