Unit 14: The Phillips Curve and Expectations
The inflation-unemployment tradeoff that looks solid in the short run and disappears in the long run, and why what people expect decides which world you are in.
6 topics · 20 questions
Each topic is a path, not a menu: work down it in order and every question builds on the one above. Click any of them to watch the answer draw itself.
The Short-Run Phillips Curve
- How it worksHow does a rightward shift in aggregate demand turn into a movement along the short-run Phillips curve?
- Worked exampleFind the move along the short-run Phillips curve when unemployment falls from 6 percent to 4 percent as inflation rises.
- Common mistakeWhy isn't the Phillips curve a menu that a government can simply pick any point from and keep forever?
Your turn1 of 2
Along a short-run Phillips curve given by inflation = 11 minus 1.15 times unemployment, in percent, find the change in inflation when unemployment falls from 7 to 3.78 percent.Adaptive Expectations and the Long-Run Phillips Curve
- How it worksHow do workers and firms who form adaptive expectations by looking backward eventually catch up to actual inflation and pull the short-run curve upward?
- Common mistakeWhy isn't permanently higher inflation able to buy an economy permanently lower unemployment?
- Going furtherWhat happens to an economy that tries to hold unemployment below the natural rate for five straight years?
- Ties togetherHow does the vertical long-run Phillips curve line up with the vertical long-run aggregate supply curve?
Your turn1 of 2
A government tries to permanently hold unemployment below its natural rate by accepting a bit more inflation, hoping this tradeoff lasts forever. Under adaptive expectations, does unemployment eventually settle back at its natural rate?Rational Expectations and the Lucas Critique
- How it worksHow do rational expectations let workers and firms build a fully anticipated policy straight into their wage and price decisions in advance?
- Common mistakeWhy doesn't a policy that worked well historically automatically keep working once people learn to expect it?
- Going furtherWhat happens to the short-run Phillips curve tradeoff when a disinflation is announced in advance and believed by everyone?
- Ties togetherHow does the Lucas critique explain why a rule estimated from old data can break down the moment policy itself changes?
Your turn1 of 2
A central bank announces a credible disinflation policy well in advance, and workers and firms, forming rational expectations, immediately build the lower expected inflation into their wage and price decisions. What does rational expectations theory predict about the cost of this disinflation, compared to an unannounced, surprise disinflation?Disinflation and Central Bank Credibility
- How it worksWalk me through a credible, believed disinflation shifting expected inflation down with far less unemployment than an unexpected one.
- Worked exampleFind the sacrifice ratio when disinflation costs an economy 5 percentage points of cumulative lost output to bring inflation down by 2 percentage points.
- Common mistakeWhy isn't every disinflation equally costly in terms of lost output and jobs?
Your turn1 of 2
Find the sacrifice ratio when disinflation costs an economy 6 percentage points of cumulative lost output to bring inflation down by 2 percentage points.What Shifts the Phillips Curve
- How it worksWalk me through an oil shock shifting the short-run Phillips curve outward and upward.
- Common mistakeWhy doesn't a change in aggregate demand ever shift the short-run Phillips curve itself?
- Going furtherWhat happens to both Phillips curves once a country's natural rate of unemployment permanently falls?
Your turn1 of 2
A short-run Phillips curve shifts up by exactly the rise in expected inflation. If expected inflation rises from 2 percent to 5.12 percent, by how many percentage points does the curve shift up?Translating AD-AS into the Phillips Curve
- How it worksHow does each point of AD-AS equilibrium turn into one dot plotted on the Phillips curve diagram?
- Common mistakeWhy isn't the horizontal axis of the Phillips curve just real output flipped upside down?
- Ties togetherHow does a recessionary gap on the AD-AS graph map onto its matching point on the Phillips curve?
Your turn1 of 2
An output gap of 4 percent maps to cyclical unemployment using Okun's rule of thumb of 2 percentage points of output per 1 point of unemployment. What cyclical unemployment does this output gap imply?