Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Seeking Low Unemployment and Low Inflation: The Phillips Curve


In This Chapter


Understanding the short-run trade-off between inflation and unemployment


Looking at why this trade-off disappears in the long run Taking action to reduce inflation

Whether you have children, want to have children in the future, have no interest in children or are a child, you know one fact: small children cry. Even the most placid and happy baby cries – and sometimes screams. You may be wondering what on earth crying babies have to do with macroeconomics; well, the answer is – quite a lot.

Picture this: after a long day you’ve finally managed to put the little nipper to bed. You and your partner are relaxing on the sofa watching the latest episode of your favourite soap. Suddenly the baby monitor flashes red and you hear the unmistakable sound of little Jimmy crying. What should you do? You’ve noticed from past experience that when you go to comfort him, he tends to stop crying, and yet when you’ve left him alone, he continues to cry.

You don’t like your baby crying, so you go and comfort him: as expected, he stops crying. Smugly you get back to your soap, thinking: ‘I’ve cracked this – all I need to do when he cries is to comfort him’. The thing is, Jimmy has other plans. He learns quickly that whenever he cries, you come a-running and so he responds by crying more frequently. Now, not only are you comforting your baby throughout the night, but also he’s crying as much as he did before! Only, now you are too – with frustration!

One way of thinking about what happened is that you notice a statistical relationship between how much you comfort him and how much he cries: more comfort equals less crying. But when you try to take advantage of this statistical relationship, it breaks down. Your baby is smart, and he now

expects you to comfort him whenever he cries. He rationally responds by crying more frequently.

A very similar relationship exists in macroeconomics between unemployment and inflation, called the Phillips curve:


Certain periods of history seem to show a statistical relationship between unemployment and inflation: low unemployment is associated with high inflation.


When policy makers try to exploit this relationship by consistently having high inflation (in order to have low unemployment), the relationship breaks down because people now expect high inflation.

In the long run, therefore, by stoking up inflation, policy makers can only succeed in creating high inflation, not reducing unemployment.

In this chapter we discuss the relationship between unemployment and inflation in the short and long runs and why it breaks down over time. We also describe how policy makers can successfully reduce inflation in an economy when inflation is high – hopefully without increasing unemployment. The trick is to try to shift the Phillips curve by altering people’s inflation expectations.