Long-Run Phillips Curve

Definition

The long-run Phillips curve represents the relationship between inflation and unemployment when the economy is at full employment and prices have fully adjusted. Unlike the short-run Phillips curve, which shows an inverse relationship between inflation and unemployment, the long-run version indicates that there is no tradeoff between these two variables in the long run, as any attempts to reduce unemployment below the natural rate will only lead to accelerating inflation.

5 Must Know Facts For Your Next Test

1. The long-run Phillips curve is vertical at the natural rate of unemployment, suggesting that there is no tradeoff between inflation and unemployment in the long run.
2. In the long run, persistent efforts to reduce unemployment below its natural rate result in higher inflation rates without any lasting decrease in unemployment.
3. The concept of the long-run Phillips curve was developed by economist Milton Friedman, who emphasized the role of expectations in determining the inflation-unemployment relationship.
4. Shifts in the long-run Phillips curve can occur due to changes in factors like labor market policies, productivity growth, and demographic changes that affect the natural rate of unemployment.
5. Understanding the long-run Phillips curve helps policymakers recognize that while they may influence short-term economic conditions, long-term stability requires addressing structural issues rather than solely focusing on demand-side policies.

Review Questions

• How does the long-run Phillips curve differ from the short-run Phillips curve in terms of its implications for economic policy?
  • The long-run Phillips curve differs significantly from the short-run Phillips curve as it indicates that there is no tradeoff between inflation and unemployment over a longer period. While policymakers might reduce unemployment temporarily by accepting higher inflation in the short run, in the long run, attempts to push unemployment below its natural rate will only lead to increasing inflation without reducing unemployment sustainably. This distinction suggests that effective economic policies should focus on maintaining stability rather than exploiting a temporary inverse relationship.
• Discuss how adaptive expectations influence the positioning of the long-run Phillips curve.
  • Adaptive expectations play a crucial role in shaping individuals' perceptions of future inflation based on their past experiences. As people adjust their expectations, if they perceive ongoing inflationary pressures due to attempts to lower unemployment, they will demand higher wages, further pushing inflation upward. This behavior reinforces the vertical nature of the long-run Phillips curve, as sustained inflation does not lead to lower unemployment over time; rather, it results in a continuous cycle of rising prices and unchanged natural rates.
• Evaluate how changes in labor market policies could shift the long-run Phillips curve and what implications this may have for economic stability.
  • Changes in labor market policies can significantly affect the natural rate of unemployment, thus shifting the long-run Phillips curve. For instance, if a government implements policies that enhance workforce skills or remove barriers to job creation, it may lower the natural rate of unemployment. Conversely, overly restrictive regulations can increase this rate. Understanding these dynamics is essential for economic stability because shifts in the long-run Phillips curve can influence monetary policy decisions and shape expectations about inflation and growth in the broader economy.

Related terms

Natural Rate of Unemployment: The level of unemployment that exists when the economy is at full employment, factoring in frictional and structural unemployment but not cyclical unemployment.

Short-Run Phillips Curve: A downward-sloping curve that illustrates an inverse relationship between inflation and unemployment in the short run, indicating that lower unemployment can be achieved at the cost of higher inflation.

Adaptive Expectations: A theory suggesting that individuals form their expectations of future inflation based on past experiences, impacting how they respond to changes in economic policy.