Study Phillips Curves and Stabilization Trade-offs with 12 free online flashcards. Review key terms, definitions, and concepts with this interactive flashcard deck.
What relationship does the short-run Phillips curve describe?
The Phillips curve describes a short-run inverse relationship between inflation and unemployment: lower unemployment tends to accompany higher inflation, and higher unemployment tends to accompany lower inflation.
What is the simple short-run Phillips-curve equation?
π = πe − α(u − un). π is actual inflation, πe expected inflation, u unemployment, un the natural unemployment rate, and α inflation’s responsiveness to unemployment conditions.
What unemployment does the natural rate include?
The natural rate includes normal frictional and structural unemployment but excludes cyclical unemployment. It is consistent with stable inflation absent unusual supply shocks.
How does expansionary demand affect the short-run Phillips curve?
An expansionary demand shock moves the economy up and left along the existing short-run Phillips curve: inflation rises while unemployment falls.
What happens when expected inflation increases?
Higher expected inflation shifts the short-run Phillips curve upward, producing higher actual inflation at every unemployment rate.
How can adaptive expectations make inflation persistent?
Adaptive expectations rely partly on recent inflation. Persistent past inflation can raise expected inflation, wage demands, and prices, creating further inflation.
What do rational expectations use to forecast inflation?
Rational expectations use available information about economic conditions and policy. A credible commitment to price stability can keep long-run expectations stable.
Why is the long-run Phillips curve vertical?
The long-run Phillips curve is vertical at the natural unemployment rate because permanently higher inflation cannot permanently reduce unemployment.
What is the long-run result of expansionary policy?
After expansionary policy, expectations rise, nominal wages and prices adjust, and unemployment returns toward its natural rate. The lasting result is a higher price level or continuing inflation.
How does an adverse supply shock affect inflation and unemployment?
An adverse supply shock raises inflation and unemployment simultaneously by increasing production costs, reducing output, and encouraging firms to raise prices.
What is stagflation?
Stagflation is the simultaneous occurrence of high or rising inflation, high unemployment, and weak or stagnant economic growth.
How can an oil-price shock create stagflation?
A sharp oil-price increase raises transportation and production costs. Firms cut production and employment while raising prices, causing inflation and unemployment to rise together.