Chapter 8: The Phillips Curve - Exam Flashcards

A series of flashcards covering key concepts from Chapter 8 on the Phillips Curve, its implications on inflation and unemployment, and related economic theories.

What is the main message of Chapter 8?

Low unemployment puts upward pressure on inflation, but the relationship depends on how people form expectations.

How is the Phillips Curve related to the Labor Market?

It is the 'price-change' version of the labor market; low unemployment increases bargaining power, leading to higher wages and prices.

Interpret Equation 8.3: $ext{pi}_t = ext{pi}^e_t + (m + z) - ext{alpha} imes u_t$

Actual inflation is driven by expected inflation, markups/bargaining factors, and the inverse effect of unemployment.

What was the original Phillips Curve?

A stable, negative relationship where the government could achieve lower unemployment at the cost of higher inflation.

Define 'Anchored' Expectations.

When people assume inflation will return to a steady, fixed target, regardless of prior fluctuations.

Why did the original Phillips Curve disappear in the 1970s?

Inflation became persistent, leading people to distrust the anchor and expect continued high inflation.

What is the formula for Adaptive Expectations (theta)?

$ext{pi}^e_t = (1 - ext{theta}) ext{pi-bar} + ext{theta} imes ext{pi}_{t-1}$.

What do theta = 0 and theta = 1 represent?

Theta = 0 indicates purely anchored expectations; theta = 1 indicates purely de-anchored expectations.

Interpret Equation 8.9: $ext{pi}<em>t - ext{pi}</em>{t-1} = - ext{alpha} imes (u_t - u_n)$

Unemployment affects the change in inflation; lower unemployment than the natural rate leads to increased inflation.

What was the major contribution of Friedman and Phelps?

They proved there is no permanent trade-off between inflation and unemployment; excessive low unemployment accelerates inflation.

What is the NAIRU?

The Non-Accelerating Inflation Rate of Unemployment, also known as the Natural Rate, where inflation remains constant.

What is the effect on inflation if actual unemployment is 4% and the natural rate is 6%?

Inflation will increase compared to last year due to a tight labor market.

Define a 'Wage-Price Spiral.'

A cycle where low unemployment leads to higher wages, firms raise prices, and workers demand higher wages, accelerating inflation.

Why did the Phillips Curve re-anchor in the 1990s?

The Fed maintained low and stable inflation, restored trust in the inflation anchor.