Exam 35: The Short-Run Tradeoff Between Inflation and Unemployment

Other things the same, a decrease in aggregate demand decreases both inflation and unemployment.

Which of the following are vertical?

Suppose that in 2018 and 2019, households and firms reduced desired expenditures. During the same period inflation fell and unemployment rose.

Assuming that rational expectations theory does not hold, if a central banks attempts to reduce the inflation rate what happens to the unemployment rate in the short-run?

In most of the 1970s, the Fed's policy created expectations of high inflation.

If inflation expectations rise, the short-run Phillips curve shifts

A decrease in government expenditures serves as an example of an adverse supply shock.

What is meant by accommodation?

If an increase in inflation permanently reduced unemployment, then

The Phillips curve and the short-run aggregate supply curve are closely related, yet one slopes downward and the other slopes upward. Discuss.

Suppose that the Prime Minister and Parliament of Veridian are disappointed with the high inflation rates under the current system where the Veridian Ministry of Finance is in charge of the money supply. They make reforms to lower inflation from its current rate of 8%. Suppose further that the public is confident that with the reforms in place that inflation will fall to 2%. Also suppose that those in control of the money supply actually conduct monetary policy so that the actual inflation rate is 4%. Using long-run and short-run Phillips curves and assuming the natural rate of unemployment is 6%, show the initial long run equilibrium of Veridian and label it "A". Assuming that the government had actually set inflation at 2% and that the public believed this, label the long-run equilibrium "B". Now, suppose that inflation expectations fell to 2% and that the government unexpectedly created inflation of 4%. Show the short-run equilibrium and label it "C". If the money supply continues to grow at a rate consistent with 4% inflation, show where the economy ends up and label that point "D".

What would a central bank need to do to reverse the effects of a favorable supply shock on inflation? What would its reaction do to the unemployment rate in the short run?

The Fed increases the money supply growth rate. Assuming inflation expectations remain constant, use a Phillips curve diagram to show the short-run effects of the Fed's policy.

A movement to the left along a given short-run Phillips curve could be caused by

List one specific policy that would shift the long-run Phillips curve to the right.

Assume the natural rate of unemployment is 6%. Draw the short-run and long-run Phillips curves and show the position of the economy if expected inflation is 3% and the actual inflation rate is 2%.

The sacrifice ratio is the percentage point increase in the unemployment rate created in the process of reducing inflation by one percentage point.

In the long run, the natural rate of unemployment depends primarily on the growth rate of the money supply.

​According to the Phillips curve, policymakers can reduce both inflation and unemployment by increasing the money supply.

Suppose, as in the 1970's in the U.S., that demographic groups which typically have higher unemployment rates become a larger percentage of the labor force. Would this have any effect on the long-run Phillips curve?