Short-Run Phillips Curve
What is Short-Run Phillips Curve?
The short-run Phillips curve shows the inverse relationship between the inflation rate and the unemployment rate in the short run.
It suggests that policymakers may face a trade-off: lower unemployment can be achieved at the cost of higher inflation, and vice versa. This relationship breaks down in the long run due to adaptive expectations and shifts in the curve from supply shocks or changing expectations.
Short-Run Phillips Curve: a worked example
An economy sits on a short run Phillips curve at 5 percent unemployment and 3 percent inflation. A drought doubles the cost of key agricultural inputs, a negative supply shock. Production costs rise across industries, so firms raise prices and cut output at the same time. Inflation climbs to 7 percent while unemployment rises to 8 percent. Check whether this can be one movement along the original curve. A movement along requires the two rates to move in opposite directions, and here both rose, inflation by 4 percentage points and unemployment by 3. The only way to draw it is a shift of the whole short run Phillips curve up and to the right. The new curve offers a worse menu everywhere, pairing higher inflation with every unemployment rate.
The mistake students make with short-run phillips curve
Every short run Phillips curve is drawn for one expected inflation rate, and it crosses the long run curve at exactly that rate. Students forget this and drop the starting point anywhere on the curve. With expected inflation at 3 percent and a natural rate of 5 percent, the curve has to pass through the point at 5 percent unemployment and 3 percent inflation. Points to the left of the natural rate are points where actual inflation is running above the 3 percent workers expected, and points to the right are where it runs below.
Short-Run Phillips Curve questions
What shifts the short-run Phillips curve?
Two things shift it: a change in expected inflation and a supply shock. When workers and firms revise expected inflation from 3 percent to 6 percent, the whole curve moves up by roughly 3 percentage points, so every unemployment rate now comes paired with higher inflation. A negative supply shock such as a spike in energy prices shifts it up and to the right as well. Aggregate demand changes do not shift the curve, they move the economy along it.
Why does the short-run trade-off between inflation and unemployment exist at all?
Wages and prices are sticky in the short run. When aggregate demand rises, output prices climb faster than wages already locked into existing contracts, so real labor costs fall and firms find it profitable to hire more workers. Unemployment drops while inflation rises. The mechanism runs on a gap between actual and expected inflation, which is why the trade-off vanishes once expectations catch up and contracts get renegotiated.
Where does the economy move along the short-run Phillips curve during a recession?
Down and to the right. Falling aggregate demand leaves firms with unsold output, so hiring slows, unemployment climbs, and price increases ease off. An economy starting at 5 percent unemployment and 3 percent inflation might slide to 8 percent unemployment and 1 percent inflation. Notice that inflation falling to 1 percent still means prices are rising, only more slowly, which is disinflation rather than deflation. Deflation would need the inflation rate to drop below zero, further down the same curve.
This is the live Phillips Curve sandbox. Drag the curves, or open the full version.
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