Economics,

Arab World Edition

R. Glenn Hubbard, Anthony Patrick O’Brien,
Ashraf Eid, Amany El Anshasy,

Inflation, Unemployment, and

Central Bank Policy

1 © Pearson Education 2011

 How Do Central Banks
React to Economic
Downturns? Learning Objectives

24.1 Describe the Phillips curve and

the nature of the short-run trade-off
between unemployment and
inflation.

24.2 Explain the relationship between

the short-run and long-run Phillips
curves.

24.3 Discuss how expectations of the

inflation rate affect monetary policy.

24.4 Use a Phillips curve graph to show

how the Federal Reserve can
permanently lower the inflation rate.

Central banks in the Arab countries

responded to the low investment
and lending rates by applying
expansionary monetary policies.

2 © Pearson Education 2011

 Learning Objective 24.1
The Discovery of the Short-Run Trade-off
between Unemployment and Inflation
Chapter 28: Inflation, Unemployment, and Central Bank Policy

Phillips curve A curve showing the short-

run relationship between the unemployment
rate and the inflation rate.

FIGURE 24.1
The Phillips Curve

3 © Pearson Education 2011

 Learning Objective 24.1
The Discovery of the Short-Run Trade-off
between Unemployment and Inflation
Chapter 28: Inflation, Unemployment, and Central Bank Policy

Explaining the Phillips Curve with Aggregate

Demand and Aggregate Supply Curves FIGURE 24.2
Using Aggregate Demand
and Aggregate Supply to
Explain the Phillips Curve

4 © Pearson Education 2011

 Learning Objective 24.1
The Discovery of the Short-Run Trade-off
between Unemployment and Inflation
Chapter 28: Inflation, Unemployment, and Central Bank Policy

Is the Phillips Curve a Policy Menu?

Structural relationship A relationship

that depends on the basic behavior of
consumers and firms and remains
unchanged over long periods.

5 © Pearson Education 2011

 Learning Objective 24.1
The Discovery of the Short-Run Trade-off
between Unemployment and Inflation
Chapter 28: Inflation, Unemployment, and Central Bank Policy

The Long-Run Phillips Curve

Natural rate of unemployment

The unemployment rate that
exists when the economy is at
potential GDP.

6 © Pearson Education 2011

 Learning Objective 24.1
The Discovery of the Short-Run Trade-off
between Unemployment and Inflation
Chapter 28: Inflation, Unemployment, and Central Bank Policy

The Long-Run Phillips Curve FIGURE 24.3

A Vertical Long-Run Aggregate Supply Curve
Means a Vertical Long-Run Phillips Curve

7 © Pearson Education 2011

 Learning Objective 24.1
The Discovery of the Short-Run Trade-off
between Unemployment and Inflation
Chapter 28: Inflation, Unemployment, and Central Bank Policy

The Role of Expectations of Future Inflation

Nominal wage $31.50

Real wage 100 100 $30
Price level 105

Table 28-1
The Impact of Unexpected Price
Level Changes on the Real Wage

8 © Pearson Education 2011

 Learning Objective 24.1
The Discovery of the Short-Run Trade-off
between Unemployment and Inflation
Chapter 28: Inflation, Unemployment, and Central Bank Policy

The Role of Expectations of Future Inflation

Table 24-2
The Basis for the Short-Run
Phillips Curve

IF… THEN… AND…

actual inflation is the actual real wage is the unemployment rate falls.
greater than expected less than the expected
inflation, real wage,
actual inflation is the actual real wage is the unemployment rate rises.
less than expected greater than the expected
inflation, real wage,

9 © Pearson Education 2011

 Learning Objective 24.1

Making
the Do Workers Understand Inflation?
Chapter 28: Inflation, Unemployment, and Central Bank Policy

Connection

Will his wage increases keep up with inflation?

10 © Pearson Education 2011

 Learning Objective 24.2

The Short-Run and Long-Run Phillips Curves

Chapter 28: Inflation, Unemployment, and Central Bank Policy

FIGURE 24.4
The Short-Run Phillips
Curve of the 1960s and the
Long-Run Phillips Curve

11 © Pearson Education 2011

 Learning Objective 24.2

The Short-Run and Long-Run Phillips Curves

Shifts in the Short-Run Phillips Curve
Chapter 28: Inflation, Unemployment, and Central Bank Policy

FIGURE 24.5
Expectations and the
Short-Run Phillips Curve

12 © Pearson Education 2011

 Learning Objective 24.2

The Short-Run and Long-Run Phillips Curves

How Does a Vertical Long-Run Phillips Curve Affect
Chapter 28: Inflation, Unemployment, and Central Bank Policy

Monetary Policy?
FIGURE 24.7
The Inflation Rate and the
Natural Rate of Unemployment
in the Long Run

13 © Pearson Education 2011

 Learning Objective 24.2

Making
the Does the Natural Rate of
Unemployment Ever Change?
Chapter 28: Inflation, Unemployment, and Central Bank Policy

Connection
Frictional or structural
unemployment can change—
thereby changing the natural
rate—for several reasons:

• Demographic changes.
• Labor market institutions.
• Past high rates of unemployment.

14 © Pearson Education 2011

 Learning Objective 24.3
Expectations of the Inflation Rate
and Monetary Policy
Chapter 28: Inflation, Unemployment, and Central Bank Policy

Is the Short-Run Phillips Curve Really Vertical?

Many economists have remained skeptical of the argument
that the short-run Phillips curve is vertical. The two main
objections raised are that

(1) workers and firms actually may not have rational

expectations, and

(2) the rapid adjustment of wages and prices needed for

the short-run Phillips curve to be vertical will not
actually take place.

Real Business Cycle Models

Real business cycle models Models that
focus on real rather than monetary
explanations of fluctuations in real GDP.
15 © Pearson Education 2011
 Learning Objective 24.4

The Effect of a Supply Shock on the Phillips Curve in

the industrial Countries: the Case of Oil Shocks
Chapter 28: Inflation, Unemployment, and Central Bank Policy

FIGURE 24.9
A Supply Shock Shifts the SRAS
and the Short-Run Phillips Curve

16 © Pearson Education 2011

 Learning Objective 24.4

Solved Problem 24-4

Using Monetary Policy to Lower the Inflation Rate
Chapter 28: Inflation, Unemployment, and Central Bank Policy

17 © Pearson Education 2011

 An Inside LOOK The Monetary Policy of the Central
Bank of Jordan
Chapter 28: Inflation, Unemployment, and Central Bank Policy

Inflation in 2010

18 © Pearson Education 2011

 Key Terms
Chapter 28: Inflation, Unemployment, and Central Bank Policy

Disinflation
Natural rate of unemployment
Nonaccelerating inflation rate of
unemployment (NAIRU)
Phillips curve
Rational expectations
Real business cycle models
Structural relationship

19 © Pearson Education 2011

Chapter 28: Inflation, Unemployment, and Central Bank Policy