Possible conflicts between macroeconomic policy objectives

Question 1

How do negative and positive output gaps relate to unemployment and inflationary pressures?

Answer 1

A negative output gap occurs when actual GDP is below potential GDP, often leading to higher unemployment and lower inflationary pressure. A positive output gap occurs when actual GDP exceeds potential GDP, typically resulting in lower unemployment but higher inflationary pressure.

Question 2

What is the short-run Phillips curve?

Answer 2

The short-run Phillips curve shows an inverse relationship between unemployment and inflation, suggesting that lower unemployment comes with higher inflation, and vice versa. It indicates a trade-off between inflation and unemployment in the short run.

Question 3

What is the long-run, L-shaped Phillips curve?

Answer 3

In the long run, the Phillips curve becomes vertical (or L-shaped) at the natural rate of unemployment, suggesting no trade-off between inflation and unemployment. In this view, long-term unemployment is determined by supply-side factors, and inflation is influenced by monetary policy rather than unemployment.

Question 4

What are the policy implications of the short-run Phillips curve?

Answer 4

The short-run Phillips curve implies that policymakers can reduce unemployment at the cost of higher inflation in the short run. However, this trade-off is temporary, as expectations adjust and may lead to inflation without reducing unemployment in the long term.

Question 5

What are the policy implications of the long-run, L-shaped Phillips curve?

Answer 5

The long-run Phillips curve suggests that trying to reduce unemployment below the natural rate will only lead to higher inflation without a sustainable reduction in unemployment, emphasizing the importance of supply-side policies for long-term employment gains.

Question 6

How can economic policies reconcile conflicts between macroeconomic objectives in the short run and long run?

Answer 6

In the short run, demand-side policies like adjusting interest rates or government spending can address conflicts by managing demand to control inflation and unemployment. In the long run, supply-side policies (e.g., improving education, training, and infrastructure) can help reconcile conflicts by increasing productivity and shifting the long-run aggregate supply (LRAS), reducing inflationary pressure while supporting employment.