Chapter 19: The Phillips Curve and Inflation

Vocabulary flashcards covering the drivers of inflation, inflation expectation models, the Phillips curve framework, and supply shocks.

Inflation

The macroeconomic trend of rising prices across the economy over time.

Inflation Expectations

The rate at which average prices are anticipated to rise across the whole economy over the next year.

Demand-Pull Inflation

Inflation resulting from excess demand, occurring when aggregate demand exceeds the economy's productive capacity and pulls inflation above expected inflation.

Cost-Push Inflation

Inflation that results from an unexpected rise in production costs, leading sellers to raise prices above existing inflation expectations and demand pressures.

Virtuous Cycle (Inflation)

A self-reinforcing cycle in low-inflation economies where low inflation leads to low inflation expectations, which in turn reinforces low inflation.

Vicious Cycle (Inflation)

A self-reinforcing cycle in high-inflation economies where high inflation leads to high inflation expectations, which perpetuates high inflation.

10-Year Break-Even Rate

A financial market measure of expected inflation over the next $10$ years, calculated as the nominal interest rate on a $10$-year bond less the yield on a $10$-year inflation-indexed bond.

Adaptive Expectations

A theory of expectation formation where people expect recent levels of inflation to continue into the future.

Anchored Expectations

Inflation expectations formed by people who believe the Federal Reserve will deliver on its promise to keep inflation around $2\%$.

Rational Expectations

Inflation expectations formed by people who use all available data and information to formulate the most accurate forecast possible.

Sticky Expectations

An approach where people revisit their views on inflation only irregularly, causing them to stick with their previous view.

Excess Demand

A situation where the quantity demanded at the prevailing price exceeds the quantity supplied, resulting in a positive output gap and upward pressure on prices.

Insufficient Demand

A situation where the quantity demanded at the prevailing price falls below what is supplied, causing a negative output gap and price restraint.

Unexpected Inflation

The difference between actual inflation and expected inflation, expressed as $\text{Unexpected inflation} = \text{Inflation} - \text{Inflation expectations}$.

Phillips Curve

An upward-sloping framework linking the output gap on the horizontal axis to unexpected inflation on the vertical axis.

Labor Market Phillips Curve

A formulation of the Phillips curve where the unemployment rate is plotted on the horizontal axis to measure unused resources, showing that low unemployment creates excess demand and higher unexpected inflation.

Equilibrium Unemployment Rate

The unemployment rate that occurs when output equals potential output, resulting in zero unexpected inflation.

Supply Shock

Any unexpected change in production costs—such as changes in input prices, productivity growth, or exchange rates—that leads suppliers to change prices at any given level of output, shifting the Phillips curve.

Wage-Price Spiral

A cycle where rising prices erode workers' spending power, prompting higher nominal wages, which raises production costs and leads businesses to increase prices further.

Output Gap

The measure of actual real GDP relative to potential GDP, serving as the primary driver of demand-pull inflation and movements along the Phillips curve.