Intermediate
Macroeconomics
Lecture 10
Inflation,Unemployment,and
the Phillips Curve
? Phillips Curve,relationship between inflation
and unemployment
A.W.Phillips (1958),The relationship between
unemployment and the rate of change of
money wages in the united kingdom,1861-
1957,” Economica 25
Inflation,Unemployment,and
the Phillips Curve
? 1861-1913 Original Phillips Curve
( * )wg u u?? ? ?
wg
u
Inflation,Unemployment,and
the Phillips Curve
? Inflation rate and unemployment rate in the
U.S,after 1961
61
69
71
72
73
74 75
76
79
80,81
82,83 84
86
89
92
97
?
u
Phillips Curve
? Inflation rate depends on
① Expected inflation
② The deviation of unemployment from the natural
rate (cyclical unemployment)
③ Supply shocks
?????? ???? )( ne
From AS to the Phillips Curve
? AS,
? Phillips Curve,
)( ePPYY ??? ? ?
)(1
?
??? YYPP e
?
)(111
?
?? ????? YYPPPP
e
?
)(1
?
??? YYe
?
??
?????? ???? )( ne
Expectations and Inflation Inertia
“Why is our money ever less valuable? Perhaps it is
simply that we have inflation because we expect
inflation,and we expect inflation because we had it.”
Robert Solow
1?? ??
e
?????? ???? ? )(1 n
The Two Causes of Rising and
Falling Inflation
A,Cyclical unemployment
---,demand-pull inflation”
High AD ? high employment
B,Supply shock
---”cost-push inflation”
Adverse supply shocks
SR Tradeoff Between Inflation and
Unemployment
? Expected inflation and supply shock cannot be
controlled by the government,Therefore,the only
channel is to use monetary and fiscal policy to
change AD to affect the unemployment rate
M ↓ or G ↓ ? AD ↓ ? u ↑? inflation ↓
()en? ? ? ? ? ?? ? ? ?
SR Tradeoff Between Inflation and
Unemployment
?
?
Higher expected
inflation
Disinflation and the Sacrifice Ratio
? The percentage of a year’s real GDP that must
be forgone to reduce inflation by one
percentage point
“For every percentage point that inflation is to
fall,five percent of one year’s GDP must be
sacrificed.”
--- Arthur M,Okun
Rational Expectations and Painless
Disinflation
? The length of time should be much shorter and the
costs should be much lower of stopping inflation if
people have rational expectations
? However,it requires,
① The plan to reduce inflation must be announced
before the crucial expectations are formed
② Those setting wages and prices must believe the
announcement
New Keynesian Economics
1,Small menu costs and AD externalities
How can small menu costs explain recessions?
Externalities to price adjustment
p↓? P ↓ ?(M/P) ↑? LM shift outward
“AD externality”
New Keynesian Economics
If the society could make the decision of whether
to reduce the price,it is obvious that the
benefit would be much larger than the menu
costs,
However,if an individual firm is responsible for
the decision,it may fail to pay the menu cost,
New Keynesian Economics
2,The staggering of wages and prices
Story 1,
① Firms adjust prices on the 1st of every month
② MS and AD rise on the 10th,
? Output is higher 10th - 1st
? On the 1st,the boom ends
? The economy back to normal till 10th
New Keynesian Economics
Story 2,
① ? firms adjust prices on 1st
② ? firms adjust prices on 15th
③ MS and AD rise on the 10th
? Output is higher 10th-15th
? Will the firms raise their price on 15th?
? No! If they do,their relative price ↑sales↓
New Keynesian Economics
3,Recession as coordination failure
Society sometimes fails to reach an outcome that
is feasible and that everyone prefers,In this
case,we say that the members of society
have failed to coordinate in some way,
New Keynesian Economics
? Game theory
Cut price Keep high price
Cut price
Keep high price
Firm 2
Firm 1
Firm 1 --- $70
Firm 2 --- $10
Firm 1 --- $100
Firm 2 --- $100
Firm 1 --- $10
Firm 2 --- $70
Firm 1 --- $30
Firm 2 --- $30
New Keynesian Economics
? When there is multiple equilibria,the optimal
equilibrium is not always the result
? Prisoners’ Dilemma
Confess Not confess
Confess
Not confess
B
A
A,30yrs
B,5yrs
Both 15yrs A,5yrs B,30yrs
Both 0 yrs
New Keynesian Economics
4,Hysteresis and the challenge to the natural
rate hypothesis
A recession can have permanent effects so that
the natural rate of employment and output
would change,
Macroeconomics
Lecture 10
Inflation,Unemployment,and
the Phillips Curve
? Phillips Curve,relationship between inflation
and unemployment
A.W.Phillips (1958),The relationship between
unemployment and the rate of change of
money wages in the united kingdom,1861-
1957,” Economica 25
Inflation,Unemployment,and
the Phillips Curve
? 1861-1913 Original Phillips Curve
( * )wg u u?? ? ?
