p
 The Short-Run Tradeoff between

Inflation and Unemployment

The natural rate of unemployment depends on various features

of the labor market.
Examples include minimum-wage laws, the market power of unions, the
role of efficiency wages, and the effectiveness of job search.
The inflation rate depends primarily on growth in the quantity of money,
controlled by the Bank of Korea.

1
Society faces a short-run tradeoff between unemployment and
inflation[ᰍỮ‫ إ‬₡⸵ᄱ₝᪁ԭ₁ ఑‫ݙ‬K ᧪⛒‫(׭ة‬trade-off)እ ᘝἕ ∥஽ ؊ᩉ].
‡ 1958੭ỹ ‫צ‬ⅅ⺂₹ Phillipsԩ 1861੭ᚩ⩙ 1957੭ ᧕₝₁ Ἢ‫ ږ‬ᰍỮ኉‫إ‬
ᑥԩ᧪ᯢ኉ ₹ᇵእ ‫ܡ‬Ⴡ⸭ỹ ⶅᰅ⺝ ᘡ ‫إי‬, ઩Ⴅ῝ ⼭᧪ ᕅ‫ו‬
ᰍỮ኉₝ ৗ⁩ ⺝஽ ᑥԩ᧪ᯢ኉₝ ઻؉, ᰍỮ኉₝ ઻⁩ ⺝஽ ᑥԩ᧪ᯢ
኉₝ ৗ౽Ⴅ.
‫ ܡ‬₝⁉஽ ‡ ‡ ‡
‡ ờໍ ₝⁉ỹᩅ ⺅ ⺝ ംṱ ♆ᭁ᾽ԩ ⋆ԩ⺱఍᎝, ‫⺝ ܡ‬ỹ஽ ‫ݙצ‬ԩ ᧪
ᯢ⺁؉, ംᰅỹ ᑥԩ೭ ᧪ᯢ⺁ֵ ൉ ֬₝఍.(‫ ܡ‬ᕁ఩೭ ዱ╕ԩ⋩)
‡ ‫ݙצ‬ԩ ᧪ᯢ⺁᎝, ᰍỮ኉⁩ ৗṭ⋭఍.
‡ ఑‫ݙ‬K⁥ᆅ ‫ݙצ‬₁ ᗩം⁩ ఩ᚩᚭ ♆ᭁ᾽ ₁ ᗩംỹ ₁⺝ ⁉ᕅ൅఍.
๙Ⴅᩅ ⹭ዦᯍ ؊ᩉ ‫׭ة‬ԩ ᕅᨆ⺅఍.

2
 The analysis proceeds with the aggregate
demand/aggregate supply model. The Phillips
The Phillips Curve curve shows the short-run combinations of
unemployment and inflation that arise as shifts
in the aggregate demand curve move the
   economy along the short-run aggregate supply
 
curve.



The greater the aggregate demand for goods and




services, the greater is the economy·s output,
6 B and the higher is the overall price level.
A higher level of output results in a lower level of
unemployment.

A
2

Phillips curve

0 4 7 ×


 




m







 ³ow the Short Run Phillips Curve is Related to
Aggregate Demand and Aggregate Supply

 


!


"
 

#
 !
!
"
 


'


$
&

$
  
%
&
 Short-run  

aggregate 


supply 



6 B
106 B

102 A
High
A
aggregate demand 2
Low aggregate
Phillips curve
demand
0 7,500 8,000 á  0 4 7 ×


(unemployment (unemployment 
 (output is (output is  




is 7%) is 4%) 8,000) 7,500)

)







Expectations are important in shifting the Philips curve. The Phillips
curve seems to offer policymakers a range of possible inflation and
unemployment outcomes.
If policymakers expand aggregate demand, they can lower unemployment,
but only at the cost of higher inflation[ ᚩԩ ♆ᭁ᾽እ ⋆ԩᰅ⧍᎝, ‫ݙצ‬እ ᚩẺᰅ
⡅ ᰍỮ ఑‫ݙ‬K⁥ᆅ ∭₥ ᭁ ₱఍. ‫ܡ‬ᄕু ‫ إי ܡ‬ᑥԩԩ ᧪ᯢ⺅఍].

