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Inflation and Unemployment: The Phillips Curve

Inflation and Unemployment: The Phillips Curve. Can Governments Lower Unemployment at No Cost?. The Short-Run Phillips Curve. Inflation rate. When the unemployment rate is low, inflation is high. 0. When the unemployment rate is high, inflation is low. Short-run Phillips curve, SRPC.

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Inflation and Unemployment: The Phillips Curve

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  1. Inflation and Unemployment: The Phillips Curve Can Governments Lower Unemployment at No Cost?

  2. The Short-Run Phillips Curve Inflation rate When the unemployment rate is low, inflation is high 0 When the unemployment rate is high, inflation is low Short-run Phillips curve, SRPC Unemployment rate

  3. The Short-Run Phillips Curve and Supply Shocks Inflation rate A negative supply shock shifts SRPC up 0 SRPC1 A positive supply shock shifts SRPC down SRPC0 SRPC2 Unemployment rate

  4. Expected Inflation and the Short-run Phillips Curve Inflation rate SRPC shifts up by the amount of the increase in expected inflation 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0 6 8 7 10 9 1 3 5 2 4 -1% SRPC3 -2% -3% -4% SRPC0 -5% -6% Unemployment rate

  5. The NAIRU and the Long-Run Phillips Curve Suppose the government attempts to push unemployment down, at the cost of higher inflation. What will happen? Long-run Phillips curve, LRPC Inflation rate 10% 9% 8% 7% C What happens if the government continues on this course (trying to force down unemployment with higher inflation)? 6% 5% B E4 4% 3% A E2 2% 1% E0 0 6 8 7 10 9 1 3 5 2 4 -1% -2% SRPC4 Nonaccelerating inflation rate of unemployment, NAIRU -3% -4% SRPC2 -5% -6% SRPC0 Unemployment rate

  6. Phillips Curve Questions • Draw a graph AND EXPLAIN what would happen to SRPC in the following scenarios: • Government increases spending • The price of crude oil and most energy sources increase • Inflation expectations rise from 3% to 6% • The Fed increases interest rates with contractionary monetary policy • Inflation expectations fall from 5% to 2% • The government increases income taxes • What happens in the LONG RUN in Question #1?

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