Falling Inflation Expectations
When people expect less inflation, the short-run tradeoff improves.
Falling Inflation Expectations
Phillips CurveWhen people expect less inflation, the short-run tradeoff improves.
Start with high expected inflation
The economy sits at the natural rate of unemployment on a short-run Phillips curve that reflects relatively high expected inflation. Actual inflation equals that elevated expected rate.
Now try it yourself: shift the curves in a graded FRQ drill, or open this graph in the free sandbox.
Falling Inflation Expectations, step by step
- 1
Start with high expected inflation
The economy sits at the natural rate of unemployment on a short-run Phillips curve that reflects relatively high expected inflation. Actual inflation equals that elevated expected rate.
- 2
Expectations fall
A credible central bank, an oil price collapse, or a period of low actual inflation convinces people that future inflation will be lower, so expected inflation falls. Lower expected inflation shifts the short-run Phillips curve down and to the left.
- 3
A better short-run tradeoff
On the new lower short-run Phillips curve, the economy faces less inflation at every unemployment rate. At the natural rate of unemployment, inflation is now lower, and any given unemployment target can be reached with a smaller inflation cost.
Where it ends up
A fall in expected inflation shifts the short-run Phillips curve down and to the left, giving lower inflation at every unemployment rate and improving the short-run inflation-unemployment tradeoff.
Now draw it yourself
Same graph, graded on whether you move the right curve and leave the rest alone.
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