Econ 2020 Chapter 19 Phillips Curve

What drives inflation?

Inflation expectations, demand-pull inflation, supply shocks & cost-push inflation

Inflation expectations

The rate at which average prices are anticipated to rise next year

Key factors for setting prices

Your marginal costs, your competitor’s prices

What determines peoples expectations?

Adaptive expectations, anchored expectations, rational expectations, sticky expectations

Adaptive expectations

People who expect recent levels of inflation to continue

Anchored expectations

People who believe the Fed will deliver on its promise to ensure inflation stays around 2%

Rational expectations

People who use all available data to come up with the most accurate forecast possible

Sticky expectations

People who revisit their views on inflation irregularly, so they stick with their previous view

Demand-pull inflation

When excess demand pulls inflation up, so that it rises above expected inflation

When the output gap is positive:

Actual output > potential output

When actual output = potential output:

Inflation = expected inflation

Cost-push inflation

Inflation that results from an unexpected rise in production costs

Supply shocks

Any change in production costs that leads suppliers to change the prices they charge at any given level of output

Causes for shifts in the Phillips Curve

Input prices, productivity, exchange rates. It is shifted by changes in the production cost

Causes of movements along the Phillips Curve

Changes in demand-pull inflation