Chapter 22 Phillips Curves Shift Left There Is no Change

8684 The Short-Run Trade-off between Inflation and Unemployment

Problems

1. As the aggregate demand curve shifts to the right, what happens to the price level and output?

What do these changes imply happens to the inflation rate and the unemployment rate?

2. According to the Phillips curve, which fiscal policies can be used to reduce unemployment in the

short run?

3. If asset prices fall and inflation expectations remain unchanged, what happens to inflation and

unemployment? Defend your answer.

The Short-Run Trade-off between Inflation and Unemployment 8685

4. Suppose that businesses become less optimistic about the future. Assuming no change in inflation

expectations, how would the effects of this shock be shown on the Phillips curve diagram and what

would happen to inflation and unemployment?

5. Government expenditures increase. What happens to the price level and output? Explain how the

change in the price level and output effect the inflation rate and the unemployment rate.

6. If consumer confidence rises and inflation expectations remain unchanged, what happens to

inflation and unemployment? Defend your answer.

8686 The Short-Run Trade-off between Inflation and Unemployment

7. U.S. net exports fall due to recessions in foreign countries.

A. According to the aggregate demand and supply model, what happens to the price level and

output in the short run?

B. According to the short–run Phillips curve what happens to inflation and unemployment in the

short run?

C. If the Fed wanted to reverse the effects of this shock on output, what should it do?

8. According to the long-run Phillips curve, if the Fed increases the growth rate of the money supply,

what happens to the inflation rate and the unemployment rate in the long run?

9. What is meant by the natural rate of unemployment?

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10. List one specific policy that would shift the long–run Phillips curve to the right.

11. Suppose, as in the 1970’s in the U.S., that demographic groups which typically have higher

unemployment rates become a larger percentage of the labor force. Would this have any effect on

the long–run Phillips curve?

12. For a given short-run Phillips curve, if expected inflation is 10% but actual inflation is 8%, is the

unemployment rate above or below its natural rate?

8688 The Short-Run Trade-off between Inflation and Unemployment

13. If expected inflation rises but actual inflation remains the same, what happens to the

unemployment rate? Defend your answer.

14. If expected inflation decreases does the short–run Phillips curve shift? If so, what direction does it

shift? Does the long–run Phillips curve shift? If so, what direction does it shift?

15. If the Fed raised the money supply growth by more than expected then the unemployment rate

would_______in the short run. Explain the process by which the economy moves to the long run

if the Fed maintains the higher money supply growth rate.

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16. What does the natural-rate hypothesis claim?

17. An increase in the natural rate of unemployment shifts the short-run Phillips curve to the .

If the central bank sees the increase in the unemployment rate, but thinks the natural rate has

remained the same and so wants to reduce unemployment, it would the

money supply growth rate. If it maintains this money supply growth rate, eventually the short run

Phillips curve will shift and unemployment will be .

8690 The Short-Run Trade-off between Inflation and Unemployment

18. The Fed increases the money supply growth rate. Assuming inflation expectations remain

constant, use a Phillips curve diagram to show the short-run effects of the Fed’s policy.

19. What does an unexpected decrease in the growth rate of the money supply do to inflation and

unemployment in the short-run? What does it do to inflation and unemployment in the long run?

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20. For a given short-run Phillips curve, if expected inflation is 8% but actual inflation is 10%, is the

unemployment rate above or below its natural rate?

21. If expected inflation falls but actual inflation remains the same, what happens to the

unemployment rate? Defend your answer.

22. Use the sticky-wage theory of aggregate demand to explain the short-run Phillips curve.

8692 The Short-Run Trade-off between Inflation and Unemployment

23. Write the equation representing the short-run Phillips curve.

24. List three things that shift the short-run Phillips curve to the right.

25. Friedman and Phelps argued that it was dangerous to think of the short-run Phillips curve as a

menu of options for policymakers to choose from. Explain the logic of their argument.

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26. How is a decrease in the natural rate of unemployment shown in the Phillips curve diagram? Does

this decrease change the inflation rate?

27. A central bank raises the money supply growth rate and keeps it at that higher rate. Explain the

process by which the economy moves to long–run equilibrium.

