Phillips Curve

The inflation-unemployment tradeoff, real in the short run, gone in the long run.

Equilibrium: u* = 5.0, π* = 3.0

Current equations

SRPC: π = 8 − 1·uLRPC: u = 5

The tradeoff every policymaker wishes were permanent. In the short run, pushing unemployment below normal comes with higher inflation, you slide along the downward SRPC. But the vertical long-run curve says: no such menu exists permanently. Unemployment returns to its natural rate; only inflation stays.

Source: Blanchard, Macroeconomics, ch. 8

Shift the curves

Expected inflation0

Higher expected inflation shifts the whole short-run tradeoff up, same unemployment, more inflation.

The Phillips Curve model, in writing

Definition

The short-run trade-off between inflation and unemployment: when unemployment falls below its natural rate, inflation tends to rise, and expectations shift the whole relationship.

π = πe − β(u − u*) + supply shocks

The intuition

Tight labour markets bid up wages and then prices. But workers learn: once people EXPECT higher inflation, the curve shifts up and the same unemployment rate comes with more inflation. That is why the trade-off exists in the short run and vanishes in the long run, where the curve is vertical at the natural rate.

Exam tip

Distinguish a movement ALONG the curve (demand shock) from a SHIFT of the curve (changed expectations or supply shock). The 1970s stagflation is the standard evidence for the shifting curve.

Related models in Macro Foundations

AS-AD (Aggregate Supply – Aggregate Demand) →Keynesian Cross & the Multiplier →Business Cycle Phases →Money Multiplier →