Inflation and Unemployment

Read this chapter to examine the relationship between inflation and unemployment. As you will see, while there have been some periods in which a trade-off exists between inflation and unemployment, there are also periods in which such clear-cut negative relationship between these variables falls apart. The chapter offers some explanations for these variable behaviors and the stabilization policies that are used to address undesirable trends in the variables.

3. Inflation and Unemployment in the Long Run

LEARNING OBJECTIVES

  1. Use the equation of exchange to explain what determines the inflation rate in the long run.
  2. Explain why in the long run the Phillips curve is vertical.
  3. Describe frictional and structural unemployment and the factors that may affect these two types of unemployment.
  4. Describe efficiency wage theory and its predictions concerning cyclical unemployment.

In the last section, we saw how stabilization policy, together with changes in expectations, can produce the cycles of inflation and unemployment that characterized the past several decades. These cycles, though, are short-run phenomena. They involve swings in economic activity around the economy's potential output.

This section examines forces that affect the values of inflation and the unemployment rate in the long run. We shall see that the rates of money growth and of economic growth determine the inflation rate. Unemployment that persists in the long run includes frictional and structural unemployment. We shall examine some of the forces that affect both types of unemployment, as well as a new theory of unemployment.