Short-Run Phillips Curve
Phillips Curve in the Short Run
Long-Run Phillips Curve
In the long run, the Phillips curve is vertical (completely inelastic) at the natural rate of unemployment; the rate at which the economy is at potential or full-capacity output. When the economy is at full capacity the unemployment rate does not depend on inflation. Phelps and Friedman argued that rational, well-informed workers and employers consider real wages—the inflation-adjusted purchasing power of nominal wages, when determining the quantity of labor to supply. When workers expect inflation, workers ask for higher wages and firms raise prices so actual inflation inevitably equals the expectation of it. Actual inflation equals expected inflation and the long-run Phillips curve is vertical because the economy is at its potential output or full capacity. The more quickly workers anticipate future inflation, the sooner the economy will settle at the natural rate of unemployment.
Higher inflation will only lead to workers’ increased demands for higher wages. Firms pass these increased wage costs to consumers in the form of higher prices, which results in higher inflation. This, in turn, again leads to workers’ further demands for higher wages. This wage/price spiral therefore has no effect on unemployment.Fiscal policy, that is, government intervention in the economy through spending and tax policies, may stimulate aggregate demand in the short run, causing unemployment to decrease; workers will eventually adapt their expectations to the resulting inflation, and unemployment will return to the natural rate.
Phillips Curve in the Long Run
Shifts in the Phillips Curves
Stagflation Shifts the Phillips Curve
The long-run Phillips curve corresponds to the natural rate of unemployment—the rate of unemployment when the economy is at capacity or its potential level of output. In the long run, changes in inflation don't affect output or unemployment. Policy changes such as changes in minimum wage laws, collective bargaining laws, unemployment insurance and job training programs will cause shifts in the long-run Phillips curve. Things that affect the natural rate or potential output will shift the long-run Phillips curve. Examples include changes in the labor force, changes in the labor market, and government policies that affect the labor market.