Inflation and Unemployment
The Phillips Curve
Module 34
Inflation and Unemployment

Inflation problems
◦ Inflation Tax
 Because we use fiat money, gov’t can print money
to pay of debts (seigniorage)
 Ex – US gov’t debt purchased by the Fed
Inflation and Unemployment

In times of hyperinflation
◦ ppl hold less money
◦ Causes more shortages
◦ Less money transactions
 Gov’t turns to seigniorage, prints more, leading to
more issues

Who pays for inflation
◦ People who currently hold money – inflation
tax
Inflation and Unemployment

Cost-Push inflation
◦ Caused by dramatic spike in price of
input/commodity
 1970s oil crisis

Demand-Pull inflation
◦ Inflation caused by increase in AD
 “Too much money chasing too few goods”
The Short Run Phillips Curve
Negative relationship btw inflation rates
and unemployment
 Factors: supply shocks, expected inflation
(1960s)
 Used often in 50s and 60s to help
determine economic policy
 Initially, some people believed accepting
high inflation = low unemployment

Where the Phillips Curve fails: https://www.youtube.com/watch?v=qQjAbHR40nk
Still the Phillips Curve

Long-Run Phillips Curve (LRPC)
◦ Policy makers have two choices:
unemployment or inflation? Not so much
Natural Rate of Unemployment

Natural Rate Hypothesis
◦ Reminder: Natural Rate = Structural +
Frictional
◦ Unemployment rate must be high enough that
the actual rate of inflation matches the
expected rate of inflation
 If unemployment BELOW natural rate, inflation
ever accelerates
 Rate ABOVE natural rate, decelerating inflation
◦ NAIRU (Non-Accelerating Rate of
Unemployment)
Long-Run Phillips Curve

Relationship between unemployment and
inflation in LR
◦ After expectations of inflation have had time
to adjust
◦ Normal Human Terms: it is vertical, the LRPC
shows limits to expansionary policies
◦ Any rate ABOVE, leads to decelerating
inflation
Inflation and Unemployment

Disinflation and Deflation
◦ Disinflation – process of bringing down
inflation that has become embedded in
expectations
◦ Deflation – fall in the overall level of prices
◦ Monetary Shortcomings
 Zero Bound
 Liquidity Trap
Zero Bound causes Liquid Trap