Short-run Tradeoff between inflation rate and unemployment rate

Economics
Tutor: None Selected Time limit: 1 Day

a.    If you were macroeconomic policymaker, how do you balance the short-run tradeoff between inflation rate and unemployment rate? Explain.
b.    What is the historical relationship between rates of unemployment and inflation in the U.S. economy? What are the most current figures for the unemployment rate and the inflation rate? What does this say about the U.S. economy today?

Dec 12th, 2015

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a. If the economy experienced a rise in AD, it will cause increased output; as the economy comes  closer to full employment, we also experience a rise in inflation. However, with the increase in real GDP, firms take on more workers leading to a decline in unemployment ( a fall in demand deficient unemployment).

if an economy experienced inflation, then as the monetary policy make I will raise interest rates. Higher interest rates will reduce consumer spending and investment leading to lower aggregate demand. This fall in aggregate demand will lead to lower inflation. However, if there is a decline in Real GDP, firms will employ fewer workers leading to a rise in unemployment. This would be a trade off between inflation and employment. The phillips curve is one the prior depiction of such a state. 

b. Historical relationship:

In some periods, we have seen both falling unemployment and falling inflation. For example, in 1990s, unemployment fell, but inflation stayed low.This suggests that it is possible to reduce unemployment without causing inflation.

However, you could argue there is still a potential trade off except the Phillips curve has shifted to the left, because there is now a better trade off.

It also depends on the role of Monetary policy. If monetary policy is done well, you can avoid some of the boom and bust economic cycles we experienced before, and enable sustainable low inflationary  growth which helps reduce unemployment.

Current figures:

There are occasions when  you can see a trade off. For example, between 1979 and 1983, we see inflation (CPI) fall from 15% to 2.5%. During this period, we see a rise in unemployment from 5% to 11%.

In 2015, we see inflation fall from 5% to -2%. During this time, we see a sharp rise in unemployment from 5% to over 10%.

View of the US:

Rational expectation monetarists, believe there is no trade-off even in the short-term. They believe if government or Central Bank increased money supply, people would automatically expect inflation, so there would be no improvement in real GDP.



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Dec 12th, 2015

Awesome answer! Where did you get your figures from?

Dec 13th, 2015

Awesome answer! Where did you get your figures from?

Dec 13th, 2015

I think I messed up your review. I put 5 stars but the disappeared when I submitted it

Dec 13th, 2015

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