Journaling of Chapter 35: The Short-Run Trade-off between Inflation and Unemployment

Chapter 35, titled ‘The Short-Run Trade-off between Inflation and Unemployment’, explains why policymakers face a short-run trade-off between inflation and unemployment. However, this inflation-unemployment trade-off disappears in the long run. This chapter also discusses how supply shocks can shift the inflation-unemployment trade-off. Readers also learn that there is a short-run cost of reducing the rate of inflation. The costs of reducing inflation are also affected by policymakers’ credibility.

            Since both inflation and unemployment are undesirable, the sum of inflation and unemployment has been termed the misery index. In the short run, inflation and unemployment are related because an increase in aggregate demand the short-run trade-off between inflation and unemployment temporarily increases inflation and output while it lowers unemployment. The Phillips curve shows the combinations of inflation and unemployment that arise in the short run as shifts in the aggregate-demand curve move along a short-run aggregate-supply curve. The long-run Phillips curve should be vertical at the natural rate of unemployment—the rate of unemployment to which the economy naturally gravitates. For any given expected inflation rate, if actual inflation exceeds expected inflation, unemployment will fall below the natural rate by an amount that depends on the parameter a. However, in the long run, people learn to expect the inflation that actually exists, and the unemployment rate will equal the natural rate. The chapter then goes on to explain the role of supply shocks as well as the cost of reducing inflation. Overall, I would give this chapter a difficulty rating of 2 out of 3.