phillips curve

Question 1

what are the three causes of inflation?

Answer 1

1. inflation expectation
2. demand-pull inflation
3. cost-push inflation

Question 2

what is inflation expectations?

Answer 2

the rate at which average prices are anticipated to rise next year

workers expect inflation to rise, so they demand higher wages so prices go up, and as a result, there is inflation

self-fulfilling prophecy

Question 3

what is demand-pull inflation?

Answer 3

inflation resulting from excess demand

demand increases, so prices increase and there is inflation

increase in output gap -> increase in inflation

driven by the output gap

leads inflation to diverge from inflation expectations

Question 4

what is cost-push inflation?

Answer 4

inflation that results from an unexpected rise in production costs

increase in production costs -> increase in inflation

Question 5

what are the two types of cycles in inflation expectations?

Answer 5

vicious cycle: high inflation, so high inflation expectations, and so high inflation

virtuous cycle: low inflation, so low inflation expectations, and so low inflation

Question 6

what are the three methods for measuring inflation expectations?

Answer 6

• surveys of consumers
• surveys and forecasts of economists
• financial markets

Question 7

what are inflation expectations based on?

Answer 7

inflation expectations can be
1) adaptive: based on recent inflation numbers
2) anchored: believe in central bank 2% inflation goal
3) rational: use all economic info available to form expectation
4) sticky: stick with previous expectation

Question 8

what happens to inflation with excess demand?

Answer 8

inflation rises above inflation expectations

Question 9

what happens to inflation with insufficient demand?

Answer 9

inflation falls below inflation expectations

Question 10

what does it mean when the economy is operating at full capacity?

Answer 10

inflation = inflation expectations

Question 11

what does the output gap measure?

Answer 11

the imbalance between output and productive capacity

Question 12

what is unexpected inflation?

Answer 12

the difference between inflation and inflation expectations

Question 13

what is the philips curve?

Answer 13

illustrates the link between the output gap and unexpected inflation

upwards sloping

x - axis: output gap

y-axis: unexpected inflation

Question 14

what happens to inflation when output gap is positive?

Answer 14

when the output gap is positive, inflation typically rises above inflation expectations

Question 15

what happens to inflation when output gap is negative?

Answer 15

when output gap is negative, inflation typically falls below inflation expectations

Question 16

how do you forecast using the phillips curve?

Answer 16

investment banks, businesses, and government economists forecast inflation using estimates of the phillips curve

it is a two step process:
1. assess inflation expectations
2. forecast unexpected inflation

Question 17

what is the labour market phillips curve?

Answer 17

the labour market phillips curve links unexpected inflation to the unemployment rate (rather than the output gap)

in this version, inflation is stable at the equilibrium unemployment rate

x- axis: unemployment rate

y-axis: unexpected inflation

downwards sloping

Question 18

what is the general trend in the labour market phillips curve?

Answer 18

as unemployment decreases, unexpected inflation decreases

Question 19

what does cost-push inflation lead to?

Answer 19

leads to more inflation at any given level of the output gap and for any given level of inflation expectations

Question 20

how do rising costs affect the phillips curve?

Answer 20

shifts the curve upwards, leading to higher inflation

Question 21

what are supply shocks?

Answer 21

any change in production costs that lead suppliers to change the prices they charge at any given level of output

shifts the phillips curve

Question 22

what factors affect the phillips curve?

Answer 22

1. input prices
2. productivity
3. exchange rates

Question 23

how do input prices affect the inflation rate?

Answer 23

rising input prices - shift up, more inflation

falling input prices - shift down, less inflation

price of labour: workers spending power falls, so they want higher nominal wages, but this means the cost of production rises so prices rise, becoming a cycle

Question 24

how does productivity influence inflation?

Answer 24

slower productivity growth = shift up, more inflation

faster productivity growth = shift down, less inflation

Question 25

how do exchange rates affect inflation?

Answer 25

depreciating US dollar = shift up, more inflation

appreciating US dollar = shift down, less inflation