The Phillips Curve and Inflation Expectations Flashcards
What does the Short-Run Phillips Curve (SRPC) illustrate?
The trade-off between lower unemployment and higher inflation in the short run.
This trade-off is based on the relationship between unemployment and inflation, indicating that lowering one can lead to an increase in the other.
What happens when unemployment falls according to the SRPC?
Firms compete for workers, pushing wages up.
This increase in wages raises production costs, which in turn leads to higher consumer prices.
What is the impact of stable inflation expectations on the SRPC?
Wage demands remain moderate, keeping the SRPC intact.
Stable inflation expectations prevent shifts in the curve, allowing the trade-off to function as expected.
What occurs when inflation expectations shift?
The SRPC can change, disrupting the trade-off between unemployment and inflation.
Changes in expectations can lead to different economic outcomes, as seen in historical examples.
What was a key belief during the 1960s regarding the Phillips Curve?
There was a belief in a stable Phillips Curve trade-off.
This belief led to government policies aimed at reducing unemployment, often through expansionary measures.
What economic approach did the Johnson administration in the U.S. adopt in the 1960s?
Expansionary policies to reduce unemployment at the cost of higher inflation.
This approach was based on the belief in the stable Phillips Curve trade-off.
What economic phenomenon occurred in the 1970s as a result of shifting inflation expectations?
Stagflation, which is the simultaneous occurrence of high inflation and high unemployment.
This was a significant failure of the policies based on the earlier belief in the Phillips Curve trade-off.
What concept did Milton Friedman and Edmund Phelps challenge?
The stable Phillips Curve concept
They introduced the idea of expectations in the context of unemployment and inflation.
What does the Long-Run Phillips Curve (LRPC) suggest about unemployment?
Unemployment returns to its Natural Rate of Unemployment (NRU) or Non-Accelerating Inflation Rate of Unemployment (NAIRU) in the long run.
What happens when policymakers exploit the Short-Run Phillips Curve (SRPC)?
Workers and firms adjust their expectations and demand higher wages, embedding inflation into the economy.
What occurs once inflation expectations rise?
Workers demand higher wages, firms raise prices, and the economy experiences an upward shift in the SRPC.
What economic phenomenon was evident during the 1970s stagflation crisis?
High inflation remained despite rising unemployment, contradicting the short-run Phillips Curve.
What fueled inflationary pressures in the late 1960s?
Expansionary fiscal and monetary policies.
What exacerbated inflation during the 1970s?
The 1973 oil shock.
What was the outcome of attempts to reduce unemployment through demand-side policies in the 1970s?
It led to spiraling wage-price inflation and high unemployment.
What did the high unemployment during stagflation lead to?
The breaking of the traditional Phillips Curve trade-off.
What policy approach was adopted to curb inflation after the stagflation crisis?
Monetarism, focusing on controlling the money supply.
Fill in the blank: The Natural Rate of Unemployment is also known as _______.
Non-Accelerating Inflation Rate of Unemployment (NAIRU)
True or False: The Long-Run Phillips Curve supports the idea that inflation can be permanently reduced by maintaining low unemployment.
False.
What happens when workers expect higher inflation?
They demand higher wages preemptively.
This can lead to cost-push inflation as firms anticipate higher costs.
What is the effect of rising inflation expectations on the Short-Run Phillips Curve (SRPC)?
The SRPC shifts upward.
Higher wage demands lead to increased prices, requiring tighter monetary policy.
What monetary policy did Paul Volcker implement to control inflation?
High interest rates, reaching nearly 20%.
This policy was effective in breaking inflationary expectations but initially raised unemployment.
What was the long-term effect of Volcker’s monetary policy on the Phillips Curve?
It shifted the Phillips Curve downward.
This occurred as long-term inflation was reduced.
What occurs when central banks commit to low inflation?
Expectations adjust downward.
This leads to reduced wage and price pressures.
What is the impact of falling inflation expectations on the SRPC?
The SRPC shifts downward.
This allows for low inflation without increasing unemployment.
What inflation target did the Bank of England set after gaining independence in 1997?
An inflation target of 2%.
This helped anchor inflation expectations in the UK.
How did the UK’s inflation targeting affect unemployment?
Unemployment fluctuated largely due to external shocks rather than inflationary pressures.
The targeting helped maintain stable inflation.
True or False: Higher inflation expectations lead to lower wage demands.
False.
Higher expectations result in higher wage demands.
Fill in the blank: Rising inflation expectations lead to a shift in the SRPC _______.
upward.
Fill in the blank: The effect of credible low inflation commitments is to reduce _______ pressures.
wage and price.
What do central banks focus on today to anchor expectations?
Credible policies (e.g., inflation targeting)
Anchoring expectations helps maintain economic stability.
What phenomenon may not hold due to external shocks, such as COVID-19 disruptions?
The Phillips Curve
The Phillips Curve suggests an inverse relationship between inflation and unemployment.
What are examples of external shocks that can affect the Phillips Curve?
- COVID-19 disruptions
- Energy crises
These shocks can lead to rising inflation without changes in employment.
How does labour market flexibility affect the Phillips Curve mechanism?
Wage responsiveness is lower in highly flexible labour markets
This includes markets like the gig economy.
