short run phillips curve

Daniel Parker

3 min read

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13-03-2025

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The Short-Run Phillips Curve (SRPC) is a macroeconomic concept illustrating the inverse relationship between inflation and unemployment. This means that, in the short run, lower unemployment is often associated with higher inflation, and vice versa. This seemingly simple relationship has profound implications for economic policy and understanding economic fluctuations. This article will delve into the details of the SRPC, exploring its mechanics, limitations, and relevance in modern economics.

The Inverse Relationship: Lower Unemployment, Higher Inflation?

The SRPC suggests a trade-off: policymakers can choose to prioritize lower unemployment, but this often comes at the cost of higher inflation. Conversely, focusing on price stability (low inflation) might lead to higher unemployment. This inverse relationship is based on several key factors:

• Aggregate Demand: Increased aggregate demand (total spending in the economy) pulls up employment. As businesses see rising demand, they hire more workers to meet production needs. However, this increased demand also pushes up prices, leading to inflation.

• Wage-Price Spiral: Higher employment often translates to higher wages as workers have more bargaining power. Businesses then pass these increased labor costs onto consumers through higher prices, further fueling inflation.

• Supply Constraints: When the economy is operating near its full employment capacity, further increases in aggregate demand encounter supply-side bottlenecks. Businesses struggle to expand production rapidly, leading to price increases rather than significant output gains.

Graphing the Short-Run Phillips Curve

The SRPC is typically depicted graphically as a downward-sloping curve. The x-axis represents the unemployment rate, and the y-axis represents the inflation rate. Each point on the curve represents a combination of unemployment and inflation that might occur in the short run.

[Insert a graph here showing a downward-sloping SRPC curve. Clearly label axes.]

The Expectations-Augmented Phillips Curve and the Long Run

The original Phillips Curve analysis, based on observations from the 1950s and 60s, proved to be an oversimplification. Economists later incorporated the role of inflation expectations. The Expectations-Augmented Phillips Curve (EAPC) acknowledges that persistent inflation can lead to higher expected inflation.

This has significant implications: If people expect higher inflation, they will demand higher wages, even if unemployment remains unchanged. This pushes up prices further, shifting the SRPC upward.

In the long run, the EAPC suggests there is no stable trade-off between inflation and unemployment. The long-run Phillips curve is vertical at the natural rate of unemployment (also known as the NAIRU – Non-Accelerating Inflation Rate of Unemployment). This natural rate represents the unemployment level consistent with stable inflation. Attempts to persistently reduce unemployment below the NAIRU will only lead to accelerating inflation.

Policy Implications and Limitations

The SRPC has significant implications for monetary and fiscal policy. Central banks, such as the Federal Reserve in the US or the European Central Bank, often try to manage inflation and unemployment using tools like interest rate adjustments. However, navigating this trade-off requires careful consideration of inflation expectations and the natural rate of unemployment.

The SRPC is a simplified model, and its limitations are crucial to understand:

• Supply Shocks: Unexpected events like oil price shocks can shift the SRPC, leading to stagflation (high inflation and high unemployment simultaneously). This shows that the inverse relationship isn't always guaranteed.

• Structural Changes: Changes in the labor market, technology, or global competition can alter the natural rate of unemployment and the shape of the SRPC.

• Measurement Issues: Accurately measuring inflation and unemployment can be challenging, potentially affecting the perceived relationship between them.

Conclusion: The SRPC in Modern Macroeconomics

While the simple inverse relationship depicted by the original Phillips Curve has been refined, the core concept remains relevant. The SRPC, especially in its expectations-augmented form, provides valuable insights into the short-run trade-offs faced by policymakers. Understanding these trade-offs is crucial for effective macroeconomic management, even though the long-run implications highlight the limitations of attempting to exploit the short-run relationship for sustained gains in employment at the expense of price stability. The natural rate of unemployment and inflation expectations remain central concepts in modern macroeconomic analysis, directly stemming from the insights generated by studying the Phillips Curve.