4.2.3.4 The Phillips Curve

Phillips curve

shows that in the short-run there is an inverse relationship between improving inflation and improving unemployment

demand pull and cost-push inflation

What causes the inverse relationship in the Phillips curve?

demand-pull inflation

excess demand in economy => businesses need more workers => unemployment drops and wages rise => spending and average price levels rise

cost-push inflation

unemployment falls => more workers in trade union => more power to demand higher wages => workers spend more => average price level rises

short term given the lack of trade union power now

Demand pull infaltion tends to have a bigger effect in the ______________________________

stagflation

both inflation and unemployment are high

policy makers may use the Phillips curve to support higher interest rates, which can bring in revenue for the gov.

Why might policymakers be tempted to ‘exploit’ the Phillips curve?