I n t h I s c h a p t e r y o u w I l L

P
1
to 
P
2
, but because the aggregate-supply curve
is vertical, output remains the same. In panel (b), more rapid growth in the money
supply raises the inflation rate by moving the economy from point A to point B.
But because the Phillips curve is vertical, the rate of unemployment is the same at
these two points. Thus, the vertical long-run aggregate-supply curve and the ver-
tical long-run Phillips curve both imply that monetary policy influences nominal
variables (the price level and the inflation rate) but not real variables (output and
unemployment). Regardless of the monetary policy pursued by the Fed, output
and unemployment are, in the long run, at their natural rates.
What is so “natural” about the natural rate of unemployment? Friedman and
Phelps used this adjective to describe the unemployment rate toward which the
economy tends to gravitate in the long run. Yet the natural rate of unemployment
is not necessarily the socially desirable rate of unemployment. Nor is the natural
rate of unemployment constant over time. For example, suppose that a newly
formed union uses its market power to raise the real wages of some workers above
the equilibrium level. The result is a surplus of workers and, therefore, a higher
natural rate of unemployment. This unemployment is “natural” not because it is
good but because it is beyond the influence of monetary policy. More rapid money
growth would not reduce the market power of the union or the level of unem-
ployment; it would lead only to more inflation.
Although monetary policy cannot influence the natural rate of unemploy-
ment, other types of policy can. To reduce the natural rate of unemployment,
policymakers should look to policies that improve the functioning of the labor
market. Earlier in the book we discussed how various labor-market policies, such
as minimum-wage laws, collective-bargaining laws, unemployment insurance,
and job-training programs, affect the natural rate of unemployment. A policy
change that reduced the natural rate of unemployment would shift the long-run
Unemployment
Rate
0
Natural rate of
unemployment
Inflation
Rate
B
Long-run
Phillips curve
High
inflation
Low
inflation
A
2. . . . but unemployment
remains at its natural rate
in the long run.
1. When the 
Fed increases 
the growth rate 
of the money 
supply, the 
rate of inflation 
increases . . . 
F i g u r e 3 3 - 3
T
HE
L
ONG
-R
UN
P
HILLIPS
C
URVE
.
According to Friedman and
Phelps, there is no tradeoff
between inflation and
unemployment in the long run.
Growth in the money supply
determines the inflation rate.
Regardless of the inflation
rate, the unemployment rate
gravitates toward its natural
rate. As a result, the long-run
Phillips curve is vertical.

---

C H A P T E R 3 3
T H E S H O R T - R U N T R A D E O F F B E T W E E N I N F L AT I O N A N D U N E M P L O Y M E N T
7 6 9
Phillips curve to the left. In addition, because lower unemployment means more
workers are producing goods and services, the quantity of goods and services
supplied would be larger at any given price level, and the long-run aggregate-
supply curve would shift to the right. The economy could then enjoy lower unem-
ployment and higher output for any given rate of money growth and inflation.
E X P E C TAT I O N S A N D T H E S H O R T - R U N P H I L L I P S C U R V E
At first, the denial by Friedman and Phelps of a long-run tradeoff between infla-
tion and unemployment might not seem persuasive. Their argument was based on
an appeal to 
theory.
By contrast, the negative correlation between inflation and un-
employment documented by Phillips, Samuelson, and Solow was based on 
data.
Why should anyone believe that policymakers faced a vertical Phillips curve when
the world seemed to offer a downward-sloping one? Shouldn’t the findings of
Phillips, Samuelson, and Solow lead us to reject the classical conclusion of mone-
tary neutrality?
Quantity
of Output
Natural rate
of output
Natural rate of
unemployment
0
Price
Level
P
2
P
1
Aggregate
demand, 
AD
1
Long-run aggregate
supply
Long-run Phillips
curve
(a) The Model of Aggregate Demand and Aggregate Supply 
Unemployment
Rate
0
Inflation
Rate
(b) The Phillips Curve
2. . . . raises
the price
level . . . 
1. An increase in 
the money supply
increases aggregate
demand . . . 
B
A
AD
2
B
A
4. . . . but leaves output and unemployment
at their natural rates.
3. . . . and
increases the
inflation rate . . . 
F i g u r e 3 3 - 4
H
OW THE
L
ONG
-R
UN
P
HILLIPS
C
URVE
I
S
R
ELATED TO THE
M
ODEL OF
A
GGREGATE
D
EMAND AND
A
GGREGATE
S
UPPLY
.
Panel (a) shows the model of aggregate demand and
aggregate supply with a vertical aggregate-supply curve. When expansionary monetary
policy shifts the aggregate-demand curve to the right from