TAILIEUCHUNG - Ten Principles of Economics - Part 77

Ten Principles of Economics - Part 77. Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. Economists also study how people interact with one another. | CHAPTER 33 THE SHORT-RUN TRADEOFF BETWEEN INFLATION AND UNEMPLOYMENT 785 rate of inflation. The widespread belief that there is a permanent tradeoff is a sophisticated version of the confusion between high and rising that we all recognize in simpler forms. A rising rate of inflation may reduce unemployment a high rate will not. But how long you will say is temporary . . . I can at most venture a personal judgment based on some examination of the historical evidence that the initial effects of a higher and unanticipated rate of inflation last for something like two to five years. Today more than 30 years later this statement still summarizes the view of most macroeconomists. Summary The Phillips curve describes a negative relationship between inflation and unemployment. By expanding aggregate demand policymakers can choose a point on the Phillips curve with higher inflation and lower unemployment. By contracting aggregate demand policymakers can choose a point on the Phillips curve with lower inflation and higher unemployment. The tradeoff between inflation and unemployment described by the Phillips curve holds only in the short run. In the long run expected inflation adjusts to changes in actual inflation and the short-run Phillips curve shifts. As a result the long-run Phillips curve is vertical at the natural rate of unemployment. The short-run Phillips curve also shifts because of shocks to aggregate supply. An adverse supply shock such as the increase in world oil prices during the 1970s gives policymakers a less favorable tradeoff between inflation and unemployment. That is after an adverse supply shock policymakers have to accept a higher rate of inflation for any given rate of unemployment or a higher rate of unemployment for any given rate of inflation. When the Fed contracts growth in the money supply to reduce inflation it moves the economy along the shortrun Phillips curve which results in temporarily high unemployment. The cost of disinflation depends .

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