AP® Macroeconomics · Unit 5 · Topic 5.2
The Long-Run Phillips Curve
The long-run Phillips curve is a vertical line at the natural rate of unemployment, showing that once expectations catch up, higher inflation can't buy lower unemployment forever.
In the short run a government or central bank can push inflation up and watch unemployment fall, because higher prices catch workers and firms off guard. Workers think their raises are real gains, firms see rising prices for their output and hire more, and unemployment dips below its natural rate. That is the short-run Phillips curve: a real tradeoff, but a temporary one.
The trick only works while people are surprised. Once workers and firms see inflation staying high, they build it into contracts, wage demands, and price-setting. Real wages and real profit margins go back to where they were before, and firms no longer have a reason to keep extra workers on. Unemployment drifts back to the natural rate, but now at a higher inflation rate than before. Plot that outcome and you get a vertical line at the natural rate: any inflation rate is consistent with it once expectations catch up, so inflation alone cannot buy permanently lower unemployment.
This vertical long-run Phillips curve is the labor-market twin of vertical LRAS. LRAS is vertical at potential output because flexible wages and prices mean the price level alone cannot change real output in the long run. The long-run Phillips curve is vertical at the natural rate for the identical reason: once nominal variables like wages and prices fully adjust, they cannot hold real unemployment away from its natural level. A central bank that keeps trying to run the economy below the natural rate just ratchets inflation higher and higher, generation after generation of expectations, without any lasting employment payoff.
Key terms
- Natural rate of unemployment
- The unemployment rate that remains once cyclical unemployment is zero, consistent with full employment and stable inflation.
- Short-run Phillips curve
- A downward-sloping relationship showing that unexpected inflation can temporarily lower unemployment below its natural rate.
- Long-run Phillips curve
- A vertical line at the natural rate of unemployment showing no permanent tradeoff between inflation and unemployment.
- Adaptive expectations
- The idea that people adjust their expected inflation based on recently observed inflation, eventually matching actual inflation.
- LRAS (long-run aggregate supply)
- A vertical curve at potential output showing that in the long run the price level cannot change real output.
Watch it explained
- How it worksHow do adjusting expectations pull an economy back onto a vertical long-run Phillips curve?
- Common mistakeWhy isn't permanently higher inflation able to buy permanently lower unemployment?
- Ties togetherHow does the vertical long-run Phillips curve line up with the vertical LRAS curve?
- Going furtherWhat happens to an economy that sits at 3 percent unemployment for five straight years?
Check yourself
End of topic.