The Vertical Long-Run Phillips Curve Lecture Notes PDF

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Important keys to remember about the lesson on Vertical Long-Run Phillips Curve...

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THE VERTICAL LONG-RUN PHILLIPS CURVE LECTURE NOTE

 When the unemployment rates depart from the NAIRU, the inflation rate will tend to change.  Because of the gap, inflation will tend to rise from year to year.  Inflation might be 3 percent in the first year, 4 percent in the second year, 5 percent in the third year and might continue to move upward there-after.  When would this upward spiral stop? It stops only when unemployment moves back to the NAIRU. Put differently, as long as unemployment is below the NAIRU, wage inflation will tend to increase.  The opposite behavior will be seen at high unemployment. In this case, inflation will tend to fall as long as unemployment is above the NAIRU.  If the unemployment is at the NAIRU will inflation stabilize; only then will the shifts of supply and demand in different labor markets are in balance.

 According to the NAIRU theory, the only level of unemployment consistent with a stable inflation rate is the NAIRU.  The NAIRU theory of inflation has two important implications for economic policy - Implies that there is a minimum level of unemployment that an economy can sustain in the long run. - But even with the long-run constraint, there is much rooms in the short run for business cycles.

 According to the view of the first implication for economic policy, a nation cannot push unemployment below the NAIRU for a long without igniting upward spiral wage and price inflation.  A country might expand the economy and enjoy low unemployment for a period.  Conversely, when a nation thinks that its inertial inflation rate is too high, it can steel itself for a period of austerity, tighten money, induce a recession, and thereby reduce inflation....