Long-Run Phillips Curve

Definition

The long-run Phillips curve represents the relationship between inflation and unemployment in an economy over the long term, indicating that there is no trade-off between the two in the long run. It suggests that, in the long run, the economy will adjust to a natural rate of unemployment, which is consistent with a stable rate of inflation, regardless of short-term fluctuations.

5 Must Know Facts For Your Next Test

1. The long-run Phillips curve is vertical at the natural rate of unemployment, indicating that changes in inflation do not affect this rate in the long run.
2. In contrast to the short-run Phillips curve, which shows a trade-off between inflation and unemployment, the long-run view suggests that this relationship does not hold over extended periods.
3. The concept is based on the idea that expectations about inflation will adjust over time, leading to a situation where no systematic relationship exists between inflation and unemployment.
4. Policymakers can influence unemployment in the short run, but any attempt to maintain lower unemployment through expansionary policies can lead to accelerating inflation over time.
5. The long-run Phillips curve supports the idea that monetary policy is ineffective in changing real variables like unemployment in the long run.

Review Questions

• How does the long-run Phillips curve differ from the short-run Phillips curve regarding the relationship between inflation and unemployment?
  • The long-run Phillips curve differs from the short-run Phillips curve in that it shows no trade-off between inflation and unemployment. While the short-run curve indicates that lower unemployment can be achieved at the cost of higher inflation, the long-run curve suggests that this relationship disappears as expectations about inflation adjust. Over time, the economy returns to its natural rate of unemployment regardless of inflation rates.
• Discuss how changes in inflation expectations impact the position of the long-run Phillips curve.
  • Changes in inflation expectations do not shift the position of the long-run Phillips curve itself, which remains vertical at the natural rate of unemployment. Instead, these expectations influence how individuals and businesses adjust their behavior concerning wages and prices. If inflation expectations rise, it could lead to higher nominal wages and prices in the short run, but ultimately, the economy will still gravitate back towards its natural rate without a sustained effect on unemployment.
• Evaluate the implications of the long-run Phillips curve for monetary policy effectiveness in controlling unemployment.
  • The implications of the long-run Phillips curve for monetary policy suggest that efforts to manipulate unemployment through expansionary monetary policy may be ineffective in achieving long-term goals. As economies adjust to new inflation rates, any temporary reduction in unemployment may lead to accelerating inflation without creating lasting improvements. This understanding emphasizes a focus on structural factors influencing unemployment rather than relying solely on monetary interventions for sustainable economic stability.

Related terms

Natural Rate of Unemployment: The level of unemployment that exists when the labor market is in equilibrium, typically associated with frictional and structural unemployment.

Short-Run Phillips Curve: The representation of the inverse relationship between inflation and unemployment in the short run, where lower unemployment can lead to higher inflation and vice versa.

Aggregate Demand: The total demand for all goods and services in an economy at a given price level and during a specific time period.