Phillips Curve Flashcards

The Phillips Curve illustrates the short-run relationship between which two macroeconomic variables?

Answer: Inflation and unemployment

The Phillips Curve shows the inverse relationship between the inflation rate and the unemployment rate in the short run.

Along the short-run Phillips Curve (SRPC), when unemployment decreases, inflation tends to:

Answer: Increase

The SRPC shows an inverse relationship — lower unemployment corresponds to higher inflation as demand for labor drives up wages and prices.

What does the Non-Accelerating Inflation Rate of Unemployment (NAIRU) represent on a Phillips Curve diagram?

Answer: The unemployment rate consistent with stable inflation

NAIRU is the unemployment rate at which inflation neither accelerates nor decelerates, representing the long-run equilibrium unemployment rate.

If the economy is operating below the NAIRU, which of the following is most likely to occur over time?

Answer: Accelerating inflation

Below the NAIRU, the labor market is overly tight, creating sustained upward wage pressure that causes inflation to accelerate over time.

The concept of 'stagflation' in the 1970s challenged the simple Phillips Curve because it demonstrated that:

Answer: High inflation and high unemployment can occur simultaneously

Stagflation — simultaneous high inflation and high unemployment — contradicted the original Phillips Curve's inverse relationship between the two variables.

Which economists are primarily credited with developing the expectations-augmented Phillips Curve in the late 1960s?

Answer: Milton Friedman and Edmund Phelps

Milton Friedman and Edmund Phelps independently argued that inflation expectations shift the short-run Phillips Curve, making the long-run curve vertical.

A.W. Phillips originally developed the Phillips Curve relationship using wage and unemployment data from which country?

Answer: United Kingdom

A.W. Phillips developed the curve in 1958 using nearly 100 years of UK wage inflation and unemployment data.

The long-run Phillips Curve (LRPC) is typically depicted as:

Answer: A vertical line at the natural rate of unemployment

The LRPC is vertical at the natural rate of unemployment because in the long run, inflation expectations fully adjust and there is no lasting trade-off between inflation and unemployment.

What causes the short-run Phillips Curve to shift to the right (outward)?

Answer: An increase in expected inflation or a negative supply shock

Higher inflation expectations or negative supply shocks shift the SRPC rightward, producing higher inflation at every unemployment rate.

According to the adaptive expectations hypothesis, workers and firms form inflation expectations based on:

Answer: Past inflation experience

Adaptive expectations means economic agents expect future inflation to resemble past inflation, gradually updating their expectations as new data arrives.

If the central bank unexpectedly expands the money supply, the short-run effect on the Phillips Curve would be:

Answer: Movement up and to the left along the SRPC (lower unemployment, higher inflation)

Unexpected monetary expansion boosts aggregate demand, reducing unemployment and raising inflation — a movement up and to the left along the existing SRPC.

In the long run, if a central bank repeatedly tries to hold unemployment below the natural rate, the result will be:

Answer: Accelerating inflation with unemployment eventually returning to the natural rate

Sustained attempts to push unemployment below the natural rate cause inflation expectations to ratchet upward, shifting the SRPC up repeatedly and resulting in accelerating inflation.

A negative supply shock, such as a sudden large increase in oil prices, would most directly cause:

Answer: A rightward shift of the SRPC

A negative supply shock raises production costs, increasing inflation at every unemployment rate and shifting the SRPC to the right — the stagflation scenario.

Which policy outcome correctly describes a movement along (rather than a shift of) the short-run Phillips Curve?

Answer: Contractionary monetary policy moves the economy to lower inflation and higher unemployment on the same SRPC

Contractionary monetary policy reduces aggregate demand, moving the economy along the existing SRPC to a point with lower inflation and higher unemployment.

The 'sacrifice ratio' in macroeconomics refers to:

Answer: The percentage points of GDP lost per percentage point reduction in inflation

The sacrifice ratio measures how many percentage points of GDP (or the increase in unemployment) are required to reduce the inflation rate by one percentage point.

A central bank with high credibility affects the Phillips Curve primarily by:

Answer: Lowering inflation expectations, shifting the SRPC leftward

A credible central bank can lower inflation expectations directly, shifting the SRPC leftward and making disinflation less costly in terms of higher unemployment.

Under rational expectations theory, a fully anticipated and credible contractionary monetary policy would:

Answer: Reduce inflation with only a minimal increase in unemployment

Under rational expectations, if agents believe a credible disinflation policy, they immediately lower inflation expectations, allowing inflation to fall without large output losses.

The 'flattening' of the Phillips Curve observed in many advanced economies since the 1990s suggests that:

Answer: Changes in unemployment now have less impact on inflation than they did previously

A flatter SRPC means large changes in unemployment produce only small changes in inflation, often attributed to better-anchored inflation expectations from credible central banks.

Well-anchored inflation expectations affect the short-run Phillips Curve by:

Answer: Keeping the SRPC relatively stable even during temporary economic shocks

When inflation expectations are well-anchored, temporary shocks do not shift the SRPC significantly because agents do not revise their long-run inflation expectations.

During the Volcker disinflation of the early 1980s, the Federal Reserve's contractionary policy primarily resulted in:

Answer: A severe recession and sharply higher unemployment before inflation finally fell

The Volcker disinflation caused a deep recession in 1981–82 with unemployment exceeding 10%, demonstrating that disinflation involves significant real short-run costs.