A Favorable Supply Shock
Cheaper energy and faster productivity growth shift the short-run Phillips curve down and to the left, so inflation is lower at every unemployment rate.
A Favorable Supply Shock
Phillips CurveCheaper energy and faster productivity growth shift the short-run Phillips curve down and to the left, so inflation is lower at every unemployment rate.
Start at the natural rate
The economy sits where the short-run Phillips curve meets the vertical long-run Phillips curve, at the natural rate of unemployment with actual inflation equal to expected inflation. The height of the short-run curve is the tradeoff policymakers currently have to work with.
Now try it yourself: shift the curves in a graded FRQ drill, or open this graph in the free sandbox.
A Favorable Supply Shock, step by step
- 1
Start at the natural rate
The economy sits where the short-run Phillips curve meets the vertical long-run Phillips curve, at the natural rate of unemployment with actual inflation equal to expected inflation. The height of the short-run curve is the tradeoff policymakers currently have to work with.
- 2
Cheaper energy, higher productivity
New supply comes online and oil prices fall sharply, while faster productivity growth means each worker produces more per hour. Both changes cut the cost of producing a unit of output. Notice that nothing here is a change in spending, so this is a supply-side shock and it moves the curve rather than the point on it.
- 3
SRPC shifts left
Lower unit costs mean firms raise prices less at any level of hiring, so the short-run Phillips curve shifts down and to the left. At every unemployment rate inflation is now lower, and any inflation target can be reached with less unemployment than before. The whole menu improved.
- 4
Inflation and unemployment fall together
Because the curve itself moved, the economy can end up with lower inflation and lower unemployment at the same time. Moving along one curve could never do that, because there lower inflation is only bought with higher unemployment. This is the mirror image of stagflation, and it is why inflation can fall without the central bank doing anything at all.
- 5
The LRPC does not move
The long-run Phillips curve does not move, because the natural rate of unemployment is set by frictional and structural forces in the labor market rather than by input prices. If the shock is temporary, the short-run curve eventually drifts back right. A permanent productivity gain raises potential output, but it shifts the LRPC only if it also changes the natural rate itself.
Where it ends up
A favorable supply shock shifts the short-run Phillips curve down and to the left, giving lower inflation at every unemployment rate. Inflation and unemployment can fall together, and the long-run Phillips curve is unchanged unless the natural rate itself changes.
Now draw it yourself
Same graph, graded on whether you move the right curve and leave the rest alone.
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