Inflation, Unemployment, and Federal Reserve Policy

1. Inflation, Unemployment, and Federal Reserve Policy

2. Why Does Whirlpool Care About Monetary Policy? 1 2 3 4 • After studying this chapter, you should be able to: Describe the Phillips curve and the nature of the short-run tradeoff between inflation and unemployment. Explain the relationship between the short-run and long-run Phillips curves. Discuss how expectations of the inflation rate affect monetary policy. Use a Phillips curve graph to show how the Federal Reserve can permanently lower the inflation rate. LEARNING OBJECTIVES In this chapter, we will explore the relationship between inflation and unemployment in both the short run and the long run and discuss what this relationship means for monetary policy.

3. The Discovery of the Short-Run Tradeoff Between Unemployment and Inflation 1 LEARNING OBJECTIVE Phillips curve A curve showing the short-run relationship between the unemployment rate and the inflation rate.

4. The Discovery of the Short-Run Tradeoff Between Unemployment and Inflation The Phillips Curve 28 - 1 Explaining the Phillips Curve with Aggregate Demand and Aggregate Supply Curves

5. The Discovery of the Short-Run Tradeoff Between Unemployment and Inflation 28 - 2 Using Aggregate Demand and Supply to Explain the Phillips Curve Explaining the Phillips Curve with Aggregate Demand and Supply Curves

6. The Discovery of the Short-Run Tradeoff Between Unemployment and Inflation 28 - 1 1 LEARNING OBJECTIVE Is the Phillips Curve a Policy Menu? Structural relationship A relationship that depends on the basic behavior of consumers and firms and remains unchanged over long periods. The Policy Menu View of the Phillips Curve

7. The Discovery of the Short-Run Tradeoff Between Unemployment and Inflation Is the Short-Run Phillips Curve Stable? The Long-Run Phillips Curve Natural rate of unemployment The unemployment rate that exists when the economy is at potential GDP.

8. The Discovery of the Short-Run Tradeoff Between Unemployment and Inflation 28 - 3 A Vertical Long-Run Aggregate Supply Curve Means a Vertical Long-Run Phillips Curve The Long-Run Phillips Curve

9. The Discovery of the Short-Run Tradeoff Between Unemployment and Inflation The Impact of Unexpected Price Level Changes on the Real Wage 28 – 1 28 – 2 The Basis for the Short-Run Phillips Curve The Role of Expectations of Future Inflation

10. 28 - 1 • Do Workers Understand Inflation? Will her wage increases keep up with inflation?

11. The Short-Run and Long-Run Phillips Curves 2 LEARNING OBJECTIVE The Short-Run Phillips Curve of the 1960s and the Long-Run Phillips Curve 28 - 4

12. The Short-Run and Long-Run Phillips Curves 28 - 5 Expectations and the Short-Run Phillips Curve Shifts in the Short-Run Phillips Curve

13. The Short-Run and Long-Run Phillips Curves 28 - 6 A Short-Run Phillips Curve for Every Expected Inflation Rate Shifts in the Short-Run Phillips Curve

14. The Short-Run and Long-Run Phillips Curves 28 - 7 The Inflation Rate and the Natural Rate of Unemployment in the Long-Run How Does a Vertical Long-Run Phillips Curve Affect Monetary Policy?

15. 28 - 2 2 LEARNING OBJECTIVE 28-2 • Does the Natural Rate of Unemployment Ever Change? • Frictional or structural unemployment can change – thereby changing the natural rate – for several reasons: • Demographic changes. • Labor market institutions. • Past high rates of unemployment. What makes the natural rate of unemployment increase or decrease? Changing Views of the Phillips Curve

16. Expectations of the Inflation Rate 3 LEARNING OBJECTIVE • The experience in the United States over the past 50 years indicates that how workers and firms adjust their expectations of inflation depends on how high the inflation rate is. There are three possibilities: • Low inflation. • Moderate, but stable inflation. • High and unstable inflation. Rational expectationsExpectations formed by using all available information about an economic variable.

17. Expectations of the Inflation Rate 28 - 8 Rational Expectations and the Phillips Curve The Effect of Rational Expectations on Monetary Policy

18. Expectations of the Inflation Rate Is the Short-Run Phillips Curve Really Vertical? Real Business Cycle Models Real business cycle models Models that focus on real rather than monetary explanations of fluctuations in real GDP.

19. How the Fed Fights Inflation 4 LEARNING OBJECTIVE 28 - 9 A Supply Shock Shifts the SRAS and the Short-Run Phillips Curve The Effect of a Supply Shock on the Phillips Curve

20. How the Fed Fights Inflation The Fed Tames Inflation,1979-1989 28 - 10 Paul Volcker and Disinflation

21. How the Fed Fights Inflation Paul Volcker and Disinflation Disinflation A significant reduction in the inflation rate. Don’t Confuse “Disinflation” with “Deflation”

22. 28 - 3 4 LEARNING OBJECTIVE • Using Monetary Policy to Lower the Inflation Rate

23. How the Fed Fights Inflation 28 – 3 The Record of Fed Chairmenand Inflation Alan Greenspan and the Importance of a Credible Monetary Policy De-emphasizing the Money Supply

24. How the Fed Fights Inflation The Importance of Fed Credibility Monetary Policy Credibility after Greenspan A Failure of Credibility at the Bank of Japan Federal Reserve Policy and Whirlpool’s “Pricing Power”

25. Keeping Up Is Hard to Do

26. Disinflation • Natural rate of unemployment • Phillips curve • Rational expectations • Real business cycle models • Structural relationship