wg
u
Inflation,Unemployment,and
the Phillips Curve
? Inflation rate and unemployment rate in the
U.S,after 1961
61
69
71
72
73
74 75
76
79
80,81
82,83 84
86
89
92
97
?
u
Phillips Curve
? Inflation rate depends on
① Expected inflation
② The deviation of unemployment from the natural
rate (cyclical unemployment)
③ Supply shocks
?????? ???? )( ne
From AS to the Phillips Curve
? AS,
? Phillips Curve,
)( ePPYY ??? ? ?
)(1
?
??? YYPP e
?
)(111
?
?? ????? YYPPPP
e
?
)(1
?
??? YYe
?
??
?????? ???? )( ne
Expectations and Inflation Inertia
“Why is our money ever less valuable? Perhaps it is
simply that we have inflation because we expect
inflation,and we expect inflation because we had it.”
Robert Solow
1?? ??
e
?????? ???? ? )(1 n
The Two Causes of Rising and
Falling Inflation
A,Cyclical unemployment
---,demand-pull inflation”
High AD ? high employment
B,Supply shock
---”cost-push inflation”
Adverse supply shocks
SR Tradeoff Between Inflation and
Unemployment
? Expected inflation and supply shock cannot be
controlled by the government,Therefore,the only
channel is to use monetary and fiscal policy to
change AD to affect the unemployment rate
M ↓ or G ↓ ? AD ↓ ? u ↑? inflation ↓
()en? ? ? ? ? ?? ? ? ?
SR Tradeoff Between Inflation and
Unemployment
?
?
Higher expected
inflation
Disinflation and the Sacrifice Ratio
? The percentage of a year’s real GDP that must
be forgone to reduce inflation by one
percentage point
“For every percentage point that inflation is to
fall,five percent of one year’s GDP must be
sacrificed.”
--- Arthur M,Okun
Rational Expectations and Painless
Disinflation
? The length of time should be much shorter and the
costs should be much lower of stopping inflation if
people have rational expectations
? However,it requires,
① The plan to reduce inflation must be announced
before the crucial expectations are formed
② Those setting wages and prices must believe the
announcement
New Keynesian Economics
1,Small menu costs and AD externalities
How can small menu costs explain recessions?
Externalities to price adjustment
p↓? P ↓ ?(M/P) ↑? LM shift outward
“AD externality”
New Keynesian Economics
If the society could make the decision of whether
to reduce the price,it is obvious that the
benefit would be much larger than the menu
costs,
However,if an individual firm is responsible for
the decision,it may fail to pay the menu cost,
New Keynesian Economics
2,The staggering of wages and prices
Story 1,
① Firms adjust prices on the 1st of every month
② MS and AD rise on the 10th,
? Output is higher 10th - 1st
? On the 1st,the boom ends
? The economy back to normal till 10th
New Keynesian Economics
Story 2,
① ? firms adjust prices on 1st
② ? firms adjust prices on 15th
③ MS and AD rise on the 10th
? Output is higher 10th-15th
? Will the firms raise their price on 15th?
? No! If they do,their relative price ↑sales↓
New Keynesian Economics
3,Recession as coordination failure
Society sometimes fails to reach an outcome that
is feasible and that everyone prefers,In this
case,we say that the members of society
have failed to coordinate in some way,
New Keynesian Economics
? Game theory
Cut price Keep high price
Cut price
Keep high price
Firm 2
Firm 1
Firm 1 --- $70
Firm 2 --- $10
Firm 1 --- $100
Firm 2 --- $100
Firm 1 --- $10
Firm 2 --- $70
Firm 1 --- $30
Firm 2 --- $30
New Keynesian Economics
? When there is multiple equilibria,the optimal
equilibrium is not always the result
? Prisoners’ Dilemma
Confess Not confess
Confess
Not confess
B
A
A,30yrs
B,5yrs
Both 15yrs A,5yrs B,30yrs
Both 0 yrs
New Keynesian Economics
4,Hysteresis and the challenge to the natural
rate hypothesis
A recession can have permanent effects so that
the natural rate of employment and output
would change,
