Chapter 19: The Phillips Curve and Inflation

Flashcards based on Chapter 19 covering key concepts related to the Phillips Curve and various inflationary forces.

Three Causes of Inflation

Inflation expectations, Demand-pull inflation, Supply shocks.

Inflation Expectations

The rate at which average prices are anticipated to rise next year. Track expectations with surveys, economic forecasts and financial markets. 

Demand-Pull Inflation

Inflation resulting from excess demand, when demand outstrips a business’ productive capacity. It is driven by the output gap, when there’s a positive output gap there is access demand, when there’s a negative output gap there’s insufficient demand. Leads inflation to diverge from expectations.

Cost-Push Inflation

Inflation that results from an unexpected rise in production costs, stemming from supply shocks.

Supply Shocks

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

Phillips Curve

Illustrates the relationship between inflation and unemployment, depicting how inflation diverges from expected inflation based on the output gap.

Adaptive Expectations

Expectations where people assume recent inflation rates will continue in the future.

Anchored Expectations

Expectations based on the belief that the Federal Reserve will maintain inflation around a target rate, typically 2%.

Sticky Expectations

Expectations that revisit inflation beliefs irregularly and tend to stick to previous views.

Wage-Price Spiral

A cycle in which higher prices lead to higher nominal wages, which in turn lead to higher prices.

Unexpected Inflation

The difference between actual inflation and inflation expectations.

Input Prices

The costs of production inputs that, when they increase, can lead to cost-push inflation.

Productivity Shifts

Changes in production efficiency that can lead to shifts in the Phillips curve and influence inflation.

Exchange Rates

The value of one currency for the purpose of conversion to another, affecting inflation through cost changes in imports.

Inflation Equation

Inflation= Expected inflation + Demand pull inflation +cost push inflation

Two key factors for setting prices 

Your marginal costs and your competitors prices. You should raise your prices for next year because you expect other businesses (both your suppliers and competitors) to raise their prices.

Self fulfilling inflation prophecy

occurs when expectations of inflation lead to behavior that causes inflation to happen.

Policymakers’ goal

Convince people that future inflation is going to be low, even when businesses are experiencing a temporary rise in inflation.

Rational Expectations

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

How to use the Phillips curve to forecast inflation

Asses inflation expectations (analyze surveys) and forecast unexpected inflation (Start with your output gap estimate. Look up and across the Phillips curve to get your forecast of unexpected inflation.)

Supply shocks take-away

Any factor that leads to an unexpected rise in production costs will cause the Phillips curve to shift upward.

Phillips curve shifters

Input prices, productivity, exchange rates