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Chapter 13: Problem 2

In the past how did economists view the rela tionship between unemployment and inflation? When did economic events begin to change this view?

Short Answer

Expert verified
Economists initially viewed the relationship between unemployment and inflation as inverse, represented by the Phillips Curve. However, this view began to change in the 1970s during stagflation when economies experienced both high inflation and unemployment. This led to newer economic theories like the NAIRU and the Long-Run Phillips Curve that suggested no long-run trade-off existed between unemployment and inflation.

Step by step solution

01

Understanding the Phillips Curve

The previous view of the relationship between unemployment and inflation was best surveillanced by the Phillips Curve. This economic model created by economist A.W. Phillips showed an inverse relationship between unemployment and inflation, meaning when inflation was high, unemployment was low, and vice versa. The logic behind this was that when the employment was high (unemployment was low), workers would demand higher wages which would then increase the cost of goods and services leading to inflation.
02

Stagflation

The economic events that changed this view happened in the 1970s, during a period known as stagflation. During this time, many economies experienced high levels of both inflation and unemployment, which contradicted the Phillips Curve.
03

New Economic Viewpoint

As a result of stagflation, economists began to change their views. Economist Milton Friedman proposed the idea that in the long run, no trade-off between unemployment and inflation exists, and that the natural rate of unemployment is independent of inflation. This resulted in the development of the theory of the Non-Accelerating Inflation Rate of Unemployment (NAIRU) and the Long-Run Phillips curve which posits that the economy will eventually return to the natural rate of unemployment no matter the inflation rate.

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Most popular questions from this chapter

Someone says, "If the federal government cuts income tax rates, tax revenues will rise." Might this person be wrong? Explain your answer.

When the money supply increases, output rises before prices. Why?

Does a decrease in the money supply cause a change in output, prices, or both?

Because firms adjust output before prices, what information do they lack?

Explain in detail how some economists believe the Fed causes stagflation. What is an alternative view of what causes stagflation?
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