Inflation and UnemploymentThe Phillips CurveModule 34

Inflation and UnemploymentInflation problems

◦Inflation Tax Because we use fiat money, gov’t can

print money to pay of debts (seigniorage) Ex – US gov’t debt purchased by the Fed

Inflation and UnemploymentIn times of hyperinflation

◦ppl hold less money◦Causes more shortages◦Less money transactions

Gov’t turns to seigniorage, prints more, leading to more issues

Who pays for inflation◦People who currently hold money –

inflation tax

Inflation and UnemploymentCost-Push inflation

◦Caused by dramatic spike in price of input/commodity 1970s oil crisis

Demand-Pull inflation◦Inflation caused by increase in AD

“Too much money chasing too few goods”

The Short Run Phillips CurveNegative relationship btw

inflation rates and unemploymentFactors: supply shocks, expected

inflation (1960s)Used often in 50s and 60s to help

determine economic policyInitially, some people believed

accepting high inflation = low unemployment

Where the Phillips Curve fails: https://www.youtube.com/watch?v=qQjAbHR40nk

Still the Phillips CurveLong-Run Phillips Curve (LRPC)

◦Policy makers have two choices: unemployment or inflation? Not so much

Natural Rate of UnemploymentNatural Rate Hypothesis

◦Reminder: Natural Rate = Structural + Frictional

◦Unemployment rate must be high enough that the actual rate of inflation matches the expected rate of inflation If unemployment BELOW natural rate, inflation

ever accelerates Rate ABOVE natural rate, decelerating inflation

◦NAIRU (Non-Accelerating Rate of Unemployment)

Long-Run Phillips CurveRelationship between

unemployment and inflation in LR◦After expectations of inflation have

had time to adjust◦Normal Human Terms: it is vertical,

the LRPC shows limits to expansionary policies

◦Any rate ABOVE, leads to decelerating inflation

Inflation and UnemploymentDisinflation and Deflation

◦Disinflation – process of bringing down inflation that has become embedded in expectations

◦Deflation – fall in the overall level of prices

◦Monetary Shortcomings Zero Bound Liquidity Trap

Zero Bound causes Liquid Trap