Lecture 19 The Phillips Curve

Question 1

phillips curve

Answer 1

describes the supply side of the economy- how do prices respond when output goes up?

Question 2

when do firms increase prices

Answer 2

when economic activity exceeds potential output (yt > 0)

Question 3

when do firms decrease prices

Answer 3

when economic activity is lower than the potential output (yt < 0)

Question 4

phillips curve formula

Answer 4

πt = π ^et + ν yt
π = inflation
π^e = expected inflation
v = sensitivity of inflation to output gap (parameter)
yt = output gap

Question 5

when are firms and workers expectations correct

Answer 5

when economic activity is “normal” aka on the trend (ex: if workers believe π^e = 5%, they ask for wage growth of 5% and firm raise prices by 5% to cover costs)

Question 6

when is inflation higher than expected

Answer 6

when economic activity is extraordinarily high
higher costs: overtime pay, suppliers raise prices, “tight” labor market forces firms to bid up wages
monopolistic power: firms get away with higher prices because of high demand

Question 7

the traditional phillips curve

Answer 7

suggests policy makers face a stable trade-off between inflation and high economic activity (low unemployment)

Question 8

critique of the phillips curve

Answer 8

with constant expectations, π^e = πbar, there is a stable trade-off between inflation and economic activity– no matter what people have seen in the past, if πbar = 2%, people will always say they expect the same rate tomorrow, as if people are surprised by positive output gaps

Question 9

expectations augmented phillips curve

Answer 9

a dynamic curve– today’s inflation depends on yesterday’s inflation

Question 10

expectations augmented phillips curve formula

Answer 10

πt = π^et + νyt = π(t−1) + νyt

Question 11

expectations augmented phillips curve

Answer 11

as before: the phillips curve is upward sloping, higher concurrent output gaps lead to higher concurrent inflation
but: over time the new phillips curve shifts