If they contract aggregate demand, they can lower inflation, but at the
cost of temporarily higher unemployment[ዱ╕ԩ⋩ᆅ, ᚩԩ ♆ᭁ᾽እ ⚾᪵ ᰅ⧍
᎝, ᑥԩ஽ ṱ
⋩ድ, ‫◝➑ݙצ‬Ὡ ᰍỮ₝ ⁉ᕅ൅఍].

In the 1960s, Friedman and Phelps concluded that inflation and

unemployment are unrelated in the long run.
² As a result, the long-run Phillips curve is vertical at the natural rate
of unemployment« ๙Ⴅᩅ ⃎‫⹭ ݙ‬ዦᯍ؊ᩉ⁩ ᭁ⋪ᩉ₝఍.
² Monetary policy could be effective in the short run but not in the
long run.
„
 The Long-Run Phillips Curve

  
 
Long-run
Phillips curve

High B
1. When the inflation
Fed increases
the growth rate
of the money
supply, the
rate of inflation 2. . . . but unemployment
increases . . . A remains at its natural rate
Low
in the long run.
inflation

0 Natural rate of ×



unemployment  

ß







 ³ow the Long-Run Phillips Curve is Related to
Aggregate Demand and Aggregate Supply

 


!


"
 

#
 !
!
"
 


'


$
&

$
Long-run aggregate    Long-run Phillips

%
&
 supply  
curve
1. An increase in 3. . . . and
the money supply increases the
increases aggregate inflation rate . . .
B
±2 demand . . . B
2. . . . raises
the price
A
level . . . ± A

2
Aggregate
demand,

0 Natural rate á  0 Natural rate of ×


of output 
 unemployment  

4. . . . but leaves output and unemployment
at their natural rates.

$







In the short-run, ఑‫⹭ ݙ‬ዦᯍ؊ᩉ₝ ₝ം⺉ ᭁ ₱఍஽ ֬₝ ᕆ⼩ⅵ఍.
‫ ܡ‬₝⁉஽ ൹ ԩ⋩
² ἱ᧪ ₡⸵ᄱ₝᪁[Expected inflation: measures how much people
expect the overall price level to change].
² ‫[ג⛒ܲ؞‬supply shocks].
‡ ఑‫ݙ‬K⁥ᆅ஽ ᧕Ⴕญ₁ ᑥԩỹ ఩⺅ ἱ❊₝ ⯩ዝ ᭁ ₱఍. ‫י ܡ‬
‫᧕ إ‬Ⴕญ₁ ᧪఩ԩ‫ג‬ỹ ఩⺅ ⰹ఑, ₭ܱ‫ إ‬ԩ‫ג‬₁ ↙ *₝ ᰍⅅ
ᑥԩ᧪ᯢ኉‫║ إ‬₝ԩ ৉ ᭁ ₱఍.
(*♆‫ܲ؞‬؊ᩉ₝ ⸵ᄕᯍ ‫ݙ‬ῡ‫ݙ‬እ ԩ⋩஽ ₝⁉)
‡ ἱ❊₝ ⯩ዙ ድ⦥, ♆ᭁ᾽₁ ᗩ⽽ԩ ఑‫ݙ‬K⁥ᆅ ᰍỮ኉₁ ᗩ⽽እ
⁉ᕅ⺉ ᭁ ₱఍.
‡ In the long run, expected inflation adjusts to changes in actual inflation.


‡ The Bank of Korea·s ability to create unexpected inflation exists only
in the short run: Once people anticipate inflation, the only way to get
unemployment below the natural rate is for actual inflation to be above
the anticipated rate.
‡ ⃎‫ݙ‬K⁥ᆅ ⹭ዦᯍ؊ᩉ⁩ ₹ἙᰍỮ⁑ ‭ỹ ᩅ ₱஽ ᭁ⋪ᩉ₝఍.
఑⋩, ᚩ₁ ỹ ₁⺝ ᧕Ⴕญ₝ ἱ᧪⺁⋩ Ꮴ⺅ ₡⸵ᄱ₝᪁
₝ ⁉ᕅ൉ ‫צ‬Ῑ ఑‫ ݙ‬K⁥ᆅ ᰍỮ኉₝ ₹ἙᰍỮ⁑ ṭჁᆅ ঢ়ᅍ
Ա ᣹₝఍.

