Long-Run Phillips Curve

Definition

The long-run Phillips curve is a macroeconomic concept that depicts the relationship between the rate of inflation and the unemployment rate in the long run. It suggests that there is no long-term trade-off between inflation and unemployment, as the economy will eventually return to its natural rate of unemployment regardless of the level of inflation.

5 Must Know Facts For Your Next Test

1. The long-run Phillips curve is vertical, indicating that there is no long-term trade-off between inflation and unemployment.
2. In the long run, the economy will return to its natural rate of unemployment, regardless of the level of inflation.
3. The long-run Phillips curve is based on the assumption of adaptive expectations, where people adjust their expectations of inflation based on past experience.
4. The position of the long-run Phillips curve is determined by the natural rate of unemployment, which is influenced by factors such as labor market frictions and the structure of the labor force.
5. The long-run Phillips curve is an important concept in understanding the effectiveness of monetary policy and its impact on inflation and unemployment.

Review Questions

• Explain the relationship between the long-run Phillips curve and the natural rate of unemployment.
  • The long-run Phillips curve is vertical, indicating that there is no long-term trade-off between inflation and unemployment. This is because the economy will eventually return to its natural rate of unemployment, which is the level of unemployment that the economy gravitates towards in the long run. The natural rate of unemployment is determined by factors such as labor market frictions and the structure of the labor force, and it represents the level of unemployment that the economy will converge to regardless of the level of inflation.
• Describe how the concept of adaptive expectations relates to the long-run Phillips curve.
  • The long-run Phillips curve is based on the assumption of adaptive expectations, where people adjust their expectations of inflation based on past experience. This means that as people observe higher inflation rates, they will gradually adjust their expectations and demand higher wages to compensate, leading to a shift in the short-run Phillips curve. However, in the long run, these higher inflation expectations will be incorporated into the natural rate of unemployment, and the economy will return to the vertical long-run Phillips curve.
• Analyze the implications of the long-run Phillips curve for the effectiveness of monetary policy in managing inflation and unemployment.
  • The long-run Phillips curve has important implications for the effectiveness of monetary policy. Since the long-run Phillips curve is vertical, it suggests that in the long run, monetary policy cannot be used to permanently reduce unemployment below the natural rate or to permanently increase inflation. Any attempts to do so will only result in higher inflation without a corresponding reduction in unemployment. This means that in the long run, monetary policy is most effective in controlling inflation, as it can influence the level of inflation without affecting the natural rate of unemployment. However, in the short run, there may be a trade-off between inflation and unemployment, and monetary policy can be used to manage this trade-off.

Related terms

Phillips Curve: The Phillips curve is a graphical representation of the inverse relationship between the rate of unemployment and the rate of inflation in an economy.

Natural Rate of Unemployment: The natural rate of unemployment is the level of unemployment that the economy gravitates towards in the long run, determined by factors such as labor market frictions and the structure of the labor force.

Adaptive Expectations: Adaptive expectations is a theory that assumes people form their expectations about the future based on past experience and information, adjusting their expectations gradually over time.