Lu12: Inflation and Unemployment (The costs of reducing inflation (To…
Lu12: Inflation and Unemployment
The role of expectations
Friedman and Phelps
concluded that i & u are unrelated in the long run.
the long-run Phillips curve is vertical at the natural rate of unemployment.
Monetary policy cannot change the natural rate
is not necessarily desirable, nor is it constant over time.
The Philips curve
shows the short-run trade-off between inflation and unemployment.
the short-run combinations of unemployment and inflation that arise as shifts in AD curve move the economy along the short-run AS curve.
A higher level of output results in a lower level of unemployment.
The costs of reducing inflation
To reduce inflation, the BNM has to pursue contractionary monetary policy.
This leads to a rise in unemployment
reduce inflation, an economy must endure a period of high unemployment and low output.
When the BNM combats inflation, the economy moves down the short-run Phillips curve.
The economy experiences lower inflation but at the cost of higher unemployment.
is the number of percentage points of annual output that is lost in the process of reducing inflation by one percentage point
An estimate of the sacrifice ratio is five
The causes and effects of supply shocks
policymakers faced two choices when OPEC cut output and raised worldwide prices of petroleum.
Fight the unemployment battle by expanding aggregate demand and accelerate inflation.
Fight inflation by contracting aggregate demand and endure even higher unemployment.