Chapter 17: Inflation, Unemployment And Federal Reserve Policy

Front 1

What is the key difference in the short and long-run relationship of inflation and unemployment?

Back 1

In the short-run, there is a trade-off between inflation and unemployment. In the long-term, the unemployment rate becomes independent on inflation.

Front 2

Why is the long-run Philips curve vertical?

Back 2

In the long-run, unemployment rate equals the natural rate of unemployment. As such, unemployment is constant for every level of inflation.

Front 3

How does expected inflation affect the unemployment?

Back 3

Due to a difference in expectations to inflation, real wages change, which changes corporate profits. This leads to hiring more or laying off workers.

Front 4

What can shift the short-run Phillips curve? At what point do people adjust it back to? Why?

Back 4

Adjustment to higher or lower than expected inflation. It is adjusted back to the long-run Phillips curve in order to maintain their previous real wages.

Front 5

What is the effect of adjustments to a different than expected inflation regarding unemployment in the long run? What does this imply?

Back 5

Unemployment reverts back to the long-run Phillips curve. This implies that there is no relationship between inflation and unemployment in the long run because it will always revert back to the natural rate of unemployment.

Front 6

What occurs when there is an expansionary or contractionary policy? What occurs after?

Back 6

A movement up or down along the short-run curve. As inflation is different than expected, real wages will be readjusted. Hence, it will shift the curve back to equilibrium.

Front 7

Why is a higher Phillips curve less favorable?

Back 7

A higher one implies that a higher rate of inflation is needed to maintain the same rate of unemployment.

Front 8

In the long-run what is the effect of monetary or fiscal policies?

Back 8

It only affects inflation, but not unemployment.

Front 9

What determines how quickly adjustments occur for inflation? Why is this?

Back 9

At different levels of inflation. I.e.

1. Low

2. Moderate

3. High and unstable

The threat to not adjust increases with inflation. As such, the higher it is, the quicker people try to adjust.

Front 10

Define: rational expectations

Back 10

Forming expectations by using all available information about an economic variable

Front 11

What does rational expectation imply for the federal reserve policies?

Back 11

Assuming that there is rational expectation, everyone will account for every information including the effects of policies. As such, there is no short-run trade off as people already adjusted for the effects accurately.

Thus, there is no short-run curve.

Front 12

What is the effect of a supply shock? Why?

Back 12

A shifting up of the short-run Phillips curve as there is both higher inflation and unemployment.

Front 13

Define: disinflation. What its difference between deflation?

Back 13

A significant reduction in the inflation rate. I.e. a slowing down. Deflation refers to a reduction in the price level.

Front 14

Explain: a permanent decrease in inflation.

Back 14

Given that the unemployment rate equals the natural rate of unemployment, a lower inflation rate from contractionary policies will be able to sustain the same rates of unemployment in the long term.

Front 15

Explain: painless disinflation.

Back 15

The theory of neoclassical macroeconomics which hypothesizes that due to rational expectations, everyone will quickly and accurately adjust to a lower inflation. This causes a movement down the long-run Phillips curve as opposed to a shift in the short-run curve.

Front 16

What does the equilibrium of the short run and the long-run Phillips curve equal to? Why?

Back 16

The expected rate of inflation because it is the rate of inflation needed to support real wages that sustain the natural rate of unemployment.

Front 17

Define: sacrifice ratio. Formula?

Back 17

The cost of reducing inflation.

The ratio of decrease in annual output per point lost in inflation.

Front 18

Define: adaptive expectation. What does it imply regarding policies? Why?

Back 18

The expectation that inflation to be the same as last period implying that expansionary policies can increase employment due to slow adjustment of nominal wages.

Front 19

Define: Okun's law. As such, what is the lost output, given cyclical unemployment (X).

Back 19

1% loss of unemployment = 2% loss of output

2X.