 





7
 
 




 ¸



 
  

ù
 ³ow Expected Inflation Shifts the Short-Run
Phillips Curve
2. . . . but in the long run, expected
inflation rises, and the short-run
   Phillips curve shifts to the right.
 
Long-run
Phillips curve

C
B

Short-run Phillips curve

with high expected
inflation

A
Short-run Phillips curve
1. Expansionary policy moves
with low expected
the economy up along the
inflation
short-run Phillips curve . . .
0 Natural rate of ×


unemployment  
10







The Natural Experiment for the
Natural-Rate Hypothesis
The view that unemployment eventually returns to its natural rate,
regardless of the rate of inflation, is called the natural-rate
hypothesis₹ἙᰍỮ⁑ ԩᩍ.
³istorical observations support the natural-rate hypothesis[‫إٹ‬ᩅ ‫ܡ‬ዥ ß‫إ‬
 ᘝ᎝ ₝ ԩᩍ₝ ‫⼁צ‬K⁥ᆅ೭ ᔡ‫ږ‬ỹᩅ ₮⋆൑ ṵ ᭁ ₱఍].
‡ 1970੭఩ ₝⿭ ⺅‫ږ‬₁ ‫⼁צ‬೭ ዱ╕ԩ⋩
‡ The concept of a stable Phillips curve broke down in the in the early ·70s.
‡ During the ¶70s and ¶80s, the economy experienced high inflation and
high unemployment simultaneously (i.e. stagflation).

11
 The Phillips Curve in the 1960s
  
 









10

1968
4
1966
1967

2
1965 1962
1964 1961
1963

0 1 2 3 4 5 6 7 8 9 10 ×


 



 12







 The Breakdown of the Phillips Curve

  
 









10

6 1973
1971
1969 1970
1968 1972
4
1966
1967

2 1965 1962
1964 1961
1963

0 1 2 3 4 5 6 7 8 9 10 ×


 



 1m







 ఑‫⹭ ݙ‬ዦᯍ؊ᩉ₁ ₝ം‫ݙצ إ‬ᭅ⾁

₡⸵ᄱ₝᪁⁑
×,
-
 
 



*( 


+
( #

( " ఑‫ݙ‬

఑‫ݙ‬
ᰍỮ኉
 ( ×, )( 1)
 0੭఩ ⿭ᕁ₁ ⹭ዦᯍ؊ᩉ

|

| |
| | 

|



|
|

|

 |


|  |                   

1„
 1ù$0~2002੭₁ ⹭ዦᯍ؊ᩉ

(%)









G




G


G






G

G

























 G

G G
G




G






1ß
‫ג⛒ܲ؞‬₁ ⿑‫إ‬: The short-run Phillips curve also shifts because of
shocks to aggregate supply. ‫ږ‬ⅅᩆ⁉ԩ‫ג‬₁ ᧪ᯢ, ᖽᩡ‫׭‬K₡ ひ
₺ บ, ‫❊ܲ؞‬᎝₁ ⺝ᆅ῝ ⛒‫ ⁩ג‬఑‫⹭ ݙ‬ዦᯍ؊ᩉ ‭⏦⁥ᆅ
₝ംᰅ⡅ ᚩᆅ ⺁ἕܱ ᰍỮ኉‫ إ‬₡⸵ᄱ₝᪁⁑ ᧕₝₁ ᧪⛒‫ة‬
‫׭‬እ Ṯ⽽ᰅ⧑఍.
² Major adverse changes in aggregate supply can worsen the short-
run tradeoff between unemployment and inflation.
² An adverse supply shock gives policymakers a less favorable
tradeoff between inflation and unemployment. ἱ: 1970੭఩₁ ᩆ⁉
ⰵം

A supply shock is an event that directly alters the firms· costs, and, as a
result, the prices they charge.
² This shifts the economy·s aggregate supply curve. . .
² . . . and as a result, the Phillips curve.

