Philips Curve

Question 1

Total inflation =

Answer 1

inflation expectations + demand-pull inflation + cost-push inflation

Question 2

Inflation expectations (2 factors)

Answer 2

• changes in marginal costs (changes in input costs and nominal wages)
• changes in competitors’ prices

Question 3

real interest rates =

Answer 3

nominal interest rates – inflation expectation

Question 4

Backwards vs Forward-looking expectations

Answer 4

• backwards looking expectations – what was inflation last year?
• forward-looking expectations – BoC has repeatedly said that they are focusing on 2% target

Question 5

Demand-pull inflation (what is it determined by, what happens when demand rises/falls)

Answer 5

• determined by the output gap
• when demand rises for a given product, companies raise prices
• when demand falls, companies raise prices by less, or lower prices

Question 6

unexpected inflation =

Answer 6

inflation – inflation expectations

Question 7

What shifts the Phillips curve?

Answer 7

Supply shocks:
- if any of these rise, the curve shifts up
1. Input prices:
- oil, weather and commodities, shipping
- wages, and wage-price spirals (wages rising makes inflation rise and it’s a vicious cycle)
2. Productivity growth (not common)
3. Exchange rates (if it depreciates, inflation goes up)
- input costs and competition
- also affects the IS-curve

Question 8

What happens to the Philips curve when there is a positive/negative/no output gap?

Answer 8

1. negative output gap: insufficient demand  price restraint  inflation falls below expected inflation
2. no output gap: inflation is equal to expected inflation
3. positive output gap: excess demand  rise in prices  inflation is above expected inflation

Question 9

Labour market Phillips curve: when is inflation equal to expected inflation?

Answer 9

-output gap is zero
-unemployment = long-run equilibrium (6%)

Question 10

Effect of unemployment on unexpected inflation

Answer 10

• higher unemployment leads to lower unexpected inflation
• lower unemployment leads to higher unexpected inflation

Question 11

What does the IS curve talk about?

Answer 11

• desired spending, Y = C + I + G + NX

Question 12

What does the MP curve talk about?

Answer 12

• monetary policy, banking sector

Question 13

Which shocks alter the IS curve?

Answer 13

Spending shocks
- C: wealth, expectations (confidence), tax rate
- I: expectations (business optimism)
- NX: foreign income, exchange rates

Question 14

Which shocks alter the MP curve?

Answer 14

Financial shocks
- monetary policy, risk premium

Question 15

Which shocks alter the Philips curve?

Answer 15

Supply shocks
- input costs, productivity, exchange rates