CHAPTER17Inflation, Unemploymentand Federal Reserve PolicyChapterOutlineandLearningObjectives17.1 TheDiscoveryoftheShortRunTrade-offbetweenUnemployment and Inflation17.2 TheShort-Run and LongRunPhillips Curves17.3ExpectationsoftheInflationRateand Monetary Policy17.4 FederalReservePolicyfromthe1970stothePresent1of36
1 of 36 Chapter Outline and Learning Objectives 17.1 The Discovery of the ShortRun Trade-off between Unemployment and Inflation 17.2 The Short-Run and LongRun Phillips Curves 17.3 Expectations of the Inflation Rate and Monetary Policy 17.4 Federal Reserve Policy from the 1970s to the Present CHAPTER 17 CHAPTER Inflation, Unemployment, and Federal Reserve Policy
TheDiscoveryoftheShort-RunTrade-offbetweenUnemploymentandInflation17.1LEARNINGOBJECTIVEDescribethePhillips curveand thenature of theshort-runtrade-offbetweenunemploymentandinflation.@2015PearsonEducafion,lnc2of36
LEARNING OBJECTIVE © 2015 Pearson Education, Inc. 2 of 36 The Discovery of the Short-Run Trade-off between Unemployment and Inflation 17.1 Describe the Phillips curve and the nature of the short-run trade-off between unemployment and inflation
Unemploymentand InflationInflationThe two greatrate(percentmacroeconomicproblemsper year)that the Fed deals with (inthe short run) are4%unemployment andinflation.But these two are related2in an important way:higherlevels of inflationare associated withlower06Unemployment5%levels of unemployment,rate(percent)Figure 17.1The Phillips curveand vice versa.ThisrelationshipisknownasthePhillipscurve,aftereconomistA.W. Phillips, the first to identify this relationshipPhillips curve:Acurve showing the short-runrelationship betweenthe unemployment rate and the inflation rate.2015PearsonEducation,Inc.3of36
© 2015 Pearson Education, Inc. 3 of 36 Unemployment and Inflation The two great macroeconomic problems that the Fed deals with (in the short run) are unemployment and inflation. But these two are related in an important way: higher levels of inflation are associated with lower levels of unemployment, and vice versa. This relationship is known as the Phillips curve, after economist A.W. Phillips, the first to identify this relationship. Phillips curve: A curve showing the short-run relationship between the unemployment rate and the inflation rate. Figure 17.1 The Phillips curve
WhyDoesthePhillips CurveExist?1.if thereisonlyaweakincreaseinAD,thepricelevelandrealGDPPricelevelInflationincreaselessthan.(GDPdeflator,rate2009=100)(percentShort-runTheeconomyin2016peryear)aggregateifthereisstrongsupply,SRASgrowthinAD.2...ifthere isa strong114.4increaseinAD.4%112.2Theeconomyin2016,110.0ifthereisweakgrowthinAD,AD2016 (strongincreaseindemand)B2AD2016 (weakAD2015increase indemand)Phillipscurve17.6RealGDP060$17.017.35%Unemployment(trillions ofrate (percent)2009dollars)(a)Theeffectsofanincreaseinaggregatedemand(b)ThePhillips curveIn the AD-AS model, a smallaggregate demandFigure 17.2increase leads to low inflation and high unemployment.t. Using aggregatedemand andA stronger AD increase results in lower unemploymentaggregate supplybut more inflationthe short run Phillips curveanalysistoexplainthePhillipscurverelationship.2015PearsonEducation,Inc.4of36
© 2015 Pearson Education, Inc. 4 of 36 Why Does the Phillips Curve Exist? In the AD-AS model, a small aggregate demand increase leads to low inflation and high unemployment. A stronger AD increase results in lower unemployment but more inflation—the short run Phillips curve relationship. Using aggregate demand and aggregate supply analysis to explain the Phillips curve Figure 17.2
Is the Phillips Curve a Policy Menu?Duringthe 1960s, some economists argued thatthe Phillips curvewas a structural relationship: a relationship that depends on thebasic behavior of consumers and firms, and that remains unchangedoverlong period.: In the 1960s, this relationship had appeared to be quite stableIf this was true, policy-makers could choose a point on the curve:trading permanently higher inflationforlower unemployment, or viceversa.But this turned out not to be true: allowing more inflation doesn'tlead to permanently lower unemployment.That is, the short-run Phillips curve moves over time2015PearsonEducation,Inc.5of36
© 2015 Pearson Education, Inc. 5 of 36 Is the Phillips Curve a Policy Menu? During the 1960s, some economists argued that the Phillips curve was a structural relationship: a relationship that depends on the basic behavior of consumers and firms, and that remains unchanged over long period. • In the 1960s, this relationship had appeared to be quite stable. If this was true, policy-makers could choose a point on the curve: trading permanently higher inflation for lower unemployment, or vice versa. • But this turned out not to be true: allowing more inflation doesn’t lead to permanently lower unemployment. • That is, the short-run Phillips curve moves over time