1$
 An Adverse Shock to Aggregate Supply

 


!


"
 

#
 !
!
"
 


'


$
&

$
  
%
&
 2  
4. . . . giving policymakers
Aggregate a less favorable tradeoff
supply,  between unemployment
and inflation.
B
±2 B
3. . . . and 1. An adverse
raises A shift in aggregate A
the price ± supply . . .
level . . . ±2
Aggregate
demand Phillips curve, ± 
0 2  á  0 ×



  

2. . . . lowers output . . .

1







‡ ᧕ᅩᚭᩆ: OPEC₝ 1970੭఩ỹ ‫ږ‬ⅅΌ⁉ ᨆ᧙ ∭₝؉, Ό⁉ԩ
‫⁥ⴖ ⦙ ג‬ᆅ ₡᧪⺁Ἡ఍. ₝ ᧪⾒ỹ ఩⁺⺁ἕ Ԫ‫ ⁩ږ‬఍⁵₁
ٝᆅ῝ ᩉ⨆ ⺝ấድ ⺱఍. (‫إٹ‬ᩅ ‫ܡ‬ዥ 9 ╡↙)
1) Tackle the unemployment battle by expanding aggregate demand
and accelerate inflation. ⫞⽽ⱦ╦ ⫞⺝ ᰍỮ኉ ᧪ᯢ ዲ֙
ু ‡ ‡ ‡ (‫ܡ‬ዕ؉ ᑥԩ᧪ᯢ ౽ ᚩ⚽‫)ু֙ݙ‬
2) ༹஽ ᑥԩ᧪ᯢ Ởⅅ⺁؉, ؉ᰍỮ᧪⨅እ Թᭁ⺁֙ু ‡ ‡.
Fight inflation by contracting aggregate demand and endure even
higher unemployment.

1ù
 The Supply Shocks of the 1970s

  
 









10
1981 1975
1980
1974
1979
8
1978

6 1977
1976
1973

4 1972

0 1 2 3 4 5 6 7 8 9 10 ×


 



 20







₡⸵ᄱ₝᪁ ৗ⚽஽ ᝭ῒ:
‡ To reduce inflation, the Bank of Korea has to pursue contractionary
monetary policy[₡⸵ᄱ₝᪁ ⺝᪵⺁ᅍ᎝, ∺Ẃ⁩⺲₝ ⫞⽽‫( ⚾ݝ‬contractionary monetary
policy) ᰅ⺲⺝ấ ⺅఍, ἱ: ܱዕ₡᧪].

‡ When the Bank of Korea slows the rate of money growth, ᰅ∺ ܱዕԩ ᧪ᯢ
⺁ἕ, ⭕₹Ὡ ᪵᝭ԩ ‭⚾൅఍, and this contracts aggregate demand.
‡ This reduces the quantity of goods and services that firms produce[₝ỹ ๙Ⴅ ♆
ᭁ᾽ԩ Թ᪵⺁ἕ, ᑥԩ₁ ᧪ᯢ Ởⅅ⺁஽ ⿑‫إ‬እ ৡ఍].

‡ This leads to a rise in unemployment[‫ܡ‬ᄕু ‫◝➑ ݙצ‬Ὡ ᰍỮ₝ ⁉ᕅ൅఍].

‡ ₝֬⁩ ఑‫ݙ‬K⁥ᆅ ᚩ₁ ỹ ₁⺝ ‫צ‬ⅅԩ ఑‫⹭ ݙ‬ዦᯍ؊ᩉ᧪ỹ
ᩅ ṭჁ⏦⁥ᆅ ῝ം⺁஽ ֬ ₁ᔡ⺅఍.
‡ To reduce inflation, an economy must endure a period of high
unemployment and low output[఍ᰅ ዹ⺝, ₡⸵ᄱ₝᪁ Ởⅅ⺁ᅍ᎝, ờஹ ুႥ ‫צ‬ⅅฉ⋩
₥ᰅK₡ ᚱ‫ݙצ‬Ὡ ؉ᰍỮ Թঢ়⺝ấድ ⺁஽ ֬₝఍].
² When the BOK combats inflation, the economy moves down the short-run
Phillips curve.
² The economy experiences lower inflation but at the cost of higher unemployment.