28. A central bank raises the money supply growth rate and keeps it higher. As the economy moves

from the short-run equilibrium created by the increase in the money supply growth back to long-

run equilibrium what happens to the unemployment rate?

8694 The Short-Run Trade-off between Inflation and Unemployment

29. What evidence does the Volcker disinflation provide concerning the importance of inflation

expectations to the costs of disinflation?

30. How are the effects of a favorable supply shock shown in the Phillips curve diagram? If the Fed

wants to return unemployment to its natural rate after the shock, what should it do?

31. If there is a large and sudden but temporary increase in the price of oil, which way does the short-

run Phillips curve shift? If the central bank does not respond what happens to inflation and the

unemployment rate in the long run?

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32. If there is a favorable supply shock which direction does the short-run Phillips curve shift? What

initially happens to unemployment and inflation as a result of this shock?

33. What is meant by accommodation?

34. If the Fed responded to an adverse supply shock by increasing the growth rate of the money

supply and maintained the higher growth rate, what would eventually happen to the short-run

Phillips curve? Why?

8696 The Short-Run Trade-off between Inflation and Unemployment

35. If there were a favorable supply shock and the central bank wanted to offset the change in the

unemployment rate, what would it do?

36. How does a central bank’s accommodation of an adverse supply shock change the long-run

results of the shock?

37. What would a central bank need to do to reverse the effects of a favorable supply shock on

inflation? What would its reaction do to the unemployment rate in the short run?

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38. Suppose that a central bank reduces the money supply growth rate to disinflate. What does

disinflation mean? If people do not alter their inflation expectations, what happens to output and

unemployment?

39. Suppose the price level is 110.00 at the end of 2020, 121.00 at the end of 2021, and 128.26 at the

end of 2022. Can we accurately describe the period 2021-2022 as a period of disinflation?

40. Suppose the price level is 115.00 at the end of 2020, 112.02 at the end of 2021, and 109.08 at the

end of 2022. Can we accurately describe the period 2021-2022 as a period of disinflation?

8698 The Short-Run Trade-off between Inflation and Unemployment

41. If because they expect the central bank to disinflate, people reduce their inflation expectations,

then is the sacrifice ratio larger or smaller the otherwise? Defend your answer by referring to the

Phillips curve.

42. A central bank disinflates. Output falls by 3% for one year, 2% the second year, and 1% the third

year. If inflation fell by 2 percentage points, what was the sacrifice ratio?

43. A central bank pledges to reduce the inflation rate from 20% to 5%. People reduce their inflation

expectations to 10%, but the central bank only reduces inflation to 15%. What happens to the

unemployment rate?

The Short-Run Trade-off between Inflation and Unemployment 8699

44. According to the Phillips curve diagram, if a central bank disinflates what ultimately happens to

the unemployment rate?

45. How are the effects of the financial crisis shown using the Phillips curve diagram?

46. A central bank disinflates. Output is 4% less for one year, 3% less the next year, and 2% less the

third year. If inflation fell by 2 percentage points, what was the sacrifice ratio?

47. Assuming that rational expectations theory does not hold, if a central banks attempts to reduce the

inflation rate what happens to the unemployment rate in the short-run?

8700 The Short-Run Trade-off between Inflation and Unemployment

48. A central bank pledges to reduce the inflation rate from 10% to 3%. People reduce their inflation

expectations to 5%, but the central bank reduces inflation to 3%. What happens to the

unemployment rate?

49. If there is a decline in business confidence and the Fed desires to return unemployment towards

its natural rate, what should it do? If business confidence eventually returns to normal but the Fed

does not reverse its policy, what eventually happens to the inflation rate?

50. Does a more steeply sloped Phillips curve make the sacrifice ratio smaller or larger than

otherwise?

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51. Assume the natural rate of unemployment is 6%. Draw the short-run and long-run Phillips curves

and show the position of the economy if expected inflation is 3% and the actual inflation rate is

2%.

8702 The Short-Run Trade-off between Inflation and Unemployment

52. Assume the natural rate of unemployment is 6%. Draw the short-run and long-run Phillips curves

and show the position of the economy if expected inflation is 3% and the actual inflation rate is

4%.