Macroeconomics Chapter 35 - The Short-Run Tradeoff Between Inflation And Unemployment

Front 1

Relationship between inflation & employment in long-run:

Back 1

Unrelated. Inflation rate depends on growth in money supply. Unemployment depends on workplace forces (min. wage, market power of unions, efficiency wages, and process of a job search)

Front 2

Relationship between inflation & employment in the short-run

Back 2

In the short run, society faces a trade-off between inflation and unemployment

Front 3

The Phillips curve

Back 3

Shows the short-run trade-off between inflation and unemployment:
- Low agg demand, low inflation, high u-rate
- HIgh agg demand, high inflation, low u-rate

Front 4

Natural-rate hypothesis

Back 4

The claim that unemployment eventually returns to its normal or 'natural' rate, regardless of the inflation rate

Front 5

The Vertical Long-Run Phillips Curve

Back 5

In the long-run, faster money growth only causes faster inflation.

Front 6

Phillips Curve Theory vs. Evidence

Back 6

Evidence: PC slopes downward
Theory: PC is vertical in the long run

To bridge the gap, we look a a new variable, EXPECTED INFLATION: a measure of how much people expect the price level to change

Front 7

Phillips Curve Equation

Back 7

Unemp. rate = Natural rate of unemp. - a( actual inflation - expected inflation)

Front 8

PC Shifter: Supply Shocks

Back 8

An event that directly alters firms' costs and prices, shifting the AS and PC curves (e.g., increase in oil prices)

Front 9

How an adverse supply shock shifts the PC

Back 9

SRAS shifts left, prices rise, output & employment fall. Inflation & u-rate both increase as the PC shifts upward.

Front 10

Disinflation

Back 10

A reduction in the inflation rate

- To reduce inflation, central bank must slow the rate of money growth, which reduces agg demand.
- In the short-run, output falls and unemployment rises.
- In the long-run, output & unemployment return to their natural rates.

Front 11

The Cost of Reducing Inflation

Back 11

Disinflation requires a period of high unemployment and low output

Front 12

Sacrifice ratio

Back 12

Percentage points of annual output lost per 1 percentage point reduction in inflation

Front 13

Rational expectations

Back 13

A theory according to which people optimally use all the information they have, including info about gov't policies when forecasting the future

Front 14

The Phillips Curve during the financial crisis

Back 14

The financial crisis caused aggregate demand to plummet, sharply increasing unemployment and reducing inflation.