21
 Disinflationary Monetary Policy in the Short Run and
the Long Run
1. Contractionary policy moves
the economy down along the
   short-run Phillips curve . . .
Long-run
 

Phillips curve

Short-run Phillips curve

with high expected
inflation
C B

Short-run Phillips curve

with low expected
inflation
0 Natural rate of ×


unemployment 2. . . . but in the long run, expected  

inflation falls, and the short-run
Phillips curve shifts to the left. 22







But there is a cost to reducing inflation. ₝Ὡ Ղ⁩ ᧪⛒‫׭ة‬እ ´ゕᨆ᝭
⁑(sacrifice ratio)µᆅ ু⧩৥ ᭁ ₱఍.
‡ The sacrifice ratio is the number of percentage points of annual
output that is lost in the process of reducing inflation by one
percentage point (ゕᨆ᝭⁑: ₡⸵ᄱ₝᪁ 1% ৗ⚽஽ ‫ إ‬ỹᩅ
☱Ⴡ
஽ Ἑԭ GDP₁ % Թ᪵⁑).
² An estimate of the sacrifice ratio is M
 (ᔡ‫ږ‬₁ ‫צ‬Ῑ ₝ ᝭⁑⁩
఩◝ᆅ 5).
² To reduce inflation from about 10% in 1979-1981 to 4% would
have required an estimated sacrifice of 30% of annual output!
² ‫ܡ‬ᄕু 1980੭఩ ☱ỹ ᑥԩṱ  ‭⺝ ᕁฅᰅ ᚱ‫ݙצ‬Ὡ ؉
ᰍỮ ⁉ᕅ⺉ ⹭᾽ԩ ữ఍஽ ₝ᆉ₝ ⅅ‫
ݙ‬఍. ₝ ₝ᆉ⁩
‡‡‡

