The Short-Run Trade-Off between Inflation and Unemployment

These flashcards provide vocabulary and key concepts from the Mankiw lecture on the relationship between inflation and unemployment in the short and long run.

Phillips curve (PC)

A curve that shows the short-run trade-off between inflation and unemployment.

Natural-rate hypothesis

The claim that unemployment eventually returns to its normal or “natural” rate, regardless of the inflation rate.

Natural rate of unemployment

The unemployment rate toward which the economy gravitates in the long run; it is considered “natural” because it is beyond the influence of monetary policy.

Expected inflation

A measure of how much people expect the price level to change.

Phillips Curve Equation

$$\text{u-rate} = \text{Natural u-rate} - a(\text{Actual inflation} - \text{Expected inflation})$$

Supply shock

An event that directly alters firms’ costs and prices, shifting the aggregate-supply (AS) and Phillips curves (PC), such as a large increase in oil prices.

Disinflation

A reduction in the inflation rate, achieved through contractionary monetary policy which reduces aggregate demand (AD).

Sacrifice ratio

The number of percentage points of annual output lost per $1$ percentage point reduction in inflation; the typical estimate is $5$.

Rational expectations

The theory that people optimally use all the knowledge they have, including information about government policies, when forecasting the future.

A.W. Phillips

The economist who, in 1958, noted that nominal wage growth was negatively correlated with unemployment in the U.K.

Paul Samuelson and Robert Solow

The economists who, in 1960, found a negative correlation between U.S. inflation and unemployment and named it “the Phillips Curve.”

Milton Friedman and Edmund Phelps

Economists who, in 1968, argued that the trade-off between inflation and unemployment was temporary and that the long-run Phillips curve is vertical.

Paul Volcker

The Fed Chairman appointed in late 1979 who presided over a period of disinflation where inflation fell from $10\%$ to $4\%$, but at the cost of high unemployment.

Accommodation

A policy response, such as the Fed's decision in 1973 to use faster money growth to address an adverse supply shock.

Adverse supply shock

An event that shifts the Short-Run Aggregate Supply (SRAS) curve to the left, causing prices to rise while output and employment fall, thereby yielding a less favorable trade-off between inflation and unemployment.