AP Economics
Mr. Bernstein
Module 34:
Inflation and Unemployment:
The Phillips Curve
April 3, 2014
AP Economics
Mr. Bernstein
Inflation and Unemployment: The Phillips Curve
Objectives - Understand each of the following:
• What the Phillips curve is and the nature of the short-run
trade-off between inflation and unemployment
• Why there is no long-run trade-off between inflation and
unemployment
• Why expansionary policies are limited due to the effects of
expected inflation
• Why even moderate levels of inflation can be hard to end
• Why deflation is a problem for economic policy and leads
policy makers to prefer a low but positive inflation rate
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AP Economics
Mr. Bernstein
The Short-Run Phillips Curve
• Review: AD/AS model and tradeoff between inflation
and unemployment
• SRPC displays the
downward sloping
relationship
• Can extend below
X axis but not to the
Left of Y axis…why?
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AP Economics
Mr. Bernstein
The Short-Run Phillips Curve
• When SRAS curve slides down the AD curve, ie
technology breakthrough, SRPC shifts downward
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AP Economics
Mr. Bernstein
Inflation Expectations and the Short-Run
Phillips Curve
• Changes in the expected inflation rate cause an
upward shift in SRPC
• Expected p translates
into higher actual p
for each level of
unemployment
• Believed to be 1-for-1
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AP Economics
Mr. Bernstein
The Long Run Phillips Curve
• NAIRU: Non-Accelerating Inflation Rate of
Unemployment
• Keeping unemployment
below NAIRU leads to
ever-accelerating p
• NAIRU implies there is
no long-term trade-off
between p and UR
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AP Economics
Mr. Bernstein
The Costs of Disinflation
• What if the government tried to reduce inflation?
• Keep UR > NAIRU,
create recession
until p subsides
• Painful in that it
creates higher UR
• Example: Voelker
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AP Economics
Mr. Bernstein
Deflation
• Debt Deflation – debts paid with dollars worth more
• So borrowers cut back on projects, causing further
deflation
• Zero Bound - expected deflation causes real interest
rates to approach zero and lenders stop lending
• Liquidity Trap – Fed can’t cut rates below zero, so
Monetary Policy becomes ineffective
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