2m
‡ The theory of rational expectationsዕK‫ݙ‬఩₝ᆉ suggests that
people optimally use all the information they have, including
information about government policies, when forecasting the future.
‡ ዕK‫ݙ‬఩₝ᆉỹ ๙ኝ᎝, ᧕Ⴕญ₁ ₡⸵ᄱ₝᪁‫ إ‬ᚩ ỹ
఩⺅ ἱ❊₝ ᖱᖱ₝ ₥‫⯩ ֵ
ة‬ዝ ᭁ஽ ữ఍؉ ᘡ఍.
‡ ⊲, ᧕Ⴕญ⁩ ᔡჁ₁ ᑥԩ᧪ᯢ ἱ❊⺉ ๵, ‫֙إ‬₁ ‫↝⼭ إ⼁צ‬
⺁஽ Ꮡฉ ᘝእ ዕK⁥ᆅ ᚭᩆⳲԩ⺁ἕ ⰹ఑⺅఍஽ ֬₝఍.
‡ Expected inflation explains why there is a tradeoff between inflation
and unemployment in the short run but not in the long run. ⊲, ᧕Ⴕ
ญ₁ ᔡჁỹ ఩⺅ ἱ❊₝ ዕK₝Ⴅ᎝, ₭ܱ‫ إ‬ԩ‫ג‬₁ ↙ℱ₝
⿑⁑K₝
‫ ݙ‬๵ᑡỹ, ఑‫ܲ؞♆ ݙ‬؊ᩉ₝ ᝭‫ٹ‬K ᝭
K₝
൅఍஽ ֬₝఍.
‡ ‫ܡ‬ዕ؉ ఑‫ܲ؞♆ ݙ‬؊ᩉ₝ ᝭
K₝᎝, ఑‫⹭ ݙ‬ዦᯍ؊ᩉ೭ ԩ
ⰵኡ ‫ݙ‬ῡ‫ݙ‬እ Կֵ ൉ ֬₝఍.
‡ ድẦ ᧕Ⴕญ₁ ᔡჁỹ ఩⺅ ἱ❊₝ ÿ⺁ֵ ዕK₝Ⴅ᎝, ఑
‫⹭ ݙ‬ዦᯍ؊ᩉ₝ ÿ ᭁ⋪ᩉ₝
ờ, ఑‫ݙ‬ỹᩅ ↙║ ᑥԩὩ ᰍ
Ữ₁ ᧪⛒‫׭ة‬ԩ ↝ ⺁⋩ ÿ ᭁ೭ ₱఍஽ ֬₝఍. 2)
‡ ⊲, ᑥԩṱ  ‭⺝ ᰍỮ ⁉ᕅ⺝ấ ⺉ ⹭᾽ԩ ữ఍஽ ‫י‬ᆉ₝
఍.
‡ ᑥᆉ ἕ‫ݙ‬ỹ஽ ᧕Ⴕญ₁ ἱ❊₝ ÿ⺁ֵ ዕK₝ờấ ⺅఍஽
ⅅԩ ᩚዦ
ờấ ⺅఍.
‡ ‫ܡ‬ᄕু ᧕Ⴕญ₁ ἱ❊⁩ ᚩ ỹ ఩⺅ ÿ
ỹ ⁩ Ἢÿ
஽఍. ๙Ⴅᩅ ‡ ‡ ‡
‡ ዕK‫ݙ‬఩₝ᆉ₝ ∥஽ ∺᾽⺅ K ᰅ᧕ÿ
‡ ³ow quickly the short-run tradeoff disappears depends on how
quickly expectations adjust.
‡ The theory of rational expectations suggests that the sacrifice-ratio
could be much smaller than estimated

2„
‡ When Paul Volcker was Fed chairman in the 1970s, inflation was
widely viewed as one of the nation·s foremost problems.
‡ Volcker succeeded in reducing inflation (from 10 percent to 4 percent),
but at the cost of high employment (about 10 percent in 1983).

2ß
 The Volcker Disinflation
  
 









10
1980 1981
A
1979
8

1982
6

1984 B
4 1983
1987
1985
C
1986
2

0 1 2 3 4 5 6 7 8 9 10 ×


 



 2$







Alan Greenspan·s term as Fed chairman began with a favorable supply
shock.
² In 1986, OPEC members abandoned their agreement to restrict
supply.
² This led to falling inflation and falling unemployment.
‡ Fluctuations in inflation and unemployment in recent years have been
relatively small due to the Fed·s actions.
 ᚩ ỹ ఩⺅ ‫ ږ‬₁ ÿ
ԩ ⿑‫إ‬እ ઻₝஽ÿ
Ῑ ∺
᾽⺁఍.

2
 The Greenspan Era
  
 









10

1990
4 1991
1989 1984
1988 1985
2001 1987
2000 1995 1992
2 1997 1994 1986
1999 1993
1998 1996 2002

0 1 2 3 4 5 6 7 8 9 10 ×


 



 2ù







 Summary
‡ The Phillips curve describes a negative relationship between inflation and
unemployment.
‡ By expanding aggregate demand, policymakers can choose a point on the
Phillips curve with higher inflation and lower unemployment.
‡ By contracting aggregate demand, policymakers can choose a point on the
Phillips curve with lower inflation and higher unemployment.
‡ The tradeoff between inflation and unemployment described by the Phillips
curve holds only in the short run.
‡ The long-run Phillips curve is vertical at the natural rate of unemployment.
‡ The short-run Phillips curve also shifts because of shocks to aggregate supply.
‡ An adverse supply shock gives policymakers a less favorable tradeoff between
inflation and unemployment.
‡ When the BOK contracts growth in the money supply to reduce inflation, it
moves the economy along the short-run Phillips curve.
‡ This results in temporarily high unemployment.
‡ The cost of disinflation depends on how quickly expectations of inflation fall.

m0