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Unformatted text preview: EC 151 Ch: 22 The Shortrun Tradeoff Between Inflation and Unemployment
The Phillips curve Shifts in the Phillips curve: the role of expectations Shifts in the Phillips curve: the role of supply shocks The cost of reducing inflation Intro: Inflation and unemployment two closely watched indicators of economic performance Misery index What does natural rate of unemployment depend on? What does inflation depend on? Society faces a short run tradeoff between inflation and unemployment aggregate D & supply model The Phillips curve A curve that shows the short run tradeoff between inflation and unemployment Offers policymakers a menu of possible outcomes By conducting monetary and fiscal policy makers could choose any point on this curve The Phillips curve simply shows the combinations inflations and unemployment that arise in the short run as shifts in aggregate demand curve move the economy along the short run aggregate supply curve Aggregate demand, aggregate supply and the Phillips curve Aggregate demand, aggregate supply and the Phillips curve Does this menu remain stable over time? The LR Phillips curve Shifts in the Phillips curve: The role of expectations According to Friedman and Phelps there is no tradeoff between inflation and unemployment in the long run. Growth in the MS determines inflation rate. Regardless of the inflation rate, the unemployment rate gravitates towards its natural rate. As a result the long run Phillips curve is Vertical Shifts in the LR Phillips curve The LR Phillips curve The LR Phillips curve Expectations and the short run Phillips curve The natural experiment for the naturalrate hypothesis Naturalrate hypotheses The claim that unemployment eventually returns to its normal or natural, rate, regardless of the rate of inflation Phillips curve in the 1960s The breakdown of the Phillips curve The natural experiment for the naturalrate hypothesis Shocks to the aggregate supply Shifts in the Phillips curve: The role of supply shocks
An event that directly alters firms' costs and prices, shifting economy's aggregate supply curve and thus the Phillips curve Shifts in the Phillips curve: The role of supply shocks Shifts in the Phillips curve: The role of supply shocks The cost of reducing Inflation The sacrifice ratio The number of percentage points of annual output lost in the process of reducing inflation by one percentage point Rational expectations Rational Expectations and the possibility of costless disinflation
The theory according to which people optimally use all the information they have, including information about government policies when forecasting the future If the government made credible commitment to a policy of low inflation, people would be rational enough to lower their expectations of inflation immediately. The SR Phillips curve would shift downward, and the economy would reach low inflation quickly without the cost of temporary high unemployment and low output The Volcker Disinflation The Greenspan Era Case study: Why were inflation and unemployment so low at the end of the 1990s Declining commodity prices Labor market changes Technological advance ...
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