Philips Curve Flashcards
What does the Philips Curve show?
In SR- Inflation + Output/Unemployment are related
SR Trade off between Inflation + Unemployment
How does Expansionary Policy affect Output + Inflation?
Increases Output + Inflation
What is the Trade off in the Philips Curve?
Increased AD –> Increased Output + Increased PL
– Increased Inflation + Decreased Unemployment
DOWNWARD SLOPING- SRPC
Where is LRPC?
LRPC is Vertical
- Unemployment remains at NRU
When AD Increases, what happens to Inflation + Unemployment in LR?
Since LRPC is Vertical
- Unemployment remains the Same
- Inflation Increases
Why is the SRAS Curve Upward sloping?
In SR- Expected Prices ≠ Actual Prices
When in the Philips Curve Downward sloping?
When Expected Inflation ≠ Actual Inflation
What does the P.C look like when Expected Inflation = Actual Inflation?
P.C is Vertical
Why does Economic Policy affect Output?
Creates Surprise/Unexpected Inflation / Disinflation
How does Monetary Expansion lead to Increased Inflation?
Monetary Expansion –> Surprise Inflation –> SR: Increased Y + Employment
– LR: People expect Increasing Inflation to persist –> Expectations catch up to Actual Inflation –> Move up LRPC –> Increased Inflation
How do you calculate the Unemployment rate?
Unemployment Rate = NRU – a( Actual Inflation – Expected Inflation )
What happens to Unemployment if Actual > Expected?
Unemployment Decreases
What causes a Shift in SRPC?
Changes in Expected Inflation
How do Supply Shocks affect SRPC?
Directly alter Costs + Prices –> Shift SRAS –> Shift SRPC
What does Contractionary Monetary Policy imply with regards to the Cost of Reducing Inflation?
AD Contracts –> Inflation Decreases- move down SRPC
– Unemployment Increases
BUT- Over time: SRPC Shifts Left –> Unemployment back at NRU with Lower Inflation
What is the Sacrifice Ratio?
% of Annual Output LOST in process of Reducing Inflation by 1%
What are Rational Expectations?
People Optimally use Info. they have- including Info on Gov. Policy when forecasting future
- If People strongly believe C.B will fight Inflation–> People Immediately Lower Expectations
What were the Results of Volker + Thatcher Disinflations + suggest a reason why
Costs NOT as large as Predicted- but still High
- May mean: Public did NOT believe Thatcher/Volker when they announced M.P to Reduce Inflation
What is Inflation Targeting?
C.B commits to an Inflation target- e.g. 2%
- Avoids people NOT believing C.B
- Consistent Inflation Expectations
How is there the possibility of Costless Disinflation?
- Rational Expectations- implies Smaller Sacrifice Ratio
- However- Gov./C.B must credibly commit to Policy of Low Inflation so:
- People Lower Expectations of Inflation–> so when Actual Inflation Falls sharply- so does Expectations
- So we stay on LRPC
How does a Rise in Oil Prices affect SRPC?
Increased Oil Prices –> Decreased SRAS –> Stagflation–> SRPC Shifts Right- at fixed U- Inflation rises
- If people expect Inflation to Rise in future–> Move up LRPC
Shift in SRAS –> Shift in SRPC
